Following the conclusion of the TAMIM webinar series earlier this week, we discuss the investment case for three top-performing holdings in the TAMIM Global High Conviction unit class. All three represent our broader investment view of 'needs not wants' and touch on aspects of our 5D's framework. Each business provides non-discretionary services to its customers, which will help shield earnings in what is likely to be a more challenging economic environment in 2023.
1. Quanta Services Inc (NYSE: PWR)
Quanta Services is a company that represents the decarbonisation theme within the global fund. The business provides speciality construction and engineering services for utilities, telecommunications, renewable energy and underground projects. This includes building and maintaining infrastructure such as transmission lines, fibre cables, substations, and pipelines.
It's estimated the United States alone will require at least $30 billion in incremental transmission investment to support the uptake of renewable energy sources. This is despite the number of utility employees falling, resulting in a tight labour market and an increased need for outsourced services offered by Quanta.
The business is more resilient than a typical building company, with 50% of its revenue on recurring service agreements. Quanta also completes over 80% of projects itself, which mitigates external cost blowouts. The defensive earnings profile and its ESG credentials have led to the share price increasing by 28% this year.
A common issue investors face when investing in construction is contract risk. We've seen recently domestic builders like Simonds need equity injections due to signing fixed-rate contracts in previous years that become unfeasible over time, largely due to inflation pressures. While this remains a risk for Quanta, the majority of its contracts are on unit or cost-plus pricing.
The valuation today is by no means cheap at 21 times next year's earnings. However, we continue to like the growth outlook for the business, especially its exposure to utility grid modernisation, system hardening, renewable generation expansion and integration.
2. Valero Energy Corporation (NYSE: VLO)
Valero Energy refines and markets a range of petroleum-based and low-carbon transportation fuels and petrochemicals. Due to insufficient global refining capacity, the business has recently benefited from strong crack spreads (the price difference between a barrel of crude oil and the petroleum products refined from it). As a result, the Valero share price has stormed 75% higher this year.
Over four million barrels of global refining capacity have been retired since 2020 due to poor economics or planned upgrades. While current margins are unlikely to be sustainable, prices will remain above historical levels for the foreseeable future given the lack of investment appetite for oil and low global inventory. The European Union banning seaborne imports of Russian oil and oil products from next year will further exacerbate the shortage.
Demand for refined products like gasoline and diesel now exceeds pre-pandemic levels. Subsequently, the company recorded a six-fold increase in quarterly earnings, which is being used to retire debt and returned to shareholders via dividends and buybacks.
In the longer term, Valero will benefit from government policies, such as the Renewable and Low-Carbon Fuel Blending Programs, that encourage the uptake of low-carbon fuels. The company owns and operates renewable diesel and ethanol assets which will be integral to helping companies and nations reduce their greenhouse gas emissions.
Valero is priced as a cyclical company with a price-to-earnings ratio of six, however we believe this is a secular growth story mispriced by the market.
3. Applied Materials Inc (NASDAQ: AMAT)
Founded in 1967, Applied Materials is a global provider of equipment, services and software to the semiconductor and related industries. Its products are used to fabricate semiconductor chips and integrated circuits, which are subsequently included in end-products including electronics, cars, storage and displays.
Applied Materials share price has suffered due to forecasts of a slowdown in the broader economy and has subsequently fallen 35% this year. However, it has recently rebounded on a strong earnings result. The business's full-year revenue increased by 12% to $25.8 billion, while operating profit increased by 7% to $7.8 billion.
CEO Gary Dickerson expects 2023 to be a down year for the broader industry but believes Applied Materials will prove more resilient given the large backlog in orders. The business is also constrained by supply-chain pressures, which is delaying revenue recognition.
Longer-term, the company will benefit from several tailwinds, including increased data consumption, more complex semiconductor applications and higher device adoption. It will also benefit from the deglobalisation trend as nations safeguard chip supply.
This is illustrated by the recently passed CHIPs Act in the United States, which aims to incentivise domestic semiconductor production. Applied Materials trades on a compelling valuation of 16 times earnings in a sector with multi-year tailwinds and double-digit growth through the cycle.
Disclaimer: NYSE: PWR, NYSE: VLO and NASDAQ: AMAT are currently held in the TAMIM Fund: Global High Conviction portfolio.
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TAMIM Asset Management provides general information to help you understand our investment approach. Any financial information we provide is not advice, has not considered your personal circumstances and may not be suitable for you.