Updates from Portfolio Holdings
Dominos and China continue to give heartache, but more hope in BAE systems
Domino’s Australia (ASX:DMP) 😥
I have written about this company here and here. The company just announced it latest trading update for the six months since the last annual report was issued. Sadly, it has been another sobering update.
It looks like Sales growth was 8.8% compared YoY and while earnings are likely to be up YoY at about $87-90m, its run rate on the PBT indicates that it will like end up at ~$170m - lower than its 5 year average. We like companies that are growing not stagnant. At this rate, for the fourth year running, it will deliver profits well lower than the $273M that it declared in 2021. The stock has now lost 75% of its value from its all time high of $162 achieved in May 2021 (around the time of the last all time high profit numbers) and now trades for a mere $39, which coincides with the $38 price I projected for the Low Growth scenario in my previous post.
Over the past 2 years, it has under performed the ASX by some 68%. It is really disappointing.
If the company is only going to generate $170M in profits and that too at risk of decline, then this stock shouldn’t trade at anything more than 10x PE at best, i.e. market cap of $1.7B. Despite the massive drop since the announcement, the market-cap is still twice of that at $3.55B. For the company to defend its current market pricing, the company has to revert to its growth days, which aren’t readily visible as yet.
At my end, I plan to add little or nothing to this position, till results get more interesting. It is possible that I am missing out an opportunity to buy at a secular bottom, but someone will have to show me some insight not available in the trading report to convince me to double down.
Quick China Update 😥
Chinese equities have continued to be a challenging position to own. Five weeks back I wrote about how Chinese equities looked cheap. In that I specifically called out that the risks:
There are fears of deflation in the Chinese economy
Geo political fears with US moving to choke China’s role in electric vehicle supply chain
After years of being the world’s factory, major companies are trying to reduce their dependence on China, e.g. Apple.
Markets have continued to punish these stocks, with Hang Seng Index declining a further 8.47% before recovering this week to land at a net negative of 2.4%. There is some evidence that this recovery might be manufactured (read 1, 2, 3, 4).
This market and this trade is not for the faint hearted. However, very often it is in these pessimistic situations that you find something interesting. The way I am playing this opportunity is:
Holding on to what I already own, true Coffee Can Style.
Write some out-of-the-money PUTs to collect some premiums. I wrote about it here.
Buy some at-the-money CALLs in order to make the most of upside. I do so on a basket basis, so I am not left with idiosyncratic risk. One can do this at the index level, but the risk-return combos of doing so at the stock level seems better to me, specifically because I only need 1-2 stocks in my basket to do mildly well to break even, but for the index, it either makes it to breakeven or not.
The PUTs typically have expiry between Feb’24 and Jun’24, while the CALLs are either Dec’24 or Jan’25 so I don’t have to worry about this on a day-to-day basis.
In position sizing terms, net premium (CALL premiums paid *minus* PUT premiums received) is a mere 0.7-0.8% of the size of the Coffee Can Portfolio. However, these options, along with the existing long-term held stock collectively represent economic interests many multiples of that.
Structuring them as options hide what is actually an outsized bet on the long side. The alpha opportunity could easily be 10 points if things go even reasonably well through the year. As and when the PUT options expire (and I very much hope they expire out of the money), then the risk runs off and the opportunity becomes very asymmetric. Having written all this, caveat emptor. This is not something I would recommend to an average investor. So, please do extra extra due diligence and consult a financial advisor before taking any of this seriously.
The Air Astana Angle ❤️
As much as I try to cover the obvious angles about the stocks I write about, I missed one very big angle on BAE systems when I last wrote about it. It is that the company owns a 49% stake in Air Astana, a Kazhak airline, which is now planning to list itself in both Kazhakstan and in London. While the listing is yet to occur, estimates are that AirAstana is expected to be valued at £780m, or BAE’s interests being £343m, assuming the 10% dilution if the company raises £95m as purported. The company carried this on their balance sheet at £63m. This means an additional £280m of balance sheet value, or about 7-8% of their market cap today, is yet to be recognised. Market has probably priced it in, but this also means the company effectively trades at 17x earnings and 15x FCF. This only adds a bit more margin of safety for what looks like a good long term prospect.
As always happy investing!
Disclaimer: I may hold positions in the tickers mentioned in this post. I am not your financial advisor and bear no fiduciary responsibility for your actions. This post is only for educational and entertainment purposes. Do your own due diligence before investing in any securities.