H1 2022 Portfolio Review

For the first half of 2022, the Superfluous Value portfolio fell 14.7% in AUD, modestly outperforming the MSCI ACWI IMI, which fell 16.5%. The weaker Australian Dollar cushioned the decline, as I was down 18.3% in constant currency (USD).

More importantly, since I began formally tracking my portfolio in Aug 2018, I have gained a cumulative 20%, narrowly underperforming the MSCI which has returned 22.7% (both in AUD).

Despite the acceptable relative performance, it was a dismal half and all the more frustrating because it should have been so much better. The short summary is that a number of my EM defensives’ poor performance was roughly netted out by my cash and energy exposure, but I booted three major own goals- Gazprom, Lukoil and Saipem.

Saipem had to perform a substantial €2b Euro capital raise at a very poor time. Despite this being highly dilutive (which I got wrong), the initial signs were that long-suffering investors would get bailed out as the stock rallied to near €4/share on optimism about the company with its financial distress removed. It proved illusory though, as the offering ended up undersubscribed and the price tumbled back down under the €1 subscription price. There are now a number of underwriting banks holding stock they will want to shed, so there will likely be pressure on the price for some time.

With regards to my Russian holdings, while I have seen some funds use creative methodologies to value these companies, I have decided I will just carry them at zero until any liquidity appears in the future. I wrote about them extensively here, and only hope for a finish to the war as soon as possible, firstly for the Ukrainians and secondly, for the portfolio.

The Russian invasion of Ukraine was the dominant world event of the half, but the overall market picture has been one of markets starting to make a little sense again. The growth bubble appears to have been punctured (hopefully terminally) and fads, such as crypto-currencies and meme-stocks, are being revealed for the ponzi schemes they are. On the whole, investors have started demanding cash-flow again, which should bode well long-term, as the portfolio has it in spades.

Of course, plenty of babies have been thrown out with the bathwater and this is where I’m getting increasingly excited. Non-US value markets haven’t been immune, due to the strength of the USD and I would nominate Latin America, Europe and Precious Metals as areas of particular pain/interest. They were already cheap before and now exhibit many companies down a further +50%.

KT Corp and Antero Resources were the two strongest contributors for the half, with KT flying under the radar and Antero being a huge beneficiary of the war-induced, global energy shortage. I was pleased a number of positions held their ground, such as First Pacific, Babcock International, Aimia and Lloyds Bank. It has been a bruising bear market thus far and absolute value has been something of a safe harbour in these names.

Of course, the overall story was the losers and there were quite a few. On top of the trio mentioned above, Liberty Latin America, ABS CBN Corp, Micro Focus and Barrick Gold detracted meaningfully. The upside being that they all look stunningly cheap and I believe the portfolio is priced for excellent forward returns.

I am learning that when investing in deep value it is essential to ensure time is on your side. Of the above, Liberty Latin America and Barrick are perfectly sound businesses and I believe it is only a matter of time until this is recognised by the market.

However, ABS CBN and Micro Focus are a little different. I have stuck with both over several years, but their runways aren’t unlimited. ABS CBN becomes more indebted each month it is starved of its franchise and Micro Focus will eventually see its leverage burden become overwhelming, if management can’t turn the business around soon. Declining revenues need to be arrested or the ice cube will simply melt away. These two are on a tight leash for now, especially while other bargains are becoming plentiful.

I stayed true to my goal of low-turnover, only transacting once in the half. I took a large swing at Millicom (NYSE:TIGO), adding an 8% position as it plummeted into its Rights Offering, which I wrote about here. It is lower still now and represents one of the most outstanding opportunities I have seen in several years (more below).

The portfolio consisted of 17 positions and a 15% cash weighting at June 30.

Top Holdings

Cameco (11%)

Cameco has been a star performer since my late 2020 purchase and all the more since I have resisited the urge to trim it along the way. I have no view on tomorrow’s uranium price, but I think the long-term view is very promising with nuclear offering a reliable, energy-rich and carbon-neutral baseload power.

I have heard many withering critiques of Cameco’s management, but that they have weathered a decade-long bear market (through hedging and mine management) and come out the other side in a strong position is an outstanding achievement. The company still looks cheap on my estimate of normalised earnings, so I will continue to sit on my hands and let it play out.

KT Corp (9%)

I must confess I don’t spend a lot of time thinking about KT. The management is average and the industry competitive, but they are entrenched in their market and the valuation is superb. They may be a prime beneficiary of the market re-focusing on profitability and possibly casting its eye ouside the US (apologies to long-term readers, I know I’ve been saying this for some time!). I’m happy to wait with a 5% yield on offer, even after the price has risen nicely out of the pandemic.

Millicom (8%)

As noted above, Millicom falling into the teens on the back of its Rights Offering to fund the buy-out of its Guatemalan JV partner was just too good to pass up. The company is the number one or two cable/telecom provider in most of its markets, which include Guatemala, Columbia, Paraguay and Panama and can be bought today at under 4x EV/EBITDA.

Normally you are stuck with middling management and stagnant domestic markets at a price like this, but in this case, the CEO Mauricio Ramos is a former Liberty executive and currently on the board of Charter Communications. He quotes John Malone and he and his team hold meaningful positions in the stock.

Additionally, Millicom’s markets are ripe for cable line-extensions and there is a substantial runway where this can be done at a relatively low cost. Much like my other Latin American telcos LILAK and Telefonica Brasil, the company should also benefit from growing internet penetration and the lagging pandemic recovery in Latin America.

Babcock International (7%)

Babcock is a case of buying right and sitting tight. In January 2021, it was crippled by pandemic margin blow-outs and on the verge of a capital raise. I was lucky to step in at what turned out to be the exact bottom and the company has managed to drag itself slowly back towards normal, under new management.

Longer-term I believe Babcock will get bought by Private Equity, but I’m fairly sanguine whether this happens or not. They have a long run-way to deleverage and profitability should continue improving as the pandemic fades into the rear-view mirror. Additionally, they are a logical beneficiary of increased defense spending, due to the war.

Telefonica Brasil (7%)

Unlike Millicom, Telefonica Brasil exhibits the sort of middling management you do typically expect at an EM Telco going for under 3.5x EV/EBITDA. They are unlikely to ever buyback stock in size or hold large stakes themselves, but the company is net cash, outstandingly cheap and has an oligopolistic postion in a fast-developing market.

It was recently part of a joint bid which carved out the assets of competitor Oi at a good price and has a fast-growing fintech division under its umbrella. After my Russian experience I thought long and hard about whether I wanted exposure to a country like Brazil (I also own a core position in Petrobras), but am happy holding for now and will be following this year’s election with interest.

Summary

The mood has changed in markets, but we won’t know how deep this bear will bottom until it is well behind us. What I do know is that there are more bargains available than I have seen since March 2020, and it is time to be leaning towards measured offence.

It is only by being cautious throughout the euphoria of 2021 that an investor can have the temperament and cash to be buying now, so hopefully we are witnessing a period that will reward the patient, fundamental investor.

Thanks for reading and happy hunting,

Guy

I own positions in all the companies mentioned.

PS. As always (and especially when I'm mentioning so many stocks), this isn't investment advice. Please do your own due diligence and seek professional advice if you're unsure about your finances.