This article was originally published on on March 1st, 2021

At the conclusion of 2020, the market witnessed a rotation from growth stocks into value stocks. The reign of growth investing came to a standstill as value investors rejoiced after an extensive drought. As growth managers dropped their jaw, the value managers capitalised on the rotation.

But how long will value sit on the market throne? Andrew McKie of Elston Asset Management believes that exposing your portfolio to both growth and value will protect investors over the long term, and is at the core of the Elston philosophy.

In this video, Andrew explains why he is ultra-bullish when considering the next three years for large-cap Aussie equities, the sectors he believes are positioned best to ride the recovery, detailing his preferred travel play and provides his thesis for the one ASX company that is still undervalued despite its stellar run.

Edited Transcript

What makes Elston Asset Management unique?
Most fund managers will talk about their competitive advantage. Whether it’s real or not is the other thing. I suppose a couple of things for us, we think distinguish ourselves, firstly, that we are genuine large cap managers. 80% of the portfolio is ASX 50, with a maximum of 20% in the 51 to 100. The reason we’ve done that is just to ensure that we can specialise and build our knowledge of not only the companies that we own, but the companies that we don’t own. In our view, a lot of people tend to focus solely on the portfolio they already have. Whereas, your next best idea is actually coming from the businesses you don’t own.
Secondly, that value growth, so style neutral approach, means we ride through most market cycles. There will be periods where we might have more value in the portfolio or more growth in the portfolio, depending on relative valuations. We don’t think that we should be talking about either/all, it’s really about the relative return that we’re receiving. How much are we paying for a business versus its growth? And that certainly comes through in our performance over a long period of time.

What are your current sentiments toward the market?
I’d be more the bullish one in the team at the moment. I think, obviously, direction is difficult in the shorter term. If we look at, particularly COVID, and the effectiveness of the vaccine that is starting to come through now it’s really providing some direction to markets. How that goes over the next six months is difficult. But for us, over the next three years, which is our investment time horizon, when we’re buying a business, it’s a minimum of three years when we’re looking at it. For us, it’s fairly clear that we won’t be operating in this sort of COVID environment then. And so, if we put that into context, then there’s potentially a lot of opportunities, particularly in some of the businesses that are more COVID challenged. Probably the other side is just the supportive environment. If we look at the amount of money and fiscal stimulus, the amount of monetary policy support that’s going into the economy and how that affects asset values more broadly, we think that relative valuation support is also supportive of equities as well as other asset classes like property.

What ASX sectors do you see as having the best prospects in the next three years?
I think if you’re looking at sector, you have to look at the COVID influence in the short term versus that three year time horizon. You have to also look at that macro support and then relative performance. Look at last year – most of the performance in the market came from technology and from materials, particularly iron ore producers – BHP and Rio and Fortescue. And a very concentrated performance over that period of time and to a lesser degree, consumer discretionary. For us going forward, one that there’s valuation concerns there, whether there is valuation support in some of those sectors and whether those beneficiaries of COVID, it’s harder for them to perform as well given the very high base of earnings going into say ’21, ’22. We are positioning more for those recovery businesses. We think it’s an easier ride coming out for them and expectations for the market are very low. And so, that’s where we’ll be positioning. Things like industrials, financials, to a lesser degree, say, energy and some selective consumer discretionary, depending on the composition of retail. There will be some change in retail behavior and household behavior, we think, as well. That’s going to influence consumption patterns and sector performances. That’s how we positioned the moment.

What company are you selecting for a recovery play?
If you’re looking for a recovery to travel consumption, we think it’s best to go to the highest quality business in that sector. And we think that is Sydney Airport, given its monopoly position. Monopoly 80% EBITDA margins, good diversification across revenues. If you look at the aeronautical, they’ve done a lot to expand around the airport in terms of property, retail, parking. We’ve got a lot of revenue contributors coming through, so good diversification there as well. And as I said, we’re pretty reasonable in terms of expectations of recovery, of both domestic and international passengers in numbers, domestic first. But really not back to where we were until ’22, ’23. But over that period of time, we think that the stock is offering close to a 20% compound return as we recover. And we look at that period where we’re back to similar distributions to we were in ’19 when Sydney Airport was trading around $9. That’s, for us, the clearest way to, and probably the safest way on the downside, to look at this shift in consumption of the consumer and business back to travel.

What is one stock you think has been undervalued by the market?
I think it goes back to what my view as an investor is, and what I bring to the team as more of a business person, I think, rather than necessarily an investor. Looking at buying businesses and, from that, very much focused on strategy, execution. What is the strategy and how well are they executing? For us, that is Macquarie. It would be a very good example, Macquarie Group. Over the last 10 years, there has been a lot of market noise and people have been in and out of Macquarie for various reasons. But if you look at the broader strategy for that business over the last 10 years, they have dramatically improved the quality of that business. If you look at 10 years ago, they had the same number of employees and as they moved to more annuity income, more assets under management, they’ve improved the operating earnings of that business and the annuity part of that business.

For example, if we look at things like assets under management per employee, they had something like $20 million, 10 years ago. It’s now $40 million. If we look at operating earnings for the same number of people from $80,000 of pre-tax earnings per employee, it’s now $220,000 of pre-tax earnings per employee. That’s meant much higher margins, much higher return on equity. There is sort of mid double digits return on equity versus single digits 10 years ago. We think that that the market has really not seen so much of that, and we would actually view that business as slightly underrated in terms of it’s multiple as well, given the high return on equity and the high quality of that business and how they’ve been able to successfully execute that strategy. That would be one longer term that people are very focusing on short term when it comes to Macquarie and sort of missing the longer term strategic picture.

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