Afterpay’s a sell for these big, small and global managers

Soaring technology company valuations are justified in some cases but a danger sign among those riding the coat-tails of the tech boom, say top stock pickers from Alphinity Global, Greencape Capital and Eiger Capital at the recent Fidante Partners Investment Forum.

Afterpay is a prime example, the financial technology company’s share price having gained almost 500% since the mid-March sell off. The stock closed at around $74 on Tuesday, up from $9.90 on 19 March.

“In any market, there’s always a few stocks that look like they’ve completely disconnected from fundamentals,” says Nikki Thomas, portfolio manager at Alphinity Global. She joined portfolio managers David Pace from Greencape Capital and and Stephen Wood from Eiger Capital in a recent investment forum hosted by multi-boutique manager Fidante Partners.

“Are they all in the tech sector? Not necessarily, but they often have a piece in them which the market is a little exuberant about.”

Thomas notes the acceleration in online shopping, virtual workplaces and entertainment streaming fostered during COVID-19 lockdowns – trends underpinned by artificial intelligence and numerous other parts of the technology spectrum that have shaken up numerous industries and companies.

“And the threat of pandemics isn’t going to go away quickly, so we’re going to have to live with these adaptations for quite some time,” she says.

David Pace, Australian equities portfolio manager at Greencape Capital, believes Afterpay lacks sufficient competitive advantage and earnings stability to justify its high PE multiple.

“We can’t find value in APT…but that’s not to say we’re adverse to tech,” Pace says, noting the stock doesn’t makes the cut when it’s compared to some other well-known tech plays.

One of these is data centre company NextDC, which Greencape held up until recently for 5 years leading into the substantial rally. The Greencape Australian equities strategy also owns job search website Seek and global chipmaker Nvidia – the latter forming part of its allowable 10% offshore allocation.

“Both these companies are hugely earnings generative led by best of breed management and have much larger competitive moats relative to APT and Next DC” Pace says.

The rapid growth of Afterpay, whose market cap of more than $21 billion now ranks it within the ASX 20, hasn’t influenced the Greencape team one way or the other.

“The passive money is indiscriminate, it thinks differently than we do, and we feel comfortable taking the other side…we think fundamentally and bottom up,” says Pace.
“Now that APT is a larger index position, we see that as an opportunity to earn alpha – by not owning it over the medium- to long-term.”

Reflecting on the way coronavirus has whipsawed markets, particularly since the mid-March sell-off, Stephen Wood, small caps portfolio manager at Eiger Capital highlights the segment’s higher proportion of tech stocks versus the broader market.

In 2008/2009, the market decline lasted 12 to 15 months, and the small cap market rebound took an additional 9 months to regain around 70% of its prior levels.

“Two years of the GFC has been compressed into less than six months ,” he says.
“But this year, within six months we saw a decline and a rebound to virtually right back where we were in small caps in February.”

This is in large part due to small caps being a “a little bit heavier on tech and a bit lighter on consumer staples like supermarkets, Telstra and the banks.”

But he echoes Pace’s concerns about buy now pay later: “we’re concerned that this space has got too hot, particularly when we consider that it really does ultimately rely on retail to drive its business case forward.”

“Retail has had some phenomenal stimulus hit it, from government plans as well as super draw down in Australia. And it seems unlikely to us that some of the key retailers that BNPL helps are going to be able to cycle these numbers next year.”

How are you coping with risk?

Eiger’s small cap strategy is managing the risk-on environment by being even more active and ready to pounce on opportunities or back away quickly.

“When we see stocks moving around 20 to 30%, whereas half a decade ago the same types of news events would’ve moved them 5 to 10%, we’ve just got to make sure that we’re ready to go when events happen,” says Wood.

While Eiger’s backing out of BNPL, it is now eyeing post-COVID opportunities that may present in the months ahead. These include some travel-related and infrastructure-exposed stocks, including names like Auckland Airport and Corporate Travel Management.

On the global side of things, Alphinity’s Thomas is closely watching how governments around the world get themselves out of lockdown “and how those costs are paid for.” But she remains confident that for at least the next six months, governments will continue to backstop their economies quite strongly.

In local large caps, Pace says investors should be thinking about adding more duration to their portfolios.

“The time to protect the portfolio and to go into damage control has come and gone.
“The beauty of being a retail shareholder is that you can bottom-drawer names without fear of being measured relative to an index in the next quarter.”

He believes the alpha his fund has generated since markets peaked on 20 February has given it the right to add duration. “That might not pay off in the next six months, but we look for a good two to three years from here.”

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