How the #1 picks went from hero to zero in just 6 months

Well, folks, we've made it - to the end of the first half that is. Last time I wrote that the first quarter had been "tough, tiresome and damn it, sometimes terrifying", but little did I know that it would only get worse. 

At this point, only three out of Australia's finest stockpickers' highest conviction calls are in the black, while the rest have slid (some more violently than others) into the red. Two of the fund managers featured in this series have sold out of their top calls for 2022.

The total return of our fundie favourites now stands at -30.99% (inclusive of dividends, capital gains and currency movements), far worse than the -3.15% total return that I hesitantly revealed in the first quarter. 

The worst-performing Aussie stock on the list was Megaport (ASX: MP1), cascading 71.51% in the first six months of the year. The best performing Aussie stock pick was QBE Insurance (ASX: QBE), which lifted 8.79%. 

That said, it's not all doom and gloom. In fact, three of our fund managers' highest conviction calls have managed to outperform the S&P/ASX 200 benchmark, including Hansen Technologies (ASX: HSN), Sims (ASX: SGM) and Equity Trustees (ASX: EQT). 

For those who prefer investing offshore, Novartis (SWX: NOVN) continues to be the best global performer, boasting a return of 4.75% in the first half. The five other global stocks featured in the 2022 Outlook Series are not doing well, to put it politely. 

Nonetheless, they say the best money is made when markets are in meltdown. After all, the lower the price you pay for a stock, the better your returns over the long term. 

And while two of our 18 fund managers have sold out of their top stocks for 2022, the remaining 16 stockpickers are adamant that their highest-conviction calls remain compelling over the months (and years) to come. 

So read on if you like a dash of drama, a squeeze of stocks, and let's face it, a good glug of guts. We hope you enjoy this first half update on our 18 fundies' number one picks for 2022 - and why (the majority) are still backing these stocks over the six months that lie ahead. 

Note: I also want to take a brief moment to thank the fund managers who shared their views in this piece in the spirit of the Outlook Series, amid what is a very challenging time for markets, investors and many of these stocks. In case it wasn't obvious, all of the fund managers on this list run diversified portfolios, and are not solely invested in their #1 picks below. 

Our featured experts include:

• Anthony Aboud, Perpetual Asset Management
• Chad Padowitz, Talaria Asset Management
• Eleanor Swanson, Firetrail Investments
• Nick Griffin, Munro Partners
• Simon Shields, Monash Investors
• Richard Ivers, Prime Value Asset Management
• Julia Weng, Paradice Investment Management
• Mark Landau, L1 Capital
• Hamish Carlisle, Merlon Capital
• Adrian Martuccio, Bell Asset Management
• Bob Desmond, Claremont Global
• Dean Fergie, Cyan Investment Management
• Matthew Kidman, Centennial Asset Management
• Nick Pashias, Antares Equities
• Steve Johnson, Forager Funds
• Steve Black, Pengana Capital Group
• Chris Demasi, Montaka Global Investments
• Michael Steele, Yarra Capital Management

Note: This list is from best to worst in performance (inclusive of dividends, capital gains and currency movements). As of June 30, 2022.

1. QBE Insurance (ASX: QBE) 

• Fund manager: Hamish Carlisle, Merlon Capital
• First half return: 8.79%

It's probably no surprise that Carlisle and the team at Merlon continue to have high conviction in their #1 pick for 2022. After all, it's the top performer, and by a long shot, out of our fundie favourite list. 

"The company provided positive commentary at their AGM in May, highlighting continued growth in insurance premiums and investment yields during the first quarter of 2022," he said. 

"These comments were largely mirrored by their US peers as they reported their first-quarter results." 

In addition, Carlisle said that the operating backdrop remains strong for the insurer as its highly leveraged (from a financial perspective) to tighter monetary conditions and inflation. 

Who said boring wasn't beautiful.

2. Novartis (SWX: NOVN)

• Fund manager: Chad Padowitz, Talaria Asset Management 
• First half return: 4.75%

Taking home the silver at the end of the first half is Padowitz with his call on Novartis, which has performed comparatively well in this tumultuous environment for global stocks. 

"Its performance versus the MSCI World Index (in CHF equivalent) was an outperformance of 21.9% (it was 9.81% at the close of Q1), while it outperformed the S&P500 (in CHF equivalent) by 21.65%," Padowitz said. 

While the Fund already has a 5.6% exposure to the Swiss pharmaceutical company, it has been topping up its position and taking advantage of the sell-off, with Padowitz revealing he would like to own more in the future. 

"The only news of note is that it is likely to spin off its generic division Sandoz – which is approximately 12% of earnings," he said. 

"This is in line with a multi-year process of focusing their business on core areas of pharmacology. We view this positively and continue to believe Novartis is well placed to perform well in the current environment, which we expect to be challenging for some time." 

3. Equity Trustees (ASX: EQT) 

• Fund manager: Richard Ivers, Prime Value
• First half return: 1.42%

In third place at the end of the first half is Ivers with Equity Trustees, which he believes has been rewarded by investors thanks to its "high-quality earnings stream and reasonable valuation," helping it to outperform amid a very weak small industrials sector. 

"Recently Insignia (IOOF) flagged its intention to divest Australian Executor Trustees – this would be a good fit for EQT which is well-positioned given the synergies available are larger than for most other acquirers," Ivers said.  

"EQT has a net cash balance sheet and a deal could be significantly accretive. We remain a holder of EQT, and as the stock is pretty much flat versus the small industrials (which is done around 25%), this position has up-weighted itself through performance." 

4. Hansen Technologies (ASX: HSN)

• Fund manager: Steve Black, Pengana Capital 
• First half return: -1.21%

Black is also still backing his highest conviction pick, which has managed to outperform in a deeply sold-off tech sector. 

"Despite the strong outperformance over the quarter we still see considerable upside as the market becomes more fully aware of the recurring nature of its’ earnings streams," Black said. 

"With a healthy balance sheet, we would expect the company to make an accretive acquisition which I have no doubt will be very well received by the market given management’s success in not overpaying and integrating past acquisitions."

5. Visa (NYSE: V)

• Fund manager: Bob Desmond, Claremont Global 
• First half return: -3.95%

Likewise, Desmond is still a fan of his #1 pick for 2022, arguing that it has performed well ahead of his expectations since December last year. 

"Cross-border business continues to recover strongly, up 47% (ex-EU), helping to drive a 17% increase in payment volume as well as a 26% increase in revenue in the latest quarter," he said. 

"As expected, Visa has resolved its issues with Amazon and the recovery in cross-border has seen incentives as a per cent of revenue fall." 

In fact, travel in May was up 8% on the same month in 2019, despite Asia still being down 40%, he said.  

"COVID-19 has only accelerated the multi-year digitisation of cash and Visa remains a core holding in the fund, owing to its deep competitive advantages, structural growth and attractive valuation," Desmond said. 

6. Sims (ASX: SGM) 

• Fund manager: Nick Pashias, Antares Equities 
• First half return: -11.60%

We were unable to get commentary from Pashias, who appears to be enjoying a well-earned break after more than two years of COVID restrictions and lockdowns. 

Sims, not to be confused with the very popular 90s online game, is a global leader in metal recycling and circular solutions for technology, and has also been emerging as a player within the renewable energy sector as well. 

The company recently released its first-half financials, including the announcement of a 74% lift in sales revenue to $4.3 billion, underlying NPAT up 622% to $269.3 million, cash flow distributions up 458% to $135 million (including $81 million in dividends and $54 million in a share buyback program, which it has already begun executing during the second quarter). 

7. Harvey Norman (ASX: HVN) 

• Fund manager: Anthony Aboud, Perpetual 
• First half return: -19.12%

While in football they say it was a game of two halves (supposedly, I know nothing about football), Harvey Norman has been a game of two quarters, Aboud explained. 

"As of 30th June, Harvey Norman has fallen by 21%, underperforming the market which was down 10% over that period," he said.

This came after a solid first quarter. So what went wrong? 

"The company has done nothing wrong. However, there has been a material change in the market’s view about discretionary retail spending over the next couple of years," Aboud said.  

"I am sympathetic to the view that with the RBA increasing interest rates into a slowing economy is going to be a headwind for HVN over the next 12-18 months. The consumer will have higher energy and food costs, combined with higher mortgage rates and may have lower confidence due to a lower stock market and house prices." 

Thus, Aboud agrees that consumers will likely reduce their spending on discretionary goods sold by the likes of Harvey Norman. However, while earnings may take a beating, he argues that Harvey Norman is one of the few retailers in Australia which owns its own property (it has $3.5 billion in property on its balance sheet with virtually no debt). 

"If we are going into a recession, this is the type of balance sheet I would like to own," Aboud said. 

"Companies with such strong balance sheets are able to invest in their business in a downturn when their competitors are struggling and hopefully HVN comes out the other side with increased market share." 

While he can't predict the future path of the company's share price over the short term, he feels that there is limited downside from here. 

"From an earnings perspective, the market is forecasting a 25% decline in profit already in FY23 and even on those numbers it is on a 10 times P/E and 7.5% fully franked yield. If the Australian consumer is not as bad as everyone thinks, we think HVN's share price will bounce back hard," Aboud said. 

8. RPM Global Holdings (ASX: RUL)

• Fund manager: Steve Johnson, Forager
• First half return: -23.26%

After that lengthy but enjoyable essay from Aboud, Johnson's message is short and sweet: RPMGlobal continues to deliver on Forager's expectations and remains one of the team's highest conviction positions. 

"The company added $11 million of very sticky recurring revenue in the year to June 2022 and will be profitable this financial year and increasingly so next year," he said. 

"We don’t see sales momentum slowing down. While the share price has fallen so far this calendar year, it is one of the better-performing tech stocks on the market and remains the largest investment in the Forager Australian Shares Fund." 

9. Envirosuite (ASX: EVS)

• Fund manager: Matthew Kidman, Centennial Asset Management 
• First half return: -29.55%

Kidman is still backing his #1 pick for 2022, arguing Envirosuite is well placed to take advantage of the ESG movement currently sweeping the corporate globe. 

"EVS produces software that collects critical pollution data for the airport, water, and mining industries," he said. 

"It helps participants in those industries measure air, water, and noise pollution so they can be run more environmentally efficient. EVS has clients across the US, Europe, Asia, and Australia." 

In fact, Envirosuite is growing at over 20% and is close to profitability, Kidman said. However, it is also, perhaps unfortunately in this environment, a software technology company. 

"This industry has been friendless in the share market since January," Kidman said. 

"The company is growing consistently and strongly, regularly winning major customers. With a market capitalisation of under $200 million and sufficient cash to fund its growth, we believe improving market sentiment will see the stock rise in the coming months." 

10. Entain (LON: ENT)

• Fund manager: Mark Landau, L1 Capital 
• First half return: -30.41%

Coming in 10th place on our list is Landau with Entain, which he said had been negatively impacted in the first half thanks to the sell-off in gaming names globally, as well as concerns over the pending UK Gambling Review and headwinds from a consumer spending slowdown in the UK. 

That said, Landau remains positive on the stock. 

"Entain (& Flutter) enjoy dominant positions in the nascent US market, which is set to enjoy enormous growth over the coming years," he said. 

"BetMGM (Entain’s JV with MGM Resorts) continues to execute very well, reinforcing its position as the second-largest operator in the US market (behind Flutter). The company reaffirmed its guidance of achieving profitability in the US in 2023." 

In fact, Landau revealed that the team had been viewing the sell-off over the past few months as an opportunity to add to this position. 

"We continue to believe Entain is extremely undervalued, trading on approximately 11 times consensus FY23 P/E, which implicitly values their US business at close to zero," he said. 

11. IDP Education (ASX: IEL)

• Fund manager: Julia Weng, Paradice Investment Management
• First half return: -30.85%

While David Moberley appeared in our Outlook Series at the end of 2021, he resigned from Paradice Investment Management after 10-years with the firm in the first quarter. Luckily, Paradice's Julia Weng has once again provided commentary on IDP Education. 

Weng revealed that Paradice exited its position in the stock during the second quarter - citing "valuation grounds". 

"We continue to like IDP’s growth trajectory, particularly fuelled by the integration of the IELTS India business, and recovery in multi-destination student placement, especially into Canada and the UK," she said. 

"However, in a sharply rising interest rate environment, we think the stock is priced to near perfection and will struggle to outperform in a relative sense." 

Paradice is also mindful that FY23 growth may normalise post a strong FY22, and is conscious of emerging geopolitical risks, as well as execution risks thanks to the departure of the company's long-serving CEO, Weng said. 

12. Nvidia (NASDAQ: NVDA) 

• Fund manager: Nick Griffin, Munro Partners 
• First half return: -47.49%

While Griffin remains convicted in Nvidia over the long term, he reveals the Fund has materially reduced its position as the stock has sold off. This is in line with Munro Partner's rules around risk management and stock stop-loss, he said. 

“Nvidia has been caught up in broader macro concerns that have evolved from the US Federal Reserve tightening monetary policy," he said. 

"In addition, Nvidia was impacted by a weaker outlook on its consumer-focused gaming business, primarily due to revenue being impacted from Russia and the China lockdowns." 

However, despite this difficult start to 2022, and following Nvidia's strong performance in 2021, Griffin believes the structural trends driving Nvidia's earnings growth will continue to endure over the long term. 

"Ultimately, their share price will follow their earnings," he said. 

"Nvidia is enabling the shift to accelerated computing that is critical for artificial intelligence, which we believe is the next era of growth in semiconductors. The data centre revenue growth grew over 80% in the first quarter, and we expect the growth in the second quarter to be over 60% year on year - so the key driver over the long-term in powering AI applications is very much still intact.

"In addition to the hardware chips designed by Nvidia today, the company acknowledged that the long-term earnings opportunity will be driven by a software model, which reinforced our longer-term conviction in the stock.”

13. Zebra Technologies (NASDAQ: ZBRA) 

• Fund manager: Adrian Martuccio, Bell Asset Management
• First half return: -47.98%

It takes a certain level of guts to admit when you got it wrong, and while Martuccio notes that it "would have been nice" not to own Zebra Technologies over the past six months, he believes the outlook for the business still remains strong. 

"The decline has primarily been due to a de-rating in the valuation from a 12-month forward P/E ratio of 22 times at the beginning of the year (50% premium to the MSCI World index) to a very attractive 14.5 times P/E now (in line with the MSCI World index)," he said.

"Although demand remains strong and the company has reiterated guidance for revenue growth of 3%-7% in 2022, we misjudged the lack of new catalysts in the near term and the rising interest rate environment has definitely impacted the price investors are willing to pay for companies like Zebra." 

So has Martuccio taken advantage of the sell-off in this stock? Yes, yes he has. 

"We have added to the position in recent months. Zebra's management believes that the strength in the broader business can offset weakness in individual customers and the company hasn’t seen a slowdown in the order book," he said. 

"There should also be a stronger recovery coming from Zebra’s SME (small and medium enterprise) customers, which slowed more during the pandemic. 

Over the longer term, Martuccio believes that the shift towards automation is a tailwind for Zebra, particularly given the labour shortages and wage inflation that we are seeing today. 

"This underwrites the long-term sales growth guidance of 5%-7% p.a.," he said.

"For example, increasing automation of a warehouse or fulfilment centre with autonomous mobile robots (AMR’s) and using more machine vision and barcode style scanning and identification means workers can spend more time doing their job and less time carting boxes from place to place, increasing productivity by 20% for some customers. 

"Zebra is accelerating their growth into this niche area of robotic automation by combining its existing technologies with products from companies they have recently acquired like Fetch Robotics and Matrox Imaging."

So although it has been a tough six months, Martuccio expects Zebra's share price to rally significantly from here once these catalysts play out.

14. Spotify (NYSE: SPOT)

• Fund manager: Chris Demasi, Montaka 
• First half return: -57.77%

Next on the list is Spotify, as selected by Montaka's Demasi. Like a lot of other global tech behemoths, Spotify has had a rough run over the past six months, falling almost 60%. 

"Unlike many of these companies, however, the selloff in Spotify’s stock contrasts completely with ongoing improvement in fundamentals and growing earnings power, which has created a terrific opportunity in the stock over the long term," he said. 

"For example, monthly user numbers keep growing at nearly 30% per annum and have reached almost half a billion listeners around the world."

During Spotify's recent (and first) investor day last month, CEO Daniel Ek forecasted that the business' addressable market will increase 10 times to $350 billion by 2030, as music, podcasts and audiobooks expand. 

"Spotify is in the box seat to lead the broader audio market as the clear #1, they have beaten the competition including Apple, Pandora, and Amazon," Demasi said. 

"Ek predicts a billion users by 2030 - each paying 100 euros a year across a number of services, making Spotify a EUR100 billion revenue company. With scale, profit margins will expand to 20%, or EUR20 billion – which is more than the entire market cap of the company today! If they get this just half-right, the stock will be a 10-bagger in the next decade." 

With that in mind, Demasi and his team have stayed the course during this drawdown. The firm has held its position rather than adding to it.

"Every company that has created massive value over the long term has had several periods where its share price has reversed heavily along the way," he said.

"We’ve seen this play out before and we’re confident that there’s a massive reward coming for Spotify shareholders, especially at these discounted prices today."

15. EML Payments (ASX: EML)

• Fund manager: Simon Shields, Monash Investors 
• First half return: -61.92%

As revealed in the last quarterly update, Monash exited its position in EML Payments in the first quarter. In retrospect, this was a good decision. At the time, the stock had drifted 6.81% into the red. Its now down more than 60%. 

"We have a strike system here at Monash - the result in February missed the mark, and we didn't see the rebound that we were hoping for in gross volumes printed," Monash's Shane Fitzgerald said at the time. 

After this disappointing result in February, Monash noticed a spike in the short interest on the stock.

"That was the second strike for this stock. Better to shoot first, and ask questions later. With both of those issues occurring so close to each other, back to back, we decided to exit the position," Fitzgerald said.

16. Raiz Invest (ASX: RZI) 

• Fund manager: Dean Fergie, Cyan Investment Management 
• First half return: -63.38%

While Fergie said he has been disappointed with the share price performance of Raiz, he believes it is still doing "incredibly well given the bloodbath we’ve seen in the markets". 

"In the past quarter (March – June) Raiz’s FUM has been remarkably resilient, declining just 8% to $940 million (versus the All Ords down 14%, the S&P500 down 17% and the NASDAQ down 22%) showing good ongoing inflows from their customer base," he said.

While Australian customer numbers have declined slightly during this period (down 1%), international customers have increased by 8%, Fergie said. 

"Overall, the company’s numbers show little change in the intrinsic value of the business and yet the share price has declined 37% over this period as investors have shunned funds management businesses," he said.

"We see this as a true disconnect and remain fully invested in the company and enthusiastic about its future." 

17. Megaport (ASX: MP1) - picked by two fund managers 

• Fund manager: Eleanor Swanson, Firetrail and Michael Steele, Yarra Capital 
• First half return: -71.51%

Last but not least we have Megaport, which has slipped from thirteenth place at the end of the first quarter to the worst performer at the end of the first half. Megaport was the only stock to be picked by two different fund managers during our 2022 Outlook Series. 

Despite the sell-off in this stock, Yarra's Steele says the team still maintains its conviction in Megaport as a highly attractive investment opportunity. He revealed the team had taken advantage of the stock's declining share price to add to the Fund's holding. 

"The share price has been negatively impacted by the general underperformance of technology companies – given the increase in long-dated interest rate expectations – and the company’s indirect sales channel taking longer to develop and requiring higher levels of investment," Steele said. 

"Industry meetings continue to support our thesis that there remains a significant global growth opportunity including within the indirect sales channel, with profitability increasing significantly over time given the compelling product economics including low churn and high gross margins." 

Similarly, Swanson believes there is "significant value" in Megaport leveraging the sales resources of some of the largest technology companies in the world, such as Cisco. However, she also notes that moving from an internal to a third-party distribution sales model hasn't come without its hiccups. 

"In the short term, this has resulted in some sales disruption in the short term, at a time when any growth company that misses expectations has been sold materially," she said. 

"We retain high conviction in the medium to longer-term outlook for Megaport and have added to our position in the past six months."

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