Sell your winners slowly

A few weeks back at a presentation I was asked whether I thought Mainfreight was expensive. With the stock up over 200% since the lows of March 2020 and a forward P/E that is 20% above two year historic averages, on arguably COVID driven inflated earnings as a result of historic high freight rates, it was probably a fair question.    

We first met the management of Mainfreight about six years ago, as part of our regular (historic) trips to New Zealand. The business was founded by Bruce Plested and Neil Graham with reportedly $7,200 of capital and a 1969 Bedford truck in the late 1970s. Listing in 1996 on New Zealand's Exchange at 84 cents, the business flew under the radar of many global investors for some years.

At EGG our investment process sees us place equal weight on both quantitative and qualitative attributes that any one company can possess. At the time of our initial investment, the stock had a mid-teens P/E multiple for mid-teens earnings per share growth profile or close to a PEG ratio of 1 and an ROE also in the mid-teens and improving. 

On the qualitative side we were attracted to managing director Don Braid's incredible track record, the alignment of management/board at more than 20% of the register, a well thought out and articulated strategic plan, and ultimately the market opportunity.

Having backed Don and his team in the lead-up to COVID, on their ability to win share from major incumbent freight providers struggling to deliver solutions to high value/low(er) volume customers, our investment thesis was certainly called into question as world trade ground to a halt in March 2020. We took comfort in the fact that “the world’s freight trade-lanes remain open”, and the quick rebound of China volumes, post the first round of lockdowns. 

  It wasn’t all smooth sailing with large capex decisions deferred and a sharp decline in NZ revenues through April, but by the time the FY20 result was released in May, it was clear momentum had improved across all key markets.

Looking back at our investment decisions then, our decision to buy stock in March 2020 was brave, but as we had more confidence in the cyclical trade, adding to the position in May 2020 post result seemed like a no-brainer. The question for many investors right now is what is the right multiple to pay for cyclical stocks on inflated earnings bases?

Mainfreight's FY21 result saw Profit Before Tax rising 27% on FY20, as operating leverage was evident. Despite wage subsidies inflating many businesses, Mainfreight was one of the first to give back the $10.6mil, and many execs took significant pay-cuts. 

Source: NBR.co.nz

Management pointed to activity levels remaining resilient, after hiring an additional 630 staff during COVID and earnings estimates were upgraded substantially. At the time of the result the share-price reaction was muted, most likely as investors grappled with the sustainability of the earnings base, and some profit taking.

In the annual report released in late June, Don reflected on the "significant result for the Mainfreight Family", but conceded that "we are no means completely satisfied… Service levels need to improve, and with heavily congested supply chains affecting the world's freight lanes, we have much to achieve on behalf of our customers". In the pages that followed a 5-year road map was outlined which included branch targets, revenue aspirations, product roadmaps and clear environmental goals.

Source: Mainfreight 2021 Annual Report

Accompanying the road map was the line "Through sharing these aspirations with our people and shareholders, we hold ourselves to account". I could count on one hand the number of ASX/NZX listed companies that would be willing to put their neck out to this extent. A couple of days later a change in director notice was filed, with MD Don Braid acquiring ~$2.3mil of stock @ $76.11 on market. Clearly Don saw value in the stock despite the premium multiple, with a significant runway ahead.

Earlier this week peer Kuehne + Nagel posted a very strong Q2 result with significant growth on both 2019 & 2020. 2Q YoY Seafreight Gross Profit per TEU was +75% and +19% on Q1 2021. 2Q Airfreight volumes +76% yoy and +28% vs Q1 2021. Both are strong indicators for Mainfreight where profit momentum remains strong.

Source Keuhne + Nagel: half-year 2021 Results

As the stock flirts with $80, one could be tempted to take profits and move on, but as the market begins to appreciate that a normalisation in margins could be 2-3yrs way, earnings could be significantly understated. One of Ben Griffiths rules of investing is 'Sell your winners slowly'. Mainfreight is the perfect case in point.

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Eley Griffiths Group is a specialist at focusing on small and emerging companies in Australia. Mainfreight is currently the largest position in the Eley Griffiths Group Emerging Companies Fund. Find out more by visiting the fund profile below.

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