Three stocks Jacob Mitchell is backing for the next five years

If you've been watching the headlines, investing in China or favouring consumer discretionary stocks at this point in time may seem like a riskier approach. But Jacob Mitchell, chief investment officer for Antipodes Partners, believes you can still be defensively positioned if you pay attention to value, quality, and – in the case of China – exposure to structural growth drivers.

Mitchell will be joining Livewire Live on 12 September as part of the panel session titled "Overhyped or underrated" alongside Alphinity Investment Management's Mary Manning and Munro Partner's Nick Griffin.

Ahead of his appearance, Mitchell answers Livewire's questions exploring opportunities in China, why he has an overweight to consumer discretionary despite a base case for a Western recession, and shares a compelling short position.

He also shares his top picks for the next five years and discusses the biggest influence on his investment philosophy.

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The Chinese economy is struggling on multiple fronts at the moment. Are there still pockets of opportunity for investors?

Confidence in the Chinese economy has been crushed after prolonged COVID disruptions, a weakened property market and a lack of an appropriate policy response. The longer this negative cycle continues, the harder it is to return to growth. This has caused international investors to largely give up on China – you can see evidence of this in investor positioning surveys and HK and US-listed Chinese stock multiples at their largest discounts to the rest of the world in over 20 years.

Companies that are at the frontline of the economic correction are likely to see returns remain structurally lower for some time. However, there remains significant upside potential in Chinese companies that have a dominant business, sustainably high returns on capital and strong free cash generation, such as Alibaba (NASDAQ: BABA) and Baidu (NASDAQ: BIDU). 

Another area of opportunity is emerging Chinese multinationals that are global leaders in their respective industries with large opportunities to export to geopolitically aligned countries. Midea (SHE: 000333) and CATL (SHE: 300750) are two such businesses.

Alibaba is one of the top positions in your global portfolio and emerging markets portfolio. What are your thoughts on its plans to spin off businesses and will you invest in any of these?

BABA’s track record in incubating new businesses has been quite poor in the past, for example Ele.me was leading in food delivery before losing out to Meituan. Hence, we see the break-up of Alibaba into six independent groups, each with its own CEO and Board, as a positive move to improve business unit-level accountability and ultimately shareholder returns. And we are already seeing results with growth in the international commerce business and narrowing losses.

We would assess any spin-offs that came to market and as things stand, Alibaba trades at a meaningful discount to its sum of the parts valuation. Management will likely monetise these businesses and return capital to shareholders if the discount remains. The intent is clear with management having bought back roughly 8% of shares on issue since December 2020, with approval to acquire another 7% of shares by March 2025.

Consumer discretionary is a big sector position in your portfolios. How have you positioned in this sector for challenging markets?

A western recession is still our base case, and we remain relatively defensively positioned with a preference for attractively priced quality and growth, while maintaining our tilt to value.

We are overweight in the consumer discretionary sector globally but underweight in the US where the stocks are not really priced for a recession, and we are overweight in China. Here, we are focusing on very high-quality names that are priced for a very deep downturn versus their underlying structural opportunities that remain intact. The property sector will be key to restoring confidence in China, so we are watching this and the policy actions around the sector closely.

In the US, while the Fed is trying to pull off a soft landing, the leading indicators continue to point to a downturn, and we are starting to see weaker prints in the services sector and in consumer confidence which have held up until now. We don’t think many of the US consumer discretionary multiples are reflecting this. We are, however, finding cheaper exposure to the US via European multinational stocks, which have substantial American consumer-facing businesses.

Can you share your biggest short position and why?

Nidec (TYO: 6594) is an example of a company we think has and continues to represent a compelling short. Its legacy is in making motors for hard disk drives (HDD) - a market it dominated with an over 80% share and which generated impressive margins. However, the business is now declining as solid-state drives take share.

Nidec is a founder/promoter-led company that has sold the market a growth narrative as it seeks to repeat its historical HDD drive success. In the past few years alone we’ve had haptic motors, drones, compressors for home appliances, machine tools, components for ADAS systems, and most recently motors for the drive systems of BEVs. All these supposed growth avenues have, in turn, failed to meet management’s lofty promises.

This scattergun growth quest and other questionable acquisitions have meant that Nidec has deployed significant amounts of capital building a disparate portfolio of non-synergistic assets, all of which has resulted in a group that delivers very modest organic growth, and for whom margins and returns on capital have been consistently falling since the peak of the HDD market. Today’s high single-digit margins are unimpressive in any context for a manufacturing business, a testament to the low quality of the portfolio.

Despite this poor financial performance, the stock trades at nearly double the multiple of a portfolio-weighted basket of best-in-class peers. It does so despite Nidec having lower growth and margins, and consistently missing financial targets for both the group and individual businesses. Much of the multiple is due to an enduring faith in the ability of founder and Chairman Nagamori, a view we don’t share despite prior success in the HDD market.

Ultimately, we see that Nidec will derate to levels consistent with its fundamentals – being those of a low-margin and low-growth company with a questionable capital allocation policy and governance structure.

If you could only hold three companies for the next five years, what would they be?

Merck (NASDAQ: MRK), Oracle (NASDAQ: ORCL) and Siemens (ETR: SIE) fit the bill.

Merck is, of course, the US-headquartered global pharmaceutical business that many would already be familiar with. The pharmaceutical business is generally economically defensive/insensitive by nature, and this company has multiple ways of winning through its premier R&D capabilities and deep pipeline, limited patent cliff risk and insulation from US drug pricing concerns. About a third of Merck’s sales are in sticky, long-duration businesses with high barriers to entry, like vaccines and animal health and the company is growing earnings at roughly 12% p.a. and trading at a forward PE of only 14x.

Oracle has been long overlooked because it’s perceived to be an old-world tech business. But this is a pragmatic value play with long-term growth prospects and exposure to AI.

The key ingredients for successful AI models are the ability to deploy compute power cheaply, and a vast amount of quality proprietary data to train models over to deliver valuable insights. Oracle has both the power and the data. 

This AI technology will be harnessed by the company’s enterprise resource planning (ERP) solutions, of which it’s a leading global provider.

It’s also important to note that for Oracle customers, moving their ERP solutions from on-premise to the cloud is a priority - both to meet the demands of hybrid work environments and for the cost-saving and productivity benefits. For Oracle, transitioning customers to the cloud and a subscription service roughly doubles the value of each customer over the contract life. At a forward PE of 21x, there is reasonable upside given that nearly 80% of back-office ERP workloads are yet to complete this transition.

Finally, Siemens AG provides well-rounded exposure to investment cycles around decarbonisation and the energy transition. To create a lower carbon world, manufacturing lines will need to be redesigned and retooled and Siemens provides both the hardware and software for plant optimisation and efficiency. Further, the Smart Infrastructure division sells energy-efficient building, factory, and grid control systems to manage power consumption, and is a top three player in rail globally, providing the signalling equipment which is critical to rail infrastructure. Siemens stands to benefit from the decarbonisation-led investment cycles that will accelerate over the coming decades, and the market is materially underestimating the company’s long-term value on a forward PE of 14x.

Who or what has been the biggest influence on your investment philosophy?

I was fortunate to start my career under the guidance of value investor Peter Pedley at Tyndall Australia, which at the time was one of the early adopters of quantamental investing. Peter was very interested in benchmarking relative profitability against relative valuation and looking for both quantitative and qualitative anomalies. This approach used bottom-up research, complemented by a top-down benchmarking of companies against the opportunity set.

And Peter really emphasised how important it was to understand a company financially. You had to study history before making bold pronouncements about the future.

We’ve tried to replicate a lot of the same philosophy at Antipodes, we don’t start by saying “This stock looks cheap therefore I’m going to prove it’s a great company.” 

We start by thinking about an industry, finding great companies within that industry, and then attempt to value them. Along with valuable quantitative context, we find that among other things, this helps to manage confirmation bias.

And of course, I ultimately went on to Platinum, where Kerr Neilson taught me the importance of management antecedents/DNA and how to understand an industry from a long-term global perspective.

Best movie, show, podcast or book this year?

White Lotus series two – even darker than series one, if that was possible. 

On a more life-affirming front, I stumbled across a documentary about the campaign to save the Franklin River in Tasmania in the early 1980s, told from a very personal perspective (see here). Like anyone who has spent time in the South Western Wilderness, you have to be extremely thankful that this campaign of civil disobedience actually worked. Anyway, a good one to watch, maybe with some teenagers, especially in this age of high cynicism. 

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