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Global stocks Shares

Discover Ends 2021 With a Decent Quarter as Purchasing Volume Impresses but Loan Growth Remains Slow

Business Strategy and Outlook

Despite initial fears, Discover came through the COVID-19 pandemic with few issues. Its credit card portfolio–its largest source of income–shrank 7% in 2020, a year when most credit card issuers saw declines in the double digits. Perhaps more surprisingly, net charge-offs fell in 2020 and have remained well below normal levels since, both in absolute terms and as a percentage of total loans. We anticipate credit costs will be higher in 2022 but given how low the firm’s delinquency rates are we do not expect a full return to normal credit costs until 2023. We don’t expect this to put any pressure on the bank’s balance sheet as Discover is in a strong financial position to withstand higher credit losses. 

Discover generates most of its revenue through interest income from its credit cards (roughly 70% of its net revenue). While the company has strong positions in the private student debt and personal loan markets in addition to operating its own payment network, its long-term health will be driven by its ability to build and sustain its portfolio of credit card receivables. Discover’s credit card business has been performing very well in recent years, with receivable growth and credit results better than most of its peers. With the majority of its credit cards and student loans charging variable interest rates, the bank will also be a beneficiary of rising interest rates, though this is limited by the firm’s reliance on online deposits. 

In the long run, Discover must continue to deal with the challenges that come with being smaller than many of its competitors in size and scope. Many of the traditional banks that the company competes with can offer their cardholders a broader selection of products and services. Discover’s more traditional competitors often benefit from a lower cost of funding driven by their strong deposit bases. While it is unlikely that Discover will ever fully replicate the product offerings of some its peers, it has made good progress in improving its funding cost through the use of online savings accounts. We are encouraged by its initial forays into checking accounts, as this should help Discover further narrow the cost of funding gap

Financial Strength

Efforts to conserve capital by suspending share buybacks in the initial stages of the pandemic paid off and the company was able to navigate the uncertainty of 2020 and 2021 with ease. Despite increasing shareholder returns in the second half of the year, Discover came out of 2021 in a strong financial position, ending the year with a common equity Tier 1 capital ratio of ratio of 14.8%. We expect the firm to continue its share repurchases in 2022 as Discover works to move back toward its target Tier 1 ratio of 10.5%. In our view, this is an adequate reserve ratio, given that historically the firm has had strong underwriting standards with credit card net charge-off rates below its peers.

 The firm has had success in improving its funding, with more than 70% of total funding now coming from deposits. On the other hand, Discover primarily relies on online savings accounts and brokered deposits. This means it must compete on price for accounts, giving it a higher cost of funding than many of its peers. The company is seeking to mitigate this with an expansion into online checking, but these efforts are still in their early stages.

Bulls Say’s

  • Discover has consistently been able to generate returns on equity that are among the highest of its peers. 
  • Discover’s credit card receivables growth has been above the industry average for some time now. This outperformance continued in 2020 when its receivables balance shrank less than its peers’. 
  • Discover has made good progress in improving its deposit base through online savings accounts and more recently online checking.

Company Profile 

Discover Financial Services is a bank operating in two distinct segments: direct banking and payment services. The company issues credit and debit cards and provides other consumer banking products including deposit accounts, students loans, and other personal loans. It also operates the Discover, Pulse, and Diners Club networks. The Discover network is the fourth-largest payment network in the United States as ranked by overall purchase volume, and Pulse is one of the largest ATM networks in the country.

(Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Dividend Stocks

TC Energy Continues to Pursue Promising Low-Carbon Efforts

Business Strategy and Outlook

TC Energy faces many of the same challenges as Canadian pipeline peer Enbridge but also offers important contrasts. The most critical differences between Enbridge and TC Energy arise from their approaches to energy transition.

Canadian carbon emissions taxes are expected to increase to CAD 170 a ton by 2030 from CAD 40 today, meaning it is critical that TC Energy, with its natural gas exposure, follow Enbridge’s approach to rapidly reduce its carbon emission profile and continue to pursue projects like the Alberta Carbon Grid, which will be able to transport more than 20 million tons of carbon dioxide. These taxes potentially increase costs for Canadian pipes compared with U.S. pipes but also make hydrogen a viable alternative to gas-powered electricity generation by 2030 in Canada, presenting an emerging threat. TC Energy recently introduced targets to reduce its Scope 1 and 2 intensity by 30% by 2030 and reach net zero by 2050, which is a start.

In addition, Enbridge’s backlog is more diversified across its businesses already, and it already has a more material renewable business, including hydrogen, renewable natural gas, and wind efforts. Morningstar analysts think the renewable business lacks an economic moat today, and considers it is an important area of investment for TC Energy that it needs to pursue. The renewable investments can compete for capital across the rest of the portfolio, generating reasonable returns on capital, allowing the overall enterprise to adapt to the markets as they evolve. This shift is especially the case as a CAD 170 per ton carbon tax in Canada opens the door for potentially sizable investments to reduce carbon emissions.

Financial Strength 

TC Energy carries significantly higher leverage than the typical U.S. midstream firm, with current debt/EBITDA well over 5 times.The high degree of leverage is supported by the highly protected nature of its earnings stream. As capital spending declines over the next few years TC Energy to currently will reach the 4s in the latter half of the decade.TC Energy is also unusual in that it will continue to rely on the capital markets to meet about 20% of its expected capital expenditures over the next few years.TC Energy has outlined plans to spend about CAD 5 billion annually on a continued basis. About CAD 1.5 billion-2 billion is maintenance spending on its pipelines, and 85% of this is recoverable due to being invested in the rate base. Bruce Power and the U.S. and Canadian natural gas pipelines will consume about CAD 1 billion each annually. ESG-related opportunities such as using renewable power to power its own operations or seeking carbon capture efforts would be on top of this spending. TC’s dividend growth remains prized by its investors, and 3%-5% growth going forward is easily supportable under the firm’s 60/40 framework.

Bulls Say

  • TC Energy has strong growth opportunities in Mexican natural gas as well as liquefied natural gas. 
  • The company offers virtually identical growth prospects and a protected earnings profile to Enbridge but allows investors to bet more heavily on natural gas. 
  • The Canadian regulatory structure allows for greater recovery of costs due to project cancelations or producers failing compared with the U.S.

Company Profile

TC Energy operates natural gas, oil, and power generation assets in Canada and the United States. The firm operates more than 60,000 miles of oil and gas pipelines, more than 650 billion cubic feet of natural gas storage, and about 4,200 megawatts of electric power.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Commodities Trading Ideas & Charts

Raising U.S. upstream oil and gas fair values would drive Pioneer’s growth

Business Strategy and Outlook:

Pioneer Natural Resources is one of the largest Permian Basin oil and gas producers overall, and is the largest pure play. It has about 800,000 net acres in the play, all of which is located on the Midland Basin side where it believes it can get the best returns. The firm acquired the bulk of its acreage well before the shale revolution began, with an average acquisition cost of around $500 per acre. That’s a fraction of what most of its peers shelled out during the land grab at the beginning of the Permian boom, giving the firm a unique advantage. And the vast majority of this acreage is located in the core of the play, where well performance is typically strongest. That gives Pioneer an extensive runway of low-cost drilling opportunities primarily targeting the Wolfcamp A, Wolfcamp B, and Spraberry reservoirs.

Pioneer has expanded fairly rapidly, with annual production growth averaging 10%-15% over the last eight years. Management still has grand plans for future growth, although it has long since abandoned its earlier goal of increasing production to a million barrels of oil equivalent per day by 2026. The current plan calls for up to 5% growth while reinvesting much less than 100% of its operating cash flows (a remarkable achievement for a company in the oft-demonized shale industry, which historically relied on capital markets to support its profligacy and is commonly expected to keep destroying value). The remaining surplus will be used to preserve Pioneer’s very impressive balance sheet, and to return cash to shareholders via a part-variable dividend.

Financial Strength:

The fair value of the Pioneer is USD 239.00. The primary valuation tool is net asset value forecast. This bottom-up model projects cash flows from future drilling on a single-well basis and aggregates across the company’s inventory, discounting at the corporate weighted average cost of capital.

Pioneer’s leverage ratios have already recovered after rising slightly in the wake of two substantial acquisitions (Parsley and DoublePoint). The subsequent divestiture of the Delaware Basin assets that were bundled with these acquisitions improved the firm’s balance sheet even further, with proceeds exceeding $3 billion. After the last reporting period, net debt/EBITDA was around 0.8 times and debt/capital is 22%. These metrics should decline further because the firm is generating surplus cash, even after its generous variable dividend payout.

Bulls Say:

  • Pioneer’s low-cost Permian Basin activities are likely to generate substantial free cash flows in the years to come, assuming midcycle prices ($55/bbl for WTI). 
  • The firm intends to target a 10% total return for shareholders via its base dividend, a variable dividend with a payout of up to 75% of free cash flows, and 5% annual production growth. 
  • Pioneer has a rock-solid balance sheet and is able to generate free cash flows even during periods of very weak commodity prices.

Company Profile:

Headquartered in Irving, Texas, Pioneer Natural Resources is an independent oil and gas exploration and production company focusing on the Permian Basin in Texas. At year-end 2020, Pioneer’s proven reserves were 1.3 billion barrels of oil equivalent with net production for the year of 367 mboe per day. Oil and natural gas liquids represented 81% of production.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Global stocks Shares

Fresenius Position as Top Dialysis Service Provider does remain Symbolic and Unique

Business Strategy and Outlook

Fresenius Medical Care treats end-stage renal disease patients through its dialysis clinic network, medical technology, and care coordination activities. Its strengths in these related areas help Fresenius maintain the leading global position in this market. After pandemic conditions recede, it is likely for the company to benefit from solid demand in developed markets, such as the U.S., and even faster expansion in emerging markets, such as China, in the long run. With global ESRD patient growth expected to remain in the low to mid-single digits in the long run, top-line growth for Fresenius to be toward the top of that range after a very weak 2021 and even higher earnings growth compounded annually during the next five years, as the firm wrings out more efficiencies and repurchases shares. 

The company’s position as the top dialysis service provider and equipment maker in the world remains symbiotic and unique. Fresenius’ experience operating over 4,100 dialysis clinics around the globe (about 1,000 more than the next-largest player, DaVita) gives it insights into caregiver and patient needs to inform service offerings and product innovation. Fresenius uses clinical observations to develop and then manufacture even better technology to treat ESRD patients. It outfits all its clinics with its own brand of equipment and consumables, which has margin implications related to system costs and operating efficiency for staff. However, other dialysis clinics appreciate Fresenius’ technology as well, and Fresenius claims about 35% market share in dialysis equipment/consumables while serving only 9% of ESRD patients through its global clinics. Especially telling, main rival DaVita remains one of Fresenius’ top product customers. 

With growing clinical and payer support for at-home treatments, Fresenius is taking aim at those ESRD therapies with significant investments, too. It recently purchased NxStage Medical for home hemodialysis, which appears differentiated in the industry for its ease of use and physical size. The company also aims to improve on its peritoneal dialysis offering where Baxter has traditionally excelled.

Financial Strength

Fresenius maintains a manageable balance sheet, despite its high lease-related obligations and capital-allocation strategy that includes acquisitions and significant returns to stakeholders. The company receives investment-grade ratings from the three major U.S. rating agencies, which should help it access the debt markets for any necessary refinancing. As of September 2021, Fresenius owed EUR 9 billion in debt and had lease obligations around EUR 5 billion. On a net debt/EBITDA basis, leverage stood at roughly 3 times, which appears manageable and in line with the firm’s previous long-term goal of 2.5-3.0 times, which excluded lease obligations. After generating over EUR 3 billion of free cash flow in 2020 including government aid, free cash flow looks likely to decline to about EUR 1.5 billion before rising to about EUR 2.0 billion by 2026. It is not held the firm will face any significant refinancing risks during the next five years even as it continues to push cash out to stakeholders and pursue acquisitions. While acquisitions remain difficult to predict, the company pays a dividend to shareholders (EUR 0.4 billion in 2020) and makes distributions to noncontrolling interests (EUR 0.4 billion in 2020). It also repurchased EUR 0.4 billion in shares in 2020, and it is alleged more repurchases going forward. With those expected outflows to stakeholders and significant debt maturities coming due in the foreseeable future, it is supposed Fresenius may be an active debt issuer going forward.

 Bulls Say’s

  • Diversified by geography and business mix, Fresenius should be able to benefit from ongoing growth in treating ESRD patients worldwide once the pandemic recedes. 
  • Increasing at-home treatment rates could raise demand for the company’s at-home systems and boost how long patients can continue to work and stay on commercial insurance plans, which can positively affect the company’s profitability. 
  • Through its venture capital arm, Fresenius is investing in new ways to treat ESRD patients, aside from more traditional dialysis tools, which should help keep it at the forefront of this market.

Company Profile 

Fresenius Medical Care is the largest dialysis company in the world, treating about 345,000 patients from over 4,100 clinics across the globe as of September 2021. In addition to providing dialysis services, the firm is a leading supplier of dialysis products, including machines, dialyzers, and concentrates. Fresenius accounts for about 35% of the global dialysis products market and benefits from being the world’s only fully integrated dialysis business. Services account for roughly 80% of firmwide revenue, including care coordination and ancillary operations, while products account for the other roughly 20%. Products typically enjoy a higher margin, making them a strong contributor to the bottom line. 

(Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Commodities Trading Ideas & Charts

Iron Ore price rise more than offsets Rio Tinto’s modest production weakness

Business Strategy and Outlook:

Rio Tinto’s fourth-quarter production was overall mildly softer than expected. The company’s share of iron ore Pilbara shipments, the key earnings driver, finished the year at 268 million tons. Shipments were down on 2020’s 273 million tonnes with headwinds from weather, delayed expansions and traditional owner relationships post the Juukan Gorge disaster. COVID-19 also reduced labour availability. The destruction of the caves sees the major Pilbara iron ore miners facing additional scrutiny around traditional owner relationships. This has slowed output and growth somewhat but has not materially impacted the value of Rio Tinto shares, given the supportive iron ore price has more than made up for the lower volumes.

Aluminium, alumina, and bauxite production was marginally below our full-year expectations. Copper output in 2021 was about 3% lower than expected and down 7% on 2020 levels. Weaker grades and COVID-19 restrictions on labour hindered output. On guidance for 2022, the main change is an approximate 2% reduction in expectation for Pilbara shipments, which reflects continued headwinds from COVID and traditional owner issues. Shipments are expected to be of 277 million tonnes in 2022, up by 3%.

Financial Strength:

The fair value estimate of Rio Tinto has been increased to AUD 91 per share. The increase reflects higher the stronger iron ore futures curve and the softer AUD/USD exchange rate, partly offset by weaker production forecasts. The iron ore price is expected to average USD 110 per tonne to 2024, versus our prior USD 100 per tonne assumption. Shares have rallied about 25% in the past two months and are again overvalued. 

The dividend yield generated by the company is a whopping 6.3% during the duration of the 2019 ad 2020.

Company Profile:

Rio Tinto searches for and extracts a variety of minerals worldwide, with the heaviest concentrations in North America and Australia. Iron ore is the dominant commodity, with significantly lesser contributions from aluminium, copper, diamonds, gold, and industrial minerals. The 1995 merger of RTZ and CRA, via a dual-listed structure, created the present-day company. The two operate as a single business entity. Shareholders in each company have equivalent economic and voting rights.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Commodities Trading Ideas & Charts

Regional refiner Lytton of Ampol Ltd. margins recover at long last

Business Strategy and Outlook:

Ampol says the Lytton refinery is expected to deliver the highest quarterly replacement cost EBIT result in more than four years. Regional refiner margins rose well above the five-year historical average as supply and demand fundamentals improved. Lytton refinery production was also strong for the period at 1.6 billion litres.  And given the strong refiner margin environment, the company does not anticipate receiving any Fuel Security Service Payment, or FSSP, in the fourth quarter.

The midcycle Lytton refiner margin assumption remains USD 10 per barrel in real terms, around 10% below the fourth-quarter 2021 actual. Material synergies can be expected from an Ampol/Z Energy tie-up. The Z board recommended scheme remains subject to New Zealand regulatory approval and a subsequent Z shareholder vote on the Scheme, expected early this year. The takeover of Z Energy seems logical. The companies have very similar business models, but Z shares have fallen from NZD 8.65 peaks due to intense retail fuel competition in New Zealand and COVID-19 disruption. Ampol can fund the Z transaction within its target 2.0-2.5 net debt/EBITDA framework while maintaining a 50%-70% dividend payout ratio. It will also consider capital returns when net debt/EBITDA is less than 2.0. Ampol’s healthy franking balance and moderate debt has long had investors marking it a favourite for capital initiatives.

Financial Strength:

The fair value of Ampol Ltd. has increased to AUD 32 and it reflects a combination of time value of money, with an increase in expected near-term refiner margins.

Ampol’s healthy franking balance and moderate debt has long had investors marking it a favourite for capital initiatives. The fair value estimate equates to a 2025 EV/EBITDA of 5.5, P/E of 12.2, and dividend yield of 4.9%. A five-year group EBITDA CAGR of 15.5% to AUD 1.4 billion by 2025, the CAGR flattered by the COVID-impacted start year. A nominal midcycle retail fuels margin of AUD 2.03 per litre versus first half 2021’s AUD 1.85 actual, but broadly in line with the three-year historical average. These estimates don’t yet include the Z transaction, but Ampol is targeting double-digit EPS accretion and 20% plus free cash flow accretion in 2023 versus pre-acquisition levels.

Company Profile:

Ampol (nee Caltex) is the largest and only Australian-listed petroleum refiner and distributor, with operations in all states and territories. It was a major international brand of Chevron’s until that 50% owner sold out in 2015. Caltex transitioned to Ampol branding due to Chevron terminating its licence to use the Caltex brand in Australia. Ampol has operated for more than 100 years. It owns and operates a refinery at Lytton in Brisbane, but closed Sydney’s Kurnell refinery to focus on the more profitable distribution/retail segment. It currently has NZD 2.0 billion bid on the table for New Zealand peer Z Energy. 

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Technology Stocks

Adobe Remains Dominant in Creative While Building Its Second Empire in Digital Experience

Business Strategy and Outlook

Adobe has come to dominate in content creation software with its iconic Photoshop and Illustrator solutions, both now part of the broader Creative Cloud, which is now offered via a subscription model. The company has added new products and features to the suite through organic development and bolt-on acquisitions to drive the most comprehensive portfolio of tools used in print, digital, and video content creation The benefits from software as a service are well known in that it offers significantly improved revenue visibility and the elimination of piracy for the company, and a much lower cost hurdle to overcome ($1,000 or more up-front, versus plans as low as $10 per month) and a solution that is regularly updated with new features for users.

Adobe benefits from the natural cross-selling opportunity from Creative Cloud to the business and operational aspects of marketing and advertising. On the heels of the Magento and Marketo acquisitions in the second half of fiscal 2018 and Workfront in 2021, Morningstar analysts believe Adobe to continue to focus its M&A efforts on the digital experience segment and other emerging areas.

Adobe believes it is attacking an addressable market greater than $205 billion. The company is introducing and leveraging features across its various cloud offerings (like Sensei artificial intelligence) to drive a more cohesive experience, win new clients, upsell users to higher price point solutions, and cross sell digital media offerings.

Financial Strength 

Morningstar analysts believe Adobe enjoys a position of excellent financial strength arising from its strong balance sheet, growing revenues, and high and expanding margins. As of November 2021, Adobe has $5.8 billion in cash and equivalents, offset by $4.1 billion in debt, resulting in a net cash position of $1.6 billion. Adobe has historically generated strong operating margins. Free cash flow generation was $6.9 billion in fiscal 2021, representing a free cash flow margin of 43.7%. Morningstar analysts believe that margins should continue to grind higher over time as the digital experience segment scales. In terms of capital deployment, Adobe reinvests for growth, repurchases shares, and makes acquisitions. The company does not pay a dividend. Over the last three years Adobe has spent $2.8 billion on acquisitions, $9.6 billion on buy-backs, while share count has decreased by 15 million shares. It is believed that the company will continue to repurchase shares as its primary means of returning cash to shareholders over the medium term. Morningstar analysts also believe the company will continue to make opportunistic and strategic tuck-in acquisitions.

Bulls Say

  • Adobe is the de facto standard in content creation software and PDF file editing, categories the company created and still dominates. 
  • Shift to subscriptions eliminates piracy and makes revenue recurring, while removing the high up-front price for customers. Growth has accelerated and margins are expanding from the initial conversion inflection. 
  • Adobe is extending its empire in the creative world from content creation to marketing services more broadly through the expansion of its digital experience segment. This segment should drive growth in the coming years.

Company Profile

Adobe provides content creation, document management, and digital marketing and advertising software and services to creative professionals and marketers for creating, managing, delivering, measuring, optimizing and engaging with compelling content across multiple operating systems, devices and media. The company operates with three segments: digital media content creation, digital experience for marketing solutions, and publishing for legacy products (less than 5% of revenue).

 (Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Funds Funds

SBI Corporate Bond Fund Direct Growth: The fund which invest in high quality corporate bond and short duration mandate

Fund Objective

The investment objective of the scheme is to provide the investors an opportunity to predominantly invest in corporate bonds rated AA+ and above to generate additional spread on part of their debt investments from high quality corporate debt securities while maintaining moderate liquidity in the portfolio through investment in money market securities.

Approach

The fund’s strategy is to generate attractive returns through high-quality corporate bonds and short duration mandates. It employs a bottom-up approach combined with a top-down overlay to generate superior risk adjusted returns. The managers use various qualitative and quantitative parameters and put a lot of emphasis on a company’s management, business, and financial health. They also use the analysis of sell-side research and credit rating agencies to form a view on the creditworthiness of companies but to a limited extent. The credit committee then reviews the rated securities, and the approved securities are assigned credit and tenor limits. While constructing the portfolio, the managers have the flexibility to implement the trades with reasonable leeway to express their views. The risk-management team periodically reviews the portfolio to ensure the managers adhere to the guidelines. We believe the flow of ideas/information is effective and fits nicely with the process in place, supporting an Above Average Process rating.

Portfolio

The fund has a higher credit-quality portfolio, making it more liquid and less prone to credit risk. The fund maintains 100% of its assets in AAA rated bonds, despite having the flexibility to take some allocation in lower-rated instruments. The duration of the portfolio is well managed between one and three years. The fund also invests in government securities based on portfolio manager’s view on interest rates, but this does not account for more than 20% of its net assets. But high allocation is made to state development loans, given attractive spreads with regard to central government securities.

The portfolio of the fund is well diversified. The manager also intermittently holds higher cash/money market instruments to take opportunistic trading calls when markets are bumpy.The strategy, however, is not without risk. The fund may underperform its peers if the market favours high-yielding bonds. Also when interest rates are falling, the fund may struggle to outperform its category peers that invest in a portfolio with a little longer duration.

Performance

Under a short tenure of the fund’s existence (February 2019 to December 2021), the fund’s direct share class has posted an excellent annualised return of 8.36% as against the category average (7.14%). The portfolio manager’s research-intensive approach has helped the fund generate superior returns, placing the fund in the first quartile.

In terms of year-on-year returns, the fund’s performance has been inconsistent. The fund outperformed most category peers by a wide margin in 2019 and 2020. However, the 2021 performance got impacted because of the fund’s conservative approach with regard to its peers. On expectation of normalisation of interest rates by the RBI, the manager kept the duration below two years. This resulted in the fund ranking in the fourth quartile as against its category peers. However, the fund has the potential and could bounce back going ahead.

About the fund

The investment objective of the scheme is to provide the investors an opportunity to predominantly invest in corporate bonds rated AA+ and above to generate additional spread on part of their debt investments from high quality corporate debt securities while maintaining moderate liquidity in the portfolio through investment in money market securities.

The fund follows a disciplined and risk-conscious investment process that draws extensively from the in depth expertise of the investment team. The process is bottom-up with a focus on high-quality business models with a top-down overlay. The team’s understanding of the markets and frequent interaction with its equity team and parent company give it an edge in forming views on the business and creditworthiness of the companies. Furthermore, it has built some additional aspects into the approach. They now do an even more detailed analysis of the group and the promoter-linked entities in which they invest.

The execution of the process has been above average with limited credit risk and a short duration strategy. Despite having the flexibility to invest up to 80% of its portfolio in AAA and AA+ rated corporate bonds, the manager constructs the portfolio with a primary focus on liquidity, avoiding exposure to the below AAA rated segment, and keeping the duration between 1 and 3 years

 (Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Technology Stocks

Alibaba Falling Weak as Competition Rising

Business Strategy and Outlook

Alibaba BABA is a Big Data-centric conglomerate, with transaction data from its marketplaces and logistics businesses allowing it to move into omnichannel retail, cloud computing, media and entertainment, and online-to-offline services. It is believed a strong network effect allows leading e-commerce players to extend into other growth avenues, and nowhere is that more evident than with Alibaba. 

Alibaba’s Internet services had annual active consumers of 953 million as of September 2021, versus the 1.2 billion online population in September 2021 per Questmobile and the 1.4 billion population in China. This provides Alibaba with an unparalleled source of data that it can use to help merchants and consumer brands develop personalized mobile marketing and content strategies to expand their target audiences, increase click-through rates and physical store transactions, and bolster return on investment. Alibaba’s marketplace monetization rates have reduced recently, due to increased compliance of antitrust laws, more competition, and weak consumer sentiment. Monthly gross merchandise volume per annual active user was CNY 770 for the year ended March 2021 for Alibaba, higher than CNY 176 in 2020 for Pinduoduo and CNY 461 in 2020 for JD. 

While it is perceived the Taobao/Tmall marketplaces as Alibaba’s core cash flow drivers, it is also seen AliCloud and globalization offer long-term potential. While AliCloud will remain in investment mode in the medium term, accelerating revenue per user suggests a migration to value-added content delivery and database services that can drive segment margins higher over time. On globalization, third-party merchants are successfully reaching Lazada’s users across Southeast Asia, something that should continue as the company rolls out incremental personalized mobile marketing and content opportunities. 

Financial Strength

Alibaba is in sound financial health. As of December 2020, the company had CNY 456 billion in cash and unrestricted short-term investments on its balance sheet against CNY 117 billion in short- and long-term bank borrowing and unsecured senior notes. Although Alibaba remains in investment mode, it is held the strong cash flow profile of its e-commerce marketplaces offers it the financial flexibility to continue investing in technology infrastructure and cloud, research, marketing, and user experience initiatives through its current balance sheet and strong cash flow profile. Additionally, it is alleged the company has the capacity to add leverage to its capital structure, which could allow it to take advantage of low borrowing rates to fund growth initiatives, introduce a cash dividend when it sees limited investment opportunities with good returns on investment, or repurchase shares. It is likely for the company to pursue acquisitions that could further improve its ecosystem, including online-to-offline, physical retail, and increased logistic capacity or capabilities.

 Bulls Say’s

  • Monthly gross merchandise volume per annual active user was CNY 770 for the year ended March 2021 for Alibaba, higher than CNY 176 in 2020 for Pinduoduo and CNY 461 in 2020 for JD. 
  • Core annual active users on Alibaba’s China retail marketplaces had a retention rate of over 90% for the year ended September 2021. 
  • Alibaba’s core commerce (which includes China marketplace-based businesses and other loss-making businesses) adjusted EBITA margin was 26.2%, higher than JD retail’s 2.3% non-GAAP EBIT margin and PDD’s 15.2% non-GAAP EBIT margin for the September quarter of 2021.

Company Profile 

Alibaba is the world’s largest online and mobile commerce company as measured by gross merchandise volume (CNY 7.5 trillion for the fiscal year ended March 2021). It operates China’s online marketplaces, including Taobao (consumer-to-consumer) and Tmall (business-to-consumer). Alibaba’s China commerce retail division accounted for 63% of revenue in the September 2021 quarter. Additional revenue sources include China commerce wholesale (2%), international retail/wholesale marketplaces (5%/2%), cloud computing (10%), digital media and entertainment platforms (4%), Cainiao logistics services (5%), and innovation initiatives/other (1%). 

(Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Global stocks

Wynn’s Macao Gaming License to Be Renewed for 10 Years, Supporting Its Regulatory Intangible Asset

fintech icon on abstract financial technology background represent Blockchain and Fintech Investment Financial Internet Technology Concept.

Business Strategy and Outlook

COVID-19 continues to materially affect Wynn’s Macao operations (50% of estimated 2024 EBITDA), which we view as transitory. But the Macao government continues to heavily regulate VIP play, elevating long-term operational risk. Wynn has outsize exposure to the expected long-term shift away from VIP gaming revenue toward nongaming and mass play. Still, we see an attractive long-term growth opportunity in Macao, with Wynn’s high-end iconic brand positioned to participate.

Long term, we see solid visitation and gaming growth for Macao, aided over the next several years as key infrastructure projects to alleviate the region’s congested traffic (Pac On Terminal and Hong Kong Bridge opened in 2018, the light-rail transit at the end of 2019, reclaimed land, and development of Hengqin island) continue to come on line, which should expand constrained carrying capacity, thereby driving higher visitation and spending levels. Our forecast for annual mid-single-digit visitation growth over the next decade is supported by China outbound travel that we expect will average high-single-digit annual growth over the next 10 years. On Jan. 14, the Chinese government announced its intention to renew Wynn’s Macao gaming license (the source of the company’s narrow moat) for 10 years, which along with plans to develop further with its Crystal Pavilion project stands to benefit the company with regard to the region’s growth opportunity. Still, the Macao market is highly regulated, and as a result, the pace and timing of growth are at the discretion of the government. We expect upcoming developments that add attractions and improve Macao’s accessibility will improve the destination’s brand, supporting our constructive long-term view on Macao.

The Las Vegas region (50% of estimated 2024 EBITDA) doesn’t offer the long-term growth potential or regulatory barriers of Macao, so we do not believe it contributes to Wynn’s moat. Still, its Wynn Interactive sports betting and iGaming brand, Boston property Encore (opened June 2019), and Vegas project (convention centre plus room and golf renovations) are set to provide incremental growth.

Financial Strength

Wynn’s financial health is more stressed than that of peers Las Vegas Sands and MGM, but the company has taken steps to lift its liquidity profile, including suspending its dividend, cutting discretionary expenses, tapping credit facilities, and issuing debt. As a result, the company has enough liquidity to operate at near-zero revenue through 2022. Should the pandemic’s impact last longer, we expect the company’s banking partners will continue to work with Wynn, given its intact regulatory intangible advantage (the source of its narrow moat), which drives cash flow generation potential. This view is supported by narrow-moat Wynn Macau surviving through 2014-15 when its debt/EBITDA temporarily rose to around 8 times, above the 4.5-5.0 covenants in those years. Finally, we believe the Chinese government could aid Macao operators if necessary, given that the nation wants the region to become a world destination resort. Wynn entered 2020 with debt/adjusted EBITDA of 5.7 times, but the metric turned negative in 2020 and was elevated in 2021 (estimated at 15.4), as demand for leisure and travel collapsed during the this period due to the COVID-19 outbreak. As demand recovers in the next few years, we expect leverage to reach 9.9 times, 7.7 times, and 6.5 times in 2022, 2023, and 2024, respectively.

Bulls Say’s

  • Wynn is positioned to participate in the long-term growth of Macao (76% of pre-pandemic 2019 EBITDA) and has room share of 9% with the opening of its Cotai Palace property in 2016.The ability to continuously innovate and commercialize new technologies should enable Aptiv to generate excess returns over its cost of capital.
  • Wynn has a narrow economic moat, thanks to possessing one of only six licenses awarded to operate casinos in China.
  • A focus on the high-end luxury segment of the casino industry allows the company to generate high levels of revenue and EBITDA per gaming position in the industry

Company Profile 

Wynn Resorts operates luxury casinos and resorts. The company was founded in 2002 by Steve Wynn, the former CEO. The company operates four megaresorts: Wynn Macau and Encore in Macao and Wynn Las Vegas and Encore in Las Vegas. Cotai Palace opened in August 2016 in Macao, Encore Boston Harbour in Massachusetts opened June 2019. Additionally, we expect the company to begin construction on a new building next to its existing Macao Palace resort in 2022, which we forecast to open in 2025. The company also operates Wynn Interactive, a digital sports betting and iGaming platform. The company received 76% and 24% of its 2019 pre-pandemic EBITDA from Macao and Las Vegas, respectively

(Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.