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Crown Draws Blood From a Blackstone

Business Strategy and Outlook

Morningstar analyst expect Crown Resorts to deliver strong earnings growth over the next decade, buoyed by the recovery from current coronavirus-induced lows as restrictions ease, the opening of Crown Sydney during calendar 2022 and continued solid performance from the core assets in Melbourne and Perth. Crown Melbourne and Crown Perth underpin the firm’s narrow economic moat. Crown is the sole operator in both jurisdictions, with long-dated licences. These properties have performed strongly, thanks to Crown’s solid track record of reinvestment, resulting in consistently high property quality, stable visitor growth, and earnings resilience. The quality of these assets, particularly Crown Melbourne, has driven strong growth in VIP gaming.

Indeed, the strong performance of Crown Melbourne helped the firm secure the second licence in Sydney to compete with The Star. As per Morningstar analyst view, the New South Wales government only issued the second licence because The Star’s performance significantly lagged Crown Melbourne in both revenue and EBITDA, depriving the state of taxation revenue. The Star Sydney’s EBITDA is roughly 60% of Crown Melbourne’s, despite Sydney being Australia’s largest city and the international gateway into Australia.

Morningstar analyst estimate Crown Sydney will not only take share from incumbent rival The Star, but will also grow the size of local casino gaming market–particularly in VIP. Morningstar analyst estimate VIP gaming will be a negligible share of revenue in fiscal 2022 amid border closures. However, it is expected that the segment to recover as border restrictions ease and tourism recovers. But VIP gaming can be highly volatile, ranging from over 30% of revenue in fiscal 2015 to 17% in fiscal 2017. Morningstar analysts estimate VIP gaming represents less than 20% of revenue at Crown Melbourne, less than 10% of revenue at Crown Perth, and will constitute more than half Crown Sydney’s sales-albeit at a lower margin than table gaming.

Crown Draws Blood From a Blackstone

Morningstar analyst have raised its fair value estimate for narrow-moat Crown by 8% to AUD 12.20 per share after directors supported an increased bid from narrow moat asset manager Blackstone. New York-based Blackstone, already Crown’s second largest shareholder with a stake of 10%, has been pursuing the beleaguered casino since March 2021 with prior bids unable to pique the interest of the Crown board. 

Crown had formally rejected Blackstone’s previous bid of AUD 12.35 and  the 1% improvement to AUD 12.50 would be unlikely to move the needle-particularly given regulatory uncertainty had eased with the Victorian Royal Commission stopping short of cancelling Crown Melbourne’s licence, instead providing Crown a roadmap to redemption. The AUD 13.10 offer is more compelling, representing a 16% premium to our standalone fair value estimate and a 32% premium to the undisturbed price on Nov. 18, 2021. Crown’s board flagged its unanimous intention to recommend shareholders vote in favour of the proposal, should a formal bid eventuate.

The increased offer is nonbinding and remains conditional on completion of due diligence, support from shareholders, unanimous approval from the board, final approval from Blackstone’s investment committees, and approvals from state gaming regulators. While Blackstone is prepared to proceed while Crown’s various regulatory investigations and consultations remain underway, negative outcomes arising in the meantime (such as the loss or suspension of a casino licence) could thwart the bid.

For the transaction to proceed, support from 37% shareholder Consolidated Press Holdings, or CPH, will be crucial. Via CPH, former executive chair James Packer’s major shareholding remains a headache for regulators. But the Blackstone deal could be seen as taking risk off the table for regulators, given the scrutiny on the relationship between Crown and CPH/James Packer since the commencement of the Bergin casino inquiry. Indeed, the Victorian commissioner’s report has since recommended CPH have until September 2024 to sell down its holding to less than 5%. 

Financial Strength

Despite near-term earnings weakness, Crown’s balance sheet remains robust. Debt levels have increased with the construction of the Crown Sydney casino and forced venue closures due to COVID-19. Crown’s net debt/EBITDA peaked at 3.7 in fiscal 2021, from 1.8 as at the end of June 2020, but still below the precarious 5.0 level (the covenant limit on Crown’s subordinated notes). We expect significant deleverage in fiscal 2022, aided by around AUD 450 million in further apartment sales from the Crown Sydney project and earnings recovery. We forecast fiscal 2022 net debt/EBITDA to fall to 0.5, and with an improved balance sheet, expect the firm to reinstate dividends from the second half of fiscal 2022 at around 75% of underlying earnings

Bulls Says

  • Long-dated licences to operate the only casino in Melbourne and Perth allow Crown to enjoy positive economic profitability in a regulated environment. 
  • Crown Sydney provides a long-term growth opportunity to capture share and expand gaming in Australia’s most populous market. 
  • Crown is well positioned to benefit from the emerging middle and upper class in China.

Company Profile

Crown Resorts is Australia’s largest hotel-casino company. Its flagship property is Crown Melbourne, an integrated complex with more than 2,600 electronic game machines, or EGMs, 540 tables, and three hotels. Crown also operates Crown Perth, a property with more than 2,500 EGMs, 350 tables, and three hotels. Crown has also obtained a licence to operate Sydney’s second casino, Crown Sydney, centred on the VIP and premium gaming market. The company also operates Aspinall’s, a boutique, premium-focussed casino in London.

(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

Although Las Vegas Remains the Core Presence, MGM’s Macao Assets Should Benefit From a 2022 Recovery

Business Strategy and Outlook

No-moat MGM Resorts is facing material near-term headwinds from COVID-19 as well as elevated operational risk in Macao from government plans to increase supervision of casinos. Still, we think MGM has a healthy liquidity profile to see it through this turmoil and remains positioned for the attractive long-term growth opportunities in Macao (22% of pre-pandemic 2019 EBITDAR), U.S. sports betting, and Japan (accounting for an estimated 10% of 2027 EBITDAR, the first year of likely operation). 

We see solid Macao industry visitation over the next 10 years, as key infrastructure projects that alleviate Macao’s congested traffic (Pac on terminal expansion and Hong Kong Bridge in 2018, light-rail transit at the end of 2019, and reclaimed land in 2020-25) come on line, which will expand the region’s constrained carrying capacity and add attractions, thereby driving higher visitation and spending levels. As MGM holds one of only six gaming licenses, it stands to benefit from this growth. Further, MGM Resorts has expanded its room share in Macao to 8% from 3% with its Cotai property, which opened in February 2018. That said, the Macao market is highly regulated, and as a result, the pace and timing of growth are at the discretion of the government.

In the U.S. (78% of pre-pandemic 2019 EBITDA), MGM’s casinos are positioned to benefit from a multi-billion-dollar sports betting market, generating an estimated mid-single-digit percentage of the company’s 2024 sales. That said, the U.S. doesn’t offer the long-term growth potential or regulatory barriers of Macao; thus, we do not believe the region contributes a moat to MGM. Still, there have been very minimal industry supply additions this decade, and this should support solid industry Strip occupancy, which stood at around 90% in pre-pandemic 2019.

We expect MGM to be awarded one of only two urban gaming licenses in Japan, with a resort opening in 2027, generating attractive returns on invested capital in the teens.

Financial Strength

MGM entered 2020 in its strongest financial health of the past 10 years, in our view. This was illustrated by its 3.7 times debt/adjusted EBITDA in 2019 versus 13 times and 5.7 times in 2010 and 2015, respectively. It was also buoyed by MGM having recently exited an investment cycle, where the company spent $1.6 billion on average annually during 2015-19 to construct and renovate U.S. and Macao resorts versus the $271 million it spent on capital expenditure in 2020. We believe MGM has sufficient liquidity to remain a going concern even with zero revenue for a few years. The recent sales of underlying casino assets (Bellagio in November 2019, Circus Circus in December 2019, and MGM Grand/Mandalay Bay in February 2020) provided it with around $6.9 billion in cash. The company recently entered into leaseback asset sales of Aria, Vdara, and Springfield, raising over $4 billion in cash in 2021. Also, MGM is set to receive $4.4 billion in cash for its ownership in MGM Growth Properties, which is scheduled to be acquired by Vici in the first half of 2022. The firm has taken further action to lift its liquidity profile by reining in expenses, tapping its $1.5 billion credit facility (which has since been paid), suspending dividends and repurchases (which have since been reinstated), and raising debt. MGM has $1 billion of debt scheduled to mature in 2022.

Bulls Say’s

  • We expect MGM to be awarded one of only two urban Japanese gaming concessions due to its strong experience operating leading resorts in Las Vegas and its successful record of working with partners 
  • MGM is positioned to participate in Macao’s long-term growth opportunity (22% of pre-pandemic 2019 EBITDAR) and has seen its room share expand (to 8% from 3%) with the opening of its Cotai casino in February 2018.
  • MGM’s U.S. properties are positioned to benefit from the expansion of the multi-billion-dollar domestic sports betting market

Company Profile 

MGM Resorts is the largest resort operator on the Las Vegas Strip with 35,000 guest rooms and suites, representing about one fourth of all units in the market. The company’s Vegas properties include MGM Grand, Mandalay Bay, Mirage, Luxor, New York-New York, and CityCenter. The Strip contributed approximately 49% of total EBITDAR in the pre-pandemic year of 2019. MGM also owns U.S. regional assets, which represented 29% of 2019 EBITDAR. We estimate MGM’s U.S. sports and iGaming operations will be a mid-single-digit percentage of its total revenue by 2024. The company also operates the 56%-owned MGM Macau casinos with a new property that opened on the Cotai Strip in early 2018. Further, we estimate MGM will open a resort in Japan in 2027.

(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

PRICING AND SHRINKING TO STABALIZE AT  BED BATH AND BEYOND INC

Business Strategy and Outlook

In October 2020, Bed Bath & Beyond put forth an updated strategy to revitalize its brand and regain customer confidence by focusing on its core properties. As such, the company divested peripheral brands such as Cost Plus and Linen Holdings in order to focus on the Bed Bath & Beyond, Buy Buy Baby, Harmon Face Value, and Decorist labels. To help elevate its brand perception, it has combined its online and in-store inventory management with its new “omni-always” initiative in the hopes of capturing more e-commerce business and avoiding the long restock times and uneven inventories that previously plagued the firm. Additionally, it’s investing heavily in both its digital and brick-and-mortar platforms, with a revamp to the website for a more frictionless checkout process and a remodel of its physical stores to offer a cleaner and more enjoyable shopping experience. The firm has attempted to rely less on its iconic blue coupons by giving consumers a good everyday value (it is concluded discounts will persist to some degree over the long term). It also plans to right size by shuttering underperforming Bed Bath stores, shrinking the total store base to around 1,000 by the end of 2021 (from 1,500 at the end of 2019). In contrast, management expects 50% sales growth at the baby label by 2023 via new markets, with the brand already set to deliver $1.3 billion in sales in 2021. It is seen total sales declining in 2021 as the footprint continues to contract before stabilizing at a low-single-digit growth rate in 2023.

Longer term, it is conjectured the 2030 operating margin to reach 5%-6%. This improvement is primarily supported by gross margin gains (which reach 37.7%, below the 38%-plus corporate goal) from a greater focus on private label, including the introduction of 10 new owned brands. It also benefits from a lower promotional cadence thanks to SKU rationalization and the utilization of more robust inventory management processes. However, it is foreseen these gains to be offset by higher investment as the home furnishing landscape remains highly fragmented and competitive, limiting profitability to levels that are structurally lower than in the past.

Financial Strength

Bed Bath & Beyond’s cash position is solid and efforts to reduce the firm’s debt load resulted in a positive net cash position at fiscal year-end 2020. Before the firm’s $1.5 billion debt raise in 2014, it had been debt-free since 1996 (excluding acquired debt), using cash generated from operations to fund new store openings and a handful of small bolt-on acquisitions. The firm has access to liquidity through its $1 billion credit facility, which expires in 2026 and captured another $600 million-plus in cash through the sale of Personalizationmall.com, Linen Holdings, Christmas Tree Shops, One Kings Lane, and Cost-Plus World Market brands. It reduced gross debt in 2020 (with long-term debt at $1.2 billion at November 2021 versus $1.5 billion at the end of fiscal 2019) and plans to continue paying down its debt, aiming to reach a gross debt ratio of 3 times by 2023. There is ample cash on hand (roughly $509 million as of Nov. 27, 2021) to cover near-term expenses like operating lease obligations.

Over the past five reported fiscal years, the firm has produced cumulative free cash flow (cash from operations minus capital expenditures) of $2.1 billion. However, it is anticipated this level to be tempered over 2021-23 as Bed Bath spends around $375 million annually to improve new stores, existing stores, its supply chain, and technology in this time frame. Free cash flow to equity has averaged about 4% of revenue during the past five reported years, which is decent for a mature company that is still spending to remain competitive, but it is likely this level to decline as secular headwinds weigh on performance and necessary investment levels pick up. Despite the higher spending ahead, Bed Bath has a plan to complete its share $1 billion in shares buy back by the end of fiscal 2021.

Bulls Say’s

  • Less discretionary categories such as linens, towels, and cookware offer some resiliency amid macroeconomic cyclicality. Registries across bridal, baby, and gift have historically provided a steady stream of customers.
  • The closure of numerous underperforming stores by the end of 2021 could help lift the profitability of the business faster than it can be anticipated as better performing stores make up a greater proportion of the fleet.
  • With a push into expanding the representation of owned brands (already accounting for 20% of sales), gross margin metrics could expand faster than it can get forecast.

Company Profile 

Bed Bath & Beyond is a home furnishings retailer, operating just under 1,000 stores in all 50 states, Puerto Rico, Canada, and Mexico. Stores carry an assortment of branded bed and bath accessories, kitchen textiles, and cooking supplies. In addition to 809 Bed Bath & Beyond stores, the company operates 133 Buy Buy Baby stores and 53 Harmon Face Values stores (health/beauty care). In an effort to refocus on its core businesses, the firm has divested the online retailer Personalizationmall.com, One Kings Lane, Christmas Tree Shops and That (gifts/housewares), Linen Holdings, and Cost-Plus World Market.

(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 Shares

PRICING AND SHRINKING TO STABALIZE AT  BED BATH AND BEYOND INC

Business Strategy and Outlook

In October 2020, Bed Bath & Beyond put forth an updated strategy to revitalize its brand and regain customer confidence by focusing on its core properties. As such, the company divested peripheral brands such as Cost Plus and Linen Holdings in order to focus on the Bed Bath & Beyond, Buy Buy Baby, Harmon Face Value, and Decorist labels. To help elevate its brand perception, it has combined its online and in-store inventory management with its new “omni-always” initiative in the hopes of capturing more e-commerce business and avoiding the long restock times and uneven inventories that previously plagued the firm. Additionally, it’s investing heavily in both its digital and brick-and-mortar platforms, with a revamp to the website for a more frictionless checkout process and a remodel of its physical stores to offer a cleaner and more enjoyable shopping experience. The firm has attempted to rely less on its iconic blue coupons by giving consumers a good everyday value (it is concluded discounts will persist to some degree over the long term). It also plans to right size by shuttering underperforming Bed Bath stores, shrinking the total store base to around 1,000 by the end of 2021 (from 1,500 at the end of 2019). In contrast, management expects 50% sales growth at the baby label by 2023 via new markets, with the brand already set to deliver $1.3 billion in sales in 2021. It is seen total sales declining in 2021 as the footprint continues to contract before stabilizing at a low-single-digit growth rate in 2023.

Longer term, it is conjectured the 2030 operating margin to reach 5%-6%. This improvement is primarily supported by gross margin gains (which reach 37.7%, below the 38%-plus corporate goal) from a greater focus on private label, including the introduction of 10 new owned brands. It also benefits from a lower promotional cadence thanks to SKU rationalization and the utilization of more robust inventory management processes. However, it is foreseen these gains to be offset by higher investment as the home furnishing landscape remains highly fragmented and competitive, limiting profitability to levels that are structurally lower than in the past.

Financial Strength

Bed Bath & Beyond’s cash position is solid and efforts to reduce the firm’s debt load resulted in a positive net cash position at fiscal year-end 2020. Before the firm’s $1.5 billion debt raise in 2014, it had been debt-free since 1996 (excluding acquired debt), using cash generated from operations to fund new store openings and a handful of small bolt-on acquisitions. The firm has access to liquidity through its $1 billion credit facility, which expires in 2026 and captured another $600 million-plus in cash through the sale of Personalizationmall.com, Linen Holdings, Christmas Tree Shops, One Kings Lane, and Cost-Plus World Market brands. It reduced gross debt in 2020 (with long-term debt at $1.2 billion at November 2021 versus $1.5 billion at the end of fiscal 2019) and plans to continue paying down its debt, aiming to reach a gross debt ratio of 3 times by 2023. There is ample cash on hand (roughly $509 million as of Nov. 27, 2021) to cover near-term expenses like operating lease obligations.

Over the past five reported fiscal years, the firm has produced cumulative free cash flow (cash from operations minus capital expenditures) of $2.1 billion. However, it is anticipated this level to be tempered over 2021-23 as Bed Bath spends around $375 million annually to improve new stores, existing stores, its supply chain, and technology in this time frame. Free cash flow to equity has averaged about 4% of revenue during the past five reported years, which is decent for a mature company that is still spending to remain competitive, but it is likely this level to decline as secular headwinds weigh on performance and necessary investment levels pick up. Despite the higher spending ahead, Bed Bath has a plan to complete its share $1 billion in shares buy back by the end of fiscal 2021.

Bulls Say’s

  • Less discretionary categories such as linens, towels, and cookware offer some resiliency amid macroeconomic cyclicality. Registries across bridal, baby, and gift have historically provided a steady stream of customers.
  • The closure of numerous underperforming stores by the end of 2021 could help lift the profitability of the business faster than it can be anticipated as better performing stores make up a greater proportion of the fleet.
  • With a push into expanding the representation of owned brands (already accounting for 20% of sales), gross margin metrics could expand faster than it can get forecast.

Company Profile 

Bed Bath & Beyond is a home furnishings retailer, operating just under 1,000 stores in all 50 states, Puerto Rico, Canada, and Mexico. Stores carry an assortment of branded bed and bath accessories, kitchen textiles, and cooking supplies. In addition to 809 Bed Bath & Beyond stores, the company operates 133 Buy Buy Baby stores and 53 Harmon Face Values stores (health/beauty care). In an effort to refocus on its core businesses, the firm has divested the online retailer Personalizationmall.com, One Kings Lane, Christmas Tree Shops and That (gifts/housewares), Linen Holdings, and Cost-Plus World Market.

(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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Shares Small Cap

Amidst Canadian Cannabis competition, Tilray seen to surpass

Business Strategy and Outlook

Tilray cultivates and sells cannabis in Canada and exports into the global medical market. It also sells CBD products in the U.S. The company is the result of legacy Aphria acquiring legacy Tilray in a reverse merger and renaming itself Tilray in 2021.

Canada legalized recreational cannabis in October 2018. Since then, recreational sales have come to represent an increasingly larger portion of sales for producers. Historically, legacy Aphria focused initially on flower and vape before expanding into edibles. In contrast, legacy Tilray focused on an asset-light, consumer-focused business model. Although the two strategies complement each other well, Tilray faces stiff competition to develop consumer brands that can lead to meaningful pricing power. 

Legacy Aphria had an extensive international distribution business, which generated the majority of its net revenue, a far larger portion than many of its Canadian cannabis peers. Legacy Tilray had also entered the global medical market. With both companies’ international capabilities intact, Tilray looks well positioned. The global market looks lucrative given higher realized prices and growing acceptance of the medical benefits of cannabis. Exporters must pass strict regulations to enter markets, which protects early entrants. It is forecasted roughly 15% average annual growth through 2030 for the global medicinal market excluding Canada and the U.S. 

In 2020, legacy Aphria acquired SweetWater, a U.S. craft brewery. Legacy Tilray previously acquired Manitoba Harvest to distribute CBD products in the U.S. It finally secured a toehold into U.S. THC when it acquired some of MedMen’s outstanding convertible notes. Upon U.S. federal legalization, Tilray would own 21% of the U.S. multistate operator. Furthermore, Tilray paid a great price while also getting downside protection as a debtholder. 

It is contemplated the U.S. offers the fastest growth of any market globally. However, the regulatory environment is murky with individual states legalizing cannabis while it remains illegal federally. It is supposed federal law will eventually be changed to allow states to choose the legality of cannabis within their borders.

Financial Strength

At the end of its second fiscal quarter 2022, Tilray had about $747 million in total debt, excluding lease liabilities. This compares to market capitalization of about $3 billion.  In addition, Tilray had about $332 million in cash, which will allow it to fund future operations and investments. Management has been deliberate with its SG&A spending given the slow rollouts and regulatory challenges the Canadian market has faced. Legacy Aphria was the first major Canadian producer to reach positive EBITDA, with legacy Tilray reaching positive EBITDA in the quarter immediately preceding its acquisition. However, the combined company continues to generate negative free cash flow to the firm, which pressures its financial health. With most of its development costs completed, it is alleged Tilray will have moderate capital needs in the coming years. As such, it is implied debt/adjusted EBITDA to decline. It is reflected Tilray is unlikely to require significant raises of outside capital. In September 2021, the company received shareholder approval for increasing its authorized shares in order to rely on equity for future acquisitions. This bodes well for keeping its financial health strong.

Bulls Say’s

  • Legacy Aphria’s acquisition of Legacy Tilray created a giant with leading Canadian market share, expanded international capabilities, and U.S. CBD and beer operations. 
  • Tilray’s management focuses on strategic SG&A spending and running a lean business model, benefiting its financial health in the early growth stage industry. 
  • Tilray management’s careful approach to expansion has allowed it to reach profitability faster than any of its Canadian peers.

Company Profile 

Tilray is a Canadian producer that cultivates and sells medical and recreational cannabis. In 2021, legacy Aphria acquired legacy Tilray in a reverse merger and renamed itself Tilray. The bulk of its sales are in Canada and in the international medical cannabis export market. U.S. exposure consists of CBD products through Manitoba Harvest and beer through SweetWater.

(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

BNY Mellon Global Stock Fund: A solid strategy led by an impressive, long-tenured team

Process:

The Walter Scott investment team executes a patient investment process, undertaking rigorous fundamental research to identify quality names that can deliver superior long-term returns. It earns an Above Average Process rating. The process starts with an initial screen of businesses that can deliver at least 20% cash flow return on investment over a full market cycle. The managers have an active watchlist of approximately 250 companies they closely monitor, and the team undertakes fundamental bottom-up analysis, assessing factors such as competitive position, industry dynamics, profitability, balance-sheet strength, financial model, and quality of management. 

Portfolio:

The team constructs a relatively concentrated portfolio that usually has 40-60 names. Adequate diversification is maintained by limiting position sizes to a maximum of 5 percentage points, but typically they don’t exceed 4% of the portfolio. The group’s long-term quality focus results in the strategy exhibiting a bias toward mega-cap stocks, though it does hold some mid-cap names. Historically, the strategy has exhibited significant country-level bets. It is typically underweighted in the United States relative to the MSCI World Index. At the sector level, the strategy favours tech, healthcare, and consumer cyclical stocks, while having a large underweighting in financial services.

People:

An experienced, stable team that works together well leads to a High People rating. Investment decision-making at subadvisor Walter Scott is team-based. All investments, new and existing, are discussed and debated until there is unanimous agreement by the research team. Stability and experience characterize Walter Scott’s investment team, with members boasting impressive experience and tenures with the firm. More than half of the investment team members have spent their entire investment careers at the company. In 2021, one of the joint portfolio managers, Yuanli Chen, left, a rare departure. Long-term cohead of research Alan Edington moved to a new position, Responsible Investment.

Performance:

The strategy has sported strong results from its late-December 2006 launch through 2021. The I shares’ 9.4% annualized gain exceeded its MSCI World Index prospectus benchmark’s 7.4% and edged the typical world large-stock growth peer. However, it’s lost a bit of an edge against a more growth-oriented benchmark, with the MSCI World Growth Index up 10% annualized during the period.

(Source: Morningstar)

Price:

Analysts find it difficult to analyse expenses since it comes directly from the returns. Analysts expect that it would be able to deliver positive alpha relative to its category benchmark index.


(Source: Morningstar)                                                                     (Source: Morningstar)

About Funds:

With a focus on investing for the long term, the portfolio consistently favors technology, healthcare, and consumer discretionary names while being significantly underweight in financial services and energy. The strategy won’t always lead the way in buoyant markets. It landed behind the MSCI World Index benchmark in 2021. The investment seeks long-term total return. To pursue its goal, the fund normally invests at least 80% of its net assets, plus any borrowings for investment purposes, in stocks. The fund’s investments will be focused on companies located in the developed markets. Examples of “developed markets” are the United States, Canada, Japan, Australia, Hong Kong and Western Europe. It may invest in the securities of companies of any market capitalization. The fund’s sub-investment adviser, Walter Scott & Partners Limited (Walter Scott), seeks investment opportunities in companies with fundamental strengths that indicate the potential for sustainable growth.

(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 Shares

Dollar Tree’s Price Hike Should Help, but Long-Term Competition Remains a Concern

Business Strategy and Outlook:

Dollar Tree’s namesake banner has a long history of strong performance, enabled by its differentiated value proposition, but, before the pandemic, its Family Dollar unit (acquired in 2015) struggled to generate top-line and margin growth. Dollar Tree banner is better positioned long-term, but do not believe the aggregated firm benefits from a durable competitive edge, as competitive pressure in a fast-changing retail environment amid minimal switching costs limits results.

Accounting for around half of sales, the Dollar Tree banner’s wide assortment of products at $1.25 or less has appealed to customers, drawing a broad range of low to middle-income consumers. We believe the concept has room to grow (with square footage rising by a low- to mid-single-digit percentage long term), expanding in new markets while also increasing density. The chain’s fast-changing assortment creates a treasure hunt experience that has a history of drawing customers (posting nearly 3% same-store sales growth on average over the past five years) and has been hard for online retailers to match.

Financial Strength:

Though it took on considerable debt to fund its 2015 purchase of Family Dollar, Dollar Tree’s leverage-reduction efforts have left it on sound financial footing. Its strong balance sheet and free cash flow generation should suffice to fund growth and investments necessary to maintain low price points and respond to competitive pressure. The firm ended fiscal 2020 with net debt at less than three-quarters adjusted EBITDA, the latter of which covered interest expense more than 17 times. Furthermore, capital expenditures to fuel store growth are fairly discretionary, so Dollar Tree should be able to curb targets if needed in the event of financial strain.

Bulls Say:

  • Dollar Tree’s $1.25 price point concept is differentiated, holding absolute dollar costs low for customers while allowing the retailer to realize higher margins than conventional retailers. 
  • Small ticket sizes make it difficult for online retailers to contend with Dollar Tree’s single-price-point model as shipping costs weigh on their ability to compete profitably. 
  • As its two banners become more closely integrated and the store network expands, Dollar Tree should leverage its supply chain and distribution infrastructure investments, generating resources to fuel its low-price model.

Company Profile:

Dollar Tree operates discount stores in the U.S. and Canada, including over 7,800 shops under both its namesake and Family Dollar units (nearly 15,700 in total). The eponymous chain features branded and private-label goods, generally at a $1.25 price. Nearly 50% of Dollar Tree stores’ fiscal 2020 sales came from consumables (including food, health and beauty, and household paper and cleaning products), just over 45% from variety items (including toys and housewares), and 5% from seasonal goods. Family Dollar features branded and private-label goods at prices generally ranging from $1 to $10, with over 76% of fiscal 2020 sales from consumables, 9% from seasonal/electronic items (including prepaid phones and toys), 9% from home products, and 6% from apparel and accessories.

(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 Shares

Nike’s Powerful Brand and E-Commerce Position It Well Despite Some Short-Term Issues

Business Strategy and Outlook

We view Nike as the leader of the athletic apparel market and believe it will overcome the challenge of COVID-19 despite near-term supply issues. Morningstar analyst think Nike’s strategies allow it to maintain its leadership position. In mid-2017, Nike announced a consumer-focused realignment. It is investing in its direct-to-consumer network while reducing the number of retail partners that carry its product. In North America and elsewhere, the firm is reducing its exposure to undifferentiated retailers while increasing distribution through a small number of retailers that bring the Nike brand closer to consumers, carry a full range of products, and allow it to control the brand message. Nike’s consumer plan is led by its Triple Double strategy to double innovation, speed, and direct connections to consumers. Triple Double includes cutting product creation times in half, increasing membership in Nike’s mobile apps, and improving the selection of key franchises while reducing its styles by 25%. We think these strategies will allow Nike to hold share and pricing.

Although its recent results in China have been inconsistent due to supply issues and a political controversy, Morningstar analyst still believe Nike has a great opportunity for growth there and in other emerging markets. Moreover, with worldwide distribution and huge e-commerce that totaled about $9.3 billion in fiscal 2021, Nike should benefit as more people in China, Latin America, and other developing regions move into the middle class and gain broadband access.

Financial Strength

 Nike is in excellent financial shape to weather the COVID-19 crisis. At the end of fiscal 2021’s second quarter, Nike had $9.4 billion in long-term debt but $15.1 billion in cash and short-term investments.Nike does not have any long-term debt maturities until May 1, 2023, when its $500 million in 2.25% senior unsecured debt matures, but it does have significant endorsement commitments that, as of the end of fiscal 2021, totaled at least $5.5 billion over the ensuing five fiscal years. The firm produced nearly $19 billion in free cash flow to equity over the past five years, and Morningstar anlayst estimate it will generate more than $38 billion in free cash flow to equity over the next five. Nike issued $1.6 billion in dividends in fiscal 2021 and analyst forecast an average annual dividend payout ratio of about 30% over the next decade. Over the next five fiscal years, Morningstar analyst forecast that Nike will repurchase about $19 billion in stock and issue $11 billion in dividends. 

Bull Says

  • Nike has a great opportunity in fast-growing markets like China. More than 70% of Nike’s growth over the next five years may come from outside North America. 
  • Nike’s Triple Double strategy of increased innovation, direct-to-consumer sales, and speed may improve margins and share. Membership growth in its digital channel has exceeded expectations. 
  • Nike’s gross margins may expand by a couple dozen basis points per year through automation, ecommerce, and higher prices. Nike is actively shifting sales to differentiated retail in North America to increase full-priced sales

Company Profile

Nike is the largest athletic footwear and apparel brand in the world. It designs, develops, and markets athletic apparel, footwear, equipment, and accessories in six major categories: running, basketball, soccer, training, sportswear, and Jordan. Footwear generates about two thirds of its sales. Nike’s brands include Nike, Jordan, and Converse (casual footwear). Nike sells products worldwide and outsources its production to more than 300 factories in more than 30 countries. Nike was founded in 1964 and is based in Beaverton, Oregon

 (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
Fixed Income Fixed Income

TCW Emerging Markets Local Currency Income Fund Class

Approach

A combination of flexibility and caution, as well as a thoughtful approach to country and currency analysis, continue to support a High Process Pillar rating. This strategy’s approach combines fundamental analysis and top-down research with an aim to manage downside risk. Analysts are responsible for setting three-, six-, and 12-month targets for local rates positions, and the team actively trades around currency positions. There is evaluation of interest rates and currencies on a country-by-country basis, and its higher-conviction positions aren’t usually more than a few percentage points off the JPMorgan GBI-Emerging Markets Global Diversified Index’s, a sensible guardrail given the exchange-rate volatility inherent here. 

In addition, it isn’t typically, complete avoid an index constituent, either taking a small position in that country’s rates or currency, which makes sense given the small number of names (roughly 20) in the sovereign bond benchmark. The strategy also allows up to 20% in U.S.-dollar-denominated debt and cash. Still, the process allows plenty of room to manoeuvre. When it’s found that emerging-markets currencies are extremely undervalued, it can take that exposure up to 125%, and when they are expensive it can hedge it to 75%. The portfolio is further diversified by off-index plays, which have included frontier markets (Egypt) and developed markets (Greece). 

Portfolio

The process allows for ample movement in the strategy’s overall emerging-markets currency exposure, which has been dialled up and down in a tactical fashion based on valuations and its market outlook. The portfolio’s overall emerging-markets currency exposure was light (around 75% of assets) following 2012’s big market runup, which served the strategy well when things got tough in 2013. The managers brought that exposure up to the 90% range at the end of the sell-off in 2015 and then let it run in the 110%-120% range as it rallied in 2016 and 2017. Since the pandemic-riled markets in February 2020, the team has kept the portfolio’s overall emerging-markets currency exposure between 93% and 100%, given it has been concerned about U.S. dollar strength. The strategy sticks close to the benchmark, but at times its high-conviction and tactical nature is on full display. In 2020, the team was overweight in longer Brazilian debt based on valuations and favorable real rates, which hurt early on during that year. But off-benchmark moves have helped combat the concentration risk associated with this bogy. The portfolio’s positioning in Egypt was a prime example in 2020: That stake sat at 5% to start the year, and the team cut it completely by the end of March to redeploy to more attractively priced opportunities before building it back to 4% at the end of September. As of September 2021, the team continued to hold a 4% stake in local Egyptian debt given its attractive yield and pending inclusion into the JPMorgan GBI-Emerging Markets Global Diversified Index.

People

This remains one of the more-experienced teams that works well together, but its size hasn’t kept pace with some larger peers. This underpins its People Pillar downgrade to Above Average from High.

Emerging-markets bond veterans Penny Foley and David Robbins took over here in December 2009. Foley cofounded an institutional emerging-markets debt and equity strategy in 1987; Robbins joined her there in 2000 after running emerging-markets trading at Lehman Brothers and Morgan Stanley. Alex Stanojevic, a trader with the team since 2005, was named comanager in mid-2017, helping build ample transition time for when Foley eventually retires. 

The managers’ supporting cast is experienced and works together well, but it’s half the size of some peers, which can leave the team stretched in an ever-expanding investment universe. The managers are supported by five sovereign analysts led by Blaise Antin, who joined TCW in 2000. Longtime team member Javier Segovia leads a group of three emerging-markets corporate analysts including Stephen Keck, who has focused on this sector for TCW since 2003, and two more experienced analysts who joined in 2011 and 2015. This corporate cast, while experienced, is much leaner than some peers. Additionally, their relative inexperience with Asian corporate credit was partly to blame for 2021’s disappointing performance. As the emerging-markets debt market grows, this midsized team will need to stick to what it knows best to maintain its edge.

Performance 

This strategy’s Institutional share class gained 0.6% annualized from its mid-December 2010 inception through December 2021, ranking third out of 14 distinct strategies in the emerging-markets local-currency bond Morningstar Category. It also outpaced the JPMorgan GBI-Emerging Markets Global Diversified Index by roughly 10 basis points annualized. Though the strategy isn’t likely to reach the heights of its more aggressive competitors in strong rallies, it’s been no slouch. It edged out its typical peer and benchmark in 2016 and 2017, for example, through smart positioning with larger index constituents such as Brazil and Russia, as well as picking out-of-benchmark winners such as the Indian rupee and Egyptian pound. The strategy has held up better than peers and the index in some tough markets thanks to the team’s valuation discipline and smart allocation moves. Taking emerging-markets currency exposure down to 75% of assets and raising cash to around 11% helped going into 2013’s taper tantrum, as did some better performing off-index investments in China and Uruguay. Still, lately there have been a few bumps in the road. The strategy’s 9.3% loss in 

2021 lagged its typical rival by 110 basis points and its benchmark by 90 basis points. Much of this underperformance owed to the team’s overweighting in emerging-markets local-currency exposure, as the U.S. dollar outperformed for most of the year. From a country perspective, an overweighting and long-duration positioning in Mexico and Columbia were painful.

(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 Shares

Wesfarmers’ Bid for API Stands After Woolworths Withdraws

Business Strategy and Outlook

To diversify from regulated PBS revenue, API acquired the Priceline chain of health and beauty stores in 2004.Priceline contributes around one quarter of API’s revenue but over 40% of gross profit. Priceline’s key growth strategies are increasing its contribution from online sales and leveraging its loyalty scheme, the Sister Club. However, Morningstar analyst have concerns regarding these endeavours. Market statistics suggest the Australian health and beauty retail market is growing at a mid-single-digit pace, which provides an attractive opportunity for API at first blush. However, Morningstar analyst believe the market growth opportunity is skewed to the premium end rather than Priceline’s mass-middle positioning and consequently forecast below-market average revenue growth for the retail business. This is despite its loyalty program that differentiates Priceline from key competitors .

Similarly, Priceline’s growing online sales will likely lead to a subdued outlook for in-store sales. Morningstar analyst forecast same-store sales climbing at just 1% per year, less than inflation. Moreover, the shift of sales from physical stores to online places pressure on margins due to challenges in evolving the cost base at the same rate.

Offsetting these challenges, API’s acquisition of the Clear Skincare clinics in fiscal 2018 offers significantly higher profitability. With gross margins above 80%, Morningstar analyst expect the rollout of Clear Skincare clinics to help API’s earnings recover in the short term and permanently reduce its exposure to the PBS.

Woolworths’ Offer for API Has Been Withdrawn but Wesfarmers’ Offer Still Stands

In yet another unexpected turn, Woolworths has withdrawn its non-binding proposal to acquire no-moat Australian Pharmaceutical Industries, or API, for AUD 1.75 per share made on Dec. 2, 2021. Following completion of due diligence, Woolworths was not convinced it could achieve the financial returns it requires. However, the takeover offer from Wesfarmers remains in place and is not subject to due diligence, which completed in October 2021. Accordingly, Morningstar analyst have decreased  API fair value estimate by 13% to AUD 1.53, back in line with  standalone assessment of API and Wesfarmers’ takeover offer.

Financial Strength

API is in a sound financial position with net debt/adjusted EBITDA of 0.6 times at fiscal 2021. We forecast leverage to remain under 1.0 over our forecast period, with API comfortably able to afford a 70% dividend payout ratio and continue to expand its retail footprint. We forecast a total of AUD 250 million in capital expenditures over the next five years, and also factor in the final AUD 32.9 million payment for Clear Skincare still outstanding.Working capital management has improved over a number of years, almost halving the net investment in working capital to 5.6% of sales over the 10 years to fiscal 2021. We forecast investment to be roughly maintained at an average of 6.2% of sales.

Bull Says

  • The Priceline and Clear Skincare offerings are relatively high-margin segments and pitched in the beauty and personal-care market which is growing at a mid-single-digit pace. 
  • API’s corporate Priceline stores offers higher margin and more product opportunity than the purely franchise business model of peers Sigma and EBOS. 
  • Management has demonstrated that it is opportunistic and having deleveraged the balance sheet, is looking to invest for growth. Value-additive acquisitions could present upside to our fair value estimate.

Company Profile

Australian Pharmaceutical Industries, or API, is a major Australian pharmaceutical wholesaler and distributor. In addition, it is the franchisor of the Priceline Pharmacy network and directly owns and operates stand-alone Priceline stores which sell personal care and beauty products. In an effort to diversify away from the highly regulated low growth and low margin pharma distribution business which contributes 74% of revenue, API is actively growing a consumer brands portfolio and also acquired Clear Skincare, a skin treatment chain. These two emerging businesses each contribute approximately 1% of revenue but are higher margin than the core distribution segment.

 (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.