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Global stocks Shares

Ramsay Health Care Ltd

Ramsay’s offer of GBP 2.40 per Spire share represents an enterprise value of GBP 2 billion or EV/EBITDA multiple of 10.9 on pre coronavirus fiscal 2019 earnings. Post-acquisition, our EPS for fiscal years 2023 to 2025 increases by an average of 11%, slightly ahead of the high-single-digit EPS accretion management guided for fiscal 2024. However, we still view the transaction price as fair, with shares still screening as overvalued.

We expect Spire’s revenue to grow at a low-single-digit percent and operating margin to largely be maintained at 10%. In addition, we factor in GBP 26 million in annualised cost synergies from fiscal 2024 through procurement benefits, capacity utilisation and a reduction in administrative costs. The scheme is first subject to a Spire shareholder vote expected in July 2021, followed by a likely 12-month review process by the U.K. Competition Market Authority, or CMA. Ramsay’s 8% market share combined with Spire’s 17% would create the largest independent hospital operator in the U.K., but at most we anticipate CMA may require Ramsay to divest certain hospitals or clinics. Accordingly, we forecast full integration and control in fiscal 2023 and full realization of synergies in fiscal 2024.

We view the acquisition as strategically sound, in addition to extending Ramsay’s geographic reach. Spire provides more exposure to private revenue streams and higher acuity inpatient admissions. This complements and balances Ramsay’s U.K. case mix, which is dominated by day patients and revenue sourced from the National Health Service. We anticipate Ramsay to fund the deal through existing debt facilities and still afford a 50% dividend payout ratio. However, Ramsay indicated potential capital management initiatives or asset sales to deleverage its balance sheet if needed.

Profile.

Ramsay Health Care is the fifth-largest global private hospital operator with approximately 480 locations in 11 countries. The key markets in which it operates are Australia, France, the U.K., Sweden and Norway. It is the largest private hospital group in each of these markets other than Norway where it is number two and the U.K. where it ranks fourth. Ramsay Health Care has a history of acquisitive growth, with the most recent acquisition being that of Stockholm-listed Capio AB in November 2018. 51%-owned Ramsay General de Sante is listed on Euro next Paris. Ramsay Health Care undertakes both private and publicly funded healthcare.

Source:Morningstar

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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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Invesco Intermediate Term Muni Inc

This is one of the larger muni credit teams in the industry, with 16 portfolio managers and 24 muni research analysts. It has grown primarily by way of Invesco’s acquisitions, though, and the current research configuration doesn’t have a significant history navigating market turbulence together. Veteran muni manager Mark Paris, Invesco’s muni-bond head, manages this strategy alongside nine other portfolio managers. The muni research team is large, and given this team’s preference for nonrated deals, the effort is adequate for this mandate.

The strategy absorbed a legacy Oppenheimer counterpart in mid-May 2020, though the portfolio’s profile largely remained intact over the past year. This team has a long-standing specialization in high-yield munis, and this portfolio can hold up to 35% of assets combined in below-investment-grade and nonrated bonds per its mandate. Over the past five years, the portfolio has maintained anywhere from 8% to 14% exposure to below-investment-grade munis and a similar range in nonrated issues. The team’s preference for smaller nonrated bonds can carry more liquidity risk than the typical muni national intermediate portfolio does. The team aims to minimize risk through sector diversification and limits issuer specific risk by keeping position sizes relatively small.

The strategy’s Y shares gained 3.6% annualized from October 2015 through April 30, 2021, modestly outpacing the typical muni national intermediate Morningstar Category peer’s 3.4% annualized gain, though it was also more volatile, with a top-quartile standard deviation over the same period.

Adequate for a higher-yielding offering

The process employed here combines top-down macro analysis and bottom-up credit research with a focus on below-investment grade fare, though it lacks a distinctive competitive edge. The 10-person management team running this strategy is responsible for portfolio construction and risk monitoring, which is essential as the managers regularly invest in nonrated bonds. Analysts provide long- and short-term outlooks and assign proprietary ratings to each bond. The credit research team leads also meet as needed to review any changes to these ratings as well as any special circumstances around distressed securities in the portfolio

This team has a long-standing specialization in high-yield muni bonds, and this portfolio can hold up to 35% of assets in below-investment-grade and nonrated bonds. Over the past five years, the portfolio has maintained anywhere from 8% to 14% exposure to below-investment grade munis and a similar range in nonrated issues. The team’s preference for smaller nonrated bonds can carry more liquidity risk than the typical muni national intermediate portfolio does. The team aims to minimize risks through sector diversification and limits issuer-specific risk by keeping position sizes relatively small.

Portfolio – Credit-oriented

As of March 2021, the portfolio’s largest sector exposures were industrial development and pollution-control (12%), hospital (12%), and dedicated tax (12%) revenue bonds. Life-care and higher education bonds were the next largest sectors at 8% and 7%, respectively. This portfolio has historically had a larger stake in nonrated fare than its typical muni national intermediate peer. As of March 2021, the portfolio’s 14% nonrated stake was more than 3 times its typical peer’s 3% stake. This exposure primarily comprises revenue bonds in continuing care retirement communities, hospitals, charter schools, and toll roads. The portfolio also has substantial exposure to tobacco settlement bonds; its 5% exposure is higher than the typical peer’s 1% exposure as well as the 0.4% in its S&P Municipal Bond Index benchmark.

Performance – Behaves as expected

The strategy’s long-term record under lead manager Mark Paris is decent, though it has seen more volatility than its typical national intermediate muni peer. Its Y shares gained 3.6% annualized from October 2015 through April 30, 2021, modestly outpacing the typical muni national intermediate peer’s 3.4% annualized gain, though it also had a top-quartile standard deviation over the same period, suggesting a more volatile ride than most.

The team’s preference to court more credit risk in this strategy than its typical peer means it may lag when muni credit markets get rough and benefit when risk is rewarded.

(Source: Morning star)

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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

Diamond Hill High Yield Inv

Bill Zox joined Diamond Hill in 2001 as an equity analyst. He was named a portfolio manager on Diamond Hill Corporate Credit DHSTX in April 2006 before taking over lead management in 2008. John McClain joined the firm in June 2014 as a credit analyst and was also named comanager of Diamond Hill Corporate Credit in February 2015.

The strategy’s investment approach stands out relative to its high-yield bond Morningstar Category peers’. The team focuses on relatively small issues and tends to make sizable bets on its best ideas (up to 10% per issuer), thereby increasing idiosyncratic and liquidity risk. The portfolio has on average about 30% of assets concentrated in its top 10 positions. That said, the team offsets those risks somewhat by treading lightly in the market’s lowest-quality names and limiting how much it will own of an individual issue. This process combines an intrinsic value-driven and contrarian approach to build a high current income portfolio with the opportunity for capital appreciation targeting a high-yield Morningstar Category best-quartile return over rolling five-year periods. While the portfolio’s concentration and idiosyncratic risks are material, the managers’ analytical rigor and responsible balancing of its risks provides comfort.

A distinctive and disciplined investment process

This process combines an intrinsic value-driven and contrarian approach to build a high current income portfolio with the opportunity for capital appreciation targeting a category best-quartile return over rolling five-year periods and a 150 basis points gross excess return over the ICE BofA U.S. High Yield Index benchmark.

Comanagers Bill Zox and John McClain execute a disciplined value approach: They buy issues when their market prices are lower than the team’s estimate of intrinsic business value and sell them when their initial thesis has played out or when there are better opportunities in the market. When valuations get rich and opportunities get scarce, the managers may run a larger-thanpeers allocation to investment-grade bonds to reduce the portfolio’s market risk

The team focuses on relatively small issues and tends to make sizable bets on its best ideas (up to 10% per issuer), thereby increasing idiosyncratic and liquidity risk. The portfolio has on average about 30% of assets concentrated in the top 10 positions. That said, the team offsets those risks somewhat by treading lightly in the market’s lowest-quality names and limiting how much it will own of an individual issue

An opportunistically managed portfolio driven by valuations

In response to the 2019 credit rally, the team raised its investment-grade bond exposure up to 20% at the end of that year, its highest level since the strategy’s January 2015 inception, leaving the strategy in a relatively good position to face the coronavirus-driven sell-off that started at the end of February 2020. As the market plunged, the team rotated capital and pushed the portfolio’s credit quality profile even higher as it found numerous investment-grade opportunities in names that included Nvidia, TJX, and Sysco. At the end of 2020’s first quarter, bonds rated BBB or higher represented close to 34% of assets.

After riding the Fed’s wave of purchases and betting on the economy reopening through the second half of 2020, the managers shifted gears. As valuations got rich, they rotated the portfolio out of some higher-rated longer-duration fare into shorter-maturity higher-yielding securities. At the end of March 2021, investmentgrade bonds represented less than 5% of the strategy’s assets, and its allocation to BB-rated bonds went down to 35% from almost 42% at the end of 2020 while bonds rated B moved the other way to 48% from 41% over the same period.

A category leader with a best-in-class long-term volatility-adjusted record

The team’s attention to valuations together with strong credit selection have helped the strategy hold up better than most rivals during high-yield sell-offs. For instance, despite the energy-led sell-off that started in June 2015, an investment in McDermott International MDR was the largest contributor that year, and the portfolio’s energy stake was the largest relative contributor to the strategy’s 0.3% return, which bested 90% of its category peers. Likewise, the strategy outperformed its typical peer by 184 basis points in the last quarter of 2018 and ended that year ahead of 97% of competitors.

(Source: Morning star)

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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

Scentre Group – Shares Still Look Undervalued

However, the group faces challenges from consumers closing their wallets in 2020 due to the coronavirus, and from e-commerce taking a greater share of spending over time. The business has been allocating more space to food, entertainment and services in response to online competition undermining the rent it receives from discretionary retailers. We expect tenants will resist agreeing to traditional annual increases above CPI without corresponding revenue growth. As such, we forecast lower income growth in the long run, weighing on property values.

Key Investment Consideration

Under pressure specialty tenants pay higher rent per square metre than anchor tenants, and therefore drive Scentre Group’s profitability.

Scentre Group has high leverage, and has so far resisted raising equity in 2020, unlike other retail REITs. It can persevere, but we think it needs an improved operating environment in calendar 2021 to avoid an equity raise. OThe quality of Scentre’s assets will ensure they remain pre-eminent shopping destinations in Australia, but we expect e commerce will undermine its pricing power.

Our base case is Scentre either avoids an equity raise, or takes advantage of a rally in sentiment towards REITs to issue equity at less dilutive prices. But we include a dilutive equity raise in our bear case. A realistic possibility is something in between, perhaps a smaller rights issue at a less dilutive price, when markets are optimistic about recovery.

It’s possible our very high uncertainty rating could reduce if operational performance improves once distancing requirements fade, and Scentre reduces debt. With income underpinned by contractual leases under nearly all circumstances, Scentre’s revenue is much more predictable than many other companies. However, the pandemic is one of those rare circumstances, and until that subsides uncertainty remains.

Australian shopping centres are in better shape than their counterparts in the United States, due to lower retail space per person, and a larger share of anchor tenants such as supermarkets.

Population growth in Australia was among the fastest in the developed world until coronavirus. If immigration recovers it would provide infill demand at Scentre’s assets.

Despite retail spending switching online, retailers still need a physical presence to maintain their brand. Premium retailers have little choice but to locate shops in the malls of Scentre and a handful of other groups, given the quality of locations and centres.

While Scentre has one of the highest-quality shopping centre portfolios in Australia, rents are higher than for convenience focused centres, and high end consumer goods are most at risk from online competition.

In response to online competition, Scentre Group has remixed its tenant profile towards food, entertainment and services. However, these categories are more sensitive to social distancing preferences, and typically require higher tenant incentives and maintenance capital expenditure.

Retail space per person is higher in Australia than it is in Europe, and the amount of floorspace devoted to under pressure department stores is high. High end malls in the U.S. may benefit from the closure of marginal malls, but outright closures of rival malls is likely to be less frequent in Australia.

 (Source: Morningstar)

Disclaimer

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

Federated Hermes MDT Small Cap Growth

Modern financier with papers sitting in front of computer monitor with chart and graph of sales rate

He is responsible for the model and research and draws on seven managers/analysts. Frederick Konopka also became a manager in 2008 and handles portfolio construction and trading for the team. MDT looks to group companies into different baskets producing various streams of alpha potential using valuation, growth, momentum, and quality indicators.

By using classification and regression tree analysis, the team can test thousands of potential combinations of factors based on 30-plus years of U.S. stock data to find the best mixtures of alpha using a three-month investment horizon. Still, such a short investment horizon can be difficult to implement. It leads to annual portfolio turnover that can be lofty and varies greatly. Over the past five years, turnover ranged from 188% to 227%, well above the 59%-66% range for the typical small-growth. The portfolio’s holdings have varied from 150 to 250, suggesting some opportunities may be too illiquid and costly to pursue unless they’re spread out across more holdings.

Since Mahr became lead manager in August 2008, the Institutional shares’ 11.9% annualized return through April 2021 lagged the small growth category’s 12.2% gain and the Russell 2000 Growth Index’s 12.2% rise. The fund has performed better since the team’s 2013 process switch to multiple decision trees, but the fund’s high volatility has kept its risk-adjusted results in line with the index.

Quantitative approach with short focus

MDT groups companies into different baskets of alpha potential. The team forecasts three month returns using valuation factors based on structural earnings, tangible book value, and forward earnings estimates; growth factors like analyst conviction and long-term earnings growth; quality factors measuring free cash flow, leverage, and reliance on external capital; and momentum factors like relative stock price trend. The team uses classification and regression tree analysis to test thousands of potential combinations based on 30-plus years of U.S. stock data.

Prior to 2013, the team used one large decision tree to forecast alpha, but that approach was subject to overfitting issues. Switching to regression analysis using multiple decision trees resulted in combinations of subsets of the factors with the best alpha potential. This leads to the fund holding stocks with different avenues to produce alpha, potentially leading to more opportunities to outperform. The MDT team continues to refine its model, usually updating the model twice a year. These revisions are typically on the margin, though. In 2020, for example, they adjusted their structural earnings indicator by using an industry relative basis.

Diversified, but high turnover

The strategy’s short-term approach has led to higher turnover than most smallgrowth peers. Its annual portfolio turnover range of 118%-227% the past five years is much higher than the median range of 59%-66%. The fund might struggle to maintain its fast-trading ways if assets hit the team’s $8 billion-$10 billion estimate of its small-cap capacity, which includes this strategy, Federated MDT Small Cap Core QISCX, and Federated MDT Small Cap Value. So far, the team is not near that limit, with around $2 billion across its small-cap charges. However, the portfolio’s number of holdings has varied from 150 to 250, suggesting some opportunities may be too illiquid and costly to pursue unless their potential alpha is spread out across more holdings. This could become more pronounced as the asset base grows

Performance – Volatile

The fund’s absolute and risk-adjusted returns lag the Russell 2000 Growth Index during lead manager Dan Mahr’s tenure. Since Mahr took over in August 2008, the Institutional shares’ 11.9% annualized return through April 2021 trailed the small-growth category’s 12.2% gain and the Russell 2000 Growth Index’s 12.2% rise. It has done so with more volatility than the benchmark, resulting in subpar riskadjusted performance measures, like the Sharpe ratio. Most of the fund’s underperformance has come during market turbulence. Mahr’s Aug. 31, 2008,start date means he took over amid the credit crisis, and the fund barely edged the benchmark through that period’s March 9, 2009, bottom. The fund lagged the bogy’s ensuing trough-to-peak (April 23, 2010) performance by 26.6 percentage points, annualized.

(Source: Morning star)

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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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Invesco Global Growth A

The world large-stock Morningstar Category split into three new groups based on investment style. This offering lands in the world large growth category. That’s appropriate, as it follows a growth-oriented strategy and its primary self-chosen benchmark is the MSCI All Country World Index Growth rather than the core MSCI ACWI, which it considers secondary. That said, the fund’s approach to growth investing is more restrained than those of many other funds in the new category. The managers belong to an Invesco international team that follows a doctrine they call EQV, with valuation being the “V,” and they take that aspect seriously. The fund’s most recent portfolio statistics put it nearly on the border with the blend portion of the Morningstar Style Box, while the average for the world large-growth average is much further into the growth area. Recently, that difference has benefited the fund’s relative ranking in the new category, as value and core have outperformed growth, but longer-term, the opposite is true.

This strategy has been proved on other offerings from the same team that focus exclusively on non-U.S. markets. This one hasn’t had the same level of success, partly owing to that once-deep U.S. underweighting, but also stock selection in that important market was subpar. Selection has improved recently, but the portion of that team focused on the big U.S. market remains just Amerman and two analysts.

The Fund’s Approach

The fund uses the same process that has provided solid long-term returns for a variety of Invesco international funds. It receives an Above Average Process rating. The managers look for sustainable earnings growth available at reasonable valuations and try to avoid companies with high debt levels. They put importance on the “quality” of earnings, looking for recurring revenue streams, strong cash flows, and solid operating margins. At one time, the managers of the fund’s U.S. portion used a different approach, but in mid-2013 the U.S. manager was incorporated into what had been the international team (which Invesco calls EQV, for earnings, quality, and valuation), so now the entire fund uses the EQV strategy. The valuation portion plays a significant role, leading this portfolio to be more moderate on the growth spectrum than most rivals in the new world large-growth category.

Before the U.S.-focused manager joined the EQV team, the fund heavily underweighted the U.S. side of the portfolio. That portion gradually increased; by March 31, 2021, it stood at 56%, close to the level of the MSCI ACWI Growth. The managers say they probably won’t allow such a large gap to recur, so that stock choices drive performance. Meanwhile, the fund’s small-cap weight rose after it absorbed a small-mid sibling in 2020. It now has a market cap around one third that of the index.

The Fund’s Portfolio

Matt Dennis and his comanagers took advantage of the early-2020 bear market to make many changes. Dennis and Ryan Amerman, who focuses on the U.S. side of this offering, say they added 19 new stocks to the portfolio in 2020’s first quarter, while selling 11. That’s a much higher level of activity than usual for this fund, as the managers prefer to hold on to stocks for longer periods of time, and since then activity has slowed down. Compared with its MSCI ACWI Growth benchmark, the fund has some noteworthy distinctions. Not surprisingly, given this fund’s moderate take on growth and attention to valuations, the tech-sector stake of 21% is about 10 percentage points lower than the indexes. But the managers do like a number of tech names, such as JD.com, which they say has become preferable to Alibaba BABA (though they still own the latter) because they see a greater potential for margin expansion, and Dropbox DBX, which they also added last year. Conversely, the fund’s stake in financial services is twice the index’s level, even though they are wary of big U.S. and European banks. Rather, they own investment-focused stocks such as LPL Financial LPLA in the U.S. and Fineco in Italy, along with payment-focused firms such as Visa V and PayPal PYPL. The managers say the portfolio’s substantial U.K. overweighting owes not to macro factors but to the appeal of a number of specific stocks.

The Fund’s Performance

This fund now lands in the new world large growth category. Because growth has outperformed value and core over most of the 10 years since Matt Dennis was named sole lead manager (until the past six months saw a reversal of that trend), and this fund is more moderate than most of its new peers, it has been at a disadvantage. Over the trailing 10-year period ended April 30, 2021, the 9.1% annualized return of its A shares lagged the world-large-growth category average by 2 percentage points and the MSCI ACWI Growth by 2.8 percentage points. It’s worth noting, however, that it essentially matched the return of the core MSCI ACWI over that time period, and beat the average of the new world-large-blend category by 0.8 points. (The fund’s portfolio currently lands barely on the growth side of the growth/blend border of the style box.) One hindrance has been the fund’s so-so performance in major downturns. It didn’t stand out in 2015’s third quarter, and its 13.5% loss in 2018 was more than 5 percentage points worse than the growth index and new growth category, From Jan. 21 through March 23, 2020 (the peak and trough of foreign indexes in that bear market), its return was again similar to the MSCI ACWI and the category norm.

Source: Morningstar

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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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Lazard International Strategic Equity

Lead manager Mark Little, based in London, joined Lazard in 1997 and has run this fund since its October 2005 inception. The other three managers have all served this strategy since at least 2009, meaning the group has worked together extensively. Lazard’s large and experienced international and emerging-markets equity teams provide the managers with excellent support.

The team’s all-cap relative-value strategy allows the managers to pursue opportunities wherever they see fit. Ideas sometimes come from quantitative screens, though the managers and analysts often uncover ideas themselves through their own research. Two of the four comanagers have accounting backgrounds, allowing the team to conduct thorough analysis on the attractiveness of a company based on their preferences. They search for companies with an alluring combination of valuation and profitability, though the portfolio’s profitability metrics fell in line with those of the MSCI EAFE benchmark as of March 2021.

As with many all-cap mandates, the resulting portfolio’s characteristics vary, and the managers have navigated well without becoming too dependent on any type of stock. The portfolio’s average market cap nearly tripled to $30.8 billion from $11.8 billion since 2013 as small- and midcap opportunities faded and large-cap stocks surged (though that tally is still lower than its median peer and benchmark). The managers aren’t afraid of making bets on specific countries either: The March 2021 portfolio had an 8% allocation to each of Canada and Ireland, while the benchmark had less than 1%

The Fund’s Approach

A flexible and well-executed approach earns this strategy an Above Average Process rating. Like other Lazard strategies, this one uses a malleable relative-value strategy that ranges across the market-cap spectrum. The team searches for companies with an attractive combination of valuation and profitability, a balance that landed the March 2021 portfolio squarely in the large-blend section of the Morningstar Style Box. However, the strategy’s flexibility also allows the portfolio’s style to drift to where the managers see opportunity, and it sat in the large-growth category for several years prior to 2019.

Quantitative screens sometimes produce ideas, though the managers and Lazard’s deep analyst bench often find ideas through their own research. Two of the four comanagers have accounting backgrounds, allowing the team to conduct nuanced analysis on the attractiveness of a company to see if it aligns with their preferences. The management team works with the analysts on top-down analysis (like economic and political situations) to supplement its fundamental research as well. If the managers decide to invest, they usually replace an existing holding, resulting in a portfolio that consistently holds between 65 and 75 stocks.

The Fund’s Portfolio

While the portfolio invested 40% of its assets in mid-cap stocks in 2013, manager Michael Bennett notes that appealing small- and mid-cap stocks have been more difficult to find in recent years. As a result, the portfolio’s stake in mid-caps had fallen to 12% by March 2021 while positions in large- and giant-cap companies rose. The portfolio’s average market cap tripled to $35 billion from $11.8 billion over that time, though it’s still lower than its median foreign large-blend peer and MSCI EAFE benchmark. Despite the managers’ emphases on financial health and valuation, the portfolio’s profitability metrics fall in line with those of the benchmark and median peer while price metrics are marginally higher.

The portfolio’s style has drifted toward the large-blend category from large growth in recent years, though risk factor exposures have always tended to align closely with the core-oriented benchmark. The managers want stock selection to drive returns, but meaningful sector bets are common, such as the 5-percentage-point underweighting in tech and a similar-size overweighting in industrials in the March 2021 portfolio. Investors here should also expect meaningful country bets, such as the 13-percentage-point underweighting in Japanese stocks in March and 8-percentagepoint over-weightings to Canadian and Irish stocks that month.

The Fund’s Performance

This strategy performed poorly in early 2020’s pandemic-related sell-off. It lost 35.5% from Jan. 22 through March 23, worse than the MSCI EAFE benchmark’s 33.7% decline. Investments in several out-of-benchmark Canadian companies dragged on returns, such as National Bank of Canada and Suncor Energy, which respectively suffered as both interest rates and oil prices plummeted. The strategy’s positions in several air-travel stocks also hurt, such as Air France, Airbus, and Canadian manufacturer CAE Inc. CAE.

Over longer periods, however, performance has been more impressive. From its October 2005 inception through April 2021, the strategy’s institutional shares’ 7.1% annualized return outpaced its foreign large-blend Morningstar Category’s 5.0% and benchmark’s 5.2%. Furthermore, it outperformed without excess volatility, resulting in superior risk-adjusted metrics (such as the Sharpe ratio) over that time frame. The strategy typically wins by shielding capital in sell-offs, capturing only 92% of the index’s drawdowns since inception. It performed well in 2018, a challenging year for international equities, and during the 2007-09 global financial crisis, though as noted it failed to provide a meaningful cushion in early 2020. While it can outperform in bull markets, such as that of 2012-13, its performance in rallies tends to be middling.

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

Xiaomi Produces Record Smartphone Sales and Gross Margins; FVE Raised to HKD 20.70

The smartphone gross margin of 12.9% was up 480 basis points on the previous corresponding period. Up until third-quarter 2020 Xiaomi’s smartphone gross margins averaged 7.5% and never rose above 9% in any quarter. Fourth quarter last year these margins increased to 10.5% and then jumped to 12.9% in the first quarter. The smartphone performance drove consolidated operating profit (less investment gains) up 161% with an 8% consolidated operating margin, much better than its previous best quarterly operating margin of 6.1% in second-quarter 2019. Huawei’s retreat seems to have lifted margins across the industry with Samsung’s smartphone business and Apple’s consolidated business also reporting their best operating profit margins since 2016. We lift our fair value estimate to HKD 20.70 from HKD 16.30 previously due mainly to increased gross margin forecasts in the smartphone business as well as increased smartphone revenue growth forecasts in 2021, with the lift in the value of Xiaomi’s investment portfolio over the quarter and a slightly stronger CNY also helping. Our no-moat rating is retained as we believe Xiaomi is predominantly an electronics hardware supplier with limited switching costs with its internet services business not yet well enough developed to assign a moat to. On our estimates Xiaomi currently trades on a 2021 price/earnings ratio of 31 times. Despite Xiaomi’s growing Internet of Things and lifestyle services business revenue giving it some differentiation from other consumer electronics peers, we believe this multiple is still above what could be reasonably justified.

Xiaomi’s smartphone segment had another strong quarter with Xiaomi’s total number of smartphones sold globally rising by 69% and smartphone revenue increasing by 70% from the previous year. Smartphone gross profit was up 170% with gross profit margin increasing to 12.9% from 8.1% in first-quarter 2020. Until the third quarter of 2020, the average smartphone gross margin for the previous 15 quarters had been 7.5% with a range of 3.3% to 9%. The margin then jumped to 10.5% in fourth-quarter 2020 and 12.9% in first-quarter 2021. Given Xiaomi generates around two thirds of its revenue from smartphone, its valuation is very sensitive to the smartphone gross margin assumption. If we double the smartphone gross margin assumption from 7.5% to (say) 15%, holding all other assumptions equal, Xiaomi’s valuation nearly doubles. Xiaomi pointed toward the shift in product mix toward higher end smartphones and reduced marketing and promotion spend given tightness in the semiconductor supply chain as the key drivers for the margin increase.

We estimate that reduced competitive intensity from Huawei has probably also helped smartphone industry margins and there may also be some premium attached to 5G phones. In the first-quarter 2021, key competitor, Samsung, reported its highest quarterly smartphone operating margin since the second quarter of 2016. The first quarter also saw Apple reporting its highest quarterly company operating margin since first quarter of 2016.

Xiaomi admitted that gross margin expansion had not been its main focus nor does it expect it to be in the near future as it is quite rightly focused on increasing market share, particularly in the mid-high end phone segment. It expects future growth to come from increased penetration into the offline segment in China as it is currently expanding its store footprint with a target of around 10,000 stores by the end of 2021. We forecast Xiaomi to grow its smartphone revenue by 44% in 2021 and at an average of 18% per year thereafter out to 2025 and assume its smartphone gross profit margin increases from 11.0% in 2021 to 11.4% in 2025 having lifted these assumptions by around 200 basis points following this result.

Revenue from the Internet of Things and lifestyle products segment increased by 41% year over year in the first quarter after growing by 8.6% in 2020. We note that the prior period was negatively impacted by COVID-19. Gross margin increased to 14.5%, which was also a quarterly record. Management had previously indicated that it had proactively reduced the number of stocks keeping units in this division to focus more on those products that interworked with the smartphone ecosystem. The company indicated that global shipments of its smart TVs were down 4% to 2.6 million for the first quarter. Larger television competitor, TCL, reported global TV sales volumes up 33% for the first quarter with TV sales in China up 8.3% and non-China sales up 43%. We forecast that Xiaomi can grow its Internet of Things and lifestyle products revenue by an average of 15.1% per year out to 2025 with gross margins averaging 12.0%.

Revenue from internet services was below expectations, increasing by 11.4% year over year in the first quarter after growing at 20% in 2020. Monthly active users, or MAUs, of its Mi User Interface increased to 425 million at the end of March from 396 million at the end of December 2020 and were up 29% year on year. However, average revenue per user was down 13% to CNY 5.3 per month. Advertising revenue was strong growing by 20% to CNY 3.6 billion and making up 58% of total internet services revenue. This is mainly driven by smartphone sales with the improved mix of higher end smartphones helping Xiaomi to grow the preinstalled app revenue. The high percentage of advertising revenue and improved margins from the fintech business drove internet services gross margin to 68.4% for the quarter. We believe the dominance of advertising in this revenue stream speaks to the difficulties Xiaomi has faced in building non-hardware-related internet revenue streams. We forecast internet services revenue growth of 20% per year to 2025 noting that growth in first-quarter 2021, internet services revenue was slower because of the very high gaming revenue in first-quarter 2020 due to the pandemic.

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

Best Buy Co Inc

Revenue was $11.6 billion, up from $8.6 billion in 2021’s first quarter and ahead of our $10.4 billion forecast. Comparable sales were up 37.2%, bolstered by the domestic appliance segment (comps up 67%), which the firm attributed to economic stimulus and sustained spending on the home. Best Buy’s 6.6% operating margin was ahead of the 2.7% result in fiscal 2021 and our 3% projection and reflected an improvement over 2020’s first-quarter result of 3.7%. Fiscal 2022 first-quarter EPS came in at $2.32, well above our $0.90 estimate. For comparison, first-quarter 2020 EPS was $0.98.

While these results were impressive, we are skeptical about their sustainability as economic stimulus payments are set to end and other disposable income options are increasing. Management’s second-quarter guidance indicates a deceleration of comps (17%) and a flat gross margin compared with 2021 (22.9%). For the full year, we expect comps around 5% (in line with updated guidance of 3%-6%), flat year-over-year gross margins, and a slight increase in selling, general, and administrative expense. We don’t plan a material change to our $101 fair value estimate and view the shares as overvalued, given the headwinds Best Buy faces.

One notable takeaway in Best Buy’s favor was the efficacy of its e-commerce and omni channel strategy despite the reopening of physical stores. Sixty percent of online orders were fulfilled from a Best Buy store via shipping, delivery, or pickup in store. Additionally, online orders made up 33% of domestic sales, compared with 15% in 2020. The firm is planning to capitalize on this with its new Best Buy Beta loyalty program, which offers perks including same-day delivery and special member pricing. For Best Buy to remain competitive after COVID-19, an evolving e-commerce plan is imperative.

Profile

Best Buy is one of the largest consumer electronics retailers in the U.S., with product and service sales representing more than 9% of the $450 billion-plus in personal consumer electronics and appliances expenditures in 2019 (based on estimates from the U.S. Bureau of Economic Analysis). The company is focused on accelerating online sales growth, improving its multichannel customer experience, developing new in-store and in-home service offerings, optimizing its U.S., Canada, and Mexico retail store square footage, lowering cost of goods sold expenses through supply-chain efficiencies, and reducing selling, general, and administrative costs.

Source:Morningstar

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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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Change Healthcare Inc

UnitedHealth still plans to purchase Change for $25.75 per share, which is our fair value estimate. However, in March, U.S. antitrust regulators announced an extension of that merger’s review period, and if the deal doesn’t close because of regulatory concerns, we would reduce the value of Change to our stand-alone fair value estimate of $16.50.

In the quarter, Change beat consensus on both the top and bottom lines. Revenue grew 1% to $855 million, above FactSet consensus of $846 million. With cost controls likely due to rightsizing before the pending acquisition, Change turned that slight revenue beat into a bigger profit beat. The company turned in adjusted EBITDA of $272 million (above consensus of $254 million) and adjusted EPS of $0.42 (above consensus of $0.36).

On the pending merger with UnitedHealth, both the acquirer and the target look committed to the deal, but regulators have thrown a wrench into the process. Based on recent commentary from UnitedHealth, there appears to be no major financing concerns or red flags from the perspective of the potential acquirer, and Change shareholders voted to approve the merger in April, as well. However, the Department of Justice announced an extended antitrust review on the combination in March after receiving a letter from the American Hospital Association about the combination, citing concerns about sensitive healthcare data shifting hands from Change (a neutral third party) to UnitedHealth’s Optum segment (a subsidiary of the largest U.S. health insurer and a large caregiver, too). The AHA suggested that the shift could give UnitedHealth an unfair advantage in its legacy businesses by seeing competitive claims processed in Change’s clearinghouse business. Concerns like that add uncertainty about whether the deal will close.

Profile

Change Healthcare is a spin-off of various healthcare processing and consulting services acquired by McKesson over numerous years. Recently, these processing assets were contributed to a joint venture and in June 2019 public shares were issued with McKesson retaining the majority interest. As of the end of the March 2020 quarter, McKesson distributed all its interest in the public processor. Core services consist of insurance (healthcare) claim clearinghouse for healthcare payers in addition to administrative and consulting services to assist healthcare providers improve reimbursement coding, billing, and collections.

Source:Morningstar

Disclaimer

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.