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BlackRock Advantage International Fund K: Fund which aims to outperform the MSCI EAFE Index

BlackRock Advantage International Fund K seeks long-term capital appreciation, with a focus on risk management.Powered by innovation and technology driven investment process having exposures to international portfolio at a low cost.

Approach

The strategy aims to outperform the MSCI EAFE Index by combining bottom-up and top-down factors into a stock-selection model that uses roughly 40-60 signals that fall into three broad buckets: fundamentals, sentiment, and macro themes. Fundamental signals include factors such as management quality, valuation, and profitability; sentiment signals include analyst-, investor-, and broker-sentiment indicators; and macro signals include factors specific to industries, countries, and investment styles. The model weights the signals roughly evenly between the three buckets.

The team keeps a tight lid on the 375- to 715-stock portfolio’s tracking error (the volatility of its relative performance) by keeping its sector and industry weights within 4 percentage points of the index’s, generally. It mitigates stock-specific risk by typically keeping individual positions within 1-1.5 percentage points of the benchmark’s.

The systematic approach has a short time horizon of six to 12 months, which can lead to portfolio churn and higher trading costs. The strategy’s annual portfolio turnover has ranged from 106% to 247% during the past four years, much higher than the average foreign large-blend category peer’s 43%-51%.

Portfolio

In contrast to other foreign large-blend funds, the managers here allocate the strategy’s assets across positions that stick, deviated most at around 0.9 percentage points larger than the index’s share, as of November 2021. While the portfolio mostly invests in benchmark constituents, 5%-15% of assets are in stocks unique to the portfolio. Indeed, close to the MSCI EAFE Index’s weights. Its 1.1% stake in the world’s third-largest tobacco company, Japan Tobacco 10.1% of assets were invested across roughly 150 offbenchmark stocks such as Rexel SA RXL, Rightmove PLC RMV, and Électricité de France EDF.

The strategy typically has a bit more exposure to mid-cap stocks than does the index. As of November, the portfolio’s allocation to mid-caps stood at 15% versus the index’s 10%. As a result, the portfolio’s $41 billion average market cap was slightly below the index’s $47 billion.

Performance

The fund has earned mixed results since BlackRock’s Systematic Active Equity team took over in mid-2017. From July 1, 2017, through Dec. 31, 2021, the Institutional shares posted a 7.3% annualized return, which beat the foreign large-blend category’s 7.1% but trailed the MSCI EAFE Index’s 7.5%. Its risk-adjusted results don’t look much better. 

The fund has fared worse than the index during severe market drawdowns but has outperformed the benchmark during prolonged rallies. The strategy’s calendar 2021 results were solid: The fund’s 13.0% gain beat the average peer’s 9.8% return as well as the index’s 11.3%. The portfolio benefited from good stock selections in the financial services and industrials sectors, namely Nordea Bank and Recruit Holdings, respectively.

Top 10 Holdings

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About the fund

BlackRock Advantage International’s experienced and well-resourced research team plies a suitable quantitative approach and earns the strategy’s share classes Morningstar Analyst Ratings of Bronze or Neutral, depending on fees.

The team’s quant-driven approach has a lot of moving parts. It analyzes 40-60 signals that fall into three broad buckets–fundamentals, sentiment, and macro themes–that collectively consider both bottom-up and top-down factors. The strategy aims to outperform the MSCI EAFE Index by combining bottom-up and top-down factors into a stock-selection model that uses roughly 40-60 signals that fall into three broad buckets: fundamentals, sentiment, and macro themes. Fundamental signals include factors such as management quality, valuation, and profitability; sentiment signals include analyst-, investor-, and broker-sentiment indicators; and macro signals include factors specific to industries, countries, and investment styles. The model weights the signals roughly evenly between the three buckets. The team keeps a tight lid on the 375- to 715-stock portfolio’s tracking error (the volatility of its relative performance) by keeping its sector and industry weights within 4 percentage points of the index’s, generally. It mitigates stock-specific risk by typically keeping individual positions within 1-1.5 percentage points of the benchmark’s.

 (Source: Morningstar)

General Advice Warning

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

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Dividend Stocks

Wells Fargo: One of The Top Deposit Gatherers In USA

Business Strategy and Outlook

Wells Fargo remains in the middle of a multiyear rebuild. The bank is still under an asset cap imposed by the Federal Reserve, and it’s not seen as if, this restriction coming off in 2022. Wells Fargo has years of expense savings related projects ahead of it as the bank attempts to get its efficiency ratio back under 60%. It is also seen a multiyear journey of repositioning and investing in the firm’s existing franchises, including growing its capital markets wallet share, bringing an increased focus on cards, and revitalizing an advisory group that has lost advisors for years. It’s already started to be visible, that glimpses of the transition to offense from defence, as the bank released two new card products in 2021, the first attempt to do so that it can be thought of in years. However, it is anticipated the full transition to be a multiyear undertaking. 

Despite the bank’s issues, Wells Fargo remains one of the top deposit gatherers in the U.S., with the third most deposits in the country behind JPMorgan Chase and Bank of America. Wells Fargo has one of the largest branch footprints in the U.S., excels in the middle-market commercial space, and has a large advisory network. It is apprehended this scale and the bank’s existing mix of franchises should provide the right foundation to eventually build out a decently performing bank. Well Fargo may not reach the types of returns and efficiency that peers like JPMorgan and Bank of America have achieved, but it is foreseen for Wells Fargo to remain larger than any other regional bank and stay competitive as such. It is also gaining confidence that CEO Charlie Scharf is guiding the bank in a new and positive direction. 

With all anticipated asset sales completed (WFAM, corporate trust, international wealth, student lending), results should be less noisy. For now, the bank needs to consistently hit the expense targets it is laying out. Wells Fargo achieved them in 2021, and it is likely to do so again in 2022, achieving another year of net expense reductions while peers see expenses rise. Wells Fargo is also one of the most rate sensitive names under analysts’ coverage, which should help to offset some of the growth pressure from being unable to grow its balance sheet.

Financial Strength

It is perceived Wells Fargo is in sound financial health. Its common equity Tier 1 ratio stood at 11.4% as of December 2021. Given its history of prudent underwriting and current economic developments, it is alleged the bank arguably holds excess capital. 

As of December 2021, the bank estimates its liquidity coverage ratio was 118%, in excess of the minimum of 100%. The bank’s supplementary leverage ratio was also 6.9%, well in excess of the minimum of 5%. Wells Fargo’s liabilities are prudently diversified, with over 70% of assets funded by deposits. Roughly $20 billion in preferred stock was outstanding as of the end of last year. 

Wells had to cut its dividend during the height of the COVID-19 pandemic and is still in the process of bringing its dividend payout ratio back up. Over the long run, it is foreseen, the bank to return to a dividend payout ratio of roughly 30% through the cycle, a bit more conservative than what the bank has had in the past. 

In the meantime, as Wells Fargo produces plenty of capital, it is projected high share repurchase levels, projecting that 70% of earnings will be used for repurchases over the next several years. Barring other opportunities, buybacks should be outsized for the bank for the time being.

Bulls Say’s

  • Wells Fargo has some of the highest rate sensitivity among the big four U.S. banks, giving it an extra earnings boost as the next rate hike cycle occurs. 
  • Wells Fargo’s retail branch structure, advisory network, product offerings, and share in small and medium-size enterprises is difficult to duplicate, ensuring that the company’s competitive advantage is maintained. 
  • Wells Fargo hit its expense guidance in 2021, and the bank expects a net reduction in expenses in 2022 while peers are expected to see expenses increase. Wells should have several years left of net expense reductions.

Company Profile 

Wells Fargo is one of the largest banks in the United States, with approximately $1.9 trillion in balance sheet assets. The company is split into four primary segments: consumer banking, commercial banking, corporate and investment banking, and wealth and investment management. It is almost entirely focused on the U.S.

(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

PG&E on Path to Test California Wildfire Insurance Fund After Dixie Fire Report

Business Strategy and Outlook

PG&E emerged from bankruptcy on July 1, 2020, after 17 months of negotiating with 2017-18 Northern California fire victims, insurance companies, politicians, lawyers, and bondholders. Shareholders lost some $30 billion in settlements, fines, and costs, but PG&E exited with bondholders made whole and shareholders still in control.

PG&E will always face public and regulatory scrutiny as the largest utility in California. That scrutiny has escalated with the deadly wildfires and power outages. Legislative and regulatory changes during and since the bankruptcy have reduced PG&E’s financial risk, but the state’s inverse condemnation strict liability standard remains a concern. CEO Patti Poppe faces a tall task restoring PG&E’s reputation among customers, regulators, politicians, and investors

PG&E is well positioned to grow rapidly, given the investment needs to meet California’s aggressive energy and environmental policies. PG&E is set to invest $8 billion annually for the next five years, leading to 10% annual growth. After suspending its dividend in late 2017, PG&E should be positioned to reinstate it in 2024 based on the bankruptcy exit plan terms.

California’s core ratemaking regulation is highly constructive with usage-decoupled rates, forward-looking rate reviews, and allowed returns well above the industry average. California regulators are expected to support premium allowed returns to encourage energy infrastructure investment to support the state’s clean energy goals, including a carbon-free economy by 2045. This upside is partially offset by the uncertain future of PG&E’s natural gas business, which could shrink as California decarbonizes its economy.

The $59 billion bankruptcy was PG&E’s second in 20 years and likely its last. The bankruptcy exits terms all but guarantee a state takeover if PG&E has any safety or operational missteps. PG&E is still under court and regulatory supervision following the 2010 San Bruno gas pipeline explosion. The  estimated fines and penalties from the San Bruno disaster and allegations of poor recordkeeping resulted in $3 billion of lost shareholder value.

Financial Strength

Following the bankruptcy restructuring, PG&E has substantially the same capital structure as it did enter bankruptcy with many of the same bondholders after issuing $38 billion of new or reinstated debt. PG&E’s $7.5 billion securitized debt issuance would eliminate $6 billion of temporary debt at the utility and further fortify its balance sheet. The post-bankruptcy equity ownership mix is much different. PG&E raised $5.8 billion of new common stock and equity units in late June 2020, representing about 30% ownership. Another $3.25 billion of new equity came from a group of large investment firms. The fire victims trust owned 22% and legacy shareholders retained about 26% ownership at the bankruptcy exit. The fire victims’ trust plans to sell its stake over time but had not sold any shares as of late 2021. It is expected that PG&E to maintain investment-grade credit ratings. Also, it is expected consolidated EBITDA/interest coverage will remain near 5 times on a normalized basis. State legislation in 2019 will help mitigate some of PG&E’s fire-related risks and support investment-grade credit ratings. Bankruptcy settlements with fire victims, insurance companies, and municipalities totalled $25.5 billion, of which about $19 billion was paid in cash upon exit. PG&E entered bankruptcy after a sharp stock price drop in late 2018 made new equity prohibitively expensive and the company was unable to maintain its 52% required equity capitalization. It is estimated that PG&E will invest up to $8 billion annually during the next few years. Tax benefits and regulatory asset recovery should eliminate any equity needs at least through 2023. It is also estimated that PG&E’s bankruptcy exit plan restricts it from paying a dividend until late 2023. Before PG&E cut its dividend in late 2017, the anticipated 6% annual dividend growth, in line with earnings growth. In May 2016, PG&E’s board approved the first dividend increase since the 2010 San Bruno gas pipeline explosion.

Bulls Say’s

  • California’s core rate regulation is among the most constructive in the U.S. with usage-decoupled revenue, annual rate true-up adjustments, and forward-looking rate setting.
  • Regulators continue to support the company’s investments in grid modernization, electric vehicles, and renewable energy to meet the state’s progressive energy policies.
  • State legislation passed in August 2018 and mid-2019 should help limit shareholder losses if PG&E faces another round of wildfire liability.

Company Profile 

PG&E is a holding company whose main subsidiary is Pacific Gas and Electric, a regulated utility operating in Central and Northern California that serves 5.3 million electricity customers and 4.4 million gas customers in 47 of the state’s 58 counties. PG&E operated under bankruptcy court supervision between January 2019 and June 2020. In 2004, PG&E sold its unregulated assets as part of an earlier post-bankruptcy reorganization.

 (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

Normalizing Capital Markets Revenue Is a Theme for Goldman Sachs and Other Investment Banks

Stock market digital graph chart on LED display concept. A large display of daily stock market price and quotation. Indicator financial forex trade education background.

Business Strategy and Outlook

Goldman Sachs is already making progress on the strategic plan that it laid out at the beginning of 2020. The company’s financial targets include a return on equity greater than 13% and a return on tangible equity greater than 14%. COVID-19 boosted revenue in 2020 and 2021 with high trading caused by economic uncertainty and companies issuing debt and equity to initially bolster capital and then later issuing debt and equity to take advantage of low interest rates and a strong stock market. Over the next five years, Morningstar analyst model Goldman Sachs achieving a normalized return on equity of around 12% and a return on tangible common equity of 13%.

Given Morningstar analyst forecast, Goldman Sachs should trade at about 1.4-times tangible book value. Its investment management business has become a priority. Assets under supervision exceeded $2.1 trillion at the end of 2020, while related investment management fees have exceeded 15% of net revenue compared with 11%-12% before 2008. Investment management is a relatively stable, higher return-on-capital business that is well suited to the current regulatory environment. Goldman has also built out a large virtual bank and had deposits of $260 billion at the end of 2020 compared with $39 billion in 2009. The deposit base and related net interest income will add more stability to the company’s revenue stream and balance sheet.

Normalizing Capital Markets Revenue Is a Theme for Goldman Sachs and Other Investment Banks

Goldman Sachs’ revenue remained relatively strong in the fourth quarter of 2021, but expenses, including compensation, seemed to be a bit higher than expected. The company reported net income to common shareholders of $3.8 billion, or $10.81 per diluted share, on $12.6 billion of net revenue. Net revenue of $12.6 billion in the fourth quarter was about 13% higher than the company’s 2020 quarterly average and 45% higher than its 2017 to 2019 quarterly average and cemented 2021 as a year of record revenue totaling $59 billion. Return on tangible equity was a very healthy 16.4% in the quarter and 24.3% for the year. With all that said, the fourth quarter’s revenue and net earnings were also the lowest of 2021 and determining a more normal level of revenue for the company will be primary theme for Goldman Sachs and other investment banks in 2022 and 2023. We don’t anticipate making a significant change to our $356 fair value estimate for narrow-moat Goldman Sachs.The recent record revenue at Goldman Sachs can roughly be broken down into two parts: more volatile capital markets-related and steadier client asset-based. The more capital markets-related revenue (such as underwriting, institutional trading, and equity investment gains) are over 70% of net revenue and contributed about $19 billion of the $23 billion of net revenue growth at the company since 2019, according to Morningstar analyst calculations. 

Bulls Say 

  • More-stable investment management and net interest income could cause investors to reassess Goldman’s earnings quality and increase their willingness to pay a premium for it. 
  • The company has a record of success with higher-volume, lower-margin businesses, and this capability could prove useful in adapting to over-the-counter derivatives reform and changes in fixed-income trading. 
  •  Several of the company’s primary U.S. and European competitors have been forced to restructure, which could give Goldman an opportunity to gain market share

Company Profile

The Goldman Sachs Group, Inc. is a leading global financial institution that delivers a broad range of financial services across investment banking, securities, investment management and consumer banking to a large and diversified client base that includes corporations, financial institutions, governments and individuals. Founded in 1869, the firm is headquartered in New York and maintains offices in all major financial centers around the world.

 (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

Robeco QI Global Conservative Equities I: A strong option for investors looking for downside protection

Process:

The strategy’s robust foundation, high repeatability, discipline, and consistent execution remain attractive features. The team’s relentless efforts to implement new elements to the process, these also make the approach more complex and have led to a slight change of portfolio characteristics, which is appreciated. This rules-based, quantitative process is built on extensive academic research demonstrating that investing in low-risk stocks leads to better risk-adjusted returns. After an initial liquidity filter, Robeco’s quant model ranks the 4,500-stock universe on a multidimensional risk factor (volatility, beta, and distress metrics), combined with value, quality, sentiment and momentum factors. In recent years, the team has introduced several enhancements to refine the model, including short-term momentum-driven signals that can adjust a stock’s ranking up or down by maximum 10 percentage points. This should prioritize buy decisions for stocks that rank high in the model and score well on short term signals, and vice versa. Since 2020 the team also allows liquid mega-caps to have a higher weight in the portfolio. Top-quintile stocks are typically included in an optimisation algorithm that considers liquidity, market cap, and 10-percentage-point country and sector limits relative to the MSCI World Index. A 200-300 stock portfolio is constructed with better ESG and carbon footprints than the index, while rebalancing takes place monthly, generating modest annual turnover of about 25%. Stocks are sold when ranking in the bottom 40% of the model. 

Portfolio:

The defensive nature of the strategy currently translates into a higher allocation to low-beta and high yielding stocks in the consumer staples and communication services sectors, while industrials, energy and technology stocks are a large underweight. The valuation factors embedded in the model have steered the fund clear from MSCI ACWI index heavyweights Amazon.com AMZN, Tesla TSLA, and NVIDIA NVDA, while Microsoft MSFT and Apple AAPL were underweighted. Valuations make the fund lean towards European stocks while the U.S. stock market was an 8.8% underweight versus the index per November 2021. The model does like U.S. consumer defensives though, with larger positions for Proctor & Gamble PG, Walmart WMT, and Target TGT. The quant approach gives management wide latitude to invest across the market-cap spectrum, and the diversified 200- to 300-stock portfolio has long exhibited a small/mid-cap bias compared with the index.

People:

The team running this strategy is large, experienced, and stable. As such, it earns an Above Average People rating. This fund follows an entirely quant-based approach, an area where Robeco has extensive experience and expertise, and where it has invested heavily in human resources over the years. Robeco’s quant team runs various strategies: core quant equity, factor investing, and conservative equity, but there is significant interaction between them. The conservative equity team that runs this fund is led by Pim van Vliet, whose academic work has laid the foundation of the fund’s philosophy.

Performance:

This defensive strategy has generally offered good volatility reduction during turbulent markets. Robeco QI Global Conservative Equities’ C € share class absorbed 67% of the losses of the MSCI ACWI Index since inception. However, its results versus the MSCI ACWI Minimum Volatility Index have been less consistent. Disappointingly, it did not live up to its expectations in the corona-dominated markets of 2020, though the strategy’s failure can be explained by market dynamics in relation to the fund’s strategy. The portfolio lagged during the subsequent recovery that again benefited tech and ecommerce stocks, and while the value rally in the final quarter did help, cyclical value stocks that are not favoured here rallied the most.

(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:

Robeco’s quant-based conservative equities range is managed by a stable and experienced six-member team led by Pim van Vliet. They are supported by a group of 10 quantitative researchers led by David Blitz and a similarly sized group of data scientists. This credentialed team is vital to the fund’s success as it constantly refines the models used in the funds. It is also reassuring that Robeco’s broader quantitative team has successfully groomed quantitative researchers in its talent pool, allowing them to add people with complementary skills to the teams. The strategy’s academic foundation, repeatability, discipline, and consistent execution give us confidence. The rules-based, quantitative process is built on empirical research demonstrating that investing in low-risk stocks leads to better risk-adjusted returns. It goes beyond traditional low-volatility investing, combining a multidimensional risk factor with value, quality, sentiment, and momentum factors. Top-quintile-ranked stocks are included in the portfolio after running an optimisation algorithm.

(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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Daily Report Financial Markets

USA Market Outlook – 18 January 2022

USA-Market-Outlook-18-January-2022Download

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Global stocks Shares

New Oriental Education: Restructuring Impact Remains Unclear

Business Strategy and Outlook:

New Oriental Education, or EDU, is a large-scale leading provider of private tutoring in China. EDU offers a diversified portfolio of educational programs, services, and products to students in different areas. Not only does EDU offer K-12 after-school tutoring, but EDU also offers other test preparations for both overseas and domestic examinations. In non-academic fields, EDU offers adult English and other languages, and it also provides services in vocational training, such as corporate training, marketing, accounting, human resources, IT and PRC Bar. EDU has been able to raise its fees via new students or new programs to cover rising costs, driving an improving margin as utilization and operational efficiency continues to improve.

A key tenant of EDU’s strategy is to improve operational efficiency in the near term. EDU is guiding 20%-25% year-over-year growth per year for its learning center capacity for the next three years and we believe that offline classes should gradually open as the impact of the coronavirus gradually fades. Also, EDU will continue to close down underperforming centers, which also implies improving operating efficiency. EDU is aiming to raise its student retention rate to 65% from 63% in fiscal 2021.

Financial Strength:

The company’s financial status has been healthy over the past years, with a clean balance sheet and steady cash inflows. EDU has been generating net cash since 2011 with steady cash flow. However, uncertainty is expected to be ahead before the end of 2021, when businesses are required to restructure–with the estimation of 62% of their business being required to be spun off.

Bulls Say:

  • Well-established reputation and dominant position in China. 
  • Successful expansion with strong student enrolment in China should drive growth. 
  • Likely to benefits in the longer term as one of the first movers in online education known as Koolearn.com.

Company Profile:

EDU, founded in 1993, is the largest well-established one-stop shopping private educational services provider in China. EDU has had over 52.8 million student enrollments, including about 8.4 million enrollments in fiscal 2019. As of third-quarter fiscal 2020, EDU had a network of 1,416 learning centers, including 99 schools, 12 bookstores and access to a national network of online and offline bookstores through 160 third-party distributors and over 38,400 highly qualified teachers in 86 cities. EDU offers a diversified portfolio of educational programs, services and products to students in different age groups, including K-12 after-school tutoring for major academic subjects, overseas and domestic test preparations, nonacademic languages and services in vocational training, and so on.

(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

Key Catalyst For Trip.com: International Business A Hand In Recovery

Chart

Business Strategy and Outlook

Narrow-moat Trip.com competes in China’s crowded online travel agent (OTA) industry by leveraging the largest selection of both domestic and international hotels in China on its platform and relying on user stickiness as a one-stop shop for travel ticketing, accommodations, and packaged tours. The platform is now also generating revenue from advertisement in which it hopes to take 3-5% of the ad market, but nearly all its revenue streams are travel-related, and COVID-19 lockdowns in China has cratered demand due to the inability to travel or unwillingness to quarantine. 

It is anticipated 2022 to be another challenging year for the travel industry as it is valued Trip.com’s revenue to recover to only 65% of 2019 levels. The company believes it can reach long-term non-GAAP operating margins of 20-30% on the back of its international, outbound, and high-star hotel businesses given their higher monetization rates, but the lack of demand has impacted these businesses, and total international revenue has declined to less than 5% of the mix and caused operating margin to be negative. Prior to the pandemic in 2019, international revenue was 25% of the mix and non-GAAP operating margins were 19%. It is alleged that reaching its long-term margin will rely heavily on the recovery, but the pandemic has been a significant headwind and has delayed its progress. It is supposed that outbound international travel should eventually recover but visibility is still limited, and further COVID-related setbacks could add to the uncertainty and possibility that the company could fall short of its long-term outlook. 

The other key business that will drive margins is its high-star domestic hotels which generates the highest take-rate on its platform at 9-10%. Trip.com charges low rates for its budget hotels to attract new users and directs them to its high-star hotels for future bookings as its traffic acquisition strategy, where it hopes to retain users through its wide selection of hotel, ticketing, and packaged tour options. Currently, this business has already recovered to 62% of 2019 levels, and thus it is alleged that the imminent key catalyst for Trip.com will be its international business.

Financial Strength

Trip.com operates as an asset-lite company and tends to not commit heavy resources to capital expenditures other than acquisitions for its operations. As of third-quarter 2021, net debt was almost 0 as Trip.com had nearly identical CNY 57.414 billion of debt against CNY 57.411 of cash and investments. Short-term liquidity is also safe with a quick ratio of over 1 time which should reflect some margin of safety and is representative of Trip.com’s financial strength. Trip.com has CNY 45 billion of short-term debt due, and should COVID-19 headwinds continue, it is seen the company issue debt in order to cover short-term expenses to navigate through COVID-19 but given history of low net debt and 15%-20% EBITDA margin, it is not expected to be an issue. The online travel business is not capital-intensive and has historically generated positive free cash flows. The exceptions to Trip.com was mostly due to acquisitions and capitalized operating expenses. In 2014, negative free cash flow for Trip.com was mainly due to its large investment in fixed assets of CNY 4.8 billion, mostly due to its new office building of CNY 3 billion. In 2016, negative free cash flow was mainly due to the merger with Qunar, and Trip.com returned to free cash flow positive from 2017 to 2019. It is projected cash flow to be negative in 2021 due to COVID-19 but should be positive in 2022 even as revenue recover to only 65% of 2019 levels as given in our base-case scenario.

 Bulls Say’s

  • The company can eventually reach its 20%-30% long-term operating margin target as COVID-19 subsides.
  • International and outbound business will eventually recover and drive margins upwards. Margin expansion will be dictated by its higher-margin businesses, including international air and hotels. 
  • The industry will see less competition in the future than before due to current headwinds faced, and thus lesser disruptions to its long-term business plan.

Company Profile 

Trip.com is the largest online travel agent in China and is positioned to benefit from the country’s rising demand for higher-margin outbound travel as passport penetration is only 12% in China. The company generated about 78% of sales from accommodation reservations and transportation ticketing in 2020. The rest of revenue comes from package tours and corporate travel. Prior to the pandemic in 2019, the company generated 25% of revenue from international business, which is important to its margin expansion. Most of sales come from websites and mobile platforms, while the rest come from call centers. The competes in a crowded OTA industry in China, including Meituan, Alibaba-backed Fliggy, Toncheng, and Qunar. The company was founded in 1999 and listed on the Nasdaq in December 2003. 

(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

Robust balance sheet and ample liquidity support Pilgrim’s Pride Corp endure market volatility

Business Strategy and Outlook

Although Pilgrim’s Pride is the second-largest poultry producer in the countries in which it operates, we don’t believe it has carved out an edge. About 70% of Pilgrim’s products are undifferentiated and therefore have difficulty commanding price premiums and higher returns. Further, its profit margins can be quite volatile, as several factors outside the firm’s control affect costs (weather, flock disease, global trade). Prices of feed ingredients can be quite volatile, surging in 2008 and leading to Pilgrim’s bankruptcy. Since then, the industry has moved to new pricing strategies, which are helping protect the processors from revenue/cost mismatches. However, despite Pilgrim’s size, we don’t believe this affords it a scale cost advantage, underpinning our no-moat rating. 

In August, JBS, which owns 80% of Pilgrim’s, proposed to buy the remaining 20% for $26.50 per share. The board is reviewing the deal, and if approved, it will be put to a shareholder vote (excluding JBS). The offer appears light, at a 20% discount to our $34 fair value estimate and at 6.5 times adjusted EBITDA, compared with the 9.1 times for which Sanderson Farms was acquired one week prior to the offer. 

As 50% of Pilgrim’s sales stem from food service, the pandemic impaired sales and margins in 2020; organic sales were down 2.4%, and adjusted operating margins fell 240 basis points to 3.7%. But trends are recovering as vaccines become more widely available, and we expect no lasting effects. We are optimistic on the long-term global demand for chicken, as developed market consumers have been shifting consumption of red meat toward poultry, and in emerging markets, a growing middle class is driving higher per capita consumption of protein. Pilgrim’s should benefit from strong demand in China, as the country eliminated its ban on U.S. chicken in late 2019. Further, China has a shortage of protein after a 2019 outbreak of African swine fever resulted in a 40% reduction in the country’s hog population. The disease is still not fully contained, so this supply shortage should support global protein prices once the pandemic subsides and should result in strong export demand.

Financial Strength

Pilgrim’s strong balance sheet (net debt/adjusted EBITDA at a very manageable 2.2 times as of September 2021) and sufficient liquidity ($1.5 billion cash on hand and available cash through its credit facilities) should help the firm withstand market volatility. Pilgrim’s has no debt maturities until 2023, does not pay a dividend, and has sufficient liquidity and debt capacity to fund $400 million in annual capital expenditures. Even beyond the pandemic, the business is inherently cyclical with many factors outside management’s control, but we applaud changes that have improved the predictability of earnings. Chicken pricing contracts now link costs and prices. In addition, Pilgrim’s now maintains diversified exposure to fresh chicken across large, tray pack, and small bird segments, which helps stabilize margins. The firm also maintains geographical diversification, with 62% of 2020 revenue from the U.S., 27% from Europe, and 11% from Mexico. The firm has stated its optimal net debt/adjusted EBITDA range is 2-3 times, which we think is manageable, but we wouldn’t want it to move above that range on a sustained basis, given the unpredictable nature of profits despite improvements. We think it’s likely that over the next few years Pilgrim’s will make acquisitions that we have not modelled, we don’t think leverage will exceed its 2-3 times target over an extended horizon. However, given the unpredictable size, timing, and characteristics, we have opted instead to model excess cash flow being allocated to special dividends beginning in 2026, as the company prefers this approach instead of regular dividends and share repurchases are constrained by limited float. We model dividends beginning at $2.17 per share in 2026 and gradually increasing to $2.86 per share throughout our explicit forecast.

Bulls Say’s

  • The global protein shortage resulting from China’s African swine fever outbreak should support global protein prices, which should stabilize and enhance Pilgrim’s profit margins. 
  • Pilgrim’s has an opportunity to unlock value through structurally boosting the profits of its European operations by applying best practices from the U.S. and Mexico and using its key customer strategy to change the producer/customer dynamic. 
  • In November 2019, China eliminated its ban on imports of U.S. poultry, which should help boost Pilgrim’s exports.

Company Profile 

Pilgrim’s Pride is the second-largest poultry producer in the U.S. (62% of 2020 sales), Europe (27%), and Mexico (11%). The 2019 purchase of Tulip, the U.K.’s largest hog producer, marks the firm’s entrance into the pork market, which represented 11% of 2020 sales. Pilgrim’s sells its protein to chain restaurants, food processors, and retail chains under brand names Pilgrim’s, Country Pride, Gold’n Plump, and Just Bare. Channel exposure is split evenly between retail and food service, with most of the food-service revenue coming from quick-service restaurants. JBS owns 80% of Pilgrim’s outstanding shares.

(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

Challenging Scenario of Omicron, weak produce and Labour Scarcity create obstacles for Lamb Weston

Business Strategy and Outlook

Lamb Weston, the largest provider of frozen potatoes to North American restaurants, has secured a narrow moat, based on the firm’s cost advantages and entrenched restaurant relationships. The North American commercial potato market is highly concentrated with only four players: Lamb Weston (42%-43% share), McCain (30%), Simplot (20%), and Cavendish (7%-8%). Lamb Weston and Simplot both secure their raw potatoes solely from the Idaho and Columbia Basin region, an area ideally suited for growing potatoes, with very high yields. These firms secure potatoes at a cost 10% to 20% below the average price per pound. There is minimal unused land and water resources in this fertile area, so it is expected this advantage to hold for at least the next 10 years. Further, as the dominant player, Lamb Weston maintains a scale advantage. Given the high fixed costs in this capital-intensive industry, scale benefits are meaningful. Lamb Weston’s long-standing strategic partnerships with its customers provide another facet of the firm’s competitive edge. French fries are the most profitable food product for restaurants, and a key menu item. 

Lamb Weston is facing many headwinds that will dampen its earnings near term, but its long-term prospects should remain intact. The omicron variant will cause the traffic recovery in full-service restaurants (19% of sales) to pause, but consolidated sales should return to prepandemic levels in fiscal 2022, given resilience in quick-serve restaurants (58%) and retail (16%). Inflation, shortages, and a poor-quality potato crop should impair margins the next several quarters, but profitability should be fully restored by fiscal 2024. 

French fries are an attractive category, as consumers across the globe are increasing consumption, with volumes up low single digits in developed markets and up mid to high single digits in emerging markets. Lamb Weston is investing in additional capacity in China and the U.S. to meet this growing demand. While capacity utilization was uncharacteristically low during the pandemic, as herd immunity increases, French fry demand should recover, absorbing additional supply.

Financial Strength

When Lamb Weston separated from Conagra in November 2016, the firm initially reported net debt to adjusted EBITDA of 3.7 times, but leverage fell to 3.0 times last year (even considering the impact from the pandemic), and it will moderate to a very manageable 2.1 times by fiscal 2024. In addition, it can be guaranteed about the Lamb Weston’s ability to service its debt, with interest coverage (GAAP EBITDA/interest expense) averaging 7 times the past three years, and our forecast calling for a 8 times average over the next five years. As Lamb Weston’s business is capital intensive, the primary use of cash is capital expenditures, which averaged 9% of sales the three years before the pandemic, as the firm expanded capacity to meet strong customer demand. The industry began to operate at a more level utilization rate (mid-90s expected even before the pandemic hit in 2020, after 100% experienced the previous two years) causing capital expenditures to moderate to 4%-5% of sales during the pandemic. Investments should increase to 11% and 17% of sales in 2022 and 2023, respectively, as Lamb Weston expands capacity in China and the U.S. and range from 5.5% to 6.0% over the remainder of the decade. Dividends should be another significant use of cash, and It is expected for dividends to increase at a high-single-digit rate annually, generally maintaining a long-term pay-out ratio in the low-30%s, in line with management’s target. Lamb Weston has made a few small tuck-in international acquisitions in recent years, and is suspected that this may continue, but analyst have not modelled future unannounced tie-ups, given the uncertain timing and magnitude of such transactions. Instead, Analyst have opted to model excess cash being used for share repurchase, which is viewed as a prudent use of cash when shares trade below our assessment of its intrinsic value.

Bulls Say’s

  • Lamb Weston’s geographical and scale-based cost advantages should help ensure the firm remains a dominant player in the industry. 
  • Lamb Weston is a valued supplier of restaurants’ most profitable food product, and restaurants are hesitant to switch so as not to disrupt supply and quality. 
  • French fries are an attractive category, as per capita consumption is increasing in both developed and developing markets.

Company Profile 

Lamb Weston is the world’s second-largest producer of branded and private-label frozen potato products, such as French fries, sweet potato fries, tots, diced potatoes, mashed potatoes, hash browns, and chips. The company also has a small appetizer business that produces onion rings, mozzarella sticks, and cheese curds. Including joint ventures, 52% of fiscal 2021 revenue was U.S.-based, with the remainder stemming from Europe, Canada, Japan, China, Korea, Mexico, and several other countries. Lamb Weston’s customer mix is 58% quick-serve restaurants, 19% full-service restaurants, 8% other food service (hotels, commercial cafeterias, arenas, schools), and 16% retail. Lamb Weston became an independent company in 2016 when it was spun off from Conagra.

(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.