Ask A Fund Manager
The Motley Fool chats with fund managers so that you can get an insight into how the professionals think. In part 1 of our interview, 1851 Capital portfolio manager Martin Hickson tells us the telecommunications company that gets paid to build its products, then milks 40 years of recurring revenue out of it.
Investment style
The Motley Fool: Why is your fund called 1851?
Martin Hickson: Good question. 1851 was a pivotal year in Australian history. The gold rush had kicked off. Over the next decade, the population doubled.
It was a year that things started growing, and Australia became the country that it is today, with those gold rushes. We wanted a number in the name, and it seemed as good as any number to pick.
MF: What's the fund's investment strategy?
MH: We're a small micro-cap focused fund manager. So, ex-[ASX] 100 universe, we'll invest all the way down to $50 million market cap.
In that range, there are around 900 stocks on the ASX. We don't invest in resource companies — it's not our expertise or area of focus. And again, we don't really invest in the biotech space. Given we're not doctors, it's hard to work out whether a phase 2 or 3 trial result will be positive or negative. It's a binary outcome.
So we focus on those industrial style companies. So if you strip out resources and biotechs, there are about 650 stocks in our investable universe.
To describe our philosophy in a sentence, we're growth investors with a value overlay. What does that mean? It means we're looking for companies with strong earnings growth, but that are trading on attractive valuations. So to put some numbers around that, our current portfolio is trading at a 10% cheaper valuation versus the index — around 19 times price-to-earnings ratio versus the index at 21 times.
However, it has 4 times the level of earnings growth compared to the index. So that shows that we're finding those cheap companies that are growing strongly, with an event that's going to re-rate the share price.
That's us in a nutshell. We are restricting the size of the fund. It's our belief that, particularly in the smaller micro-cap end of the market, the bigger you get, the harder it is to outperform. So we've said numerous times now that, once we reach $300 million, which we expect to occur imminently, we'll put out a final call to investors, before soft-closing the fund.
MF: How concentrated is the portfolio?
MH: We're pretty diversified. We'll hold between 30 and 80 stocks.
At the moment we're at the upper end of that range, so around 75 stocks. We like having a diversified portfolio for 2 reasons. One, it helps with liquidity. So by having the funds, the remainder of the equity spread over a number of companies, means that liquidity is improved. It's easy to get into and out of them, as opposed to having a very concentrated portfolio.
And also just for risk metrics, it helps us sleep at night, knowing that we haven't got 10% or 15% of the fund within one stock. The largest holding in the fund at the moment is Uniti Group Ltd (ASX: UWL) — that represents 5% of the portfolio. And the top 5 stocks at the moment are 18% or 19% of the funds under management.
MF: To give our readers an idea, what are your two biggest holdings?
MH: Uniti, as I mentioned, is the largest position in the fund. It operates in the telecommunication space, run by [chief executive] Mick Simmons and [executive director] Vaughan Bowen, both ex M2 Telecommunications. They built up that business over a number of years. Mick was also at TPG in the older days — so both proven operators.
Uniti, what do they do effectively? They're a competitor to the NBN, focused on new broad-acre housing estates. In the growth corridors of Sydney — Oran Park as an example — what they do is, they will help the developer. When the developer might have a new housing estate, where they're rolling out 5,000 new homes over a 5 to 10 year period, Uniti will lay the dark fibre to allow those homes to connect to the internet.
They get paid by the developer to install that fibre, and then once someone moves into the home, they then sell access to that fibre to an ISP or an internet service provider, like Telstra Corporation Ltd (ASX: TLS) or iiNet.
Effectively, they are building a recurring revenue stream, with an infrastructure-style earning stream, which will generate income for the next 30 or 40 years by selling access to that fibre. But they're also being paid by the developer to install it. So they're building long-term assets and someone else's funding that build-up for them.
That's why we like it… We also think that there's a potential for earnings upgrades over the next couple of years, as they prove out that model.
Definitely over time too, there's potential for Uniti to become a takeover candidate themselves. They acquired OptiComm Ltd last year — that was a competitive process. There was a large super fund, Aware Super, also vying for control of OptiComm. Uniti won out.
More recently, we've seen Vocus Group Ltd (ASX: VOC) get taken over by Macquarie Group Ltd (ASX: MQG). So we get that there is corporate appeal in this space. 90% of [Uniti's] earnings are recurring — so high-quality renewable stream — and that's why it's recently into the ASX 200 as well.
MF: What's the second-biggest holding?
MH: Second largest is Capitol Health Ltd (ASX: CAJ). They're a radiology company, Victorian-focused — 80% of their revenue comes from Victoria.
New CEO, Justin Walters, joined around 18 months ago. He's taken costs out of the business, made the business more efficient. We're also going through a period where they've delivered strong revenue growth despite the lockdown in Victoria. So they've got positive draws, costs have come down, revenue's gone up, that's led to a large increase in their profit margins… They've got a very strong balance sheet and a very minimal amount of debt. So that provides them with a capacity to make creative acquisitions.
The company trades on EV-to-EBITDA multiple of 9 times. The largest peer, which is Integral Diagnostics Ltd (ASX: IDX), trades on 11 times. And then there's been private takeovers or transactions done at 13 times. Capitol is trading at a significant discount to those private transactions on IDX.
So we think it's very, very cheap. Again, we think that over time it could become a potential candidate for one of these private companies, given that it's trading on such a depressed multiple.
Do these shares tempt you?
MF: These are the 5 most-searched shares at the moment. Would you buy or ignore each of these? MoneyMe Ltd (ASX: MME), Cettire Ltd (ASX: CTT), Nuix Limited (ASX: NXL), iSentia Group Ltd (ASX: ISD), Patrys Limited (ASX: PAB)?
MH: To be honest, we don't own any of them… We would ignore [all five].
I mean, putting them all in the one basket, all of those stocks trade on quite high multiples. Some of them don't make earnings at all. And those that do, are trading on significant revenue multiples. So, none of them meet our investment criteria.
iSentia obviously received a takeover a bit earlier in the week. We don't own it. We wouldn't buy it… It's not part of our investment philosophy. We don't do takeover arbitrages.
Basically, we like investing in companies that are profitable, or have a very clear path to being profitable in the short term.
Tomorrow in part 2 of our interview, Hickson reveals the ASX shares that revved up his portfolio after the COVID-19 crash.
