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 II of this edition, Katana Asset Management's co-founder Romano Sala Tenna, reveals the ASX shares poised for outperformance in 2022.
MF: What ASX sectors are looking promising to you in the year ahead?
RST: There are a few sectors that look strong.
First, financials, on the back of inflation and the expected increase in interest rates. Provided the interest rates don't turn up so aggressively that you start to see an increase in bad and doubtful debts. But the early stages in recovering interest rates are generally good for financials. They can extract more margin from their book. And the front and back book become more aligned.
The other big thematics are decarbonisation and electrification, which are really 2 sides of the same coin. There's no bigger opportunity in the market at the moment. But it can be hard to play these thematics in Australia, because we don't have world leading technologies. So we've had to restrict ourselves to EV metals such as nickel, copper and lithium. I think that's the best way in Australia to play those 2 themes.
Then, on the opposite end of the spectrum from EVs, is the energy market. I think the energy market was sold down very aggressively over a short period of time. We're now starting to see good value opportunities in the energy market, even though the headwinds are there.
We're starting to see Woodside Petroleum Ltd (ASX: WPL) trade on a single digit PER [price-earnings ratio], with LNG at record prices. That's giving them some very large cash flow from current spot cargoes. The oil price is around US$80 per barrel. We think the outlook for Woodside is very good. It's been heavily sold down on the back of the ESG thematic.
We're capable and comfortable to look at both ends. The EV thematic is clearly macro driven. Energy is very much a value driven opportunity.
MF: Which ASX shares look well positioned for the EV thematic?
RST: In the lithium space, Mineral Resources Ltd (ASX: MIN) is our largest holding. We've had other positions, such as Pilbara Minerals Ltd (ASX: PLS), which we've now taken some profit on.
Mineral Resources will be the largest lithium spodumene producer in the country once they restart Wodgina and get it up to full production. At the moment it's on care and maintenance. They just announced they're in the process of getting their first train back online by the third quarter of next year. They've built 3 lines already, which should produce about 750,000 tonnes per annum when fully operational.
They've also got the joint venture with Albemarle, which enables them to do downstream production as well. So we'll see them in the hydroxide space in the future, with up to 40,000 tonnes per annum.
In terms of what the market's attributing to that value, you're pretty much buying the entire Mineral Resources asset, including all their iron ore production, all their mining services division, plus other cash and miscellaneous assets for about the same price you're paying just for Pilbara, which is quite an extraordinary state of affairs.
A $7.2 billion market cap on Pilbara and a $7.7 billion market cap on Mineral Resources, and they're the largest contract crushing company in the world. It does seem to be quite a disconnect.
MF: You also mentioned nickel and copper. Do any ASX shares stand out in that space?
RST: The nickel space is very hard to play. We have some limited exposure through IGO Ltd (ASX: IGO) and Western Areas Ltd (ASX: WSA). But not with any particular conviction.
As for copper, there are really 4 listed copper players on the ASX. We've chosen to play it through Oz Minerals Ltd (ASX: OZL) and Aeris Resources Ltd (ASX: AIS).
Oz Minerals is probably the tier-1, dedicated copper asset in the Australian landscape. And Aeris, on a valuation basis, is on 3.5 to 4 times earnings. Aeris also has some very good hits coming out of its Constellation deposit. We think that's setting them up for an extension in mine life of 10 plus years.
MF: Which sectors are you likely to avoid?
RST: We're very cautious on concept tech versus real tech.
We love some of the real technology that's coming through with real revenue, real profitability, good rates of growth and the likes. That makes sense.
But there's a lot of concept tech out there that I think is going to get caught out. As your bond yields turn up the discounted rate of return increases. When you start modelling some of these earnings 5 to 10 years out in today's dollar terms, they don't stack up. So I think a lot of the concept tech is going to come under pressure.
Also, with interest rates turning up as our base case, the infrastructure space could come under pressure.
Infrastructure stocks are often seen as a bond proxy; you buy them instead of buying bonds. As bond yields increase, infrastructure stocks are going to become less attractive. Even more importantly, a lot of these funds are heavily geared. As interest rates turn up, it will have a material impact on their bottom line and there's no way to hide that impact on those earnings.
Some REITs [real estate investment trusts] fall into that same space. But you can be discerning.
A share like Unibail-Rodamco-Westfield (ASX: URW), for example, is one of our larger holdings. We think that has a hard NTA [net tangible assets] backing at around $13 per share and it's trading just over $5 per share.
As shopping centres across Europe and the US open up, we think URW will start to get some more attention. They own 18 of the top 30 shopping centres in Europe. These are tier-1 assets. They're slowly repairing their balance sheet. As we start to see more interest coming to the reopening trade off shore, in Europe and the US, I think we'll start to see Unibail-Rodamco gain greater interest in the market place.
MF: If the market closed tomorrow for 5 years, which ASX share would you want to hold?
RST: It's a company I already mentioned, and that's Mineral Resources.
We've been an investor in Mineral Resources for about as long as our fund has been around. We've scaled our weighting up and down, but we're an ultra long-term shareholder.
Back in 2006 when the company listed, it had an EBITDA – earnings before interest, taxes, depreciation and amortisation – of about $38 million. Fast forward to 2021 and their EBITDA has grown to $1.9 billion. Now that is a peak earnings EBITDA based on a very high iron ore price. But through the cycle we think their EBITDA is somewhere north of $1billion for the business.
When you look at that, north of $1billion of sustainable levels of earnings versus $38 million in 2006, you can see the long-term trajectory that business has been on.
Over the last 3 years, it's averaged a return on equity north of 20%. There are very few companies in the Australian landscape that can boast that. And we think they've set themselves up once again for the next level of growth.
They're going to be volatile because of the cyclicality of their underlying earnings, being iron ore, lithium and mining services. But in 5 years' time, we expect them to be generating substantially more than they are today.
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If you missed part I of our interview with Romano Sala Tenna, you can find that here.
(To learn more about the Katana Australian Equity Fund, click here.)
