Finding bargains the market overlooks

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Lex Hall: Hi, I'm Lex Hall for Morningstar. Today, I'm joined by Jamie Nicol. He is the chief investment officer at DNR Capital up in Queensland. His fund, the Australian High Conviction Equities Fund, has just been awarded a special mention by Money Management and we like it at Morningstar, too. It's rated Silver. So, I thought I'd check in with Jamie to see why the strategy has done so well.

G’day, Jamie.

Jamie Nicol: G’day. How are you?

Hall: I'm well. Thanks. Now, you guys have a maximum number of holdings of about 30 stocks and you have an alpha target of about 4 per cent over rolling three-year periods. That's a relatively aggressive target. What's the sort of secret, if you like, to reaching that?

Nicol: I think it's having a strong focus. We like to focus on buying quality businesses, get them when they are out of favour; and having a really reasonably concentrated portfolio of about 25 stocks. So, where we get it right, it makes a meaningful difference.

Hall: Yeah, okay. Let's look at COVID, what we're going through now and what we've gone through compared to the GFC. Because if I'm not wrong, during the GFC, you guys were underweight to resources and overweight to defensive stocks and that gave you solid downside protection. How have you approached COVID?

Nicol: Well, coming into COVID, we weren't as defensively positioned. I think one of the challenges over the past few years has been this big increase in the valuation of growth stocks and defensive stocks, and we've had a lot of uncertainty in the world: Brexit and Chinese trade wars and Trump and so forth. So, people have been willing to bid up the value of those defensive and those growth stocks. Whereas stocks with a little bit more cyclicality look a little cheaper—or a lot cheaper actually. But once you go into COVID, of course, you still don't want to be in those cyclical areas. So, it's been a balancing act between trying to find opportunities to find quality businesses with resilient structures, resilient business models that will endure through a difficult environment but without paying too much for it.

Hall: You had a really good year in 2019. The benchmark you follow is the ASX Total Return 200 I think, and you guys really—I think you returned in 2019 something like 27 per cent versus 4 per cent for the index. What picks are you sort of most proud of? What stocks really did the bulk of the work for you?

Nicol: Yeah. Look, one of the stocks that I think has done really well for us has been Domino's. When we entered that stock, it had been out of favour for a number of years. It had faced challenges with underpayments within its business, within some of the franchise where the franchises had faced pressure from higher wages, higher electricity cost and this put pressure on the whole business. They've also been undergoing sort of global expansion into Germany, France, Japan and it takes a bit of time to get traction in new markets. They've been doing a lot of work on the ground. We've done a lot of work speaking to franchises, going over to Europe, going over to Japan, seeing where they were in terms of progress in terms of building those businesses. And I think we've seen really good progress this year, particularly in Japan and Germany. COVID has helped. As people have isolated, they could still get a pizza and that's introduced the brand to a lot of new customers in those markets that have never used it before.

Hall: Well, I've certainly been a customer of Domino's during the lockdown. Another good stock for you, and you've held it for quite a while, is Treasury Wine Estates.

Nicol: Yeah. Well, that's been a little bit more mixed this year. Like, it was a stock that did—we got into it at a really good price point some years ago when it had a lot of problems and had been on the backend of a bad cycle. It was owned by Foster's and Foster's used to manage that. But as it emerged out of that, we entered the stock and it did really well. Penfolds now is the leading brand in Chinese wine and it's overtaken a lot of the French wines. And despite the very big uncertainty that exists with COVID, our discussions with people on the ground in China suggest that they've still got that leadership.

Hall: Yeah. You must have been buoyed by this week's result from Treasury.

Nicol: Yeah. It's a good sign. We saw an uplift in China, depletions of 40 per cent in June. So, people are out again in China. There's still some uncertainty but we just think it's a good brand, good business.

Hall: And finally, Jamie, what sort of cash level are you sitting on? And I suppose that's another way of asking you what you think the outlook is like.

Nicol: Yes. Yes. I mean, we probably don't go much beyond 5 per cent cash at any one time. People tend to sit on their cash outside of our portfolio. We are sitting at about 4 per cent. So, it's towards the upper end I guess of that and that's a reflection of the fact that markets have had a pretty good bounce over the past quarter. We wanted to trim some of our stocks that have done really well. And just coming into reporting season where there can be a lot of volatility, it's nice to have a bit of flexibility. We're also a little bit mindful. You've probably got the other two key areas I think that could drive volatility is the US election and discussion around vaccines. We will see some progress on vaccine over the next couple of months. That could be very good, or it could be very negative. So, it's a bit of a binary outcome I think at present.

Hall: Okay. Jamie Nicol, thanks so much for your insights today.

Nicol: Thank you.

This report appeared on 2020 Morningstar Australasia Pty Limited

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