Sohn Conference Foundation has so far raised USD 85 million for various children’s cancer charities, including many in the UK, such as: Cancer Research UK Cambridge Institute (University of Cambridge); DKMS; Great Ormond Street Hospital Children’s Charity and Royal Marsden Cancer Charity. The flagship New York event will mark its 24th year in 2019, and the global footprint keeps expanding, with events being held in Australia, Brazil, Canada, Geneva, Hong Kong, India, London, Monaco, San Francisco and Tel Aviv.
Sponsors of the event included: The Hedge Fund Journal, Greenbrook Communications; hedge fund managers Eminence Capital, Glenview Capital Management; Titan Advisors; and brokers Bank of America Merrill Lynch, Cantor Fitzgerald and Exane BNP Paribas; lawyers Akin Gump Strauss Hauer & Feld, and Morgan Lewis & Bockius; expert network firm Gerson Lehrman Group, and 100 Women in Finance.
Twelve fund managers presented one short idea, eleven long stock ideas, and one long commodity idea, all of which are listed on European exchanges. Additionally, the Sohn Idea contest winner recommended a US-listed stock.
Kier Group’s aggressive accounting
The seventh annual London event, Sohn London 2018, held on November 29th, 2018, kicked off with a short idea that proved to be remarkably prescient as the company – Kier Group – announced a rights issue within days. Vikram Kumar, who founded Kuvari Partners in 2017 after working at TT International and UBS, enumerated his concerns about Kier Group as including: the low margin nature of its contracting and construction business; aggressive accounting; misleading adjusted cashflow figures distorted by exceptional factors; stated debt understating true leverage; and overstated cash balances. He anticipates that new accounting standards, IFRS 15, will force a restatement of some historic profits, subsequent to restatements of a cash balance and some acquisition accounting.
Kumar elaborated on how “reverse factoring” of USD 185 million – which entails asking financial institutions to pay suppliers – should really be treated as debt. He suggested that, after adjustments, his view of Kier’s true net debt to EBITDA metric is many times greater than the reported figure. He interpreted the use of “Schuldschein” debt as meaning the company was struggling to access financial markets, deemed the dividend to be unsustainable, and projected 50% downside for the shares.
Twelve fund managers presented one short idea, eleven long stock ideas, and one long commodity idea, all of which are listed on European exchanges. Additionally, the Sohn Idea contest winner recommended a US-listed stock.
The seventh annual London event, Sohn London 2018, held on November 29th, 2018, kicked off with a short idea that proved to be remarkably prescient as the company – Kier Group – announced a rights issue within days. Vikram Kumar, who founded Kuvari Partners in 2017 after working at TT International and UBS, enumerated his concerns about Kier Group as including: the low margin nature of its contracting and construction business; aggressive accounting; misleading adjusted cashflow figures distorted by exceptional factors; stated debt understating true leverage; and overstated cash balances. He anticipates that new accounting standards, IFRS 15, will force a restatement of some historic profits, subsequent to restatements of a cash balance and some acquisition accounting.
Kumar elaborated on how “reverse factoring” of USD 185 million – which entails asking financial institutions to pay suppliers – should really be treated as debt. He suggested that, after adjustments, his view of Kier’s true net debt to EBITDA metric is many times greater than the reported figure. He interpreted the use of “Schuldschein” debt as meaning the company was struggling to access financial markets, deemed the dividend to be unsustainable, and projected 50% downside for the shares.
Maxime Franzetti, CIO of Public Equities, is a founder member of Mubadala Capital Investment company’s concentrated long/short equity strategy. His largest position is currently Europe’s biggest nursing homes operator, Korian, which has 76,000 beds across facilities. It is a secular growth story driven by ageing populations, set to be accelerated by governments’ needs to promote private provision. He anticipates that the company can grow revenues by 6% per year from a mixture of volume and pricing. New management brought in two years ago have restructured the business. Valuation is also attractive: half of Korian’s market cap is accounted for by its real estate holdings, the firm trades at a discount to peer Orpea, and reportedly received unsolicited offers from KKR in 2018.
Luke Newman of Janus Henderson made the case for another stock operating in a structural growth market: Rolls Royce. Passenger kilometres travelled are growing at 6% per year, which means 425 new wide body planes are needed every year. The wide-bodied engine market is now a duopoly with GE the other player, which also bodes well for pricing power.
Aftermarket engine servicing – which is more lucrative than engine sales – generates 20 years of earnings visibility and now makes up the majority of Rolls Royce revenues. The firm has become a net cash generator thanks partly to cost cutting, and is targeting EBITDA margins of 16%. Historical analysis shows that free cash flow (FCF) per share predicts the share price. Executives are incentivised to generate FCF and Newman’s most positive scenario for FCF, FCF yields and discount rates results in 300% share price upside out to 2023.
Incidentally, Rolls Royce has been tipped at least twice before at Sohn conferences: by Selvan Masil of Westray Capital Management at Sohn London in 2015, and by Eashwar Krishnan of Tybourne Capital at Sohn Hong Kong in 2017.
The Sohn Idea contest was won by Nelson Dong, a class of 2019 student at The University of Pennsylvania Wharton School. Dong likes Insurance Auto Auctions (IAA)’s business model of bridging the gap between insurance companies and buyers who rebuild or recycle salvaged cars, because people are driving more and having more accidents, partly due to texting and mobile phone use while driving. He thinks it is recession proof because consumers will substitute used cars for new ones in a recession; indeed, IAA generated better volumes and pricing during the 2007-2008 crisis. Trump’s steel and aluminium tariffs are already increasing scrap values in the US, too. Dong is excited by KAR’s spinoff of IAA, which trades at a discount to co-duopoly competitor, Copart, and estimates 40% share price upside for IAA. Dong further expects IAA could improve its capital allocation by deleveraging and buying out leases on auction sites. Additionally, he envisages that IAA could get re-rated if it expands overseas into neglected markets such as Germany, which offer better growth prospects than the relatively mature US market.
At the opposite end of the auto pricing spectrum, Canada Pension Plan Investment Board (CPPIB) investment manager, Dureka Carrasquillo, has identified another growth market: luxury cars, which is worth $517 billion a year and is growing at 8% a year. She thinks that luxury car marker Ferrari can expand its profit margins by increasing the proportion of higher margin special cars in its product mix, rolling out new special cars, and also by simply increasing prices. These could expand EBITDA margins to 38% from 33%. Ferrari has been disciplined about managing supply by producing an average of 9,000 cars per year, well below its capacity of 16,000, and thus creates additional scarcity. Carrasquillo envisages millennial millionaires as being a key growth driver and points out that Ferrari has virtually no exposure to China so far. To tap into increased demand for electric vehicles, Ferrari is increasing its share of hybrid vehicles to 60% by 2022. She argues that valuing Ferrari in line with a peer group on PE ratios of 27 would imply 60% share price upside.
Lansdowne’s Per Lekander holds the conviction that new legislation could be transformative for the European Emissions Trading Scheme that began in 2005. Carbon prices have already quadrupled from the lows, and he sees more upside as comprehensive reforms reduce surpluses from 15 to two years’ inventory. A sea change could flip the market from years of structural oversupply to a very tight situation, almost overnight. Lekander expects the new rules could reduce emissions by as much as 120 million tonnes, with incentives to switch from coal to gas adding to the story. This investment also serves a wider social purpose of transitioning to a low carbon economy and addressing global warming – arguably the deepest problem confronting humanity.
J O Hambro Capital Management’s Rachel Reutter is of the opinion that equities are generally overvalued. This means she is sitting on dry powder in the form of cash, but is selectively finding value. Like Rolls Royce, Smiths Group makes over half of its revenues in the after-market, and has a diverse suite of products in medical, terrorism, airport scanning, energy, LNG and infrastructure segments. In 80% of these divisions Smiths is the market leader. The firm has a 78% market share in certain high-end steel products and its medical offering, Inclusion Systems, taps into a chronic shortage. The firm also has a strong balance sheet and cash generation. Management are incentivised to grow cash flows and improve return on capital invested. The firm generates free cash flow, pays a decent dividend, and a sum of parts valuation suggests 50% share price upside.
In contrast to the other long ideas based on growth stories, Albert Bridge’s Andrew Dickson (who has featured in The Hedge Fund Journal’s ‘Tomorrow’s Titans’ report in association with EY) has found value in a stock expected to see declining revenues, but which can cut costs even faster and thereby expand profits. Beyond this it can slow the pace of revenue decline by making IT systems more relevant to clients. Microfocus, which was founded in 1976, acquires and manages legacy enterprise computer systems. The shares had been ten-baggers from their flotation in 2005 to their recent share price peak in late 2017. Profits warnings in 2018 resulted in a peak to trough pullback of around 50%, but Dickson is confident that the firm can recover, partly by expanding margins on its latest acquisition – Hewlett Packard Enterprises, bought for $8.8 billion. If Microfocus can repeat its historical trick of doubling margins, its valuation might be as low as a PE ratio of 7 times with a 15% free cash flow yield – and the stock previously traded on a PE of around 15 times.
Schroders’ Andy Brough has been managing money for 30 years and is currently seeking value in domestically-oriented UK companies that have sold off on fears of a Brexit-related recession.
One of them is retailer, Sports Direct, which operates in a structurally attractive segment of retailing: sports apparel, where gross margins above 40% are relatively high. Sports Direct has historically been a roller coaster ride for shareholders, ranging between 35p and 850p. Founder, Mike Ashley, who recently added to his holding, has been adept at timing his buys and sells of the stock, which Brough views as deeply undervalued. Brough contends that Sports Direct has some of the most prudent accounts in the FTSE 350, for instance in writing down inventories immediately. Brough also expects that Ashley could continue to improve performance at acquisitions such as House of Fraser. He expects that the stock could one day re-attain its former peaks, tripling within a few years.
The UK’s largest airport and station restaurant concessions operator, Restaurant Group, has been hammered after a rights issue to fund its purchase of Wagamama, but on a three-year view Brough believes TRG is well attuned to changing consumer trends. For instances, it can rebrand some outlets as Wagamama and is using restaurants for deliveries of burgers and burritos. Yet the stock stands at a 40% discount to peers, which Brough feels will be closed over the coming years.
Bernie Akhong of UBS O’Connor (which has been profiled by The Hedge Fund Journal) has a preference for large cap stocks, offering strong free cash flow yields and high dividends. He expects a popular short amongst hedge funds – Paddy Power Betfair – could profit from the growth of sports betting in the United States, after the Professional and Amateur Sports Protection Act was invalidated by the US Supreme Court. US market growth is not only accelerating to around 7% a year but is also shifting online. Legal sports wagers in the US could reach as high as USD 5 billion a year by 2023. Paddy Power has a strong market position, being one of only four brands in New York City and also present in more competitive New Jersey, which has 43 brands. Paddy Power Betfair is at a historically low valuation and has scope to buy back 500 million of shares and boost dividends.
PrimeStone Capital’s Benoit Colas has owned Spirent Communications for three years. Spirent tests networking security, performance and interoperability of products such as mobile devices, gets 90% of its sales from the US and Asia Pacific, and boasts huge gross margins of over 65%. Colas set out a four-plank thesis for the stock. The first driver is simply cost optimisation by cutting operating, R&D, sales expenses to expand margins by 50% to the peer group level. The second catalyst could be using cash on the balance sheet to return more capital to investors through buybacks, hot on the heels of a special dividend. The third factor is refocusing and restructuring the business with potential for spinning off some units. The fourth locomotive for the company is simply organic growth, where a strong order book could be accelerated by growing concerns around cybersecurity.
Sohn watchers have no fewer than eleven events to look forward to over 2019.