September 2018 | Market Commentary
Two things are exercising our minds at the moment – how to evolve with the constantly changing times and yet how to maintain our core disciplines based around long-term investment beliefs.
One good example is how the internet and evolution of decent quality private label brands are challenging the value of inaptly named FMCG companies. Gillette for instance used to have a relatively impervious moat in the shaving category with a high market share and constant, predictable, new product innovation. But the internet has enabled competition to come from seemingly nowhere. Dollar Shave Club was launched in 2011 with the novel idea that amusing, word-of-mouth advertising and a subscription club-type model could be an interesting thorn in Gillette’s side. After a viral social media ad campaign, the business unexpectedly took off and spawned numerous competitors all seeking to do something previously thought of as impossible. Unilever ultimately bought Dollar Shave Club for an estimated US$1.0bn dollars in 2016.
In summary, as investors we need to be nimble enough with our thinking to understand and adapt to changing market structures yet anchored with an investment discipline that doesn’t see us lurching from new emerging trend to even newer emerging trend. We need to be investing in line with these shifting business dynamics and wizened enough to sift through the rubble of discarded investments looking for companies thought to be extinct, and yet whose valuations either more than reflect this or who are able to adapt and to re-emerge as strong competitors.
New opportunities in SAAS
In other areas, the internet is changing the way software is bought with Technology One, Microsoft and many other software companies moving to sell subscription of software as a service (SAAS). This creates new revenue streams for innovative businesses who can now sell their hosting services as well as their software. In the mining space the advent of driverless trucks is dramatically lowering the cost of operating mines in the Pilbara. The increase in truck sizes is enabling orebodies previously thought to be waste dumps to be re-considered and re-opened as operating mines.
Focus on Bega Cheese
We increased our weighting in Bega Cheese (BGA.ASX) which we have owned for some time as they raised capital to pay for their recent acquisition of the Koroit processing facility. Importantly Bega have been extremely adroit at deploying capital in dairy processing. Koroit is a large processing plant based in Victoria acquired by Canada’s Saputo. Koroit has a processing capacity close to 800ML of milk, making it one of the largest processing plants in the country and yet currently only processes around 300ML of milk due to the supply problems created by their former owners. At this level, the facility should earn in the order of $20m EBITDA on the acquisition price of $250m. BGA have indicated they should be able to attract additional milk supply to the tune of 400-450ML over the next year. We believe the incremental earnings on this milk supply may increase the earnings on this asset making it a very attractive investment for BGA shareholders.
Our outlook is essentially unchanged. Our view is that focusing on companies with solid cash flows and decent balance sheets will prove to be ultimately rewarding to our investors. Our Funds have performed well over most time frames and have mostly kept up with an incredible surge in investor confidence over the past year or so. If, as anticipated, the over-hyped market sectors get tested in more challenging market environments our disciplines should see our funds perform reasonably well. We will continue to apply and modify our understanding of evolving market structures and dynamics whilst remaining anchored to the core fundamental disciplines we believe will give our investors the best longer term performance.