You’re the humble finance student making your way through what I believe is one of the most challenging yet rewarding units in Commerce. But here you are, mid-semester break, and
If Range(“My_Grades”).Cells(i, j) < 0.50 Then
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So, the time has come for students to taste a dab of real life. Your finance degree is not limited to calculating the NPV, defining CET ratios, coding visual basic or the Black Scholes model. The investment group debates are all that more exciting because you get the opportunity to flex on those who have no idea whats going on outside of their textbooks (or in your case those who have not read my article).
What we’ll be posting in the next three weeks will serve to give you some tips *cough answers* on how to tackle all aspects of the stock debates.
Pilbara Minerals Limited (ASX: PLS)
Pilbara Minerals Limited (PLS) is an emerging lithium and tantalum producer focused on the development of its 100% owned Pilgangoora Lithium-Tantalum Project. While the process of mining is complex, the business model is quiet simple. For Pilbara it’s all about their ability to increase the production of lithium, hope the market has stable/rising lithium prices and secure offtake deals with lithium consumers.
Macro talk: so many investors are attracted to lithium stocks because of the so called Electric Vehicle revolution. Y’know when ever coverts to a Tesla that uses a ton of lithium-ion batteries. The problem for the past two years is that many new lithium miners have joined the market, creating a classic economics situation of supply > demand. As such, lithium spot prices have fallen significantly.
To add more context to the prices, lithium carbonate min 99.5% Li2CO3 battery grade was trading at peaks of roughly RMB$160,000 – $180,000 per tonne back in late 2017.
Reasons to LONG
- The PLS share price has hit an area where it doesn’t look like it will go much lower, so from a risk/reward perspective, it’s a good time to pick up some shares while the stock is cheap
- PLS have recently had an equity raising. This meant the company needs more money to continue growing. The equity raising was at around 65 cents per share. Buying a growth stock’s shares near the equity raising price is a good risk/reward entry.
- The electric vehicle industry is in its early days and has huge potential in the coming years, especially as many vehicle manufacturers pour millions into R&D for new electric vehicles
- PLS has recently had its main mine reach a level of commercial production, while the company hasn’t made significant cash flows as of yet, achieving commercial production is huge news
Reasons to SHORT
- PLS has no reasonable cash flows, they’re a young company and the risk/volatility is huge
- While the electric vehicle has huge potential, it is somewhat a gamble at this stage in time. All lithium stocks such as Galaxy Resources (ASX: GXY) and Orocobre (ASX: ORE) have done nothing but continue to fall. Why bother when we can abstain or invest in LYC
- PLS had a recent equity raising, why can’t the company support itself financially? Normally the share price should fall more after an equity raising as new shares hit the market and dilute the value of current shares
Lynas Corporation Limited (ASX: LYC)
Lynas Corporation Limited (LYC) is an integrated source of rare earths from mine to customer. Lynas has a portfolio of aligned assets to explore, develop, mine and process rare earth minerals. Lynas is a more established producer than Pilbara who is in its early days. Lynas needs a stable rare earth price for reliable cash flows.
The Lynas share price fell significantly during 2015-16 when China was producing an illegal amount of rare earths (ignoring the pollution effects) and saturating the market, letting prices plummet.
Reasons to LONG
- Wesfarmers’ made a proposal to acquire Lynas in an earth-shattering offer that represented some 40-50% premium to Lynas’ current share price (a few weeks ago). Lynas management rejected the offer believing the company was worth more than their offer. Imagine if you’re the C-Suite of Lynas and you just received an offer that increases the value of your Lynas shares by 40-50% in an instant … and you say “nah I can grow this company and make it worth more than that”. This is a huge statement of confidence from management.
- Rare earths are also used in renewables such as Electric Vehicles.
- If you google some prices of rare earths, the price is stabilizing, which is good for Lynas
- Lynas has delivered strong growth and production figures (if you refer to previous reports)
Reasons to SHORT
- Lynas share price soared by some 40% to match the Wesfarmers’ offer. But since Lynas rejected it, the shares should not be worth that much at the present. The share price should fall to some extent as investors take profit.
- Rare earth prices are still weak which is a negative for profits
- The Malaysian government forced Lynas to halt production due to waste and environmental woes. This is huge and political news might continue to woe the Lynas share price.
CSL Limited (ASX: CSL)
CSL Limited (CSL) is a global biotechnology company that develops and delivers innovative medicines that save lives, protect public health and help people with life-threatening medical conditions live full lives. The operational businesses include CSL Behring and Seqirus provides life‐saving products to more than 60 countries and employs 22,000 people.
Reasons to LONG
- CSL has been one of the most reliable performers in the ASX200 for many years. They should continue their growth trajectory.
- While the CSL share price has fallen. Investment banks have maintained a positive share price target.
- New product launches positively contribute to the bottom-line
- Most of CSL’s earnings are from overseas (mostly US). Therefore a weak AUD/USD will maximize overseas earnings when they are converted into Australian dollars. The AUD/USD is quite weak at the moment which is good for earnings and cash flow.
Reasons to SHORT
- CSL is a very expensive stock, meaning the share price has run past what the enterprise is actually worth. CSL has only been reporting a growth rate of 10-15%, which is fine, but when the company is valued at 35 times its current earnings. The stock is far too expensive.
Cochlear Limited (ASX: COH)
Cochlear Limited (COH) is a manufacturer and distributor of cochlear implantable devices for hearing impaired. Cochlear have operations in more than 20 countries distributing its products in America, Asia Pacific, Europe, Middle East and Africa. It offers three main products namely: Cochlear implants, Baha bone conduction implants and Cochlear Wireless Accessories.
Reasons to LONG
- Strong historic financial performance
- Cochlear is somewhat a monopoly in what they do. There is no other player that has their level of technology, marketability and scale.
- Like CSL, most of their earnings are derived from the US. A weak AUD/USD is good for COH earnings
- Expansion in Japan
Reason to SHORT
- Like CSL, COH have an extremely high valuation, trading at 40 times their FY19 earnings (meaning 40 x FY19 net profit = current enterprise value).
Westpac Bank (ASX: WBC)
Westpac Banking Corporation (WBC) is Australia’s oldest banking and financial services group, with branches and operations throughout Australia, New Zealand and the near Pacific region. The Group is organised in the following 5 Key Divisions: Consumer Bank, Commercial and Business Bank, BT Financial Group, Westpac Institutional Bank and Westpac New Zealand. Its serves nearly 13 million customers.
Reason to LONG
- Banks share price have shown a recovery, a clear indication that the share price has hit rock bottom
- While economic conditions are rough, banks are resilient in cash flows and earnings. Most banks have grown their revenues, its just the margins that have decreased
- Banks are paying above average dividends
Reasons to SHORT
- Property market prices and clearance rates coupled with increased banking competition and tougher lending rules make it difficult for banks to maintain dominance and strong growth
- High interest rates are good for banks because they can make more money from home loans. Australian interest rates are at an all time low and potentially going lower which would pressure banks net interest margins.
- Slowing global and domestic economic growth as well as poor income growth and per-capita recession
- Upcoming government election
Macquarie Bank (ASX: MQG)
Macquarie Group Limited (MQG) is a global provider of banking, financial, advisory, investment and fund management services, headquartered in Sydney.
Reasons to LONG
- Macquarie is a diversified bank so housing prices doesn’t really affect them all that much
- They have an insane historic growth performance and good financial diversification in business divisions
- Strong commodity prices is good for their commodity markets division
- Financial market performance for 2019 has been pretty good and should be reflected in a solid performance from Macquarie Asset Management and Macquarie Capital
Reasons to SHORT
- Markets have run pretty hard in the past month and should cool off, providing a window to short Macquarie
- Macquarie is at an all time high, it might be an excellent business but buying at such highs is poor risk/reward
- Slowdown in global economic growth and political tensions
How do I go about with portfolio weighting?
The concept of portfolio weighting might be one that is incredibly difficult for the non-market savvy student. The whole point of having certain weightings around stocks is to mitigate risk or leverage upside.
We’re going to jump the gun here a little bit but stay with me.
Let’s use the six stocks in this example but give them each an “identity”. I say “identity” in the context that I know these stocks pretty well, how they behave and what generally affects them.
- PLS – Miner, early growth-phase, very volatile, moves on average maybe -/+ 2.5% a day, moves somewhat with the market but more so on lithium related news
- LYC – Miner, growth-phase, very volatile, moves maybe -/+ 2% a day, moves somewhat with market but more so on rare-earths related news
- CSL – Pharmaceuticals, maturing growth, less volatile, moves -/+ 1.25% a day, largely moves with the market
- COH – Healthcare, maturing growth, less volatile, moves -/+ 1% a day, largely moves with the market
- WBC – Bank, slow growth, not volatile, moves -/+ 0.75% a day, strongly moves with the market and on macroeconomic news
- MQG – Bank, moderate growth, not volatile, moves -/+ 1% a day, moves with the market and on macroeconomic news
You kind of get the general feel that these stocks have differing levels of volatility and “on average” day-to-day share movements but move in the general direction of the market.
As I mentioned before, weighting can help mitigate risks or leverage your perception of the market. What ultimately shapes the way your portfolio is weighted is your perception of the market, sector and individual stock. Let’s make do with some examples.
- Slowing global growth, falling property market and per-capita recession. I feel like the market is going to fall.
If you feel like the market is going to fall and you want to put all your eggs in the basket for a falling market, then you would heavily short the market. At the center of a bear market would be the financials sector. A 50% short on WBC would be most appropriate. Likewise, materials markets also heavily rely on a good economy – housing, infrastructure and consumption growth. 50% short on LYC and a likwise 50% short on CSL.
While you heavily increase your upside during downturn, you expose your portfolio to the shortcoming of if the market starts running north.
- I want a balanced portfolio that can perform during both a good and bad week.
That’s the dream, right? I’ll try my best to give an example that highlights a low-risk portfolio, but in doing so, you’ll probably cap your upside by playing on the safe side. This portfolio will probably involve:
- 75% MQG Long
- 20% LYC Short
- 25% COH Long
- I believe the market is going up and want to maximise my upside
In the name of fun and destroying the performance of other groups, you can get creative with positions and reasons. The market is actually looking pretty buoyant at the moment and I don’t really feel like any of these stocks are a short. A long portfolio might look like:
- 50% PLS Long
- 75% CSL Long
- 100% MQG Long
- How I’d actually do things
PLS vs. LYC.
The lithium sector has received poor sentiment following many lithium downgrades and production woes from Tesla. The problem is that there are way too many lithium producers, creating an economic situation where supply outweighs demand. This has resulted in the lithium spot price falling.
Lynas received a takeover offer from Wesfarmers. Basically, Wesfarmers wanted to buy Lynas and offered a premium offer of A$2.25 per share (some 50%+ premium). This obviously sent the share price soaring from $1.62 to $2.15. Lynas rejected the offer because they believe the organisation is worth more than that. It’s a little difficult to gauge where the share price goes from here. When the share price gets boosted that high it’s highly likely that people take profit. It probably won’t go back to $1.60s but it’s probable it goes lower for a while.
I’m a fan of PLS. They’ve reached commercial production, recently completed a capital raising at $0.640 so I’m going to long 25% on PLS. A modest position, perhaps a touch too much for the risk.
CSL vs. COH
I’m not a fan of buying either these companies at the moment. But I am a touch on the long side for the general market, so I’m going to have a 50% long on CSL.
My argument (so you have something to talk about when you copy my weightings). I don’t have a company specific reason, I believe the general market is looking quite good. Some of the world’s biggest technology companies and big European banks are reporting their earnings this week, and investors are hoping for some better-than-expected results. I believe the momentum in global equities can continue, as such, CSL and COH have positive betas and should look to ride the headwinds.
If I had to be more company specific, I’d say there are favourable factors for CSL such as a low-Australian dollar, new product launches and a strong history for growth.
WBC vs. MQG
I hate the big four banks. But their share price is actually making a turn north and tt looks like there is potential for it to go higher. However, MQG is honestly one of the best stocks in the ASX200. So, I’m putting the remainder of my capital as a 75% long on MQG.
You could long the bank if you wanted to and suggest that the market has “priced in” the bad property markets and the banks are actually quite resilient in growing their earnings in tough conditions. On the flip side, you can go with the doom and gloom about per-capita recession, poor house prices (and how they probably will continue to flow) and credit squeeze. It’s honestly what you bring to the table and not the performance of the stock.
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