The are several definitions of stocks being ‘on the nose’. Some will never turn out OK, some will be fine as fundamentals come through and some, unfortunately, will go through mental torture with no clear path to recovery or ruin thanks to the great art of public perception.
Blue Sky Limited (ASX:BLA) is in the latter camp. We don’t own the stock but as soon as the Glaucus reports were released (US hedge fund who decided Blue Sky was not valuing its underlying investments correctly) we knew the intense elevation of scrutiny would burden the stock for some time to come, regardless if it is right or wrong. Blue Sky has had a remarkable run since listing which means the market gave it the benefit of doubt. A company whose revenue relies on uplifts in valuation of it investee companies is going to find ways to put a positive spin on its investments which in-turn endorses the management reputation. Each positive result effectively gives investors less reason to question the fundamentals and allows the momentum to build.
Now that the initial damage has been done there can be a couple of lasting impacts on Blue Sky. First it will probably never achieve the market rating it once commanded. It is tainted and the market will forever be more cautious. Second, the added scrutiny and negative sentiment attached to the parent could easily rub off onto its subsidiary investment companies … potentially inhibiting, even derailing the ability to raise fresh capital. This will in-turn impact the valuation of the head stock. It’s a cruel world that reflect the part perception plays in investment circles.
A second example of ‘on the nose’ relates to industries in structural decline. The so-called value represented by stocks in these sectors can often appear attractive but ultimately becomes a trap. We mentioned Myer a couple of weeks ago, where a once-proud retailer behemoth has shrunk because its offering is fast becoming irrelevant in today’s digital world.
For so many years GC1 has avoided investing in PMP (ASX:PMP), the printing and letterbox distribution company. Printing is a notoriously over-competed industry and none of the listed players in it have enjoyed success in recent years. A few catalysts suddenly made it look attractive. PMP merged with one of its major competitors as another major player, Ive Group (ASX:IGL), did likewise. A raft of cost saving measures were announced and forecasts of huge dividends returns on the back of savings had investors scrambling. It even got us in for a while on the back of positive conversations with all of the main players involved.
But in the end the sub-optimal nature of the printing sector ended up stealing the show. Price competition stuck around, even worsened and before the gains could be realised they were significantly being whittled away. We exited almost quickly as we entered but the damage had been done. We learned another lesson … but probably one we already knew deep down.
The third category of ‘stocks on the nose’ is where the market misreads a situation and gets it nose out of joint, regardless of whether the underlying story is any good or not. Perhaps the misreading is partially the company’s fault (poor communication of a new situation, for example), often simply a couple of broker analysts getting a little over-excited with their forecasting and sometimes a simple issue becomes public and journalists get hold of a juicy story and run with it. These stocks have the best chance of recovering and ultimately may represent a good buying opportunity.
GC1 recently bought into BWX (ASX:BWX). We didn’t time it perfectly but the underlying business is growing strongly and, on the back of three significant acquisitions, will continue to do so. The share price depreciation has brought a lot of value into the stock (PER of 14x FY19).
When BWX reported its most recent profit result the numbers were a little light on, caused by some front-ended sales by the vendors of one its acquired businesses in the US (Mineral Fusion – the number one organic makeup brand) and the delayed start of a new contract. Our forecasts sat a little above the reported result as did those of a couple of leading broker analysts, but two broker analysts had numbers way higher than consensus – they were simply wrong. The fallout of their overt disappointment caught attention just when the market was losing some of its high PER appetite and it has caused a PER de-rating for BWX.
Most analysts downgraded their numbers by 5-10% in FY18 and less in FY19. The stock has fallen 44%. The Net profit is expected to grow around 20% in FY18 (the company is comfortable with its guided range) and closer to 40% in FY19. It is a multinational business with strong consumer brands.
The point is some companies have a better chance of recovering than others. If the story is good then it is a matter of time and proof. We believe BWX is one of these and we like finding similar opportunities.
But if there is an industry impediment or if a company has been called out for spurious practices, it will be a long wait for such a recovery, if it happens at all.