InvestNow News 11th Oct – Pie Funds – Fund Update – Sep 2019

7th October, 2019 – Mike Ross, Senior Investment Analyst and Portfolio Manager

The Dividend Fund returned 11.3% during the September quarter versus the benchmark return of 3.1%. The fund held an average cash balance of 32% over the quarter with market hedging.

Data#3 (ASX:DTL), Baby Bunting (ASX:BBN), Eclipx (ASX:ECX) and Austal (ASX:ASB) were the largest contributors to returns during the quarter. Vista (NZE:VGL), Midway (ASX:MWY), SRG (NYSE:SRG) and market hedging detracted from performance.

The fund navigated the August reporting season well. The best performing stocks tended to be the higher weighted positions and detractors were lower-weighted/conviction ideas. There are important lessons to be learned here, including backing best ideas and following process to justify holding lower conviction positions (or selling them).

The fund favours investment opportunities that fall into one of three buckets:

  1. Businesses undervalued by the market that can achieve a “re-rating”;
  2. Businesses that can grow earnings above market expectations;
  3. Great businesses with tailwinds at a reasonable price.

It is always hard to find businesses in the third category, especially after the market has enjoyed a good run.

There are opportunities to invest in businesses with prospects of a valuation re-rate but these are weighted to cyclical industries such as retail and mining services. The fund does have exposure here although it is hard to have conviction about businesses very exposed forces outside of their control. Therefore, when hunting for opportunities in this space we look for attributes that can help to withstand a deterioration in the macro.

Baby Bunting is a good example of this. The company has a strong store roll-out program that is likely to be upgraded, an improved competitive landscape, margin upside and arguably a more defensive product category.

Comparing Baby Bunting to the investment framework above, the company ticked two of the three points:

  1. We first invested in Baby Bunting in mid-2018. The company was a “fallen-angel” at the time, having been de-rated by the market following a number of earnings downgrades caused by the impact of competitor closures. My view was that a normalisation of operating conditions would lead to a re-rate.
  2. We believed analysts had become too pessimistic on the potential earnings of the business.
  3. Retail is competitive industry and earnings are volatile, so it is rare to find a retailer that is a great business. A strong management team and the characteristics above gave us the confidence to invest.

Baby Bunting’s shares are up by more than 60% since the FY19 result and almost 140% since our original purchase. We’ve taken profits to trim the position and will continue doing so, depending on price.