10 March 2020

Capital-hungry growth stocks vulnerable in market correction

Original Article published 9 March in the Australian Financial Review

Jonathan Shapiro - Senior Reporter

_____

The rapid change in share market sentiment will pose a severe test to the sustainability of high growth capital hungry companies that have until now been the market darlings.

As the entire stock market was hit by a wave of selling – high growth stocks such as Afterpay, Zip Money and Wisetech fall sharply, but in line with major corporates such as BHP, which fell 14.4 per cent.

But an increase in the cost of debt and equity capital could alter the economics or the growth plans of these companies.

As a proxy for the recent performance of high growth stocks, the newly formed S&P/ASX All Technology Index has fallen 22 per cent since its launch on 22 February.

“You want to avoid those that are selling a dollar for 80 cents and will need to go back to the market to replenish the cost,” Pengana's Rhett Kessler told The Australian Financial Review.

“There are other companies that are fully funded and cash flow positive, and you have to look at the underlying business and whether they’re disrupting for value proposition.”

But he says for companies that had used access to cheap capital to accelerate growth, they may be in danger of being caught out.

“The biggest problem is that all these stocks were going to grow into their multiples or be taken over by a competitor private equity but the game has changed in that respect.”

Mr Kessler said he could not have predicted the coronavirus but held close to one fifth of his Australian equities portfolio in cash, and bought put options on the market, on the basis that the market was expensive.

He also held significant positions in Telstra and Evolution Holdings, a low cost gold producer. The gold miners exchange traded fund, GDX, is up 6.7 per cent so far this year.

These combined strategies have helped him to avoid the worst of the sell off as his portfolio is down by less than half of the fall in the broader market.

Mr Kessler said he invests money based on analysing three things – the cost of money, and the quantum and certainty of future cash flows.

"I used to spend 95 per cent of my time on the latter but now it’s the cost of money – its something I have never done before. The cost of money should be a derivative of the risk involved and if you get that wrong you’re going to get inflation."

"The cost of money is artificially suppressed and you’re going to find out what momentum investing is all about. It's fantastic on the way up, not so much on the way down."

As the coronavirus crisis has unfolded and central banks have responded by slashing interest rates, global bond yields have collapsed to near zero levels.

Low bond rates have propelled certain sectors – such as infrastructure – as investors have turned to these defensive assets for income.

Shares in infrastructure companies such as Transurban and Sydney Airport have tended to track the 10-year bond rate, but that relationship has broken down in recent days.

Transurban fell 3 per cent on Monday, faring relatively well amid the broader sell off. However over the last month as Australian bonds have gained 2.4 per cent, Transurban has fallen by close to 10 per cent.