Spun-off businesses, stigmatised companies that have come out of bankruptcy or under-researched ones provide some of the best value opportunities, according to Investec Asset Management’s Alessandro Dicorrado.
Dicorrado, who co-manages the four FE Crown-rated Investec Global Special Situations fund alongside Steve Woolley and sits with the value team run by veteran investor Alastair Mundy, said some of his key holdings have come from spun-off businesses or the "extraordinarily cheap” UK market.
“There is a lot of ‘I don’t want to be the first’ in the market. I think people are scared to be the first ones investing in some types of companies,” the manager noted.
“But we aren’t. In order to do well you have to do something that is different: if you do what the rest are doing, you are going to have an average performance.
“We look at the companies people are getting rid of and it is true that a lot of times the market is right before selling these things, but occasionally it makes a mistake and we capture that inefficiency. We do a lot of fundamental due diligence before buying these stocks.”
Businesses that have come out of bankruptcy – and have a stigma attached to them as a result – is one example of the ‘I don’t want to be the first’ mentality, the Investec manager said.
“Often, the sell-side research with these companies is a bit slow to catch on because research firms need to see a year of accounts in order to cover them,” he explained.
“This lack of coverage by the big banks or the famous research firms results in a very interesting stock price.”
Taking advantage of this lack of coverage the team decided to buy American utility company Vistra Energy, that has been performing well since they bought it.
Performance of stock since end-2016
Source: Google Finance
Vistra Energy came out of bankruptcy in late 2016 and, unlike famous companies such as Microsoft – that has around 70 analysts constantly publishing reports on it – Dicorrado noted it had little coverage when he and co-manager Steve Woolley added it to the portfolio.
Japan Airlines (JAL), the main competitor to market leader All Nippon Airways, has a similar story, said Dicorrado.
“JAL came out of bankruptcy and we realised it was a much leaner, lower-cost business, but the strange thing is that Japan Airlines was the cheapest stock of the two,” he said. “The reason is that JAL had the stigma of coming out of bankruptcy and people didn’t want to get involved.
“Obviously you have a new management team after the bankruptcy, but people don’t know them. At that time, they had very little attention and we thought the low cost was going to stay with us for some years.”
He added: “The company has done very well: we paid 1,600 Japanese yen when we bought into it and now is around 4,000.”
Another attractive hunting ground for value is spun-off businesses, or those independent companies created through the sale or distribution of new shares of the division of a parent company.
While these are usually worth more as independent entities than as parts of the larger business they belonged to, the screens used by most value teams tend to miss them.
Not only do these companies trade at low valuations but they are also quite unknown by most investors and unrelated to the parent company that initiated the spin-off.
Welbilt, one of Investec Global Special Situations largest positions, is an example of a successfully spun-off company that the team holds.
“Welbilt makes high performing kitchen equipment that you see in fast food restaurant such as fridges or fryers like the ones they use in McDonalds,” the manager explained.
“The interesting thing about this business is that it used to be owned by Manitowoc that makes construction cranes.
Performance of Welbilt since spin-off
Source: Google Finance
“There is no commonality between making cranes and kitchen equipment, but they were in the same company because past management teams had decided they wanted to diversify the company,” he explained.
“But, all of a sudden, an activist investor spotted the company and bought a stake in it, he put the board in a little bit of pressure and the company announced they were going to spin-off Welbit.”
He added: “They did it in advance, so we had time to look at the business and found out it’s a great business, it’s growing, it takes very little capital to run and is delivering very high returns on invested capital.”
Dicorrado said Welbilt is not an isolated case, however. The team currently holds a few more stocks that are the result of a spin-off, including Cars.com, the American equivalent to Auto Trader – the UK's largest digital automotive marketplace for new and used cars.
As Dicorrado noted, companies like Cars.com are hidden gems rarely found at such attractive valuations: “These businesses are normally so simple and so good that the market recognises it and valuations are usually quite high.”
“The only reason we were able to buy Cars.com at 10x earnings is because it was a spin-off by a company that does newspapers,” he explained.
Although they are bottom-up stock pickers, Dicorrado noted that the team is currently overweight UK domestically-exposed companies including construction company Travis Perkins and banks such as Barclays and Lloyds.
Along with emerging markets, the domestic market continues to be one of the most unloved areas by investors, although the reasons behind the poor performance of both markets are very different.
Whilst sentiment towards domestically exposed stocks has to do with issues such as political uncertainty, Dicorrado noted investors should be careful with emerging markets.
Performance of fund vs sector & benchmark under Dicorrado & Woolley
Source: FE Analytics
Since taking over the fund at the start of 2016, the £61.2m, four FE Crown-rated Investec Global Special Situations has delivered a 71.12 per cent total return compared with a gain of 48.47 per cent for the average fund in the IA Global sector and a 54.30 per cent gain for the MSCI AC World index. It has an OCF of 0.91 per cent.