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Merryn Somerset Webb: Hello and welcome to the MoneyWeek magazine podcast. I am Merryn Somerset Webb, editor-in-chief of the magazine, and with me today I have Andrew Hunt. Andrew is a personal investor, very much a value investor, and author of a book called Better Value Investing, which if you haven't read, I suggest you do. Andrew, welcome. Thank you for joining us today.
Andrew Hunt: Thank you. Hi, good morning.
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Merryn: The first thing I'd like to talk to you about is what exactly is value investing right now? We talk to a lot of fund managers. All of them, while they might not call themselves a value investor, they believe, of course they're buying value. Who would buy something that they didn't think was slightly undervalued and therefore going to make them money over time? The real question to you is what is value investing? What do you mean by it?
Andrew: That’s a great question. It is a difficult concept and different people have different interpretations. Even people like Terry Smith and Baillie Gifford would say in a way they're value investors. They're buying things that they think are almost priceless, so of course they're undervalued. When I talk about value investing, I'm talking about what some people call deep value investing. This is operating at the market extremes in often quite obscure, quite small, very troubled companies.
Things that even on very conservative assumptions, where you're not assuming much growth, can probably go up 300%, 400% minimum. We're talking companies that will typically trade with a tenth or even a twentieth of the typical valuation multiples that many of the fund managers you interview will be investing in. It's investing at the extremes, in the forgotten, the neglected, the hated things in the market, the underbelly, if you like, that’s what I mean when I talk about deep value investing.
Merryn: It's interesting because you look at that and think it's such a huge market, thousands of fund managers all looking for similar opportunities. How does that fringe of companies that are that cheap and able to survive, even on conservative assumptions, why do they even exist?
Andrew: That is one of the fascinating things. A lot of the people talk about the behavioural quirks and the difficulties of psychologically being able to invest in them.
But a more fundamental reason to understand why they're there, and particularly why they're there just now, because let's face it most things are really expensive, so why can you buy these crazy cheap things? You're right, it's odd. No one’s picking them up. To really understand that you have to look at the structure of today’s markets. If you went back to the 1970s, 20% of the market would be institutional investors. Today it's over 80%. In a way, sadly, a lot of the big institutional investors have lost their way a bit.
There's a lot of pressures and agendas. They have these risk models and they have all these PR and ESG stuff they're expected to do. They worry about headline risks. They might have certain client groups that don’t want to own an oil company or a gambling company. They have to worry about liquidity and they have to worry about regulators. They don’t always have time to go and look at these tiny little stocks. If they do buy them, then their funds aren't scalable, and that’s a problem.
You’ve got all these reasons that have come together, and in a way institutional managers have dug themselves into a hole. They can't do this sort of stuff. A helpful analogy for any personal investor is if you can imagine being a free runner. You put your trainers on and you can run up the hill. You can run down the road. You can around around your house. You can run to Australia. You can run wherever you like if you're a free runner. That’s the position a personal value investor is in.
But if you're a big institutional manager you have to run straight down the road with your shoelaces tied together. It's having that flexibility to be opportunistic and pragmatic and not to worry about things like liquidity and headline risks and all these other things all the time and to be able to seize these opportunities. Not many people out there can do that. It’s a big inefficiency.
Merryn: The rise of the institutional investor, the rise of all the compliance and regulatory stuff around the institutional investor, and in particular perhaps the rise of the ESG agenda, and the fear of an attack social media, or the fear of getting in trouble with your big client who may have ESG parameters inside which you have to invest, have meant that the big institutional investors have effectively voluntarily limited the universe in which they can invest, and left possibly more outlying value opportunities than there have been in the past?
Andrew: That’s exactly right. That’s precisely it, yes.
Merryn: So right now, almost ridiculously, given how expensive we see markets are in the face of it, right now is actually a really good time to be a value investor. Is that fair?
Andrew: It’s a fabulous time. It's wonderful. There's some really great stuff out there.
Merryn: Let us talk about some of that great stuff. You have written in the magazine about buying into energy services. This came from a conversation you and I were having on LinkedIn about fossil fuels.
I wrote about how we've got to stop ignoring fossil fuels, or ignoring investment in fossil fuels, because we know we’re going to need fossil fuels for many decades to come. If you like to or not, we need them. Not investing in them is turning out to be, I don't think we can see around it at the moment, some of you have mistaken, and you’ve agreed with that, right?
Andrew: Absolutely, yes. We've done an awful lot. We’ve made a huge amount of progress with renewables, but it's only scratching the surface as the world continues to grow and develop. I could not agree more with that.
Merryn: One of the things that comes out at me, I was reading a book, There Is No Planet B, which I'm sure lots of people have read. It was very much designed to encourage people to be more enthusiastic about renewables. But when I read it and I looked at the energy uses and looked at how our fossil fuel demand continues to rise a couple of percent a year, my takeaway from this book was not, oh my God, I must invest more in wind, it was, oh my God, we must find a way to get people to be more enthusiastic about fossil fuels.
Andrew: I couldn't agree more. I have a scrapbook about this because every day you have these headlines. The past week you've got, gas boiler ban risks increasing carbon emissions. US coal and oil demand is on the rise again. Experts say alternative energy sources are overhyped and attack blue hydrogen. What we get wrong about green. Smart meter rollout has failed. It really is two steps forward, one step back.
I looked this up the other day. Pre-pandemic, it was 2019, the major economies of the world could use 10 000 terawatt hours of electricity in 2019. Of those, 60% were fossil fuels, only 10% were wind and solar. Now you think over the past decade, we've busted our coconuts on this. Our utility bills have gone through the roof. Governments have taken on loads of debt. We've had ESG investors just throwing vast sums of capital at this.
We've got to 10% of global electricity generation, and that’s before we start thinking about gas usage and motor cars and everything else. That shows how long and difficult this transition is going to be. If you're realistic about it you realise were going to need a lot of these fossil fuels for a long time. It's very important, because a lot of people try and take the moral high ground on this, that there's an awful lot of very poor people in the world. They are getting richer and they want the lifestyles that we have.
Why shouldn't they have a holiday each year and a fridge and a microwave and some air conditioning and a car? We have them. We take them for granted. They're not things we are willing to give up. This is the thing when you go and talk to these people in these emerging countries, they're, like, we’ll care about the environment, thanks, when we've got our two cars in the forecourt and our three holidays a year and our free at the point of use healthcare, thanks.
When we've got all that then we’ll join you, but until then why don’t you go and get on with it. I must say I have a lot of sympathy with that.
Merryn: But then there's not much point in us getting on with it by ourselves. If you look at the UKs carbon emissions are 1% of global emissions. China’s are 30%+. All the things that we do while they might make us feel good and it may allow people in the UK to grandstand around the place on, as you say, the moral high ground, not actually making any difference.
Andrew: That’s the sad thing. We’re less than 1% of carbon emissions. The other slightly icky thing is we've been really good. The UK gets a lot of criticism for its emissions, but it's been better at cutting them than most other countries. But then if you dig into that, a lot of the cuts have happened because we torched our manufacturing sector and outsourced it to China. In a way you're even worse off because we're now importing everything from China that’s dirty and polluting. We just get China to make it and ship it over.
It makes you sound like a bit of a pessimist, but it is a difficult problem to solve. It will take time. The optimistic thing is we will solve it. Over decades we will get there. In the meantime the solution is, yes, you're right, to carry on innovating. Actually, the solution might be to buy our way out of this, to get richer. One idea I'm particularly interested in is the Bangladesh hypothesis.
You and many of your readers may remember in the 1980s you’d switch on the news and you'd see these harrowing pictures of often children waist-deep in dirty water because of the Bangladesh floods. You say, well, what happened? The answer is that Bangladesh followed the IMF playbook and get a lot richer. It bought its way out of the flooding problem. It got everyone working and then it spent the money on building the infrastructure. Then you look at places like Dubai, which is basically a desert, and they’ve done well.
You look at Holland, half of which would be under water, but they've gone and built those incredible land reclamation projects. The cool thing is if you want to be an optimist, if we give ourselves time and money, we can buy and innovate our way out of this. It doesn't have to end in everyone getting flooded and drowned. There is human ingenuity there.
Merryn: It's an interesting one. We talk so much about reducing carbon emissions, about the work we have to do very globally. One of the things that we've just discussed is that it's incredibly hard, but getting rich enough to mitigate the effects is something we don’t talk about nearly as much, and possibly we should at this point.
Andrew: Yes, exactly. It's been the story of the world. It's a lovely story because when people get richer they do all sorts of good things. They care about the environment. They can make better decisions, better lifestyle choices. Also, particularly when women get richer and become empowered they have fewer children, and that takes a huge amount of pressure off the environment ultimately.
In some of these projects we're funding empowering women in the developing world and giving them great educations. In the long run that’s really going to help our environment and it's going to make people a whole lot better off. I don't want to throw shade on Greta Thunberg, but I don't like this sackcloth approach to the problem. You can be optimistic about human ingenuity and good things solving this, and constructive things, so making ourselves wealthier and better off and better people, rather than somehow having to go back to the Middle Ages.
Merryn: You can also be optimistic about fossil fuels, can't you? One of the slightly frustrating dynamics in the last few years has been this idea that it’s somehow evil, immoral, wrong, to put any money at all into the fossil fuel sector. In investment you see this trend towards divesting rather than remaining investing and attempting to improve. Whereas, in fact, a better way to look at it may be to say we do need fossil fuels. We're going to have them for a long time.
Let's all invest to make them better, to make them more efficiently extracted, to make them more efficiently used. One of the things you wrote about in the magazine was about the energy services companies and the extent to which they’re a deep value opportunity and they can be used to make this a more efficient and better sector all round.
Andrew: I couldn’t agree more. We've had huge amounts of technological progress over the past decade and energy is no different. One other thing you’ve got to remember is that, for example, gas is much cleaner than coal. Gas is part of the way out of this, certainly in the shorter term. Often you get a lot of gas is a product of creating oil. Internal combustion engines are getting cleaner all the time and more efficient, so we are again making real technological progress, and the energy services industry is making real technological progress.
As I wrote, those are going to be really exciting tech stocks, because you can't buy any other tech stocks on bombed-out multiples, apart from energy fossil fuels tech stocks. They're going to have a cyclical boom like the rest of the tech industry. They just haven't had it yet. They've been waiting ten years for their cyclical boom. When they do they're going to go the way of Tesla. Some of these companies that have invested a lot of R&D in solving a lot of the problems of the fossil fuel industry, we're really going to need them.
We're going to need to embrace them pretty quickly because these shortages are starting to bite. The thing is it takes a long time to bring new oil and gas on. A deep-water well will take you about five or six years starting from scratch, so this isn't a problem we can solve overnight, and we’re going to have to throw a lot of resource at it.
Merryn: One of the things you say in your article is that these kind of businesses are risky and they're cyclical. Don't own one or two, own quite a few, and once you've got them don’t sell them too soon. What are your favourites in this sector?
Andrew: The easiest one, particularly for UK investors, is Petrofac. I like it because it got very bombed-out. They do oil and gas engineering. No one’s been doing any big engineering projects for the best part of a decade, so they were cyclically very bombed-out. Then to make matters worse there was a big SFO investigation into historic corruption, which they've now settled for a much lower fine than anyone thought they’d get, so they're out of the woods.
Because they've settled that they can now go and win new work. The good thing about Petrofac is they are really good what they do. In spite of the dodgy contracts and the past, they have very strong capability. The other great thing is that many of their competitors have simply gone bust in the downturn. You’ve probably seen a few of the headlines. A lot of these oil and gas services companies have just disappeared. They've hit Chapter 11.
There's this huge pent up demand coming and very few players who can fulfil these contracts who have the engineering capability. I look at Petrofac and you think if it goes right for them, the shares are probably 1.70 today, and you can get 9 or ten quid without trying that hard. Petrofac is a great place to start and its UK listed. It's fairly liquid. It's easy for your readers to buy. Petrofac is one my favourites. It's also personally one of my bigger positions for the record.
Merryn: Good to know. Thank you. Wood Group?
Andrew: Wood Group is similar. Less troubled than Petrofac, but similar. Serial disappointments, no one doing any energy services work for the best part of a decade, but good capability. Wood Group has more debt. It's about three times levered. These things are so operator geared, so once profitability and demand starts picking up, the debt evaporates so quickly because these guys throw off so much cash once the industry gets going.
Merryn: Those are interesting UK companies. Anything abroad that you just can't live without in your portfolio?
Andrew: As I say if you can get an account with someone like Interactive Investor, you can invest in quite a broad range of markets, including developed Asia. Some of the most interesting opportunities are in developed Asia. I mention in my article Sinopec Engineering, which is again the oil and gas engineering division of Sinopec. This company is literally trading at the same value as the cash and investments on the balance sheet, so you're getting the entire company for free.
This is basically a Chinese state-backed company and it's got loads of work and that work is going to grow. Even at the bottom you're paying trough P of 6 and a 9% yield for a company with a perfect balance sheet. Again, what's interesting about it is they've adopted these profitability measures, EVA, ROE measures, which for a Chinese state company is incredibly rare, incredibly unusual. That suggests that someone high up wants Sinopec Engineering to start making a lot of money.
If you’ve got that reformed management plus a cyclical boom, that company should just absolutely fly. You're getting paid 9% in the meantime. That seems pretty good.
Merryn: That’s a stunning bet that you can get a 9% yield on anything at the moment. It's fairly extraordinary, particularly on something that you're suggesting is reasonably low risk.
Andrew: Exactly. Yes, precisely. The other one which I also mention in the article is CSE Global. We've talked about the benefits of technology and bringing technology to the energy service industry and that’s what this company does. They do all the internet of things. They do automation. They do IT processing. They do all the trendy tech stuff that if you buy in the NASDAQ you'll pay umpteen times sales for.
This company is on a trough P of 11 and a 6% yield, for a tech company which is probably likely to face a massive cyclical and secular boom and a clean balance sheet. That seems almost too good to be true. It's really worth looking around for this stuff. It is there.
Merryn: That’s incredibly interesting and I know our readers are going to be very taken by that story. Are there any other areas of market where you can see deep value being ignored by the wider market?
Andrew: There's some things around Hong Kong and China. It's very difficult for institutional investors to buy companies with links to the Chinese government, for example, and that’s created some really odd anomalies. To give a couple of examples, which, again, silly multiples here. Goldpac, which is a leading payment technology company in China, again, trades on an enterprise value of roughly zero, so the market cap is about the same as the net cash. PE of 7, 7% dividend yield, for a payments technology company.
You can buy a satellite company on 0.3 times book, so that’s like a third of just the book value. Again, net cash is roughly the market cap. There are these crazy little anomalies of things often listed in Hong Kong that have these connections to the Chinese government. It's quite an esoteric little quirk. What's also odd is there's so many of these things exist, just that they're these odd, forgotten little companies.
One that you'll like, because you did that interesting article about India the other day, for example. I could talk about these all day. I own about 100 of them. Just bringing them to life, these things are crazy. OPG Power, which is listed on AIM, they have state of the art coal-fired power stations in India. India is now recovering really strongly as you say and power demand is going through the roof. That sounds quite a nice way to get Indian exposure.
Do you know what the multiples on that company are? It's basically paid out. It's almost debt free, which is very rare for a utility. You can go out today, you can buy it on a p/e of four and a 45% free cash flow yield.
That’s a tenth of what other investors are paying for Indian exposure. Wow. These little things keep cropping up, so I'm a pretty happy hunter.
Merryn: It sounds like it. Andrew, let me ask you, do you own any cryptocurrency exposure?
Andrew: I don’t own cryptocurrency exposure at all. It's something I've looked it. I've not been able to understand it or get my head round actually and so I’ve just left it. I always think of the Buffet admonishment to stay within your sphere of competence and stick with what you understand. It's timeless. It's always good advice. I haven't bought any crypto.
Merryn: What about the goldmining sector? Anything of interest there for you?
Andrew: I've always struggled with gold. I love a lot of the commodity stuff, but you look at it and you're like… I get the whole central bank debasement argument on the one hand, but then you look at the cost of digging out a pound of gold, and it's about $800, $900, allegedly, and gold is 2000-odd. I've never been able to square that circle between the reproduction cost argument on the one hand, which is very bearish, and the mining cost. And then on the other conspiracy theory, central banks are going to print money and destroy their currencies.
Again, I've never been able to answer that and get comfortable with those two arguments both ways.
Merryn: What I'm really thinking about is how our readers are hedged against inflation. It would seem to me that perhaps the deep value style of investing is a natural hedge against inflation.
Andrew: I think it absolutely is. If you go back to the real proponents of this deep value stuff, and this is what people like Warren Buffett and Rick Guerin were doing in the 60s and 70s when inflation took off, and this is when they were making hay. Buffett’s best period was in the 60s and 70s. It wasn't when he became famous. He was compounding at a much higher rate before he became well known in the 1980s.
When inflation booms it's great because you’ve bought some real hard assets at a massive discount to their reproduction cost. Almost no matter whether it's shopping malls or satellites or whatever it is. They just get dragged up. The value of them gets dragged up along with inflation because you’ve got these hard assets backing things up. If you're worried about inflation then deep value is a great place to be.
But if stuff is so cheap and if you're getting your 9%, 10% yields and you're paying p/es of one or two then that’s going to bail you out anyway. It's a happy place to be.
Merryn: Andrew, that is all absolutely fascinating. We have to leave it there, but thank you so much for joining us today. I'm rather hoping, and at this point our readers are probably hoping as well, that you will join us again one day and tell us more about your deep value picks.
Andrew: I'd be absolutely delighted to. Thank you, Merryn.
Merryn: Thank you. Listeners, if you'd like to hear more from MoneyWeek you know where we are, moneyweek.com. On Twitter we're @Moneyweek. You can hear more from me on Twitter @MerrynSW and John @John_Stepek. Andrew, are you on Twitter or anywhere else people can hear from you?
Andrew: No, I keep myself to myself actually. But now and again I write things for things like ValueWalk and stuff like that.
Merryn: And for us, of course, so watch out for that.
Andrew: I’ll tell you if I find something really good.
Merryn: Thank you. If you haven't read Andrew’s book yet go out and get it. Thanks very much. Talk to you next week.
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