Andrew Hunt: why it's a great time to be a deep value investor

Merryn talks to Andrew Hunt, author of Better Value Investing, about his adventures in the market's dark underbelly, looking for the hated and neglected companies that could not only shoot up by 300%-400%, but could help bring about the cleaner future everybody wants.

By MoneyWeek

published 22 October 2021

in Features

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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.

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.

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?

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.

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.

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.

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.

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.

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.

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.

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.

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.

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.

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.

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.

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