Disruptors create value opportunities | Mackenzie Investments

Disruptors create value opportunities


Summary

The Mackenzie Cundill Team is finding ways to make money in stocks that have suffered from massive negative sentiment when disruptors such as Tesla, Netflix and Amazon enter a market creating the belief that these companies will win all the spoils and eventually “own” the market, thus destroying business models and stock prices. The Team has been able to take advantage of overreactions by investors to find good value in beaten-up companies such as Fiat Chrysler Automobiles (a perceived Tesla victim), 21st Century Fox (a perceived Netflix victim) and Advanced Auto Parts (a perceived Amazon victim).

Below we explain how we took a critical look at negative market reactions to the disruptors, did our research, and took positions in these stocks.

Fiat Chrysler Automobiles

  • Fiat Chrysler Automobiles (FCA) is the eighth-largest automobile manufacturer globally, with brands that include Jeep, Ram, Dodge, Chrysler, Alfa Romeo, Maserati and Fiat
  • In the summer of 2017, share price weakness gave us the opportunity to initiate a position with a 2.2% weight in Mackenzie Cundill Value Fund, on investor concerns that the company had no credible electric vehicle strategy, the U.S. auto cycle was potentially peaking, Chinese growth was slowing and there was economic weakness in Latin America

Fiat Chrysler

Source: Bloomberg

Catalysts

  • Management had a plan in place to reduce debt and become cash positive within a year and a half
  • We felt the components operations could potentially be spun off
  • We felt the Alfa Romeo and Maserati brands could be revitalized
  • European economic recovery was underway, which we believed would further benefit earnings

Key Developments

  • U.S. tax reform was a significant contributor to fair value increase in the fourth quarter of 2017
  • Net debt (debt minus cash) is on track to becoming net cash – a significant milestone
  • Standard & Poor’s upgraded FCA’s credit rating to BB+ in February 2018
  • 2017 sales were flat, but earnings were up 50%, to €3.8 billion, due to profit margin expansion, consistent with our investment thesis
  • 2018 earnings are expected to grow another 30%, to €5.0 billion
  • Discounted valuation to peer group
  • Our intrinsic value is €201 with potential upside to €24 if management hits targets this year
  • June 1, 2017 to March 13, 2018:
    • +90% FCA
    • +10% General Motors
    • +14% Volkswagen
    • +0% Tesla
    • -6% Ford
    • -7% Hyundai

21st Century Fox

  • 21st Century Fox (Fox) is a media conglomerate with an impressive suite of entertainment assets, including the Fox television and movie production studios; FX broadcasting network; highly rated cable channels including Fox News, FX and Fox Sports; and key international assets through its ownership in Sky Plc and Star India
  • Netflix’s strength has wreaked havoc in the media space, so we went looking in this sector for great value opportunities

21st Century Fox

Source: Bloomberg
  • In August 2016, we initiated a position with a 2.5% weight in Mackenzie Cundill Value Fund, believing that the issues of cord-cutting and streaming disintermediation of traditional media companies were overblown
  • We added to the position in June 2017
  • Our intrinsic value is US$442

Key Developments

  • We’ve seen a few proof points of our thesis:
    • AT&T acquired Time Warner, which we felt reaffirmed the value of content in the battle for subscribers
    • Various over-the-top streaming skinny bundle services were announced, all of which included key Fox channels
    • Disney plans to acquire Fox for US$52.4 billion, excluding Fox News, Fox Broadcasting and FS1 sports channels
  • These points – most notably, the Disney offer to buy Fox assets – affirmed our investment thesis and crystalized value

Why Disney wants Fox’s assets

  • Disney plans to accelerate the direct-to-consumer model with its own application, but to do so requires critical mass in content
  • Disney arguably has critical mass, but we believe that adding Fox’s movie and television library and future content increases the appeal of a Disney subscription service substantially
  • That said, Disney can’t make everything exclusive to the new Disney streaming application the day the deal closes; Fox already has licensing deals in place with players such as Netflix (as does Disney’s Marvel and Lucasfilm) – but when these licences expire, Disney will probably take the content off Netflix
  • Buying Fox’s 25% stake in Hulu would make Disney a 50% owner, and there’s probably strategic value in that as well
  • Fox Sports channels bolster ESPN
  • Fox’s international assets increase Disney’s reach in international markets
  • Sky has launched its own direct-to-consumer application in the U.K., and Disney may be interested in that experience

Advanced Auto Parts

  • Advanced Auto Parts (AAP) is a leading automotive aftermarket parts provider in North America and serves professional installers (do-it-for-me) and do-it-yourself customers; the company offers brand name, original equipment manufacturer (OEM) and private label auto replacement parts, accessories, batteries and maintenance items for vehicles
  • Amazon creates substantial fears in the retail markets it enters, and market confidence in the retail sector in general has been weakening due to slowing same-store sales growth and challenges from other e-commerce players
  • We looked for opportunities in segments of retail where valuation has been damaged but where Amazon might not have a great advantage over the incumbents (yet); we found such an opportunity in a retailer selling aftermarket auto supplies to professionals who need multiple parts fast
  • In November 2017, we initiated a position with a 1.5% weight in Mackenzie Cundill Value Fund With a new management team installed in 2016, AAP began executing a plan to be as efficient and profitable as its peers

Advanced Auto Parts

Source: Bloomberg

Catalysts

  • Successfully executing management’s business plan would lead to significant margin expansion and working capital reductions, in our view
  • Severe weather should benefit AAP as more customers inevitably need new auto parts (e.g., car batteries)
  • Improving economic health for lower-income consumers should drive more traffic and sales
  • As vehicle design becomes more complex (i.e., electrification, sensors for semi-autonomy, emission controls), consumers’ dependence on auto professionals increases; this is a large boon for AAP, which is skewed towards professionals
  • Investment in supply chain capabilities make ordering from AAP’s stores or through e-commerce easier than ever

Key Developments

  • U.S. tax reform has contributed to the increase in share price since we made our initial investment
  • The industry has remained resistant to e-commerce disruption as auto parts retailing is service-oriented with a much of its sales driven by unplanned, time-sensitive demand
  • Valuation is attractive with a significant margin expansion opportunity and a large working capital release to increase capital efficiency • Our intrinsic value
  • Our intrinsic value is US$1603

1,2,3 Intrinsic value at March 1, 2018, subject to change.

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This document includes forward-looking information that is based on forecasts of future events as of March 14, 2018. Mackenzie Financial Corporation will not necessarily update the information to reflect changes after that date. Forward-looking statements are not guarantees of future performance and risks and uncertainties often cause actual results to differ materially from forward-looking information or expectations. Some of these risks are changes to or volatility in the economy, politics, securities markets, interest rates, currency exchange rates, business competition, capital markets, technology, laws, or when catastrophic events occur. Do not place undue reliance on forward-looking information. In addition, any statement about companies is not an endorsement or recommendation to buy or sell any security.