Ask A Fund Manager
The Motley Fool chats with fund managers so that you can get an insight into how the professionals think. In part 1 of our interview, Forager Fund senior analyst Alex Shevelev explains how his ASX-listed fund nabs under-appreciated bargains, plus the stock it’s still holding after 9 years.
Investment style
The Motley Fool: What’s your fund’s philosophy?
Alex Shevelev: At the Forager Australian Shares Fund (ASX: FOR), we’re opportunistic investors. We hook and gravitate towards unloved and under-appreciated stocks. And it’s often stocks and sectors that others aren’t able to, or won’t, be particularly interested in.
The fund is a listed investment trust. So it’s listed on the ASX and can be purchased in the same way as other ASX shares. We’re currently trading at a 10% discount on its net asset value.
MF: To give our readers an idea, what are your two biggest holdings?
AS: There are actually two very interesting names.
Mainstream Group Holdings Ltd (ASX: MAI) is actually our largest holding at the moment. You may have seen the auction process for Mainstream that’s been ongoing for about the last couple of [months].
But I might take you back to the beginning. We’ve actually been the shareholder in Mainstream since the IPO [initial public offering], the largest institutional shareholder, and the business has some really interesting characteristics. It is a highly recurring revenue stream. Once a fund manager like Magellan signs up for fund administration services, they usually don’t change for a very long time…
The business has been growing really well but didn’t quite attract investor attention and, in fact, spent the better part of the last 5 years somewhere between 40 and 60, 70 cents.
Meanwhile, they’d been growing revenue more than 20% per annum into June 2020. So we thought the business had been doing a pretty good job… but it wasn’t really being recognised in the market.
So we went to the board and management and proposed a strategy for communicating with investors to close that gap. But then also to put the business in a position where it could be auctioned off. And that auction strategy was because the business is more valuable, given it’s a recurring revenue stream, in the hands of a much bigger player.
They’ve executed that really, really well. So [chief executive] Martin Smith and the team there communicated well, the stock ran up to a little over $1 at the beginning of the year.
The management and the board, headed by Martin Smith — they actually gave up some of the upside on their own shareholdings in the business. They got the option process started at $1.20. The subsequent bid to that was $2, and now we’re at $2.65.
The second largest is RPMGlobal Holdings Ltd (ASX: RUL). They provide software for mining companies and mining contractors. It allows a mining company to work out, for example, what part of the deposit to mine next or when a piece of equipment needs to be maintained.
So it’s an enterprise software business. Those have some interesting characteristics. Chief amongst them is that revenue is often very sticky. Much like Mainstream, someone puts in a piece of software within a key process in a mining company, they’re hesitant to change that, and that product will often be in place for a very long period of time.
Interestingly, RPM was going through a transition that wasn’t quite recognised by the market. They used to sell their software on a perpetual license and maintenance model, so they would charge quite a lot up front and then a smaller maintenance fee over time. They were moving that to a subscription model, which is roughly equal amounts over each year.
That meant that revenue and profits were in fact lower in the first couple of years while the business was growing and doing quite well. [But] it didn’t quite look like that when you looked at the accounts.
The management team at RPM also attracted us to the business. So [chief executive] Richard Matthews is an executive in this space that has done a lot with enterprise software businesses in Australia. He took over and sharply increased the spend on software for the business and really went about developing some products that are best-of-breed, the best technology, and is happy to spend money developing those products.
It could be another M&A candidate. Even without that, though, we think in the financial year 2023, RPM will be trading at a price-to-earnings ratio of about 15 times, excluding the excess cash on the balance sheet. Then in the subsequent year that drops down to about 10 times.
Buying and selling
MF: What do you look at closely when considering buying a stock?
AS: We start with: Is there a psychological edge to this purchase, or is there an analytical edge? I’ll run through the two elements.
The psychological edge is more like March 2020. Market panic, lots of uncertainty around COVID, lots of selling across the entire market. Other things in that psychological edge category: over-reactions to specific company news or to sector news, [and] motivated selling.
For example, an investor might not be able to hold a particular stock if that stock drops out of an index or becomes too small for them — or the money is being redeemed and that investor is a forced seller. So that’s the psychological edge component.
On the information edge side, we try to understand the businesses very well. So misunderstood business models are one of the interesting elements to that informational edge [as] I talked about RPM earlier.
Often we get these opportunities in smaller stocks or in areas of the market that we know well — where we have spent time researching other investments.
Sometimes we pick up trusted [businesses] that may not belong to individual markets. We had an investment in Virgin Money UK CDI (ASX: VUK), which we bought in April of 2020 — that’s a UK bank listed in Australia. It creates a little bit of uncertainty amongst local investors who may not be posted up to the business.
Beyond those reasons, the psychological and the informational edge, we do look at as much information as we can gather. So we look at the quality of the business. What it does, where it sits in the industry, what sort of returns on capital we can expect, how sustainable the cash flows of the business are. We look at the management aspects — who are we actually trusting with our money? The history of treating shareholders well and successfully running businesses, like the one they’re currently running, is helpful.
We are quite valuation-driven in our approach. So we do make sure that we pay an appropriate price for the cash flows that we expect and the growth of those cash flows over time.
MF: What triggers you to sell a share?
AS: Oftentimes, that’s when the thesis is not playing up. So we think that a business should be progressing in a particular way and it’s just not getting there. Something’s gone wrong.
Perhaps it’s something in the numbers, perhaps something in the environment and our confidence in the future cash flows that we had originally assumed gets dented. That’s a situation where the thesis doesn’t play out.
Where the thesis does play out, we’re also interested to see when we sell out of a stock. So again, we looked at our view of the appropriate valuation for the business to really drive the exit. We are cognisant, though, that oftentimes the businesses that we’ve gotten right continue to get better, and other investors may be more excited than us about certain stocks that may well inform our exit as well.
MF: Do you have a horizon in mind when you buy in?
AS: We’re long-term investors in our stocks. So we’ve held one investment in the fund since inception in 2009, and we’ve held quite a few others for a very long time as well.
MF: What is the one you’ve held since 2009?
AS: That’s Enero Group Ltd (ASX: EGG). It’s a marketing services business which we’ve held for a long time, and it’s had an interesting history over the last 10 years. One of the businesses in its marketing services umbrella has particularly started to perform very well over the last 12 to 24 months. And the stock price has rallied dramatically on the back of that as well.
Tomorrow in part 2 of our interview, Shevelev reveals the stock purchase that he’s most proud of.
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