Bear market resumed

After a strong rally over the last couple of months, things have come crashing back down to earth over the past week or so. Fears about rising interest rates have come back to the fore and were crystallised in Jay Powell’s comments last Friday, aimed to signal that the Fed will take no prisoners when it comes to tackling inflation.

I had been getting fairly bullish prior to the last couple of weeks and had reinvested much of my cash balance. The rebound was looking strong and the general sense of bearishness still permeating the market felt promising. Inflation was showing signs of rolling over and being replaced by concerns about recession (at least in the US) which should be good for defensive growth stocks. After the last couple of weeks I’m naturally feeling a bit less confident.

Not that much has changed. It is unsurprising that the Fed is trying its hardest to signal it will be tough on inflation. I don’t think this changes the fact that it will ultimately be driven by the short term priorities dictated by the economic data ie if the economy worsens substantially then their resolve to deal with inflation may go out the window. My suspicions are that over the coming months inflation will continue to fall below expectations and the economy show more signs of weakening (at least in the US) but I don’t really have any special insight. There is a lot of uncertainty and likely to be volatility ahead. It may be prudent to withdraw some cash again to take advantage of a possible further crash but I may have missed the boat. I’m not convinced this is now a good idea given how far the market has already fallen.

A silver lining to the current macro situation is that the Pound has fallen a great deal, particularly against the Dollar. This is good news for UK investors with foreign denominated assets (or especially for assets with foreign denominated cash flows but costs in Sterling). I doubt this has been fully anticipated for some UK listed shares and is worth thinking about when looking for ideas.

I made several trades over the last month. I took quick small profits in my recent purchases of Etsy, JD Sports and Veeva as my conviction in their short term prospects was not so high and the share prices had started to roll over. I also lost patience with Keystone’s relentlessly falling share price and took a significant loss, unfortunately just before it staged a small rebound. Finally, I sold Fortinet for after its last results seemed insufficient to justify its high rating, crystallising a large profit.

In the earlier part of the month I bought Moncler and Canada Goose, aiming to take advantage of their reasonable valuations and stronger than expected trading in luxury goods. My other trades in the latter part of the month when the market started weakening were all quite defensive. I bought Diageo, PepsiCo, Fonix Mobile, Celsius. Diageo I have previously held and written about.

PepsiCo

PepsiCo is a large, £200bn, drinks and snacks company. As well as the eponymous drink it owns a range of other brands, such as Cheetos, Lays, Walkers and Doritos. Most of its profits actually come from snacks rather than carbonated drinks such as Pepsi.

Quality

  • Business economics: Pepsi is highly profitable. It has 16% margins, which are very decent given the nature of the business and makes mid-teens returns on capital which are levered up to very high returns on equity.
  • Track record: PepsiCo, originally formed in 1965 from the merger between Pepsi-Cola and Frito-Lay, has been around for a very long time. Over the past twenty-odd years it has an extremely consistent track record of slow but steady growth in revenues and profits and a steadily appreciating share price.
  • Competitive advantage: PepsiCo owns a lot of strong brands that have been around a long time. Consumer recognition and trust in these brands results in a very strong competitive advantage. Tastes may change slowly over time but PepsiCo’s distribution network and marketing capabilities should allow it to shape and respond to this effectively. The strength of PepsiCo’s brands gives it pricing power, allowing it to effectively manage rising input costs.
  • Growth prospects: given PepsiCo’s size, growth is and is likely to remain pretty pedestrian. However, it should also be very consistent given demand is defensive.

Price

PepsiCo is one of very few companies on my watchlist with its share price near its highs. Then again, if you look back the share price is almost never too far from its highs as it plods along making steady progress. The valuation is not very cheap but seems reasonable given the quality of the business. Overall this is not the most exciting investment but, along with some of my other recent purchases, provides a safer ‘port’ for some of my funds in the current storm.

Fonix Mobile

Fonix is a payment service provider that provides a mobile carrier billing solution, which allows consumers to pay for transactions via their mobile contract. It is a small UK business worth about £170m. In my opinion Fonix is less high quality than many of the other businesses on my watchlist but it’s correspondingly cheaper and seems attractive at the moment.

Quality

  • Business economics: Fonix has a simple commission-based business model that benefits from scale and is already very profitable. It doesn’t capitalise many of its costs and has decent margins in the high teens and returns on capital north of 100%. It has a policy to distribute 75% of adjusted EPS as dividends to shareholders.
  • Track record: Fonix has a relatively short track record. It was founded in 2006 and held its IPO in 2020. Over the past few years it has been successful in rapidly growing revenues and profits.
  • Competitive advantage: carrier billing is a rather niche payment solution. These days most consumers prefer to use credit cards (or digital wallets linked to credit cards which remove a lot of the ‘friction’ associated with entering credit card details). However, it is convenient for some consumers. Note that in most cases carrier billing would be presented as an additional payment method to credit card etc. so Fonix does not need to displace these methods but rather show it has incremental value. In addition, it is fairly well-suited for certain contexts – television, radio, charity donations. Fonix markets its USP as the fact that its technology also allows clients to acquire new customers through SMS marketing rather than just process payments. I’m sceptical about the long term potential of Fonix’s technology but can see it has niche appeal.
  • Growth prospects: while not very exciting, the growth prospects look reasonable. In particular there is some scope for international expansion, starting with Ireland, which looks promising in the short to medium term. Demand should be fairly defensive.

Price

Momentum is relatively strong at Fonix. The last trading results were ahead of expectations and the share price is near new highs, bucking the general market trend. The valuation seems very reasonable.

Celsius

Celsius is a £6bn US-listed company that makes energy drinks. It markets itself as a healthier alternative to other energy drinks like Redbull and Monster. There is a lot of hype about Celsius at the moment, which does make me wary, but I think the opportunity looks interesting enough to warrant a small investment.

Quality

  • Business economics: Celsius has just reached the inflection point where it becomes profitable. It is difficult to assess how profitable it will be when it reaches maturity. Celsius follows a similar business model to other small drinks businesses of outsourcing manufacturing and distribution to third parties. Long term I think this is a pretty sound business model. Ultimately profitability should be driven by the strength of the Celsius brand.
  • Track record: Celsius doesn’t have much of a track record. It was initially founded in 2004 and had one ‘false start’, listing in 2008 before delisting again after it was unsuccessful in getting much traction. Second time around it has been a lot more successful and has generated some explosive growth over the past couple of years.
  • Competitive advantage: the competitive advantage depends on the success of the brand so is as yet fairly uncertain. Celsius has a fairly compelling USP of being more natural and healthy than other energy drinks as well as being backed up by some clinical research. Based on current progress it looks very promising that Celsius will be able to carve itself out a decent niche that can endure. However, there is certainly the possibility that it could face stiff competition from similar brands in the future.
  • Growth prospects: are pretty exciting, albeit somewhat speculative. Celsius is growing incredibly rapidly at the moment and looks like it could keep it up for some time. Energy drinks is a huge and rapidly growing category and Celsius’s ‘healthy’ brand looks like it could sustainably take a lot of share. Celsius has just agreed a distribution deal with Pepsi which should enable it to turbocharge its growth in the shorter term.

Price

Momentum is excellent. The share price is near its highs having rocketed over the past couple of years. The last results were ahead of expectations and the Pepsi deal provides further positive news. The valuation is hard to judge given uncertainty about the medium term growth trajectory.

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