- Risks came home to roost for the Great Expectation screen over the last 12 months
- Still, 10-year performance looks very impressive at 389 per cent versus 115 per cent from the FTSE 350
- Six new Great Expectation stocks for 2022
The Great Expectations screen has been a real rip-roarer over the last decade. Since I started to run it in late 2011 it has produced a 389 per cent total return compared with 115 per cent from the FTSE 350, which is the index the screen selects stocks from.
But it’s been a high-octane ride that’s come with spills as well as thrills. It’s high rewards are built on a ravenous appetite for risk, and risk came home to roost last year.
When I ran the screen 12 months ago, it was at the height of euphoria over lockdown darlings. It may be the fall from grace of US companies of this pedigree, such as Zoom (US:ZM) and Peloton (US:PTON), that has captured the most headlines, but there have been plenty of homegrown examples, too. Unfortunately, the Great Expectations screen was all over them. The standout case in point being online white-goods retailer AO World (AO.).
A year ago these stocks were singing out a siren’s call that the strategy could not resist: giddying price rises coupled with rapacious forecast upgrades.
But it turned out analysts were extrapolating from a trend that could not continue and the shares had priced in the best-case scenario rather than the litany of disappointments that were instead served up.
When things are going well, almost everyone believes the hype more than is healthy. I count myself as no exception. It is human nature. And betting we’ll all keep downing the kool aid is one of the games the momentum focused Great Expectations screen explicitly sets out to play.
But last year it lost that particular game. The screen massively underperformed the 14 per cent total return from the FTSE 350 with its negative 14 per cent return. The screen has arguably had even greater traumas in the past. In particular its 54 per cent peak-to-trough fall during the market’s March 2020 Covid sell-off, which compares with a 35 per cent drop by the FTSE All-Share, all on a total return basis.
|Name||TIDM||Total Return (12 Jan 21 - 4 Jan 22)|
|Source: Thomson Datastream|
Despite these horrors, over the decade the strategy of blending share-price and earnings-upgrade momentum has still been quite tremendous. It has also highlighted some brilliant stocks. The long-term performance record is testament to this.
While the screens are best considered a source of ideas rather than off-the-shelf portfolios, if I factor in a 1 per cent annual dealing charge, the cumulative total return from the screen based on annual reshuffles when new results are published comes in at 342 per cent.
The performance of this screen may be strong, but its criteria are nevertheless pretty straightforward. They are as follows:
■ EPS forecasts for next financial year upgraded by at least 10 per cent over the preceding 12 months.
■ EPS forecasts for the financial year after next upgraded by at least 10 per cent over the preceding 12 months.
■ EPS growth of 10 per cent or more forecast for the next financial year.
■ EPS growth of 10 per cent or more forecast for the financial year after next.
■ Share price momentum at least double that of the market over the past year.
■ Share price momentum better than the market over six months.
■ Share price momentum better than the market over three months.
■ Share price momentum better than the market over one month.
This year six stocks passed all the screen’s tests. I’ve taken a closer look at one that appears cheap, hot and risky. A full list of the stocks highlighted by the screen can be found at the end of this article along with a downloadable table containing lots of extra data.
|Airtel Africa Plc||AAF||Internet Software/Services||134p|
|Size/Debt||Mkt Cap||Net Cash / Debt(-)*||Net Debt / Ebitda||Op Cash/ Ebitda|
|Valuation||Fwd PE (+12mths)||Fwd DY (+12mths)||FCF yld (+12mths)||P/BV|
|Quality/ Growth||EBIT Margin||ROCE||5yr Sales CAGR||5yr EPS CAGR|
|Forecasts/ Momentum||Fwd EPS grth NTM||Fwd EPS grth STM||3-mth Mom||3-mth Fwd EPS change%|
|Year End 31 Mar||Sales*||Pre-tax profit*||EPS*||DPS*|
|Source: FactSet, adjusted PTP and EPS figures converted to £|
|NTM = Next 12 months|
|STM = Second 12 months (ie, one year from now)|
An increasingly popular vision of the future of investment is that we will see a move away from the old model of 'risk and reward' to one of 'risk, reward and impact'. Impact refers to the positive and negative impact a company’s activities have on the wider world.
Airtel Africa (AAF) is a company that scores big on all the individual components of the risk-reward-impact tricolour. That’s to say, it has significant potential to improve the wealth of shareholders at the same time as improving the lives of its customers. But this comes with a big dollop of risk.
The company is the FTSE 250-listed subsidiary of Indian telecoms firm Bharti Airtel, which owns 56 per cent of the shares. The closeness of the relationship with the majority shareholder includes a “cross default clause” on bonds. But more on this and other risks in a minute. Let’s start with the reasons to be cheerful. The 'reward and impact' part of the investment case.
Doing good while doing well
Airtel Africa provides mobile data, voice and banking services to more than 120m customers in 14 sub-Saharan countries. There are huge opportunities for growth. The populations of these countries are among the most underserved in the world for voice, data and banking services. Furthermore, this is a part of the world where population growth is expected to remain high for the rest of the century – a reflection of the strong link between poverty and demographic trends.
The huge opportunity means Airtel Africa’s track record and outlook is a million miles away from the mature, low-growth, low-return mobile telecoms operators in developed markets. The company has reported double-digit revenue growth and cash-profit (Ebitda) margin expansion for 15 consecutive quarters. Forecast growth is also phenomenal (see graph).
Airtel Africa’s growth is not only transforming its own top line. The company boasts that it’s also transforming lives by introducing services that are vital for the development of economies and communities in Africa. The doing-well-by-doing-good message is underlined by projects with the likes of Unicef aimed at boosting education. And the company’s mobile money business plays a vital role in providing basic banking services to the huge numbers of 'unbanked' individuals and small businesses; a crucial step in increasing economic participation.
The money business is growing at an eye-watering pace. Revenues soared42 per cent in the first half of the current financial year to $259m (£191m), or 11.4 per cent of total group sales. The division’s cash profit margin of 48 per cent, meanwhile, is broadly on a par with the rest of the group.
Recent fundraising rounds for the money mobile division, which provided cash for the company to pay down debt, have put a value of $2.65bn on this business. That is equivalent to just under one-third of the company’s enterprise value (market cap plus net debt). Management is mulling an IPO of the business within four years.
So, clearly there is a lot to feel good about on both the reward and impact front. But the relatively low valuation of the shares should alert us that there are also reasons for caution.
While the growth being reported by Airtel Africa may be in a different league to its developed world counterparts, the long-term dynamics of its business are unlikely to prove a thing apart. Mobile telecoms is a fiercely competitive and capital-intensive industry. Indeed, in its last full-year results Airtel Africa cited increasing competition as one of the biggest and most significant risks the business faces. Increased competition puts pressure on prices and margins. And given the company produces only around 50¢ of sales for each $1 of capital employed, falling margins can seriously dent returns on capital and thereby the rationale for investing in growth.
As far as competition goes, there is even the rather nebulous threat that projects to provide 5G services beamed down from low-orbiting satellites could at some point disrupt incumbents.
But Airtel Africa has some competitive merits. In an industry where scale matters, it holds the number one or two position in 12 of the 14 markets it serves. It is also the second-biggest player in the African market as a whole. Furthermore, it seeks to create customer “stickiness” through its mobile money services, product bundling, innovation and customer-service levels.
A less-familiar risk than competition to investors in telecoms companies serving western markets are those associated with currency and politics. In particular, there are currently worries about Africa’s most populous country and Airtel Africa’s biggest geographic source of revenue, Nigeria.
Nigeria accounted for two-fifths of Airtel Africa’s sales last year and 46 per cent of cash profits. The Nigerian operation also accounts for $1.3bn of goodwill on the balance sheet (in the last report and accounts the company’s auditor pointed out that it viewed a goodwill-impairment test based on five-year forecasts to be “more appropriate” than the company’s use of a 10-year forecast period).
Many view Nigeria’s democracy to be in a very fragile state with the potential for political chaos. That said, while recently introduced mobile-user identity requirements in the country have meant a drop in customer numbers, fast rising per-customer revenue meant the Nigeria business still powered ahead in the first half. Indeed, despite the reasons to fret, sales were up 32 per cent, although a negative 6 per cent currency move was a headwind on dollar denominated reporting.
Further currency pressures may result from the prospect of a series of US interest rate rises this year. While Airtel Africa bills chiefly in local currencies, a noteworthy proportion of costs, especially for equipment, are denominated in dollars.
Bharti Airtel’s majority ownership is another significant consideration for any would-be shareholders. As well as its general influence over the company, there is an added dimension to the relationship in the fact that a covenant on Airtel Africa’s $1.5bn of bond debt depends on Bharti Airtel not defaulting on its own debt. Bharti’s debt currently hovers around junk status based on the assessments of major debt rating agencies – Moody’s has its debt at a just-junk Ba1 rating while S&P gives it a just-not-junk rating of BBB-.
But debt is being paid down fast by Airtel Africa which is a positive for the investment case. As well as the group’s own cash generation and external investments in the mobile business, the company has raised nearly $300m through two disposals of towers over the last 18 months. Debt is also being transferred to businesses at the local level. While this helps address concerns about the cross default clause and currency mismatches, local debt is more expensive. The group’s weighted-average interest cost rose from 4.8 per cent to 5.5 per cent in the first half.
Bigger, better, bolder
For fast-growing, capital-intensive companies like Airtel Africa, the big question is alway whether returns from investment in the business can be kept above the cost of investment. If the answer is yes, then growth will create value. If no, it will destroy value. Everything has been moving in the right direction for the company over recent years. Based on a standardised calculation using FactSet data, return on capital employed (ROCE) has risen from 2.8 per cent in 2017 to just over 14 per cent last year, which is a healthy level.
But the risks are plentiful. That makes Airtel Africa one for the bold. The compensation is that the low rating. The shares are valued on a next 12 month price/earnings ratio of 12 and forecast free cash flow yield of 9 per cent. Recent fundraising for the mobile banking business also imply one-third of the valuation is accounted for by a division generating about one-tenth of the profits. The low rating means the shares could do very well if growth continues to come through, the balance sheet overhaul continues, and nasty surprises don’t become realities.
The business’s positive 'impact' credentials could also help sentiment; so too could a reduction in the Bharti stake.
So the stock may deliver for the Great Expectations screen, but it certainly requires a high risk appetite and many of the dangers, such as currency movements and politics, are near impossible to predict.
|Six great stocks for 2022|
|Name||TIDM||Mkt Cap||Net Cash / Debt(-)*||Price||Fwd PE (+12mths)||Fwd DY (+12mths)||FCF yld (+12mths)||Fwd EPS grth NTM||Fwd EPS grth STM||3-mth Mom||12-mth Mom||3-mth Fwd EPS change%||12-mth Fwd EPS change%|
|Watches of Switzerland||WOSG||£3,400m||-£271m||1,420p||29||-||2.9%||38%||18%||50%||145%||29%||77%|
|St. James's Place||STJ||£9,098m||-£307m||1,683p||21||3.6%||-||22%||12%||12%||49%||9.5%||62%|
|Liontrust Asset Management||LIO||£1,348m||£82m||2,200p||17||3.3%||3.6%||22%||13%||3.5%||69%||12%||49%|
|*FX converted to £|
|NTM = Next 12 months|
|STM = Second 12 months (ie, one year from now)|