A Scientific Investor’s Review Of The SuperNormal Portfolio
In the previous OmniView we have discussed how the SuperNormal portfolio is created using the Scientific Investing approach. Further, we also provided the portfolio governance process during a time of crisis like the current times.
In this OmniView we will introduce you to the key segments comprising the US OmniSupreme portfolio. This is a multi-cap portfolio of US companies from the Top 1500 US companies which are part of the large, mid and small cap stock universe. of There are broadly 4 segments in this portfolio, viz. AIoT (Artificial Intelligence & Internet of Things), HNWMA (High Net Worth & Mass Affluence), Sports & Wellness, and Consumption. Each segment provides exposure to a completely different set of growth vectors with different market sizes, growth rates and growth drivers. This provides significant diversification to the portfolio and positions it to benefit from multiple growth vectors increasing the probability of portfolio growth and wealth creation over the long-term.
The AIoT segment primarily consists of technology based companies which are part of the ecosystem for digital transformation of businesses via the use of AI, Analytics, AR/VR built on the infrastructure of Big Data, Cloud, IoT, 5G, and Cyber security. Currently, this segment has the largest allocation in the portfolio. This segment provides exposure to the broad digital transformation market which is growing at 22-23% CAGR and is expected to grow to nearly $3 trillion by 2025.
The annual revenues of the companies in this segment range from $300 million to nearly $300 billion with free cash flows (FCF) ranging from $130 million to nearly $60 billion. The companies range in enterprise value (i.e. EV = [market capitalization + net debt] provides the true market value of the whole firm irrespective of the capital structure) from a billion to more than a trillion dollars. In fact, 3 companies are nearly a trillion dollars, 2 companies are around $40-50 billion, and rest are between $1 billion to $2 billion. This segment is a mix of mega caps, large caps, and small caps. Most of these companies are growing in double digits and sport an FCF yield of 4% to 12%. FCF yield is the ratio of FCF to EV.
The FCF yield is the return one should expect from the company if the company keeps performing in steady state. The FCF is “free” to be distributed to the shareholders. It can be distributed as dividends or can be used for share repurchases or it can be used to make acquisitions. The total returns the shareholders are likely to make are the FCF yield + growth. Of course, if Mr. Market reprices the shares to a lower yield then the returns to shareholders could be much higher. For example, if you buy a company with an FCF yield of 25% and the market reprices it to an FCF yield of 20%, i.e. a 25% return over the holding period in addition to whatever FCF and growth that has been generated during this period. So, yield changes due to change in market perception can deliver very high returns.
A couple of very fast-growing companies generate very low FCF since they redeploy all the cash flow available for future growth. For these companies, the discretionary cash flow is very high, but they choose to deploy it for growth and hence it is not visible. However, the delivered growth is typically 15% to 30% in most years. An estimate of the true FCF would provide an FCF yield of nearly 5.5%-6% for these companies.
The HNWMA segment primarily consists of companies which provides goods and services belonging to experiential luxury to the High Net Worth and Mass Affluent segment of the population. While the focus is on the US-based HNWMA segments, due to their global operations, some of the companies provide exposure to the global segment as well. The US HNW population is more than 5 million with a wealth of $18 trillion while the global population is 18 million with a wealth of $68 trillion. The HNWMA segment grows at around 6-7% CAGR.
The companies in this segment have annual revenues ranging from $2 billion to $8 billion and FCF ranging from $20 million to more than $400 million. The EV ranges from just below $600 million to $9 billion. Normalized FCF yields are around 4% to 40%. In one case, the reported FCF yield is very low due to large and lumpy capex for growth. However, adjusting for the growth capex, the normalized FCF yield would be around 4%. The growth rates of these companies range from 5% to double digits. In one case, the company is likely to be seeing shrinking revenues in its traditional products and markets while experiencing double digit growth rates in its new products and markets.
The Sports & Wellness segment has companies which provide products and services to a diverse segment of the population. The US has more than 130 million obese people who need help with weight management and need to enhance their fitness levels. Some of the companies in this segment provide nutrition services and others provide footwear and other athletic apparel which supports the fitness efforts of the segment. The US footwear market is $86 billion and growing at a CAGR of 4%. While most of the companies are focused on the local markets, there is exposure to the international markets as well.
The companies in this segment have annual revenues ranging from around $700 million to $8 billion, while the FCF ranges from $56 million to nearly $600 million. The EV ranges from $400 million to $5 billion. The FCF yields range from 5% to nearly 14%. Even modest growth expectations in the GDP+ range would make the total return expectations in double digits.
The final segment is the Consumption segment which provides exposure to the US personal consumption expenditure of nearly $15 trillion annually, which is the largest contributor to the US GDP. This segment includes companies selling products and services for the homes, apparels, other personal goods, and credit cards.
The enterprise value of these companies ranges from $500 million to nearly $24 billion. The annual revenues of these companies range from $900 million to $43 billion. Some of these companies are available at an enterprise value which is just worth 3-4 years’ worth of the free cash flows generated by these companies. In terms of EV-to-FCF ratio, it can be understood as a PE equivalent of 3-4. Other companies are available at an EV-to-FCF of 8 to 15. In some of these cases, there is an expectation of large-scale cost cutting and other efficiency measures which are likely to generate a large amount of additional free cash flow over the next few years, thus bringing down the forward EV-to-FCF ratio significantly.
On the issue of Covid-19 impact on the portfolio companies, there are a lot of companies which would actually benefit from the Life-From-Home (LFH) shift which it is likely to trigger on a permanent basis. We conjecture that the Work-From-Home (WFH) is a permanent shift that will make more and more aspects of life home-centric. This shift is what we label as LFH and includes, Play-From-Home (PFH), Learn-From-Home (LnFH), Shop-From-Home (SFH) and Live-From-Home (LvFH). Many of the portfolio companies would thrive under such shifts and are already seeing a temporary spike in revenues during the current lockdown phase.
On the survival analysis of portfolio companies, we have conducted the survival analysis and most of the companies are likely to survive for several months to more than a year even with zero revenues and some reasonable cost cutting measures.
Of course, the new business models which are likely to evolve post a serious shift to the LFH paradigm cannot be predicted fully and some amount of uncertainty should be expected. We will be monitoring these shifts very carefully and will be vigilant to shuffle the portfolio is such a situation arises.
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