Emma Wall: Hello and welcome to Morningstar. I'm Emma Wall and here with me today is Michael Hulme, Manager of the Carmignac Portfolio Commodities Fund.
Hello Michael.
Michael Hulme: Hello Emma.
Wall: So, commodities fund, but you do invest in equities. So, you are here today to give three stock picks. What's the first?
Hulme: Well, that's right, Emma. We are an equity investor. The first company I wanted to talk to you about today is really a core part of our portfolio, Suncor (SU), which is an oil sands company. I think people might find this counterintuitive, but we really are looking at the quality oil sands produces at the moment in the light of this fall off in crude prices largely because even when CapEx gets cut and many of the producers are cutting CapEx and you are going to see declines in supply, these companies are able to maintain supply throughout this downturn and indeed, when oil prices return to more attractive levels, they will still be able to maintain their production and indeed grow it while other companies may well suffer and see much lower production levels.
So, we like that for that perspective, we like it for the ability to generate incremental free cash flow as oil prices return and we really like the management. We think they are focused on shareholder value.
Wall: This is point of picking up sort of quality company while its market share is depressed?
Hulme: Exactly, it's really contrarian approach and that's a key way for us to try and make money. I think costs obviously look elevated on a unit basis when oil prices come down and these businesses are quite expensive producers in terms of the P&L, the profit and loss statement. But in terms of capital intensity, most of Suncor's business is already sunk capital. So, they are really reaping the benefit of historical capital investment and on that basis we think that offers quite an attractive long-term annuity stream for investors, particularly when oil prices recover.
Wall: What's the second stock today?
Hulme: So, the second stock I wanted to talk about in contrast to Suncor is one of the beaten up oil shale names. I spend a lot of time going over to the U.S. and picking over some of these businesses and meeting managements. One of the management teams I really like is the management of Oasis Petroleum (OAS) who specialise in shale oil in the Bakken shale formation and they are being particularly good at managing capital returns through the cycle and I think it obviously sold off along with the a number of the other names given this drawdown in crude but we like it because we think in the longer term Oasis will be able to generate an attractive discretionary free cash flow yield.
We think they drill wells generally on a very economic footing, so they are able to get back their investment and then make a profit on top of that original investment and we think the valuation is compelling down here. So, Oasis we think is particularly attractive amongst the shale names.
Wall: I mean, sentiment around the oil producers is very low at the moment because oil prices come off so considerably. How do you sort the sort of ones that will be able to make it through this low from the value traps?
Hulme: Yes. I mean, I think that's the challenge. We have an industrial model in-house I have spent many years developing which really just looks over history at each individual well that the company has drilled to see if it's actually made a return on that well, the return on its investment. You can get that data from state files easily in the U.S. There is great availability of rims and rims of data both in Texas and North Dakota and you can generally tell whether a company has delivered a return on its investment.
What you find is quite surprising is that probably the majority of those businesses even in the good years have struggled to generate a return on that investment. So, it is vital to buy businesses that are able to recycle cash effectively. Otherwise, it's just a washing machine and over time you are not generating incremental value. You are just taking more and more money from shareholders and that's what these – the bad companies do. They just keep coming back to the market to bail themselves out either in terms of more credit or more equity. So, it's really important to pick those businesses that have a virtuous recycle ratio.
Wall: I believe the third stock is a copper stock?
Hulme: Yes. Copper has obviously sold off in sort of highly correlated surprisingly with oil. Well, the copper has very different supply and demand fundamentals and I think actually probably more positive even in the short term. One of the companies that's really been beaten up in this environment is a company we've owned for some time, First Quantum.
First Quantum (FQM) is a very high-quality copper operator. It's operated a number of projects. It took over the Ravensthorpe mine and did a fantastic job turning that one around. It has a number of projects, particularly in Zambia but also elsewhere. There is the Cobre Panama project that they are investing in. We think these projects are in the process of being completed and when they are completed, this business will generate an attractive stream of profits and cash flow and given our feeling about the copper price at the moment, this is a good opportunity to buy a stock that is really slightly unloved at the moment we think for the wrong reasons.
Wall: So, three slightly contrarian picks there?
Hulme: That's right.
Wall: Michael, thank you very much.
Hulme: Thanks Emma.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
