This month the fund was up 0.5% driven by positive contribution from our long positions in all key geographic regions, while our short book was a minor detractor.

THE FUND’S PERFORMANCE & MARKET REVIEW

October 2021

 

Our top contributor was SOFI, the company we highlighted in our previous monthly newsletter. The stock rallied strongly as several sell side brokers initiated overweight recommendations and price targets in-line with ours. While the stock has pleasingly moved in our favour after building our position, we continue to believe its best days are ahead of it and the story still very much undiscovered.

The main detractor by far this month was currency. We typically do not actively position for FX but do review movements regularly. We converted the majority of our foreign cash holdings into AUD near the September lows, but in hindsight it would have been even better to convert all of it! AUD appreciated 4% in October alone which resulted in a -1.2% drag on performance. There were no material stock specific detractors.

Our net exposure decreased to 50% as we trimmed our lower conviction positions, took some profits and added slightly to our short book. We continue to upgrade the quality of our portfolio towards our highest conviction ideas.

 

Market Views

Markets are starting to look more and more likely to push interest rates higher as inflationary pressures continue to rise. The cost of goods is rising and it’s not just asset bubbles (property/equities), but also now real goods and services. We have been saying this for a while now.

One thing we haven’t discussed is the ramifications of a rising oil price. A rising oil price is one of the most detrimental “taxes” on the world’s growth trajectory. This is because it is so broadly used across so many different aspects of life. As supply has tightened at the same time demand is rising (as the world opens again post COVID), input costs will remain elevated. This means more expensive energy, fuel and as a result, goods consumed as input costs are pushed up and passed through to consumers globally.

The impact of this is that suddenly real purchasing power is eroded as inflationary pressures are making everyday goods more expensive. Businesses margins are then squeezed as input costs rise and profitability starts to deteriorate. Now depending on what happens from policy makers there is typically a loss of wealth/purchasing power from the population as the cost of living becomes more expensive. As people wind back spending on non-essential consumption to spend on more inelastic goods (fuel or food as example which higher costs of production due to oil have now become more expensive). This typically slows growth, and the economy can start to stagnate as a result. For example, if driving to work is now 40% more expensive as is purchasing lunch etc… most consumers have less available capital to spend in the economy. A big reason the US likes to keep gasoline prices low and goes to wars over oil!

The difficulty of this (that we can see) is that as margin pressures hurt business profitability, businesses typically start to lay off workers to improve margins/profitability at the same time growth/demand for product slows. Rising cost of goods combined with rising unemployment is a double wack on the economy.

If central banks print more money and provide further stimulus it only further pushes costs of goods higher as demand remains artificially higher (inflationary pressures). Stagflation is arguably the hardest type of inflation to deal with from a policy perspective. Amazingly, the last time this was a big issue was in the 1970’s after a period of strong growth which was then proceeded by an oil crisis (sound familiar?).

The 1970’s saw markets trend sideways in what was a very difficult economic period.

The alternative is if growth doesn’t stagnate and rather accelerates (which is difficult to see when oil prices remain elevated and higher cost green alternatives continue to be pushed by governments) then wages must rise to compete, further adding to inflationary pressures. This then forces central banks to reverse easy monetary policy and rates must also go up. The sheer level of debt in the economy currently would then put significant pressures on over-leveraged economies and curtail growth. The serious problem with a loss of purchasing power due to inflation is that real returns on cash or risk-free assets further deteriorate.

Currency volatility typically then begins and the desire to hold bonds/treasuries becomes even less so due to the negative return profile, making central banks balance sheets come under even more pressure. As buyers flee the central bank becomes the only buyer of the government debt, further printing only then adds to the problem. There is a reason Zimbabwe didn’t do very well as an economic powerhouse.

Now while we don’t think it gets quite to that level, we can see a period of very difficult policy making ahead. Again, we are normally early and we first thought this could occur when COVID first hit (and did a video detailing some of those thoughts at the time). While the narrative has somewhat changed, we think the underlying conditions for some serious pressures remain and will begin to eventuate soon.

Why is this so relevant? Well, we can see a period ahead where being in actively managed funds will be one of the few places where returns will be decent, in what could be a lost decade in the markets. Right at the time the popularity of the ETF investing is at all-time highs – what could possibly go wrong!

Stock Insights

It’s hard to imagine operating a business in today’s world without an online presence. For many businesses, this begins with having a website. Today, there are nearly 2 billion websites and growing, with ~500k being created every day. A website is a critical foundation for businesses as it often acts as the first point of digital contact for customers. Having a website that looks good vs one that looks more akin to a high school project can mean the difference between gaining or losing a customer.

Building a website has historically been the domain of expert web design and development consultants which requires a substantial investment (often well into the tens of thousands) and time (months) to build a quality website. This can be a dealbreaker, particularly for smaller businesses. This is where easy to use website builder, Wix comes in. With Wix, you can now create a professional looking website in a matter of hours (or even minutes!) with no coding or prior experience required.

 

Furthermore, Wix operates a freemium model, meaning you can create and operate your own website for zero cost forever. However, additional features will require an upgrade to paid subscription plans. Even so, the paid plans are highly affordable, with the average customer spending just ~$200 per annum. Founded in 2006, Wix now has over 210m registered users of which 5.5m are paying users.

 

Wix exhibits many of the qualities we look for in a business.

  • Long growth runway: Wix accounts for a small fraction of the website creation market with plenty of room to gain market share in a growing end market. Even among its existing registered user base, <3% of users have been monetised. Its app market and expanding functionalities also offers room to increase its addressable market.
  • Compelling value proposition: Offers an easy to use, value for money and quality product. High revenue retention ratio of >110% demonstrates its value proposition.
  • High switching costs: Anyone who has ever attempted to move their website knows it’s a pain to change! Also, is it worth the hassle when it only costs $200 pa?
  • Scale advantage: Wix is the leader in the DIY website creation market which allows it to spend more on R&D to improve its offering to users which in turns attracts more users and improves its unit economics.
  • Attractive business model: Majority of revenues are subscription based which provides superior visibility. Its freemium model also provides an easier path for new users to join and lowers customer acquisition costs.

The stock has recently come under pressure as growth decelerates from the COVID-19 driven bump, and margins contract due to a shift in revenue mix and continued reinvestment into the business. The stock trades at ~7x revenue and is one of the rare stocks that has the combination of growing revenues at a healthy ~20% clip while being cashflow positive. We took advantage of the share price weakness as we see this as a transient period that does not alter the longer-term attraction of Wix as a business.

As always if you would like to learn more about investing in our fund please contact us – investor@fiftyonecapital.com