VALUE: After Hours (S07 E26): The Tyranny of The Few

During their recent episode, Taylor, Carlisle, and Gwen Hofmeyr discussed Valuation, Cyclicality, and Robotics Potential. Here’s an excerpt from the episode:

Gwen: So, valuation. Yeah, I think they’re trading about €67. So, their last high was around €110. So, I guess they’re about 40% off their prior high. It’s in a position where it is higher than when we published it out. We published at about €54. But I think that it’s still in a position where you can probably beat it up and get a satisfactory rate of return. In fact, I’m looking at it every single day, because I have uncharacteristically cash in my portfolio right now and that always makes me sweat, because I don’t like cash on the books. And so, looking at it every day and thinking about the valuation, for sure, but I would say, yeah, base has probably gone from 12% to around 10%, and so that’s something to consider.

The upper end’s probably gone from about 25% to about maybe 20%. But there is this potential for, I guess, a bird in the bush to be captured in the sense that they’re in the same position as they were with autos 25 years ago, where there was this real opportunity to carve out a niche within magnetic sensors, but specifically with robotics.

So, robotics, in terms of articulated hand functions and things like that would be using three-dimensional position sensors, which is Melexis’s specialty. They have a lot of interest from China and they have prototypes that they’re developing. And so, they really want to be in that industry. I think that that’s a potential boon for them over the long run. It’s not something that I have put any thought into, because I don’t know.

You’re getting the cake that you also might get the cherry as well. So, it’s a position where heads, you make a satisfactory return, tails, you make a really exceptional return. But in the interim, the shares have effectively gone nowhere for 10 years. It’s very compelling. The firm is being discounted relative to peers where in the past, it would have a premium over peers just in terms of their upper profitability.

The IR spokesperson described it as what he’s been calling the tyranny of the few, where if you’re not a large company, you basically just don’t matter in terms of sponsored research. He’s beside himself at why the business is being valued the way that it is. But there are inventory issues still and that will probably take, I don’t know, maybe 12 or 18 months to even out.

That’s a great time to get interested in cyclicals, in my opinion, is when you see that supply blowout and you see demand, that supply demand mismatch, because the market fears lower forward earnings and naturally sells off the stocks. That’s the equivalent of rain. Almost every company is cyclical to some degree. Just some are more cyclical and some are less cyclical. Most of Warren’s businesses have periods where they over earn and under earn. There’s very few Microsoft’s in the world.

And so, with a more cyclical business like Melexis, where it’s tied to a autos, I picture it as when they experience that supply-demand mismatch as it being raining outside. So, the cyclical can almost be thought of as an umbrella. When it’s raining outside, umbrellas are valuable. When the sun comes out, it’s time to put the umbrella away. That’s how I feel about cyclicals is the value, is when they’re in a period of opacity with regards to future earnings.

The attention shifts away from, “Okay. Well, what are earnings going to be next quarter or next year,” whatever, and towards “Okay. Well, this is a product that is driven by necessary demand,” which means that it’s very likely that demand will be higher in the future, or at least as strong. That almost makes it easier for an investor in the sense that they can shift their attention away from what is broadly unknowable, which is forecasting the future economics of a business. They can shift their attention towards the balance sheet, which is asking questions like, “Can this company survive?”

With cyclicals, a lot of them, if you survive, you get free market share for the most part, because a lot of firms are short-term oriented. They will lever up, acquire, mimic the herd mindlessly in a way that ultimately detracts from their ability to invest in those downturns. Melexis is one of those companies that continues investing throughout the cycle. The last repurchase they did was at €65 per share, but they initiated buybacks between about €50 to €65 per share. The company is majority owned by the founders. This is the first time that they’ve done that since the Eurozone crisis. So, when share prices were significantly lower. So, that’s a huge, huge buy signal.

They have stopped, which suggests they’re not willing to purchase at a price above €65. But I don’t know, I think it’s up for an investor’s interpretation, but it’s an excellent company to learn about. I think a lot of the opportunity comes from doing preparatory work and investing. You often don’t have time to do the work when the opportunity presents itself. So, even just learning about companies without any expectation of immediate reward can be very, very valuable over a long-time horizon.