Interview with Suhas Nayak by Damon Frith
When the impact of China’s industrialisation on Australia’s resource sector started featuring on the front page of newspapers in the mid-2000s, it kicked off a resources boom in the share market. But few were listening to the story before it led the news cycle.

The S&P 300 Metals & Mining Index was flat from 2000 to mid-2003, when it did start to gain upward momentum. But the real spike in the index did not start until 2005, 18 months after the resources boom had started.

Slow down and read the signposts

It’s the type of scenario that’s excites contrarian investors, says Allan Gray analyst Suhas Nayak.
“The contrarian investor focuses on the fundamentals of a sector or stock within an industry, and tracks any mismatch in the value given to assets by the share market.

“It means you have to reach a conviction about that asset, that the market has the pricing wrong, and when that is realised, the price will rise,” says Nayak.

At the moment the oil and gas sector is out of favour, but the fundamentals are good, which is why we have been buying,” says Nayak.

Glass globe and stock charts

 

Currently the allocation of investment funds in the Australian Stock Exchange energy sector is 5 per cent, with another 1-2 per cent held in BHP Billiton.

But Allan Gray has a 14 per cent energy weighting in its Allan Gray Australia Equity Fund.

Nayak has been looking at the sector since 2013. The trigger for research was not any great insight into oil and gas prices. It was the poor performance of companies like Woodside Petroleum and Origin Energy.

“Both these companies had the capability to generate lots of cash flow, were low on the cost curve, and had long life quality assets and low forward capital spends.

At $US100 a barrel the return on equity (ROE) for most oil companies was not high, says Nayak.

“At $US60 a barrel I don’t expect they are making a lot of money at all”, he says.

But underperformance typically generates a response. Allan Gray takes a longer term view to most investment managers, and over the coming years, Nayak expects the quality assets of Woodside and Origin to boost ROE.

The path will require a sustained effort from management, but when it’s achieved Woodside and Origin will get revalued.

By the time the stocks reach fair value, the weighting in Allan Gray’s investment funds will have been reduced or exited, with Nayak happily selling to investors buying into the stock after the turnaround.

Be ahead of the curve but behind the trend

Nayak says finding sectors and stocks that fit a strategy to outperform is challenging, but the rewards over the longer term are satisfying.

Currently he is looking at gold. The gold price recently fell to its lowest level since 2010, amid rising expectations it will drop below $US1000, as prospects of rising interest rates in the US consolidate.

The S&P All Ordinaries Gold Index has more than halved since the start of the year, creating an opportunity to dig deep into the balance sheet and performance of quality gold companies.

If Nayak starts buying, it will be into a market crowded with sellers.


Suhas Nayak holds a Bachelor of Science (California Institute of Technology) and a Doctor of Philosophy in Mathematics (Stanford University).