I wanted to start, and track, a portfolio that is designed to invest only companies that have "reinvestment moats" or companies with economic moats that have the opportunity to reinvest new capital at very high rates within their current business. I'll add a hypothetical $1,000 to the portfolio each month, track it against the SPY and see if it can deliver alpha. The two key components are:
1. there must be an economic moat
2. there must be an opportunity for reinvestment in the current business
Every month, I'll assess the market situation to see whether any of these businesses represent good values. I'm expecting that the portfolio will have characteristics resembling a growth portfolio given the focus on reinvestment opportunities. I'm also hoping for some reader ideas and constructive criticism.
So, here is the first set of investments to be made all at closing prices on September 6, 2018.
The Story: Big Yellow (OTC:BYLOF) and Safestore (OTC:SFSHF) (available on the London Stock Exchange) are the two largest European self-storage owners. The main difference between the two is that Big Yellow is focused on the UK market while Safestore covers the UK and Paris. Self-storage can be a terrific investment if you can find an operator that is buying and building new properties while rental pricing is going up. Just look at Public Storage (PSA) over the years. A $10,000 investment in PSA 20 years ago would be worth $170,000 today, a CAGR of 15.5%. I'll take that any day.
The Moat: Self-storage facilities located in good locations can benefit from having a monopoly in a local market, particularly in regions like Europe where it can be difficult to get permits to build. Consolidators also benefit from economies of scale by having lower costs of capital and better ability to dynamically manage pricing and inventory across properties than independent operators.
The Reinvestment Opportunity: I believe self-storage in the US is overbuilt. Large operators like U-Haul (UHAL) have built out significant self-storage capacity over the last 5 years that is almost entirely new capacity. Drive down any interstate and there seems to be an endless supply of self-storage out there. The story in Europe is much different, however. According to the latest data I can find, there were over 7 square feet of self-storage per capita in the US compared with 0.6 square feet per capita in the UK and an even lower number in continental Europe. Now, Europe is a structurally different market than the US and I am not expecting Europe to ever catch up to the US in terms of the amount of "stuff" the average person owns. Nevertheless, there is a ton of growth potential, in terms of consolidating smaller operators, building new capacity, and increasing occupancy rates up towards the US averages. My personal choice of the group is Big Yellow simply because it has such high-quality real estate in the London area.
Dividends: Big Yellow pays a 3.3% dividend yield and increased their dividend 12% this year.
The Story: Continuing on the theme of reinvestment opportunities and self-storage, U-Haul has been plowing its earnings into new self-storage facilities on top of its existing truck rental network. The combination makes perfect sense - store your stuff and drop off your truck at the same location. Over the last seven years, U-Haul has increased its storage capacity from 36.3 million square feet to 55.2 million square feet (see SEC filings). The market hasn't given them a ton of credit, with the stock price flat over the last three years.
The Reinvestment Opportunity: U-Haul expects to increase storage investment in 2019, which will then taper off in 2020 on. There's still a ton of reinvestment potential here and as they wind down their storage build-out, there should be significant surplus cash left over to be returned to shareholders.
The Moat: U-Haul benefits from extremely strong network effects in its core moving truck rental business. Operators must reach national scale to handle intra-city moves, which prevents new entrants from breaking into the business. With the exception of Penske (PAG), U-Haul doesn't really have any competitors, particularly as Budget has retreated from the business.
Dividend: U-Haul pays a sporadic dividend.
The Story: Totally different from the other two ideas is Tencent (OTCPK:TCEHY), the giant China-based social network, payment service, and video game operator. Tencent has been hammered as a result of U.S./China trade worries and Tencent's recent troubles getting games approved for commercialization in China. This provides a major buying opportunity.
The Moat: Tencent's main business over the next decade will be its WeChat network and payment service. WeChat is so dominant in China that most people find it impossible not to be on the service given its dominance in getting everyday things done (think paying bills, communicating with friends, booking appointments, accessing bank services, etc). There is nothing quite like it outside of China. It benefits from strong network effects in the social network, links to services, and the payment businesses. There are also obviously some strong switching costs if people find it nearly impossible to live their life without WeChat. Of course, there is also the games business, but I see that more as an ancillary business - still with great value - to the core WeChat business.
The Reinvestment Opportunity: Tencent knows what you like, what you do, and what you buy. Out of the major tech companies, none knows more about its users than Tencent. And Tencent is at the very early stages of monetizing these assets through advertising, with WeChat incorporating very few ads. As Tencent continues to invest in these services and monetize them, I expect Tencent to provide significant returns. Even better, these improvements won't require much additional capital. Tencent is that rare capital light compounder.
Dividend: Tencent pays a modest dividend but has capacity for large increases over the coming years.
The Story: Zscaler (ZS) is growing at breakneck speed, with revenue increasing 54% in the most recent quarter and calculated billings growing at 72%. While Zscaler shares were sold off on the earnings, don't expect the dip to last long on this fast grower. As I've written here, robust growth should send the price/sales ratio down quickly over the next two years.
The Moat: The moat here is a bit tougher to understand but still strong nonetheless. For one, Zscaler is an independent cloud security vendor. By independent, I mean that it is not tied to any of the hyperscalers specifically, which is important for corporate clients that want to have flexibility in their use of the cloud giants' services. Second, as a cloud security vendor, they are not conflicted by the legacy hardware security business. This is important internally because they are not incentivized to protect the high margin, more expensive hardware business, and externally because clients know that Zscaler is incentivized to lower costs by ditching the expensive hardware solutions. These factors make Zscaler unique in the market, at least for now.
Going forward, Zscaler benefits from a few other moats. First, it has a scale advantage in having built out a network of data centers so that it's close to its customers and can offer the fastest service. Second, it benefits from a network effect in that by virtue of being the largest cloud security provider, it sees the most traffic, allowing it to identify the most threats and instantly attack them throughout the whole network. In other words, the more companies that use Zscaler, the better it becomes for everyone - a classic network effect.
The Reinvestment Opportunity: Zscaler has years of strong growth ahead as it continues to invest in its product, data centers, threat detection capabilities, etc. It can also "land and expand" into adjacent product areas as it has recently with the VPN product.
I'm excited to see how this portfolio performs.
Disclosure: I am/we are long UHAL, BYLOF, TCEHY, ZS, PAG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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