Project $1M: February Brings New Highs

by: Integrator

February was a strong month for Project $1M, with the portfolio retaking all time highs.

Mercadolibre, Nanosonics, and Alibaba were all material contributors to performance in February.

Valuations are once again starting to appear stretched, and I expect a 10% pullback before the end of summer.

The steep correction of December 2018 now seems a distant memory. Project $1M made new all time highs in February as a result of renewed optimism on China and a swag of positive results from portfolio components.

Overall, the portfolio finished up some 4.96% for the month, marginally outperforming the performance of the S&P 500 which was up 3.82% for February.

My broader investment focus with Project $1M is the purchase and long term hold of a clutch of high growth, cash-generating businesses that are powered by secular tailwinds, are owner-aligned and managed, and generate strong returns on equity. The advantage of these forces should be to allow the selected businesses to grow under any economic conditions that may be experienced over the life of the Project $1M portfolio (a decade or more).

Markets may move the prices of Project $1M businesses around, here and there, depending on sentiment; however, I am focused on the long term returns on invested capital that my businesses can generate and the opportunity to deploy that invested capital at high rates of return over a long-term horizon. For those that are new to the Project, here are Part 1, Part 2 and Part 3 of the initial investments in the portfolio.

The overall objective of the portfolio is to turn an initial capital base of $275,000 that was initially deployed in November 2015 into $1,000,000 by November 2025. This will be done primarily through buying businesses and holding high quality businesses, helping returns compound, and minimizing tax and trading costs.

Project $1M ended February 2019 with a balance of close to $440,000. This meant that the portfolio retook the highs of $437,000 that was reached at the end of September 2018. It's not clear to me what the precise reasons for the remarkable, sharp recovery from the dark days of December 2018 are but expectations of a trade truce between the US and China, and better than expected US earnings growth are likely all reasons. Alibaba and Tencent (OTCPK:TCEHY) have recovered from the depths of despair that they plunged to a few months ago, when it appeared that punitive US tariffs may hobble the Chinese economy. Strong performers for Project $1M in February were Mercadolibre (MELI), Nanosonics (OTCPK:NNCSF) and Alibaba (BABA).

Mercadolibre is well on track to cement LATAM ecommerce dominance

MELI delivered a strong earnings report in the most recent earnings quarter. Revenue was up almost 63% year on year on an FX neutral basis, with unique buyers up 8% and merchandise volume up 18%. Reductions in merchant subsidies and other incentives produced a sharp improvement in margin and profitability.

MELI's share price was under some recent pressure as a result of Amazon's (AMZN) renewed focus and push into the Brazil and LATAM markets generally, with a constant stream of new updates about Amazon's search for fulfilment partners and warehousing space in Brazil causing chills for MELI investors. However, MELI has had such a long headstart that it may have reached a tipping point in the local market as far as an aggregation of merchants and local users. With almost 250M registered users and almost 330M purchased items annually, MELI provides the go to destination for e-commerce in LATAM. Amazon is no doubt a formidable competitor with focused patience to invest and build a market in the absence of meaningful near-term returns, but MELI's long-term presence and traction may prove insurmountable in this case.

Not to be overlooked in MELI's results is the dominance of its payment platform, MercadoPago. Payment volumes processed passed $5B and were up almost 68% year on year on an FX neutral basis. Almost as impressive was that close to 50% of MELI's payment volume is processed off the platform. Ultimately, I really see this as the jewel in MELI's crown, with MELI taking a small cut of all payments for online and offline transactions and achieving PayPal like dominance in LATAM for payment transactions. MercadoPago will account for significant revenue long term for MELI, irrespective of how its core commerce platform performs. Fortunately for MELI, the medium-term outlook for the core e-commerce platform is healthy.

Nanosonics strong performance undermines recent weighting change

One of the things about a strongly performing, high quality business is that a decision to reduce weighting or sell is always accompanied by the fact that you may be made to look foolish by the continued outperformance of the holding. In some respects, I feel that way about my decision early last month to reduce my weighting in Nanosonics, and instead increase my weighting in CSL (OTCPK:CSLLY) and ProMedicus (OTCPK:PMCUF).

Nanosonics continued to show strong growth and continued market penetration with improving sales growth of 35% year on year, and more importantly, increasing global penetration of its Trophon disinfection unit base by another 9%. Given the rich, high margin consumable revenue stream that each Trophon unit generates, this augers very well for future revenue growth. The share price of Nanosonics was up over 20% this month on the strong result, and almost 50% year to date, versus a more modest 10% share appreciation for CSL.

So was my decision to reweight wrong? Well, arguably, you can't get them all right. However I don't regret the weighting change, and nor would I make any subsequent change to increase my weighting back in favor of Nanosonics after this fine result. I am looking to prioritize a risk weighted allocation toward the best possible returns. The character of the Nanosonics business is still very much venture capital in nature. While I'll likely miss some of the longer term upside by reducing my exposure to the business, I still believe CSL provides me with a proven business model and a stronger moat that is likely to deliver a lower risk equity return that will still achieve my high hurdle rate.

Alibaba is a beneficiary of improving China sentiment

Alibaba delivered close to a 10% share price appreciation over the last month, largely on the back of better than expected earnings and improved sentiment toward a trade deal. Slowing growth in China isn't having too material an impact on BABA, with the business notching up north of 40% growth in revenues year on year and touching close to 700M consumers across the BABA ecosystem. The likelihood of a trade deal being reached also provided a boost to the share price, however BABA's growth momentum is primarily influenced by domestic Chinese demand, and I don't see any tariffs working to materially curb BABA's near-term growth, unless such measures send the Chinese economy into a significant recession.

Portfolio Performance and expectations

Project $1M continues to handily outperform the S&P 500, providing an incremental outperformance of north of 5% annualized over the S&P 500 since inception. Year to date, the portfolio is up almost 19%. I don't believe this will last, and expect a return to increased volatility and negative returns during the middle of the year. I believe Project $1M will be able to deliver a 15% return overall in 2019, which implies some downside risk over the next few months. In fact, I expect a 10% pullback in share prices within the next 6 months, without knowing exactly what the catalyst will be. At these levels, I am not a buyer of any existing positions in the portfolio

Disclosure: I am/we are long ALL STOCKS MENTIONED. 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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