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BluGlass is seizing the opportunity in laser diodes! Check out our Investor Webinar from 28 September 2022
October 12, 2022
BLG, BluGlass, FMG, Fortescue Metals, UNI, Universal Store
A few weeks ago in our investor webinar, we spoke about laser diode manufacturer BluGlass.
– We also talked about how iron ore is under pressure … and so is Fortescue Metals (ASX:FMG) by the way!
– BluGlass (ASX:BLG) is pivoting to laser diodes.
– Universal Store (ASX:UNI) tailors to the young and the hip.
See full transcription below.
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Marc: Good afternoon on the 28th of September. Stuart, how are things?
Stuart: Well, the bear market of 2022 continues. One good thing about bear markets is they always come to an end, at which point you get some outstanding bargains. And, Marc, you and I, and the team at Stocks Down Under have discovered a few of those recently, which we’ve started to introduce to our subscribers.
Marc: Yeah, definitely. And there is more to come, actually. So, there’s a couple of stocks that we’re keeping a close eye on. We won’t say which ones, obviously, but for now, at least, this is all. So, some stocks we will write about in Stocks Down Under, other stocks are for concierge subscribers. So, by all means, check that out. If you haven’t taken out a trial to concierge, it’s worthwhile. We actually put a stock on today. But on Mondays, Stuart, we wrote about FMG, Fortescue, and we’re actually quite negative on that one. So, talk us through that one.
Stuart: Yeah. So, I feel almost unpatriotic to say this, but right now, I don’t like iron ore. Now, Marc, you would’ve been aware when you moved to Australia in 2014, the most important thing about life in Australia was iron ore. If we didn’t have that, the country would be broke. But it’s become a major contributor to our economic life because of the amount of the stuff we export, mainly out of the Pilbara, and mainly shipped to China. If we hadn’t had it and we hadn’t had the sort of price boom in recent years that we had, our economy wouldn’t have done anywhere nearly as well as we had.
A prime beneficiary of that is Fortescue Metals. This is a company that probably needs no introduction to many people. It’s the reason, if you click to the next slide, Marc, that Andrew Forrest is a billionaire. So, let’s summarize Fortescue. Major iron ore producer, shipping about 180 million tons of the stuff a year. It’s got three major mining hubs out in the Pilbara region of Western Australia, Chichester, Solomon, and the so-called Western Hub. All that iron ore flows down various railways to Port Hedland and then gets shipped out to customers mainly in China.
This was a company that was built pretty much from scratch. When Andrew Forrest realized a couple of decades ago that there would be a market in the long-term for lower grade iron ore, of which the Pilbara was rich in, he arranged for Fortescue to go and grab some of the best possible deposits. And once he had the offtake and was able to raise the money to build those, the rest, as they say, is history.
Fortescue became a top 20 company. Its market cap at the moment is about 50 billion. And Andrew Forrest, and, Marc, I hadn’t realized this, but he’s actually Dr. Forrest, not with an honorary degree, he’s actually a PhD in marine biology.
Marc: That’s correct.
Stuart: A recent acquisition of Andrew’s, he does have a pretty smart head not just for business, but for academia on his shoulders. He and his family still owns 36% of the stock, so, that makes him one of the country’s wealthiest people. As you say, we wrote about it on the Monday the 26th of September in Stocks Down Under. We’re putting two stars on it. So, if we have our way, Dr. Andrew Forrest will be slightly poorer than he is right now.
What don’t we like about FMG? You need to worry about China, and you need to worry about iron ore. You would’ve noticed a couple of years ago that China was trying to stop buying Australian products. They were a little bit annoyed with our country for various geopolitical reasons. They slapped heavy tariffs on our wine, stopped taking our barley and other products. The one product they didn’t stop taking was iron ore, and the reason was, there was no alternative. In order to feed the steel mills in China, we had the only available product that would shift.
Now, China doesn’t like that level of reliance. And it’s no secret that it’s actually cultivating alternative sources. There’s an ASX-listed company called Genmin, for example, which is developing some iron ore resources in the West African nation of Gabon. It expects to be able to use infrastructure, which is partly being built with Chinese investment, and will probably benefit from China’s need to diversify away from buying Australian iron ore. And there are other countries in Africa that are in the same boat. In the medium term, you’re gonna see China push forward and make sure it has those alternative sources of supply, in which case, it doesn’t need anywhere near the amount of iron ore that it currently takes from us.
I’d like to remind people as well that, Brazil is a strong competitor. Way up in the north of the country, as well as in the southern state of Minas Gerais, they have vast iron ore deposits. It’s slightly further away from Brazil to China, but at the right price, and with better proximity on the part of Brazil, they can be a strong competitor to us, as they have been in the past.
But the most important thing is this, the China of yesterday is not the China of today. The chart there on the right of this slide shows you what the price of iron ore has been over time in U.S. dollars. So, go back to 2011, on the peak there, when iron ore was about $180 a ton in 2011. At the time, Chinese GDP was raising ahead at 8% per annum. It’s since slowed down to about 3%. And most authorities on the Chinese economy are predicting no more than 2% growth or 2%, 3%, or thereabouts after the year 2030. So, that’s gotta have you worried that suddenly Chinese steel mills are gonna be taking less iron ore in the long run, or taking the same iron ore and paying less for it, than the roughly $100 a ton it’s trading for at the moment.
The wash up of that is that FMG is not a growth stock. It just recorded EBITDA for the financial year just ended of about $16 billion. But look at the next three years, $12.5, $10.6, and then $9.6 billion. So, every year for the next three years, the EBITDA of this company goes down. Now, the multiple partly compensates for that, you can buy it for an EV to EBITDA multiple on next year’s earnings, it’s value about four or five…well, four, and it goes up to, you know, five or six. So, you’re not necessarily overpaying for it at the current price, but you’re not buying a company that is growing anytime soon.
Marc: Probably, Stuart, what’s going to happen with FMG, just looking at these multiples over the next couple of years, that EV/EBITDA multiple will just correct itself as well to about four, four-and-a-half. So, that’s 5 and 5.5 that you’re seeing is today’s share price, right? But that’s probably gonna come down, so you get some sort of relatively stable EV/EBITDA multiple of around four to four-and-a-half.
Stuart: Right. What you do get, as we see on the next slide, is a half-decent dividend. Dr. Forrest needs dividends to maintain himself in the lifestyle to which he’s become accustomed, as do the other FMG shareholders. So, the payout ratio on this thing is about two-thirds. That means for the year ahead, if they maintain that two-thirds dividend, you’ll probably get a 9.5% dividend yield, which is not bad, Marc, I suspect you’re not getting that from your bank at the moment.
Marc: No, I’m getting nothing from my bank.
Stuart: Right. There you go. So, 9.5%, 7.5%, even at immensely 6.5%, that’s not a decent return. So, I guess, I wouldn’t quite recommend this to someone who’s on a fixed income. But if iron ore just holds its own, according to what the analysts who study this stuff day in, day out, are predicting, you couldn’t do much better if you’re on fixed income than buy FMG stock, because you’re still gonna be making out like bandits compared to alternative sources of fixed interest.
Marc: All right. Well, there’s one burning question I have about FMG, is it pronounced Fortescue or Fortescue?
Stuart: I say Fortescue. Other people say Fortescue.
Marc: Well, you just said Fortescue, so I was wondering.
Stuart: Yeah. So, the fact that I hear more Aussies saying Fortescue, and Australians are terrible at mangling the English language, tells me that the correct pronunciation is Fortescue. However, I will, against the day when I next meet Dr. Andrew Forrest, I’ll check with him.
Marc: You’re playing golf next week, right?
Stuart: I had the privilege of meeting him about a decade or so ago when he first came to prominence and my old firm was raising him some money, he came in for a presentation. And so I got to shake the hands of a great man. He’s actually a nice person to meet.
Marc: All right. And then, from iron ore to something completely different, laser diodes. And we’re talking about BluGlass here. And this is a company that’s been around for, probably about, listed on the ASX for about 16 years, more or less. I think 2006 is when they were listed, and they’ve just made a big pivot to laser diodes, I’ll talk about that in a minute. But with PittStreet Research, we just published a big report on BluGlass, and it’s, I highly recommend it, you know, you have a read. Because this company, if you look at the chart there, briefly, after the IPO, it peaked at 80 cents, right now it’s 3 cents and there’s a lot of reasons for that. But I think at these levels, although there’s still execution risk in the company, you’re probably looking at a pretty good deal. But let’s…
Stuart: I got to say, you are the only analyst in the country who can explain what remote plasma chemical vapor deposition is.
Marc: Yeah, and I won’t do it here because it gets technical really quickly, but yeah, there’s not a lot of people that will know what it is. But basically, what the company’s been doing for the last 15 years is develop that technology, RPCVD. And basically, when it’s integrated into manufacturing, it’s a really good way to produce LEDs, light emitting diodes, you know, the stuff that you can find in lighting and all sorts of stuff, in TVs. RPCVD is different in a couple of ways, including lower temperature to manufacture the wafers, which is good for the actual element in the diodes, where the light comes from. And again, it gets technical really quickly, so we won’t go there.
But what BluGlass found over years, that partners that it engaged with like Lumileds, which is the former of Phillips Lighting, a really big player in lighting. But also Fico and Extron, which are semiconductor equipment manufacturers that have a different technology, which is called MOCVD. It’s similar but slightly different, slightly inferior to what BluGlass has.
But these companies weren’t really interested, despite doing some trials and working with Blue Glass, which meant that after a number of years the company was at a crossroads, keep going with the purely focusing on the LED market, or the tools for that market, or pivot. And I think the share market has basically decided for the company, because, looking at the share price, it’s come down, and this is a monthly chart that you can see there, all the way back to IPO. You can see the market has decided that the road that the company was on wasn’t the right one.
And so, what BluGlass has done is, they made a big pivot starting last year, because they knew that the technology had potential, but their future wasn’t in LEDs, it was in laser diodes. And why laser diodes? Well, the LED market, if you wanna manufacture LEDs, that’s a highly commoditized market. So, a number of big players that manufacture at large scales, in different form factors, and so…
Stuart: And I can go into Jaycar, the electronics retailer, and buy some LEDs for a couple of bucks. That tells you something about the margin that, ultimately, BluGlass would enjoy if it stayed in this game.
Marc: Yeah. It would be a price taker, as I’ve mentioned there, and it’s not an attractive market. But however, laser diodes, it’s similar to the LED manufacturing process, but it’s different in a couple of ways. But more importantly, there’s only three incumbents, and only two of those really manufacture the laser diodes that BluGlass aims to start manufacturing. And so, the technology is similar, and BluGlass can really leverage this technology to make these laser diodes in different form factors, in different colors as well, and they could do that better than what the two big incumbents are doing in this market. So, it’s actually a much more attractive market for BluGlass than the LED market.
It’s a fast growing market as well. So, 23% compounded average annual growth, which is pretty high, so, to around $2.5 billion in a couple of years. But the two main producers that are manufacturing the specific diodes that BluGlass aims to make, they’re basically capacity constrained. There’s not a lot of room for expansion there, unless, you know, they build out more capacity, more capacity. But the big thing is, these two big players have very limited flexibility when it comes to working with their clients to come up with new designs, basically, new form factors, and that is what BluGlass is really good at, because it’s small, it’s nimble. It’s got this owned facility that it bought not too long ago, earlier this year. And I think that’s a game changer. This facility is based in Fremont in California, and the company will have much better control over its margins, over its design cycles, and ultimately, because it will be able to ditch the contract manufacturers that it’s working with right now, it should have be better margins over time. And by the way…
Stuart: So, the beautiful part is, this is not completely on the drawing board, right? We’ve got a facility that can make these things as soon as they’re designed?
Marc: Yeah, exactly. And so, if a client comes to BluGlass, “Look, guys, I want this and this design, can you work with me to develop that?” That’s what BluGlass can do, which is something that the other guys can’t do, really, and that’s the main attraction for some of these prospects to start working with BluGlass.
Stuart: And I’d add, Freemont isn’t in the middle of nowhere. We’re talking San Francisco Bay Area.
Marc: It’s the heart of Silicon Valley. I was there three years ago, you’ve got everyone there. You’ve got all the major semiconductor manufacturers, the tool suppliers, the designers, of course, all the high tech companies. Fremont is sort of at the southern end of Silicon Valley, but it’s all, you know, within half an hour driving distance. So, it’s right smack in the middle of Silicon Valley.
And this facility, once it’s fully ramped, can do about $160 million in revenue. So, that’s plenty for BluGlass to get started. And so, we’re quite bullish on that. There are obviously execution risks in transforming the company over to a production company, and this is from what the company was, it was more of an R&D company. So, there’s that risk. But Jim Haden, the new president who came on board not too long ago, he’s a veteran in this space, he’s done it before. He’s commercialized similar types of technologies. So, purely from that point of view, they’ve got the facility, they’ve got the highly experienced president now running the show. So, combine all that and we think, 3 cents is probably, if you look back a couple of years from now, 3 cents is probably a good moment to get in.
So we’ve done that report. Have a look at pittstreetresearch.com to download that report. There’s no valuation in there just yet because we think we need to see some revenue starting up. The company needs to scale up, and once that’s done, we have some visibility on where that’s going. We can actually come up with a model and do a valuation. But in the meantime, yeah, have a look at that report on the PittStreet Research website. And yeah, do yourself a favor and check BluGlass out, because we think it’s going places.
All right. That brings us to our last company for today, Stuart, Universal Store. Tell us all about that.
Stuart: I started to notice Universal Store hanging out at various shopping malls in the Sydney metropolitan area with my teenage children. Company went public on ASX not long ago, and we wrote about it in Stocks Down Under just recently. I’m pretty excited about this one. Admittedly, I don’t know too much about fashion. There’s a picture of a younger version of Marc there on the right-hand side of this slide. Marc, I was…
Marc: What do you mean, Stuart? We should see who could be this cool. I am that cool, Stuart, come on.
Stuart: So, lemme tell you about Universal Store and why it’s almost as cool as Marc Kennis. There’s about 78 of these stores around the country, and its market is hip young people, ages 16 to 35, of both genders, selling casual clothing.
Marc: What do you mean both genders? Only two genders? There’s at least five or six, these days, Stuart.
Stuart: Yeah. All right. They have both major genders and I suspect a lot of the other genders would like what they’ve got to offer as well. This company has hustled up a $200 million-a-year business returning at the EBITDA line, $31 million, serving this interesting demographic. Alice Barbery has been running the company now for five years. That makes her something of an oddity, because, ordinarily, public company CEOs don’t last longer than about four. She was chief operating officer before that, so, she’s had a lot of experience building this company.
Stock went public on ASX at $3.80, and the stock is still above that level. If you look at our article from September the 23rd, that’s 2022, I should say, rather than 2020, we’ve called it four stars. So, what’s to like about this thing? Take a look at those consensus EBITDA numbers for FY23, $68 million versus $56 million in the year just passed at the EBITDA line. What’s driving that?
Well, because this is a bricks and mortar retailer, FY22 experienced the kind of lockdowns we were having, mainly on the east coast of Australia during that year. When you free that company up from the lockdowns, the cycling against the comparables is pretty strong. But the growth doesn’t slow down to single digits, it stays at double digits in ’24 and ’25. And no surprises there. This company is still opening stores around the country. It thinks it can get to about 100 around the country, and it’ll open five more between late last month and Christmas of this year.
It’s spring at the moment, spring and the summer months tend to be harder for casual clothing. And here’s the big one, unemployment rate in Australia is so low at the moment. You’ve got more young people than usual working longer hours than usual. And that means they’re cashed up. And the thing about young people is they like to look good at a time when they’re going out to party in a serious way. I think that’s a perfect storm for earnings of this really well-managed company. Perfect storm in a good way.
So, what are the drivers of growth? They’ve said, “We’re going for 100 stores across Australia and New Zealand.” But it’s within the business that they’re also doing some interesting things. Roughly 40% to 50% of the sales within Universal Store are the company’s own brands. And they’ve created this label, which I wasn’t familiar with, called Perfect Stranger, mainly female fashion. Well, not mainly, it is female fashion, very popular with women. To the point where this particular label is so strong, they’ve actually, are trying this out with a standalone store and a website of its own.
What’s good about that one? The thing about fashion is it’s a bit fickle. I’ve noticed that ripped jeans, for instance, are back in fashion. Marc, I don’t know if it was like this in the Netherlands when we were teenagers, but when I was a teenager down here, ripped jeans were the thing and they’ve just made a comeback again.
But yeah, next season, it might be unfashionable to have ripped jeans. The wash up of all that is, if you’ve got a label that you can quickly test whether a fashion idea is gonna work, you can then roll that out through the group and make sure that it works well.
The other thing about having private brands is you can improve your sourcing better. So, they had a big jump in gross margins as a result of better sourcing. And this company may be brick and mortar, but it’s actually doing quite well with its website, 3.3% conversion rate of unique visitors coming to the website, which is pretty good. They’re adding new fashion labels to the line. They just bought a brand you could find up in Byron Bay called Thrills, lay down $50 million for that. So, what is a pretty hip brand is becoming even hipper.
Marc: All right. So, you can read all about that in the article from the 23rd. So, go to the website, click on publications, and type in Universal Store in the search box.
Stuart: Did you get that shirt you’re wearing from Universal Stores, since you’re so cool, Marc?
Marc: Probably, yeah, I have no clue because my wife is my fashion advisor, so I just wear what she gives me, so. All right, I think that wraps it up for us too, unless you wanna talk fashion some more?
Stuart: No, no, I’ve used up my complete knowledge about fashion, but if you’re into fashion, Universal Store is the thing. You might feel a bit embarrassed if you’re our age going into Universal Store to check it out, but it’s worth it. If you go into the store and it’s packed with hip young things, age 16 to 35, you know you’re onto a good thing.
Marc: All right. And on that note, we’ll wrap it up.
Stuart: See you soon.
Marc: Thanks everyone for watching, and we’ll see you next week.