IML warns buy now, pay later looks like tech bubble

William McInnesReporter

Jul 1, 2020 – 1.06pm

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Investors Mutual is shunning the buy now, pay later sector in the small and mid-cap space, saying stretched valuations and lack of profits in that part of the market are reminiscent of the tech bubble of the early 2000s.

Despite some hefty share price losses through February and March, the buy now, pay later sector remains one of the best performing in the market.

Investors Mutual senior portfolio manager Simon Conn. Edwina Pickles

Since the market bottomed out on March 23, Afterpay has rocketed 607 per cent, Openpay has risen 600 per cent, Sezzle is up 997 per cent, Splitit has advanced 486 per cent and Zip Co has soared 355 per cent.

But Investors Mutual is seeing warning signs. "We've seen increased level of retail activity in the market and there's not a lot of fundamental analysis going on but a lot of momentum," said senior portfolio manager Simon Conn.

"The small-cap market is particularly prone to fads and bubbles. You remember the dotcom boom, with stocks trading in excess of $1 billion with no profits and then falling apart."

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The fund manager pointed to Afterpay, Zip Co, Splitit, Sezzle and Openpay, which have a combined market cap of $19.1 billion but no profits between them. "There's very extreme valuations and a lot of risk in that sector," said Mr Conn.

Avoiding the soaring buy now, pay later sector may have come at a cost, however. Investors Mutual's Australian Smaller Companies fund is down 9.4 per cent in the 12 months to May, compared with its benchmark, the S&P/ASX Small Ordinaries Index, which is down just 2.2 per cent over the same period.

"We're trying to build portfolios of resilience and portfolios of quality," said portfolio manager Marc Whittaker. "One of the key factors is the balance sheet."

He said he was attracted to more established companies, with solid long-term prospects. "They have real assets, generating good cash and are able to see their way through [downturns]," he said.

"We think [SkyCity Entertainment] is a very safe bet in the current environment. Yes, it was impacted but the business is coming back to normal and it's a very quick return to normal.

"It's generating very strong cash flow. Pleasingly, we think this will return to paying dividends in a very quick space of time and the balance sheet is very significantly underpinned by freehold interests in the Auckland CBD property."

Pro-Pac Packaging had shown remarkable resilience through the COVID-19 pandemic, up 59 per cent year-to-date, Mr Whittaker said.

"They're resilient and it's the clear number two in the Australian flexibles market," he said. "Its main exposure is to agriculture, food and beverage and these are holding up in the current environment.

"It's been paying down debt from its cash generation, demonstrating the very good cash generation. We can pick up Pro-Pac on a 13 times price to earnings and it's yielding 4 per cent. We think that's a very reasonable P/E."

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Spark New Zealand is also a key holding for the fund. "It's generating good cash flow and should deliver a 25¢ per share dividend," said Mr Whittaker. "We're not overpaying for what is a very high-quality stock."

Another key holding for the fund, Integral Diagnostics, is up 2 per cent year-to-date. "It's been a great contributor to the portfolio," he said. "Even though there's been impacts from COVID, the balance sheet is in a good position and the management team is very switched on."

William McInnes covers markets from Sydney including editing the Markets Live blog. Connect with William on Twitter. Email William at w.mcinnes@copyright link.au