Sunniva Kolostyak: Welcome to Morningstar. Today in the studio, I am joined by Alec Cutler from Orbis Global Balanced, who is going to give me his three stock picks. Thank you for being here.
Let's just jump straight in with stock number one. What is it and what's the theme of the stock?
Alec Cutler: Okay. Well, let's start with defense. Defense spending had been dropping since 1989, started picking up about two years after the first Russian invasion of Ukraine and has been on a steady upswing since and now is accelerating. So, we had almost 30 years of a peace dividend, and it looks like that is kaput. Defense spending, if you use the UK as an example, in 1989 spent 4.2% of GDP on defense, got as low as 2%, just under 2% in 2018 and has been on a steady climb up. We could see that going back to 4.5% depending on how the world goes. Beneficiaries of that are companies that have been considered to be negative growth for a long time. That's no longer the case.
A good example would be a Rheinmetall (RHM) from Germany. They make artillery units. They make the guns on the Leopard 2 tank. They make anti-aircraft guns, and they make all the ammunition involved in those things. They also make heavy trucks and other stuff the military needs. We bought them in 2019-2020 when Europe was thinking about doing their social taxonomy, so trying to penalise any company that produced social ill, and they defined defense as a social ill. We looked at that and said that doesn't make any sense. There would be no such thing as social taxonomy if there was no military to protect that freedom to choose. We bought Rheinmetall at six times earnings or something, and it promptly doubled on the invasion, but the earnings power of the company has more than doubled. So, it went from a single digit P/E multiple, doubled, and now the earnings expectations are starting to ramp to reflect the need for artillery and the need for ammunition. Europe doesn't have the ammunition it needs. And now, it's back to being a low P/E or a contrarian stock. So, the stock price is up, but people don't believe that it's real. They think this is a short-term thing. We don't think that the cold war that just started is going to end in two years.
Kolostyak: So, what's your second stock then?
Cutler: Second stock would be energy transition. So, now, we all understand we need to do an energy transition. It was thought that we could just yell at the energy companies, and we could wave a magic wand and we get all the power we need from solar panels and wind. That is now kaput. We realise that we need something to transition with. One of the transition fuels is natural gas and then, hydrogen. So, the idea is to dovetail from natural gas into hydrogen. Siemens Energy (ENR), which was spun out of Siemens in 2020 because it didn't want to be involved in natural gas or energy, is the largest producer and seller of natural gas turbines that are used in these power plants. They went from a fear of having no orders to the EU saying natural gas is our energy transition fuel of choice and then hydrogen after that to saying, okay, now, every natural gas plant is certified good for the next 50 years. So, their business went from terrible to great.
The other thing they make, they're the largest manufacturer of utility grade transformers and switches. We have to completely rewire the grid and the grid is super old. Europe and UK's grid is 40 years old on average. The design life for the grid is 20 to 25 years. We're way past design life. So, we need to rewire and replumb the whole electric system and Siemens does that. They also happen to make the electrolysers that turn electricity into hydrogen. So, they've got like a closed end fund of energy transition. How could I forget Siemens Gamesa? They're also the second biggest manufacturer of wind turbines. So, they've got the whole energy transition in one pocket. Book to bill is 1.6. They're getting 160% more bookings than they're selling on an annual basis. So, their business is really ramping, and it's still selling on a normalised basis, a double-digit free cash flow yield.
Kolostyak: So, we have one defense, one energy transition. What's your third stock?
Cutler: I think I'll go with something completely different. Cinemark (CNK). Cinemark is movie theaters. We bought that in 2020 when it was thought to be that streaming was going to kill movie theaters and we'd never go back to movies again. I don't know about you, but my wife and I and our kids, we like to go into the movies now. It's kind of a real thing to do. The movie theaters, the producers that had decided that they were going to put the movie theaters out of business by going to streaming on everything, whether it's Paramount+ or Disney, we're all going to go after and follow Netflix. And then, they realised that putting a $300 million budget movie straight to streaming means you don't earn any money on that film. So, they're putting them back to theaters. They're going back to Cinemark and AMC and saying, let's do a deal. You guys are actually really important to us. So, that business is ramping back very nicely. And again, it's selling at a double-digit free cash flow yield. People still, for some reason, think that they're going to be put out of business despite the fact that they probably go to the movies after they say that.
Kolostyak: Well, thank you very much for those three stocks.
Cutler: You're welcome.
Kolostyak: For Morningstar, I'm Sunniva Kolostyak.
