NSC Investment Report NTA April 2021

The NSC Investment Portfolio returned + 6.33% for the month of April, outperforming the benchmark S&P/ASX Small Ordinaries Accumulation Index (XSOAI) which increased by +4.98%. The performance for the month of April was driven by a number of the core investments such as Big River Industries (ASX: BRI), Over The Wire (ASX: OTW) and COG Financial Services (ASX: COG), but importantly there were no significant detractors to portfolio performance. From a news flow perspective April was a relatively quiet month with only COG providing an update of any significance. We continued to add to two new investments which we mentioned last month and continued searching for any significantly mispriced opportunities that may eventuate from the recent structural rotation within the wider stock market. Over the past few months there has been no shortage of such businesses with examples such as Nuix (ASX: NXL) which just 10 months ago raised >$1 billion and was considered one of the highest quality businesses to list on the ASX, yet today sits well under its IPO price. Another example is Service Stream (ASX: SSM) which has been a great investment across our portfolios in prior years but has recently seen its share price decrease from ~$2.80 to ~$1.00 as a result of a significant transition in its earnings profile yet may present a sound longer term opportunity.

As mentioned above COG provided a trading update for Q3 FY21 and reported Q3 NPATA of $4 million, and $14.1 million YTD which is close to 3 times the YTD NPATA produced in FY20. Clearly COG is a direct beneficiary of the significant investment from many Australian businesses expanding or upgrading their current asset base. Even though the absolute profit figures for COG have increased significantly, we would argue that the quality of the earnings has also increased at a greater rate. COG now generates most of its revenue through originating finance for its customers, insurance broking to these customers, and in a few cases even providing finance to these customers, albeit not through their own capital base but via their Managed Investment and Debenture Schemes. This sets COG apart from the general finance industry as it is a very capital light model and more akin to the broking and distribution businesses of Steadfast (ASX: SDF) and Mortgage Choice (ASX: MOC). Interestingly, MOC recently received a takeover over offer from leading digital business REA Group (ASX: REA) at a significant premium to the last traded price. For us this highlights the true value of any financial services business that has the power of distribution as opposed to capital intensive financial products. Looking forward, COG will continue to acquire brokers and cement its position as Australia’s largest finance broking and aggregation business with the short-term goal of ~30% market share.

From an earnings perspective we believe the organic growth potential within the business has never been stronger, mainly due to the potential to grow the insurance broking revenue. With a dedicated executive now in place to drive this strategy the potential for insurance broking earnings to top that of finance broking earnings over the next 5-years is not out of the question. When you consider that finance brokers are the trusted advisors for many large and successful small to medium businesses there will be no time lag to develop customer relationships, but success will be heavily dependent on COG’s insurance offering and service levels. However, if COG can successfully execute on this strategy, then the wider market may value every $1 of profit from insurance broking at >20 times as is the case with SDF, as opposed to the <11 times at which it currently values COG’s finance broking profit.