This week: ASX v Wall Street
FYTD: ASX v Wall Street
This week the Australian investment world was dominated by one event – the Macquarie Equites Conference in Sydney. Unlike other financial services conferences where the highlights are music acts or Rugby tournaments, this conference is famous for the breadth and depth of the companies that present updates to the hundreds of analysts in attendance.
More than 100 companies, including many of the non-bank larger companies on the ASX, presented. In this weeks’ Investment Matters we will provide a quick run through of major themes and highlights from companies to which our clients have exposure.
Other news for the week included a strong quarterly sales result from Woolworths, and the first of the banks reporting (NAB on Thursday and ANZ and MQG on Friday). The market was particularly savage towards NAB (down 6%) and the rest of the sector fell. While results were at record levels, Net Interest Margins were softer than expected and outlook statements warned of challenging times ahead. We will provide a full report on the bank reporting season in next week’s Investment Matters.
First Samuel clients remain substantially underweight banks, including all the Big 4, in their Australian equities’ sub-portfolio. We will provide a full commentary next week following the release of all results.
Macquarie Australian Companies Conference themes
Four key themes emerged from the conference.
- Impact of strong immigration (especially health providers and insurers)
- Rising rates and the impact on the consumer
- Energy transition (lithium, copper, mining services) and the US Inflation Reduction Act (2022)
- Using customer data and cyber security investment (retailers like Super Retail and JB HiFi with their member/loyalty programs, Medibank and Domain investing to shore up systems)
The last topic remains a fraught one for Australian business and a persistent risk for equity investors and Australian consumers alike. The first three are discussed below.
Immigration and population growth
The most persistent theme across the conference was the support to business from the surge in population growth.
Next week’s likely surprise turnaround in the Federal Budget deficit, the strong sales results of Woolworths, the turnaround in house prices and the dramatic deterioration in travel times are all signs of the impact of surging population growth.
The discussions regarding population are no surprise to this investment team, the rapid rebound in the temporary visa holders that begun at the start of 2022 has since accelerated. Not all these temporary visa holders are even counted in our official population figures, yet most work, all need housing and all are consumers. The stock of temporary visitors in Australia has risen from a pandemic low of 1.6m people to more than 2.4m people in just over a year.
Feedback from the Macquarie conference, however, suggested this strength surprised businesses engaged in health services and insurance (temporary visa holders are offered enormously profitable non-pooled, non-cross-subsidised, health insurance not available to residents). Retailers also spoke to resilience, and many businesses described improving access to labour, especially in businesses that have huge labour turnover. So much for wages growth to claw back the impact of inflation!
The bigger pie or the bigger slice?
The pertinent question for investors as pertains to population growth is a straightforward one – does the company of interest benefit from more people in general, or does it benefit from the same people having more money to spend?
If you like, the difference between a bigger pie (more people) and a bigger slice (wealthier people).
That difference, increasing wealth, or increasing raw population levels, is stark for the investment landscape in Australia in 2023. GDP per capita will fall in 2023, wealth per capita will fall in 2023, real wages are already collapsing, and the rise in interest rates means huge swathes of the population face a decline in nominal cashflow.
But some companies, such as Woolworths, directly benefit from the bigger pie and from higher prices. We have consistently focussed on companies that benefit from a bigger pie, including EarlyPay, Paragon Care, Costa, Inghams, United Malt and QBE. We would love to be investing for bigger slices, have more exposure to Consumer Discretionary, wealth-related companies and those that benefit from higher productivity, but these are not the conditions favoured by current policies. Macquarie Group does represent one such exposure, given a higher net worth skew to its retail banking and its asset management businesses.
Many companies such as banks, face a mix of forces; a bigger pie means more loans, more spending and more investment, but smaller slices risk high competition for loans and deposits (discounting) and the risk of rising bad debts and defaults. Through the remainder of 2023 the relative importance of both forces on bank profitability will become clearer. Accordingly, we remain cautious.
Rising interest rates and the consumer
The surprise increase in the cash rate by the RBA on Tuesday formed the backdrop for companies to update the market on consumer behaviour. The falling household cashflow on the back of higher rates, combined with negative real wages growth is changing behaviour.
All conference attendants were keen to understand how companies are seeing the impact of the transition from previous fixed rate mortgage pricing on consumer behaviour. Macro-level data such as monthly retail sales are an important indicator, but nothing is quite as informative as listening to CEOs describe the day-to-day, in the trenches, movements in behaviour.
The clearest trend evident in supermarkets and discount department stores has been ‘trading down’, the trend where customers buy inferior brands or home brands instead of more expensive options. Coles noted in their presentation that consumer habits are changing, with downtrading occurring as cost-of-living pressures increase. Private-label purchases have up 11.5% on last year versus overall sales growth of 7%. Other forms of trading down include a trade from fresh to frozen, and switching meats or cuts of meat.
JB Hi Fi (JBH) is not seeing much down trading across its categories, apart from minor shifts in TVs, and management noted they are well placed for competition.
Cleanaway Waste (CWY) management spoke of balancing the need to pay higher wages in order to attract and retain staff, but also to assist its staff to make ends meet as the cost of rising mortgage interest rates and energy prices bites. Demand for extra shifts and weekend work has notably increased amongst their staff.
Inflation Reduction Act (IRA) – an enabler of the energy transition
The relatively obscure US Federal Law passed by President Biden in August 2022 had an outsized prominence within discussion at the Macquarie Conference. There may be extensive debate about whether the IRA is reducing or increasing inflation in the US, but the element that is critical for Australia is the USD$391 billion spending on energy and climate change.
The primary goal of this spending is to drive down consumer energy costs, increase energy security, and reduce greenhouse gas emissions. Central to these plans is improving supply chains for critical minerals and reducing the reliance on supply chains dominated by China.
Countries such as Australia and South Korea which have fully developed Free Trade agreements are well placed to receive direct and indirect support from the IRA to build new supply chains. Critical minerals that are relevant to investors which include lithium and rare earths, both of which Australia are major suppliers with low-cost strategic assets.
The fireside chat with Worley CEO Chris Ashton, along with presentations by IGO interim CEO Matt Dusci, Lynas Corporation Amanda Lacaze, and various lithium producers concentrated heavily on the long-term impacts of the US legislation. Worley’s Ashton noted that the IRA was changing balance in key old-world industries as well including chemical production. With challenges to the sector in Europe as energy costs surged with the Ukraine War, the US is a beneficiary due to lower gas costs and support from the IRA.
We have written in recent weeks about developments at IGO that seek to move downstream towards battery production. The breadth of their plans was highlighted at the conference.
Confident CEOs in Fireside Chats
There was no fireplaces at these fireside chats, just armchairs instead of lecterns and PowerPoint presentations, and whilst the “Fireside Chats” lacked the informality, one could imagine they do have the advantage of allowing the CEO to respond more readily to strategic questions.
We listened to the chat with Boral’s CEO Vic Bansal. Boral is 72% owned by Seven Group, a core holding in client’s Australian equities’ sub-portfolios. Bansal is the former CEO of Cleanaway and was appointed to the CEO role at Boral in June 2022. In our opinion, Bansal remains one of the most impressive and straightforward strategic thinkers. Unlike the previous three CEOS of Boral (Selway, Kane and Todorcevski) Bansal appeared to grasp the critical issue: getting paid appropriately for the products Boral produces.
Bansal noted prices need to continue to rise in construction materials. On top of pricing discussions, the new CEO’s handle on the issues surrounding CO2 emissions from cement was impressive. Achieving a balance of regulation and incentives that doesn’t destroy a local industry to simply prop up equally environmental destructive activity in China is key to our national interests. Politicians could do worse than take some advice here from Bansal.
Another fireside chat we attended was with the CEO of copper producer Sandfire Resources, Brendan Harris. The difference between the polished, investor-aware Harris, and the former CEO Karl Simich couldn’t be more pronounced. Simich is a genius-developer, market-promoter and visionary, who built a $3 billion company from very little over the course of 15 years. We have no concerns that Harris, a former CFO at South32, a former BHP Global Head of Investor Relations and former Macquarie analyst would be poor at communicating a message. We did worry about changes in strategic directions at Sandfire just as it anticipates first production in Botswana and continues to bed down its operations in Spain. Pleasingly, the strategic imperatives Harris elaborated upon were broader, better developed and more nuanced that expected. Project extensions in Black Butte in the US, ideas to retain optionality in the runoff of DeGrussa, and some rethinking in Spain were all areas we had been disappointed by the interim CEO. Copper remains a critical focus in the portfolio and Sandfire is one of very few pure-play copper exposures listed on the ASX following BHP’s takeover of Oz Minerals.
Strategic acquisitions and disposals were the theme of the Wesfarmers CEO Rob Scott’s presentation. Wesfarmers, which owns consumer brands such as Bunnings, Target, Officeworks and Catch.com.au, is a holding for ‘conservative’ clients. The companies track record of business acquisitions and divestments (including Coles) has always been supported by the strong core cash flow generation of Bunnings is impressive over a 20+ year period, across several CEO’s. Recent expansion into lithium has proven timely, and we expect that the company will be able to leverage additional opportunities in the energy transition in the future.
Woolworths 3Q Sales
Woolworths released its sales results for the 3rd quarter of FY-23 on Tuesday and it was another impressive result. Sales growth on last year was 7.6% across all formats in Australian Food retailing. Inflation had moderated to 5.8% (although we take their reporting inflation figures with more than a grain of salt).
What struck us about this result is the performance of Woolworths across the four-year period that spans the COVID era. In 2019, Woolworths already had a market leading position in Food Retailing, with industry leading sales per square metre and highest margins. It was beginning to rapidly expand its online (non-store originated) offering, which only accelerated when COVID struck.
The risk for Woolworths was that in building out its on-line and delivery options, which was vital protect its market position, it faces explosive cost growth and cannibalisation of its in-store offer.
Whilst the final results on profitability will not be seen until later in the year, the sales performance through this challenging change are now clear. Woolworths has been able to generate 40% per annum growth in e-commerce sales, moving from 3 per cent of sales to more than 11 per cent of sales, at the same times as seeing in-store sales grow by 3.7 per cent per annum.
This performance across the COVID interruption has set up Woolworths for continued innovation in e-commerce from a position of strength and has enabled significant amount of customer education around non-store options, without missing a beat. The risk of significant future competition has been reduced, and this execution is one of the reasons why Woolworths trades at a significant price-earnings premium to both its history and the market.