Quarterly Report March 2022

Quarterly Reporting: out of the frying pan…

The Markets

This week: ASX v Wall Street

FYTD: ASX v Wall Street


As we creep into the last quarter of the financial year, there has been a flood of quarterly reports.

While we would like to think our investment time horizon is a little longer than a single quarter, reports from the March quarter have been particularly informative.

They have given us a glimpse of how companies have fared as Omicron hesitancy has begun to fade and inflationary pressures have started to bite (for some).

This has, of course, been heterogenous across the market.

For some, the March quarter represented a reprieve, as their operations got back to “business as usual”, with activity and demand returning.

For others, it was a case of out of the Omicron frying pan, into the inflationary fire.

We were generally pleased with how companies in the portfolio performed in this respect and we hold a degree of confidence that the majority can pass on rising costs (or will see commensurate revenue benefits to offset it).

We discuss below.

Endeavour Group has continued to see strong demand over the March quarter.

Its retail business (Dan Murphy’s & BWS) was relatively flat (factoring in the changed timing of easter this year), with revenue stable on a year-on-year basis.

The real surprise was its Hotels business, which has returned to pre-COVID levels of revenue despite the impact of Omicron over January. The company attributes this to a growth in accommodation revenue, as well as gaming, with on premise consumption and live entertainment yet to rebound.

We continued to be pleased with the way in which the business has been able to manage its costs and the degree to which inflationary pressures have been able to be passed onto consumers (which gives us a good look through to how well United Malt will be able to be pass on its costs – discussed below).

Furthermore, premiumisation trends have continued with consumers still willing to pay a premium for “indulgence and immediacy”, which bodes well for gross margins.

Aurelia Metals released their activity report for the March quarter.

In general, what we have seen across commodity producers is an increase in costs, be it labour, energy or transport.

Aurelia was not immune to this, with rail transport availability hampering sales in the quarter somewhat.

Gold grades had the biggest impact on the result, with grades produced at Peak lower than expected. This was compounded by issues at Dargues over the quarter relating to flooding in NSW which constrained processing capacity.

Pleasingly, work at Federation continues to progress well, with first blast occurring over the quarter and progress being made on the exploration decline.

Furthermore, drilling results at Federation, Peak and Great Cobar continue to be promising, showing regions of very high-grade mineralisation. This includes grades as high as 17% Lead and 32% Zinc at Federation (which are close to concentrate grade) as well as grades as gold grades as high as 107.9 grams per tonne at Peak.

First blast for the exploration decline at Federation
Source: Aurelia Metals

Sandfire Resources produced what was a reassuring quarterly activity report.

There was much trepidation around the performance of the recently acquired MASTA complex in the Iberian Peninsula (northern Spain). The company recently spent AU$1,258m on acquiring the mine, which will replace production from the Degrussa mine.

At the company’s last result, it flagged costs at MATSA were significantly higher than the market expected. This was attributed to rising energy costs in Spain, as well as higher labour costs and general inflationary pressures (see below).

Source: Sandfire Resources

The good news in the result was it appears things are back on track. Energy costs have begun to fall and could potentially be capped in the near term through government intervention. Furthermore, production volumes are back in line with market expectations. And of course while costs have risen, so have copper prices, meaning margins continue to be very healthy.

Shares in the company rose by 12% on the day of announcement.

We expect uncertainty around MATSA will begin to ease with time.

While it is sometimes thought of as a mine, in reality it is a complex of smaller mines, with varying minerology. Added to this complexity the deposits are volcanogenic massive sulphide deposits (VMS). These deposits are typically smaller but often high grade and polymetallic (i.e., containing more than just copper).

However, this means production can be variable in terms of grades, as producers work through the sequence of the various mines. This variability can make it difficult for those who react to production variances on a quarter-by-quarter basis but can provide opportunity for those who take a longer-term view.

Wide Open Agriculture has seen revenue continue to grow, with revenue over the quarter more than doubling on a year on year basis.

This has been driven by a ramp up in online sales of Dirty Clean Food, (now run rating at $1m in sales per month) as well as a ramp up in sales by virtue of contracts signed for the distribution of its OatUp oat milk.

Key contracts signed over the quarter include an agreement to range OatUp in 650 Woolworths stores nationwide and an agreement to range OatUp across Hong Kong and Macau, potentially across 1,600 locations.

However, in our eyes, the potential for a step change growth remains in the commercialisation of the company’s lupin derived Buntine Protein.

Wide Open continues to build out its pilot plant which will be used as a staging ground for the development of more products utilising the protein.

This will allow it to capitalise on the significant interest its product has generated due to its potential use for the protein fortification across a range of plant-based products (noodles, yoghurt, plant-based meat, protein powder, enriched plant milk).

Construction of Wide Open’s Lupin Pilot Plant begins
Source: Wide Open Agriculture

United Malt has seen its fair share of challenges over the quarter.

However, its update was very much a case of short-term challenges amidst a background of a longer-term recovery.

The good: volumes in its processing segment (the segment that processes barley into malt for brewers big and small) are close to returning to FY-19 levels. In fact, save for some logistic issues (containers becoming scarcer and more expensive) which have constrained production capacity, it is likely processing levels in FY-22 would be returning to FY-19 levels. In short – people are back to consuming alcohol at their local and volumes are recovering.

The other good news: the company’s Warehousing and Logistics business continues to make strides, with operating profit growth of 14% expected (on a year-on-year basis). This segment of the business caters directly to craft and micro-breweries by providing a one stop shop for consumables, ingredients and alike (curious Victorians can visit the company’s newest centre in Derrimut) and has shown a good ability to optimise mix and pass on costs.

The bad news is that the current geopolitical backdrop (rising wheat and barley prices, higher energy costs) and some not so favourable growing conditions for Canadian malt producers have resulted in higher-than-expected costs for the half, that will spill over to the financial year result.

However, we are less concerned that there will be a longer-term impact. United Malt’s contracts (of varying tenors) allow them to pass on a large amount of these costs (particularly energy) and the planting season for Canadian looks to produce a more than 50% increase in crop production, which should see sourcing issues dissipate.

More importantly, malt generally represents a small cost (single digit in percentage terms) in the terms of final produced goods for brewers, and so we see merit in the company’s confidence in passing on any cost pressures.

Carbon Revolution’s quarterly report disappointed.

Cost pressures identified in the previous quarter, stemming from resin and finishing (facia) issues, raw material costs and rising labour costs have carried over into the current quarter, which has not stemmed the company’s cash burn.

Furthermore, one of the projects underpinning the company’s ‘mega-line’ has been pushed out by a customer (OEM), which will see a delay in the implementation of the mega-line.

We were aware that the path of industrialise what was largely a manual process would be a bumpy one, however continued setbacks have made us more cautious about the position, which is amongst the smallest in the Australian Equities portfolio.

We have no doubt value being built by the business, who are is of few producers able to produce single piece carbon fibre wheels at scale. However, we are less confident about the amount of capital that needs be spent to reach a point where these wheels can be produced efficiently, in industrial quantities, and profitably.

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