The Markets
This week: ASX v Wall Street
FYTD: ASX v Wall Street
A rainy Friday complements a week where it has been raining profit results on the ASX.
It has been a busy week, to say the least, with more than 14 companies reporting across clients’ Australian Equities sub-portfolio.
We have provided a detailed review of a range of the companies in this week’s Investment Matters, leaving some to be covered in the following weeks. On many occasions, we will also have had the opportunity to meet management.
Sitting above the detail provided in a range of updates throughout the reporting season, important themes have emerged in a range of positions. These include the transition to new energy, the increasing importance of investment and capital goods, and the strength of transaction activity through the economy provide strong support for a portfolio built on such themes.
Company Description
Reliance Worldwide is a designer, manufacturer and supplier of water flow, control and monitoring products/solutions for the plumbing and heating industry. Its flagship products are push-to-connect fittings pipe fittings (Sharkbite, Speedfit) and associated piping. Products are sold through retail (primarily HomeDepot and Lowes) trade and wholesale channels into major markets including the US, UK and Australia.
The result (shares returned -6.2% on the day of the company’s profit announcement):
Reliance has seen a jump in demand for its products over the past two years.
Part of this has been related to a boom in the US housing market (Reliance’s primary market), with record low 30-year fixed rate mortgages and people spending more time at home post-COVID stimulating strong demand for new and existing housing as well as home improvement (repair and remodel).
This has seen Reliance’s net sales grow by 50% in the last two years and a 59% growth in operating profit.
However, with interest rates now rising, we have seen these extraordinary levels of demand begin to taper off, with housing starts in the US and Australia (the number of new residential construction projects that have begun during any month) beginning to slow.
This has weighed on the sentiment around Reliance’s share price.
Long before the post-COVID property boom, we purchased shares in Reliance on the basis that it had a strong, defensible brand and a product portfolio that continues to grow. These aspects of the business have not changed. We continue to see the company as having strong drivers for structural growth over the long-term including greater penetration of push to connect fittings, ageing housing stock in the US, new product launches, as well as additions to its product portfolio through acquisition.
Above: A slide from reliance’s recent Investor Day outlining the longer-term structural drivers behind its growth.
Source: Reliance Worldwide
In the short term, the market is focused on the impact the housing reversal will have on Reliance’s earnings next year. We saw Reliance’s CEO respond to the market’s questions around the outlook in a manner that was optimistic, but conservative and acknowledged the general uncertainty that exists at present.
However, as with Origin last week this lack of certainty and conservativism, given the economic backdrop, was enough to prompt selling of the stock.
We note two things.
The first is that Reliance has minimal exposure to newly built residential homes. In fact, the company estimates only 10% of the US business is exposed to new residential construction, with the remainder exposed to commercial construction (10%), repair and maintenance (60%) and renovation and remodelling (20%). This is similar in other geographies (although Australia has a higher exposure to residential construction) and concords with the feedback we have had when speaking to industry experts over the past few years.
The second is that Reliance’s CEO, an engineer by training, has a long history of conservatism when speaking to the market. His conservatism of Monday in our view was no different to that which he has maintained over the past few years, despite the 50% in revenue the company has seen!
We added to clients’ position this week alongside substantial shareholder Bennelong Funds.
Company Description
Nanosonics is a manufacturer and distributor of the Trophon, a high-level disinfection device used to sterilise ultrasound probes. The device has become the gold standard for probe disinfection globally and is vastly superior to chemical and mechanical cleaning. Nanosonics is currently developing a new device to disinfect endoscopes called the CORIS, which is due to launch in 2023.
The result (shares returned -1.7% on the day of the company’s profit announcement):
Nanosonics’ profit number was largely preannounced in July, and therefore generated few surprises.
The key drivers of Nanosonics’ growth are unit sales (the number of new devices sold), and the ongoing sale of consumables to its installed base of customers.
New unit sales in the US, Europe and the Asia Pacific (largely Australia) were largely in line with our expectations. Consumables revenue showed some slowdown; however, this is likely due to a reduction in the number of procedures over the course of the year given COVID-related challenges.
The broader investing community was largely focused on two areas.
The first was the completion of its transition to a direct sales model. The Trophon was previously distributed by GE Health care, under an arrangement where GE earned a margin on devices sold. However, this year the company announced that it would now sell to these customers directly (capturing the full margin on sales), assisted by a number of key hires from GE’s team. Pleasingly, its result points to this having been successfully executed.
The second was an update on its highly anticipated CORIS solution. CORIS is a big leap forward for the company, representing a completely new platform. The company has largely completed the design of the product and is well underway in conducting trials that will enable it to seek approval for sale in its relevant markets.
Nanosonics estimates that it costs currently between US$11-37 to manually clean an endoscope used in the gastrointestinal tract (gastroscope). This process is both time intensive and ineffective, with a 2015 study demonstrating persistent contamination of 92% of endoscopes, despite manual cleaning. CORIS aims to automate a significant proportion of the current manual cleaning including complex channel cleaning and deliver significantly superior outcomes compared to what can be achieved today.
To allow for flexibility, endoscopes consist of a number of channels, which can accumulate a significant amount of soil (debris) as well as groups of bacteria that form biofilms which can be incredibly difficult to clean.
The company presented a simulation which demonstrates the CORIS’ efficacy in cleaning these channels, inoculating a channel with a purple stained biofilm that was subjected to manual and automated cleaning using CORIS.
The results can be seen in the picture below:
Source: Nanosonics
We were pleased with the update, with the company expected to begin marketing the device in the next calendar year (2023).
Company Description
A longstanding position in client portfolios, Earlypay (formerly CML Group) is an invoice, trade and equipment financing company that finances small to medium sized businesses (SMEs). It has grown its business over many years both organically and through acquisition.
The result (shares returned 1.0% on the day of the company’s profit announcement):
EarlyPay set itself a high bar to clear during the year, upgrading its profit forecast a total of three times.
Although its net profit of $14.7m (adjusted for amortisation of intangibles) was slightly short of the $15m+ it had guided towards, it still represented impressive growth of 69% on the previous year.
EarlyPay has consistently grown its earnings over the past 6 years
Source: Earlypay
We saw the company significantly grow the value of invoices funded during the year ($2.4bn vs $1.9bn the previous year) and growth in its equipment finance book (with the net addition of $23m in loans).
Importantly, the company highlighted that all of its invoice finance facilities receive a variable rate and thus adjust in line with its funding costs, preserving its net interest margin.
Similarly, its equipment finance book, although fixed, is financed by debt with a fixed interest rate.
The company has funded $240m of invoices in July, which implies total invoices funded in FY-23 could exceed $2.8bn – a growth of 16%.
It will pay a final dividend of 1.8 cents per share – which represents a total dividend yield of 6.7% for FY-22 based on its current share price.
Company Description
MMA Offshore Limited provides vessels, and marine and subsea services to the offshore energy, renewables, and wider maritime industries in Australia and internationally. It operates through Vessel Services, Subsea Services, and Project Logistics segments.
The result (shares returned +2.4% on the day of the company’s profit announcement):
What a difference a few years can make.
Only two years ago MMA Offshore was staring into a stagnating offshore vessel market, with $267m of debt on its balance sheet, necessitating a debt restructure.
Through a supportive vessel resale market, a restructuring of its debt (which included a degree of debt forgiveness) and the sale of non-core assets, the company has reduced its gross debt to $125m ($51.5m after netting off its cash balance).
More importantly, the market for offshore vessels appears to have reached an inflection point. This can be seen in data below provided by shipping services provider Clarksons below.
Day rates for platform supply vessels (PSV) and anchor handling tug supply vessels have begun to inflect upwards. We have seen this in recent contracts MMA Offshore has written, and in the results of its peers such as TideWater which are beginning to see a significant improvement in day rates (approximately 15% in the July quarter alone).
Higher oil prices and Europe’s need to rapidly establish energy independence have led to a rapid tightening of the offshore vessel market – which can be seen in the chart on the right representing higher utilisation across the global fleet of offshore vessels.
Source: Clarksons
This is beginning to flow through to MMA’s bottom line, with a significant improvement in its operating profit in the second half of FY-23 ($18m vs $14.3m in the previous half), despite the company being hampered by direct and indirect COVID costs (it estimates this dampened profit by at least $2-3m in the second half and $5-6m in FY-22).
The market has tightened to an extent that the company has written up the value of boats on its balance sheet less debt to 95 cents per share (previously 80 cents), in line with a revised independent valuation of its fleet. We note this valuation includes a 15% “block sale” discount on the entire fleet and remains significantly above its current share price (65 cents per share).
MMA Offshore has been a strong performer in portfolios this financial year, returning approximately 16%.
Company Description
Inghams Group Limited, together with its subsidiaries, produces and sells chicken and turkey products in Australia and New Zealand. The company provides fresh, fresh with flavor, frozen, gluten free, and ready to cook chicken and turkey products under the Ingham’s brand name. It also offers stock feeds for poultry and pig industries.
The result (shares returned -4.8% on the day of the company’s profit announcement, -0.4% for the week):
It has been a challenging year for Inghams, who have been sailing into a number of headwinds.
These challenges have primarily related to feed costs and labor challenges.
With grain and natural gas prices at record levels, the cost of animal feed has presented challenges to profitability. Furthermore, Inghams is heavily reliant on labor to process its poultry and produce many of its higher margin, value-added products. COVID-related absenteeism and a tighter labor market, in general, has presented challenges to this.
As a result, we have seen Inghams have to sell a large volume of poultry as whole birds, into the lower margin wholesale market.
However, this is beginning to turn around. The company has implemented price rises across its customer base and with greater labor availability is beginning to see a return to a more favourable mix of products sold. We can see this below, with average selling prices across the group beginning to recover late in the financial year:
Source: Inghams
Despite the short-term factors that have hampered profitability, we see that the company will come out better for it over the longer term
It is aiming to achieve full recovery of the cost increases it has experienced through price rises over the coming year which should help restore margins.
Furthermore, we expect that the current price differential between poultry sources of protein (beef and lamb) provides scope for price increases and that customer switching may be beneficial to volumes. In fact, in their earnings call this week, Woolworths noted that customers have begun switching to cheaper sources of protein as a result of rising beef prices.
Company Description
Seven Group Holdings Limited engages in heavy equipment sales and service, equipment hire, construction materials, media, broadcasting, and energy assets businesses. It operates through WesTrac, Coates, Boral, Energy, Media Investments, and Other Investments segments.
The result (shares returned +2.2% on the day of the company’s profit announcement):
There are many moving parts to Seven Group, which fully owns or has a stake in a number of companies, both listed and unlisted.
These include listed companies such as Boral (ASX:BLD), Seven West Media (ASX:SWM) and Beach Energy (ASX:BPT), as well as unlisted companies such as WesTrac (a Caterpillar dealer, providing equipment to the construction, mining and agricultural industries) and Coates (Australia’s largest equipment rental company).
With the results of its listed holdings pre-announced, our focus was on the performance of WesTrac and Coates.
Pleasingly, both businesses are showing strong momentum.
While supply constraints have hampered sales of new equipment for WesTrac, sale of parts and servicing has been strong (and are set to benefit from price rises next year), leading to approximately 13% operating profit growth in the second half of FY-22 and 6.1% overall for the year.
Furthermore, Coates is experiencing strong demand, with equipment utilisation ending at 60%, having started the year at 47.5%. This translated to operating profit growth of 8% in FY-22.
We established a position in Seven as it holds interests in businesses that are embedded in the core of the Australian economy (civil and residential construction, infrastructure spending – roads highways and bridges and resource production). These businesses stand to benefit from government spending, as well as strength in commodity prices.
In our assessment, the company is trading at a significant discount to the sum of its many parts. The company is trading at a net profit multiple of 10x (next year’s profit), a price that we see as representing strong value given the privileged assets it holds.
Company Description
Woolworths Group Limited operates retail stores. Its operating segments include Australian Food, Australian B2B, New Zealand Food and BIG W.
The result (shares returned -3.2% on the day of the company’s profit announcement):
We have been slightly reducing our holdings of Woolworths over the past 3 months, reflecting a view that;
- the transition post-COVID world
- the problem coordinating customer messaging in an inflationary environment, and;
- the first impacts on households from rising interest rates,
would present more challenging environment than the market expected.
We remain confident the management team is executing plans to generate long-term growth, growth that is being assisted by inflation, the growth of online shopping and a supportive industry structure. Woollies’ success is best borne out by the Australian Supermarket business which has enjoyed the lead in like-for-like (LFL) sales growth over Coles since 2018, including the fourth quarter of this financial year.
Having said that, it was clear from the results and management commentary that there are many competing forces at play. Sales in July and August are cycling lockdowns in some states, customers are responding to higher prices by shopping more and buying a little fewer items overall.
People are returning to malls, reducing sales in standalone stores, and customers are trading down to frozen vegetables and alternative protein sources. WOW flagged that food inflation is showing no signs of moderation in the short term.
Management commentary highlighted some factors that lie a little below the surface of operations in a business that generates $45bn of sales in Australia. With razor-thin margins, factors such as staff absenteeism and marginal productivity of boxes through warehouses make a difference.
Staff absenteeism declined over the half, from a peak of 6.5% in Jan to 5.3% in Jun. This remains above pre-COVID levels of ~4%. Distribution centres have outbound service levels are still lower than pre-COVID.
After more than 3 years of interruptions the key investment question is straightforward:
What is the underlying profitability of Australia supermarket when conditions normalise? We suspect that the combination of progress made in online, distribution, ranging and the positive impacts of inflation will combine to generate higher returns on capital than pre-COVID.
Company Description
Paragon Care Limited supplies durable medical equipment, medical devices, and consumable medical products to health and aged care markets in Australia, New Zealand, and internationally.
The result (shares returned +13.3% on the day of the company’s profit announcement):
FY-23 will prove to be a year where Paragon Care is re-introduced to the Australian stock market.
The company is now helmed by Mark Hooper (former CEO of Sigma Healthcare) and has revealed an ambitious target to be a $1bn company with $100m in operating profit (EBITDA).
In FY-22 the group achieved an operating profit of $30.2m (adjusted for a number of one-off expenses), which was aided by a 5-month contribution from the recently acquired Quantum Healthcare business.
Turning to the businesses’ pillars, we saw strong performance of the Diagnostics (blood reagents, pathology equipment) pilar which grew its revenue by 15% for the year.
Devices was weaker, seeing significant COVID-related disruptions in the second half which were in line with the fall in revenue seen by the prosthesis market as a whole (according to quarterly Medicate data).
Capital and Consumables continues to be impacted by delays in elective surgery across Australia and New Zealand but is expected to recover in the near term.
Lastly, Service and Technology held its revenue but is yet to return to the levels of profitability we expected, hampered by access restrictions because of COVID (primarily its Total Communications business).
The company also announced what is a small bolt-on acquisition of Specialist Medical Supplies (SMS) for $15.5m. SMS is a supplier of biopsy and skin lesion instrumentation as well as urinogenital products and has an operating profit of approximately $3.0m per annum and will complement the business’ existing Capital and Consumables pillar.
With a recovery in revenue of these COVID-affected pillars and a full-year contribution from Quantum and SMS, the company expects underlying profit growth of 30% next year and has guided towards ambitious organic growth in operating profit of 10% per annum thereafter.
Company Description
Perpetual Limited is a publicly owned investment manager. The company offers a range of financial products and services in Australia. These span funds management, portfolio management, financial planning, trustee, responsible entity and compliance services, executor services, investment administration and custody services, and mortgage processing services.
The result (shares returned -9.4% on the day of the company’s profit announcement):
The biggest headline from Perpetual’s result was that after several months of negotiations, it has come to an agreement to purchase fellow listed fund manager Pendal.
Pendal is a fund manager of similar size to Perpetual and one of the last remnants of 80s powerhouse Bankers Trust Australia and has A$111 billion of funds under management.
The deal will see the combined group’s funds under management grow to approximately A$201.4bn, creating one of the largest fund managers (based on assets under management) in Australia.
We will provide a further update on the company’s profit result next week, along with the remaining companies that have reported today.
The information in this article is of a general nature and does not take into consideration your personal objectives, financial situation or needs. Before acting on any of this information, you should consider whether it is appropriate for your personal circumstances and seek personal financial advice.