Investment Matters

Company profit reporting season: wrap-up

General

Broadly, results released in the recently concluded reporting season were in line with expectations.  This is measured by the number of "hits" and "misses" as compared to previous reporting seasons.

The market experienced a small bounce over reporting season.  We view this as likely to be more technical (e.g. covering of short-sold positions), rather than being based on fundamentals.  We consider it likely that the market will continue to be influenced by technical drivers, and the volatility we have experienced over recent months is likely to continue.  But it is really difficult to predict.

As expected, results in the mining and energy sectors were down considerably - at both the statutory level (including asset writedowns), and on the underlying level - driven by lower commodity prices.  This flowed into lower dividends. 

Speaking of dividends, this reporting season is note-worthy because we believe it heralds the end of the dividend golden era.  This has come about because of:

  1. the miners and energy producers (mentioned above);
  2. bank dividend pressures (CBA kept its H1 dividend flat pcp) - regulatory and other pressures mean bank dividends are under pressure; and
  3. many companies (not all though) taking a more conservative position regarding payout ratios and payment of dividends.

Companies with exposure to international markets (but not emerging markets) generally performed well.  The lower AUD benefited many results, although currency movements also muddied results (making it harder to identify performance on an underlying basis).  Those companies with an import exposure (including Pacific Brands) have been quite resilient to the AUD (e.g. by raising prices, use of hedging, etc).

There were some notably bad results, such as WoolworthsCrown and Slater & Gordon.  These were mostly of their own making.

Your portfolio

We are pretty pleased with reporting season in relation to your equity investments.  There were a few good results, most were in line with expectations, there were a couple which for varying reasons were below our expectations, and there were no disasters.  Please refer to the table below for a high-level summary, and to the last three editions of W&D for more detailed information on each company.

Total portfolio dividends have not grown as fast as in recent periods.  This is for a variety of reasons:

  1. because of the relatively high cash balance (cash doesn't pay dividends) we hold;
  2. BHP cut its dividend substantially (as expected given its old dividend policy was unsustainable), and South32 retains its conservative zero dividend payout; and
  3. we also own more companies than usual that are paying low or no dividends: these companies have considerable long-term growth opportunities.

Reflecting on our reporting season, Pacific Brands is the most noteworthy story.  It has been a journey, since its inclusion in the portfolio in Feb-13.  It is, however, an illustration of the investment approach we adopt.  Whilst we can (and usually do) experience volatility in our investments, standing behind our investment approach does bear fruit - with time.

More specifically, Pacific Brands, presented an opportunity for turnaround.  It owned (and designed, manufactured and distributed) a number of underperforming brands, but also what we assessed to be two really strong and undervalued core brands (Bonds and Sheridan).  Management had been challenged in the past, and there was some management turmoil in the early days of our investment.  In Aug-14, the current CEO (previously the CFO / COO) was appointed.  He, and his team, have cleaned out (sold or ceased) many brands, refocused the company, reduced debt, and improved operational performance substantially. 

The core brands have really shown their strength in this reporting season's result - whereas in the past their performance was buried underneath everything else that was going on (unless you looked, like we did).  The average cost price of your Pacific Brands shares is around 62.8 cents.  It briefly saw lows of 32 cents at the end of Jun-15 (not helping FY performance at the time!), it spent considerable time trading in the 40 cent range (we did "top-up" the investment in these times), and it is trading today at 91.5 cents.  So, including some dividends through our investment period, it has resulted in a good financial outcome.

The investment rationale of owning Pacific Brands has transitioned.  It is now a well managed, 'clean' company, without the drag of its legacy issues (underperforming brands, and debt in particular).  We were impressed with the company's management of FX exposure (lower AUD) in these results.  The opportunity now is one of growth - really driving the Bonds and Sheridan brands, as well as the opportunity in the Berlei brand - which we don't believe is well recognised currently.  It is also expected to generate strong cash flow and pay meaningful dividends in the future.

More generally...

Company results FY 16 1