Annual General Meeting (AGM) season begins
In contrast to what is typically a more pedestrian period, annual general meetings this year function as an epilogue to reporting season. With the market climbing a wall of worry, many are eagerly anticipating the opportunity to receive updates from their companies as economic activity recovers.
We received two updates from your companies: Bapcor and James Hardie – both which we were extremely pleased with.
In short, the sales momentum both companies showed coming out of lockdown has continued to exceed expectations.
Bapcor’s revenue for the three months to September was up 27% compared to last year. Strong sales momentum has been seen across the board, however, we continue to be amazed by strength in Retail (with Autobarn same-store sales up a 36%!) as well as Burson Trade (same-store sales were up 7.75%) and Specialist Wholesale (with revenue up 18%). Shares in the company finished 10% higher for the week (to Thursday).
Likewise, strong sales momentum has continued for James Hardie. It now expects its operating profit for the year to be 12% higher than levels it guided towards only 2 months ago. All regions have shown strong growth that has been above the market, with a strong improvement in margins. In particular, the US housing market continues to fire on all cylinders (detailed below).
“Builders can’t build homes fast enough” – a look at the US housing market
In an interview with Bloomberg, renowned US housing analyst Ivy Zelman exclaimed “builders can’t build homes fast enough” this week. A chart of lumber prices over the past few months tells much of the story:
The US went into the pandemic with a shortage of housing in many regions, due to years of underbuilding. This was illustrated in an analysis by the Federal Home Loan Mortgage Corporation (Freddie Mac) which highlighted that 29 states are expected to have a significant housing undersupply.
Critically, the analysis looked to estimate household formation that has been suppressed by high housing costs, particularly amongst Millennials.
The projected deficit is illustrated in the diagram below, which shows an estimate of the percentage deficit in housing by state.
The impact of COVID has been twofold. Firstly, it has resulted in a dramatic lowering of interest rates – which has lowered housing costs. In the US, borrowers can lock in fixed mortgage rates for extended periods (up to 30 years) with no break costs. Post-COVID, the average rate for a 30-year fixed mortgage is now 2.88% (Source: Freddie Mac) a significant fall from pre-COVID rates of 4%. These lower borrowing costs have brought many new homeowners into the market, particularly Millennials – who have looked to purchase affordable housing outside of city centres.
Secondly, COVID has significantly changed the way we work, and the amount of time spent at home. It has resulted in greater work flexibility, which has facilitated the migration of labour, as fewer people need to live close to their workplace. This has seen an exodus from densely populated states to those with cheaper land and are more business/tax friendly. Furthermore, with more time spent at home, many have looked to “trade up” – with more buying power thanks to lower rates. This has allowed them to purchase larger, more expensive homes without increasing their loan service costs.
While this activity has been at the expense of multi-unit dwellings (with rental rates and apartment vacancies rising) it has been a boon for homebuilders and detached housing.
This can be seen in rising home prices and record new home sales. To illustrate, in August new home sales were 43.2 per cent above those in the previous year (see below).
This boom in activity has benefited several companies in your portfolio, particularly Reliance Worldwide, Boral (US divisions) and James Hardie. We built positions in these names in March at depressed prices, with the knowledge that US housing activity was buoyant pre-crisis and would likely be spurred by lower rates.
These stocks have achieved significant returns for the portfolio of approximately 26%, 27% and 100% respectively over the year (note: these figures represent an average across clients).
We are, however, cautions that recent US housing activity does to an extent represent a pulling forward of future demand. Furthermore, strong fiscal support remains critical to the US economy and recent activity may mask the negative impact of COVID on unemployment and wages.
Thus, if the share prices of these companies begin to extrapolate some of the recent activity we have seen, we will look to reduce your exposure.
The XTX blows past the NASDAQ
After a brief correction in September, the NASDAQ retested its previous high this week.
Australia’s local NASDAQ proxy - the S&P All Technology Index (XTX) has not only recovered but blown passed the NASDAQ.
A few things are notable about this.
The first is that the size of the technology sector in Australia is dwarfed by that of the US. The NASDAQ consists of approximately 3000 companies while the XTX only consists of 56.
The menu for investment managers in Australia is a rather short one. And with investable opportunities in the sector relatively small, it has been a case of a rising tide lifting all boats.
While the NASDAQ suffers from the effects of concentration (the top 5 stocks constituting approximately 40% of the index) and resulting narrowness of performance – our own XTX is not to be outdone. The 5 largest stocks constitute 50% of the index. There is no doubt that there are some great businesses within this list of companies – including Xero, Appen (which you have previously owned), REA Group and Seek. These are all businesses we would happily own (at cheaper prices).
However, we see some preconditions for exuberance that Charles Kindleberger described in his seminal “Manias, Panics and Crashes”. These include a fundamental change in the economy (COVID and related the changes), a convincing and justified narrative that has led prices to rise, the necessary fuel for this price rise (in this case, renewed retail investor interest) and a resulting positive feedback loop for prices.
We look at the sector on a stock by stock basis (bottom-up) and see that current prices leave these companies with little margin for error, in terms of future operating performance. We remain cautious and continue to search for opportunities at favourable prices.