Investment Matters

The week gone by

A slower week

The market began the week in a sombre mood, after America’s biggest advocate and Mr Value himself (Warren Buffet) revealed he had been relatively inactive during the COVID-19 sell-off. Furthermore, Berkshire’s poor track record of investing airlines has continued, with the company selling its stake in the four largest US airlines - at their lows.

Australian retail trade figures showed an 8.5% increase in spending in March (month-on-month). However, this was largely driven by consumers “stocking up" (food retailing +6.4%, household goods retailing +2.2%) which offset a sharp contraction in eating/drinking out (-8.5%) and spending on apparel (-12.1%). As with most of the economic data for the March quarter, we can safely place these figures in the disregard pile.

At the opposite end of the spectrum: retail share market investors have been busy during the market sell-off. Perhaps too busy. ASIC has reported a tripling of the growth in new retail trading accounts between February 24 and April 3. With this came an increase of trading in all forms: in terms of the number of securities, frequency of trading and complexity of products used (and leverage).

A sobering statistic: the average time between trades during the period was one day. How did these day traders fare? Not so well (on average). For more than two-thirds of the days in which retail investors were net buyers, share prices declined the next day. For more than half of the days in which they were net sellers, share prices increased over the next day. Another reminder not to tempt fate with what is a voting machine in the short term (the market)…

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Source: ASIC
Macquarie Australia Conference

There are five occasions during the year when companies provide updates to the market. Some are relatively well known – two profit reporting seasons, which coincide with six-monthly financial reports, and annual general meetings (AGM). The other two are the Macquarie Conference in May and the UBS Conference in November.

Investors tend to tread lightly in May – a period is typically referred to as “confession season”. The moniker is derived from investor experience – April/May is often the period in which companies typically deliver unwelcome news before the financial year end.

Over the week we attended the Macquarie Australia Conference 2020 (virtually), where we heard from several of your companies.

There were several positive surprises, with few negative surprises or confessions to speak of. We were particularly pleased with the two technology companies added to your portfolio – Appen and Pushpay, which share prices increased by 12% and 50% respectively over the week.

In general, updates provided some more clarity on the impact of COVID-19, recent trading results and the outlook in the near term, which we discuss below.

Pushpay Holdings

Pushpay released its annual report this week. The result and subsequent profit guidance were incredibly strong – leading to a 50% increase in its share price over the week.

As we have mentioned previously, Pushpay has been one of few companies to upgrade its profit guidance during COVID-19 and had upgraded its profit expectation a total of three times this year.

We have been buying Pushpay through early March, at average levels of $3.60 (its current share price is $6.00).

The closure of places of worship and shelter-in-place restrictions has been favourable for digital giving, dramatically accelerating transaction volumes. This has been through broader adoption of digital giving services by donors belonging to new and existing customers.

This is growth that we expected to achieve over the next 2 years, all consolidated into changes in behaviour over the past 2 months.

Additional revenue flows quickly profit for Pushpay. As such, in FY-20, Pushpay achieved an operating profit (EBITDAF) of US$25.1m – a significant increase from $1.6m the year before.

As such, with continued revenue growth, the company expects operating profit in FY-21 of between US$48 and $52m. This was above expectations and would represent a dramatic increase in its profitability.

Appen

Appen presented at the Macquarie Australia Conference on Wednesday.

Its share price increased by over 14% over the week – with a significant move in its share price on Thursday.

The presentation began with a demonstration of Microsoft’s image recognition software (SeeingAI) – which can audibly describe the gender, age and general features of the subject.

Appen is responsible for the labelling that assists with the training of the machine-learning algorithm that powers the application (i.e. labelling eyes, ears, age, gender and expression of the subject under a range of conditions).

This provides a great example of Appen’s value proposition - it helps make artificial intelligence work in the real world.

The technology sector has been minimally impacted by CV-19, particularly larger technology firms such as Microsoft – which constitute more than 80% of Appen’s revenue. Furthermore, Appen’s workforce is already “at home” ready – with its crowd workers already working from home and internal staff seamlessly moved to a work from home setting.

Reflecting this, the company recently restated its full-year guidance (which maintains), indicating the business remains on track.

Worley

Worley provided an update at the Macquarie Australia Conference.

The company provided evidence of the impact of COVID-19 that was less than the market feared.

Part of our thesis in owning the company is the flexible way it manages its workforce across a range of industry exposures. The update strengthens our conviction.

In responding to COVID-19, the company has implemented swift measures to transition its workforce to work from home. In doing so over 40,000 staff moved to a work from home setting over the past six weeks. Worley remains confident in its balance sheet and ability to collect its receivables and has recently extended its debt facilities to provide additional headroom.

Viva Energy

Viva Energy presented at the Macquarie Australia Conference.

Pre-COVID-19, the company had seen strong retail fuel volumes (fuel sold at Shell, Shell Coles Express and Liberty service stations) and an improvement in market share. This is after renegotiating its contract with Coles Express early last year, which gave it better control of pricing.

We have taken the opportunity of the dramatic slowdown surrounding COVID to establish a larger position in this company. Despite falls in the volumes of fuel sold and the curtailing of demand for jet fuel, Viva Energy is well-positioned in the medium-term.

Critical to the investment at this point in the disruption is Viva’s exceptionally strong balance sheet (particularly after the recent sale of its stake in Viva Energy REIT).

In the short-term lower volumes are partially mitigated by higher margins – motorists aren't getting the full benefit of lower crude prices and global production margins.

In terms of its refining operations (Geelong), the company has been proactive in implementing measures to adjust to a reduction in volumes in the near term. This includes the shutting of several refining units – (reducing its production of gasoline and aviation fuel), adjusting crude inputs (to maximise margin) and the delay of maintenance spending. It continues to produce middle distillates (such as diesel) where demand has remained strong.

James Hardie

James Hardie provided an update to the market on Monday.

In addition to the great products, dominant market position, and large exposure to the US market, we are attracted to the James Hardie management ethos of flexibility, technological investment, efficiency and long –term thinking. The COVID sell-off provides an opportunity to buy the company for less than $20 down from a peak of $32 in February.

The company maintained its previous guidance for operating profit after tax (NOPAT) (for the full year ending 31st of March)– although this will be at the lower end of its guided range.

Its flexibility and long-term focus was exemplified by the announcement of several proactive measures to mitigate any potential reduction in activity as a result of COVID-19. This includes suspending its dividends, a reduction in planned capital expenditure (relative to historical) and phasing of compensation fund contributions.

It also announced other measures including the temporary closure of a few of its manufacturing plants, as well as delaying the commissioning of a new plant in North America.

We took the opportunity to speak to a key customer (contractor) earlier in the week, who is based in the key market of Austin Texas. The general feedback was that demand leading up to the crisis had been incredibly strong – driven by repair and remodelling activity in the area.

While there was a significant decline in work after shelter in place orders were put in place, demand has rebounded strongly in the past few weeks, with an easing of restrictions and the availability of financing has released a significant amount of pent up demand (with clients less concerned about have workers on-site).

Furthermore, HardieBoard continues to maintain its dominant position as the preferred brand of siding, with relatively little substitution to date.

Radio: Here, there and everywhere (HT1) and Southern Cross Media

HT1 and Southern Cross provided updates on Thursday.

Over the first quarter, (to March) ARN (HT1s radio network) gained share, outperforming the broader market.

However, revenue for the market overall remained subdued. Despite this, there are signs that radio consumption has grown over the lock-down period.

Both companies have balance sheets that can mitigate the impacts of COVID, despite the severity of the downturn in the short-term.

HT1 indicated listening grew by 1 hour and 30 minutes on average per week during lock-down relative to pre-lock-down. Furthermore, the company’s podcast platform, iHeartRadio grew its number of active users by 24% (to 1.2m).

However, both companies are yet to see an improvement in bookings, with advertisers remaining tentative.

They have, however, both implemented significant measures to reduce costs during this period.

HT1 has identified an additional $9.5-12.5m in cost savings (bringing total savings in 2020 to $20-30m) and its balance sheet is strong (it had net cash of $111 at the end of 2019).

Furthermore, Southern Cross was able to remain profitable operationally (EBITDA) in April through operating cost reductions and has raised additional equity to firm up its position.