Investment Matters

Company Profit Reporting season

Challenger released a reasonable result.  Underlying net profit increased 6%, to $406m. 

The biggest division, annuities, had strong sales growth: +12%.  However, the negative financial impact of diversifying the product offering, and lower margins on products, equated to earnings from this division growing at a more moderate (but still good) +6% vs FY-17.

Challenger’s smaller funds' business had strong funds inflows of +$5.3 billion, contributing to a funds under management increase of 19% vs FY-17.  Earnings grew strongly: +28% vs FY-17.

Generally, cost containment remains strong, along with the company’s capital position.  But the company was subject to a 2% higher tax rate, impacting profit post tax.  Additionally, dilution of shares (because of a share issue to a Japanese partner as part of its Japanese expansion) meant that EPS was flat.

The company provided FY-19 guidance of 8% to 12% growth in normalised net profit before tax.

Lofty expectations were hoisted onto Challenger for this result, and they have been somewhat tempered.  Thus, the share price was down 6.9% on the day of the release.  We see the long term growth thematic (aging population retiring) supporting continued strong earnings growth in coming years.

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Aveo released a pleasing result – both financially, and in relation to achieving goals it set itself back in 2013 when it set about becoming a pure retirement company (which is also when we made the initial investment, then named FKP).  The market liked it too: +9.7**% on the day of the announcement.

Aveo delivered a 17% increase in profit vs FY-17 (or +16% on a per share basis).  Delivery of 506 new retirement units in FY-18, on strong margins.  The Newstead high-rise complete care offering was the standout success in FY-18.  The general product offering (new and refurbished), as well as care and support services, are expected to drive further sales growth in coming years (418 new sales are forecast for FY-19).

The sell-down of the non-retirement property assets is mostly complete, with only some residential land estates remaining.  Earnings from this division are declining in line.

Back to 5-year plan that Aveo completed successfully in FY-18: Return on Assets (RoA) has doubled from 4% to 8%, and the business has transitioned to become, almost, a pure-play quality retirement operator and developer.  Aveo’s retirement business now represents 97% of Aveo’s assets.  Aveo has also responded positively to the changing needs and expectations of retirement and has transitioned from a property company to a more holistic provider of retirement products and services (for example, leading the change of retirement contracts, and provision of medical and in-home-living services).

Net tangible assets per security was $3.92 as at 30-Jun-18.  This compares to a security price of circa $2.40.  The significant discount was a key driver of Aveo announcing a strategic review aimed at closing this gap.  Outcomes include the possibility of bringing in a strategic capital partner.

Aveo has forecast EPS of 20.4cps for FY-19.

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Pact’s result reflects that it has been a tough economic environment, and increasingly so.  The nature of Pact’s business (packaging used across a range of sectors) means it reflects a diversified exposure to the Australian and Asian economies – especially the consumer facing component.  (And it also doesn’t do cigarette packaging, which acts as a stabiliser for some other packaging companies.)

For Australian operations (~60% of earnings), the impact of lower rigid packaging volumes (excluding growth in the health and wellness sector), was offset by past acquisitions (including the Australian crate pooling business) and growth in the manufacturing, sustainability and infrastructure sectors.  Thus sales increased 14.5%.  But earnings only increased 3% as greater raw material costs weren’t fully recovered and higher energy costs hit.

Volumes were also down in the company’s Asian operations (including NZ), and industrial demand from China was weak.  This meant that the sales revenue increase of 10%, supported by past acquisitions, was lower than expected.  Recovery of rising material input costs was also noted as a negative factor for this division, as well as a higher depreciation expense.  Thus earnings declined 12.9% vs FY-17.

Overall, this equated to a sales revenue increase of 13.5%, and a profit decline of 5.3% (vs FY-17).  The dividend was held constant.

We expect economic conditions to weigh on the business over the coming year to two years.  But as past acquisitions are expected to contribute to future sales growth, and the impact of raw material increases and electricity costs are expected to moderate, we assess the immediate outlook is better than market reaction implied.  Additionally, we view Pact as a good manager and business builder.  They operate in a fragmented sector – presenting opportunities for further acquisitions, and we expect it will be a bigger business in 5 years time.

 

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The takeover offer for Adshel complicates the HT&E result.  Given the offer price is fixed, the focus is on how the remaining operations – principally Australian radio – has performed for the half year ending 30-Jun-18 (HT&E has a FY = CY).

Ratings across HT&E’s Australian metropolitan network were good, especially in the key markets of Sydney and Melbourne.  This contributed to the 7.3% growth in advertising revenue from these operations.  Cost growth was slightly higher than revenue growth, as the company invested in new talent – we will watch this going forward.

So, the radio business has performed well.  Additionally, the Hong Kong outdoor business returned positive earnings in the half.  Overall, profit from continuing operations increased 28.4%, supported by strong advertising revenue growth (and profit increased 56.7% if exceptional items, FY-17 = ACMA fee benefit and FY-18 = reversal of earnout provision, are excluded). 

The dividend was held constant at 3.0cps.

HT&E advised good conditions for Australian radio in H-1 have continued into the start of H-2.  H-2 focus is on the 30-Aug-18 expected ACCC decision re the Adshel takeover and assuming it is approved, implementing the divestment of Adshel.

 

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Although Origin Energy delivered strong earnings growth in FY-18 (vs FY-17), it disappointed vs expectations in the market.

The Energy Markets division, energy retailing and electricity generation, increased earnings 21%.  The Integrated Gas division, principally the APLNG project, grew earnings 67%.  Overall, underlying net profit more than doubled, to $838m.  We were disappointed that the dividend was not reinstated for the second half, given the factors that drove the dividend suspension (e.g. investment in APLNG) have passed.

Issues we are watching in relation to Origin are the impact of wholesale electricity price declines, customer churn, and regulatory pressures such as baseline pricing (the latter actually could be a benefit to Origin as more aggressive electricity retailers will be curtailed somewhat).

The company has forecast FY-19 underlying earnings from Energy Market division to be 14.4% (using the midpoint) lower than for FY-18, driven by absorbing higher electricity prices in NSW, retail competition, and reclassification of some hedge premiums to include them in underlying.  It is forecasting production of 660-690PJ from APLNG in FY-19 (compares to 676PJ in FY-18).  It is also likely to recommence dividends in FY-19.

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QBE’s result was well received, by the market and by your Investment Team. Cash profit increased 3.4% to US$385m  

Looking underneath the result provided some positive insights into the underlying business trends.  We certainly saw a good recovery in insurance profit / margins following the disappointing H-2 FY-17 result.  Metrics in the insurance business, such as premium rate increases, attritional claims ratio and COR (combined operating ratio) are moving in the right direction.  Operationally, the company is progressing with its goals of simplifying the business, reducing earnings volatility, and writing profitable insurance policies (including the sale / exit of a number of businesses through FY-18).

The one exception to the positive performance was in regards to investment return (short-term investment of premium proceeds), which fell to 2.1% (compared to 3.6% in H-1 FY-17).   QBE is leveraged to increasing interest rates, and thus at some stage will benefit from the changing global interest rate environment.