Investment Matters

A big week for your portfolio

We kept busy this week by wading through a river of company reports – which included over ten companies in your portfolios.

Results cleared some of the fog which has hung over the market and provided some more visibility.

However, companies have remained cautious in their outlook while uncertainty remains - few companies have issued guidance for profits next year.

We have been given some indication of trading conditions for the beginning of the fiscal year, as restrictions have lifted. In particular, we have been surprised by the strength of the Consumer Discretionary sector with companies such as JB-Hifi and Bapcor (detailed below) seeing a dramatic acceleration in sales.

Larger commodity producers have also fared well, given the strength of iron ore, gold and copper prices.

At the end of the month in the regular video presentation, we will provide higher-level commentary surrounding the portfolio, including the overall impact of the company reporting season.

We briefly summarise the results for your companies this week below: 

Australian Equities Portfolio

Bapcor FY-20 result (Positive)

The result for FY-20 was ahead of expectations – with revenue growing organically by 7% and adjusted net profit resilient (-5.5%). This was impressive, given the challenges the company faced during the period – such as the impact bushfires had on holidaying/travel and COVID related restrictions.

The company has benefited from higher spending during the COVID period, with spending boosted by Government support as discussed in last week’s Investment Matters.

This spending flowed through to the company’s Trade segment which sells parts to motor vehicle workshops and benefited from spending at retail stores (Autobarn) in particular with sales an astounding 46-60% higher in May and June (year on year).

This momentum has continued into the current financial year, with the impact of the Melbourne lockdown being offset by the strength of sales in other states.

Overall, the result exceeded expectations proved up the defensiveness of Bapcor’s earnings and after raising capital the company’s balance sheet is in good health.

In the near term, the company will likely see some benefit from current conditions, as fewer people commute by public transport leading to greater road traffic and consumers delay the purchase of new vehicles.


ANZ (Positive) and National Australia Bank (Mixed) Third Quarter updates

While CBA is the only bank to report its full-year profit numbers in August – the remaining three banks provided updates which coincided with CBA’s result.

Last week NAB provided an update for the third quarter. NAB’s revenue was slightly better than expected, driven by Treasury and Markets income.

The proportion of home loans deferred were higher than CBA’s, with a high percentage of home loan deferrals relating to small business owners.

After raising capital NAB is in a much stronger capital position – which has bolstered its resilience.

ANZ’s third-quarter result was a reminder that ANZ is more than just a home loan bank, with income strong as a result of a big spike in profitable institutional revenue.

The company elected to pay a modest dividend at 25c reflecting the bank’s greater confidence in the outlook, relative to 3 months ago.

However, as with NAB’s update, we were also reminded that the banks continue to face short term challenges, with the percentage of home loans on ANZ’s book that are deferred being similar to that of NAB.

While challenges remain for banks in the coming period, they are trading at historically cheap prices and will likely benefit from continued government and regulatory support.

We, therefore, continue to see merit in exposure to banks – however, this remains small, relative to the S&P/ASX200 Index.


Mineral Resources FY-20 result (Positive)

The case for investing in Mineral Resources has been a relatively simple one: it is a company that continues to produce a lot of profit from its assets (or in finance parlance – it is a high ROIC business) while continuing to find opportunities to re-invest.

This has been through:

  • Providing leading mining services (pit to port – including mining, processing, and haulage) with equipment it is able to deploy between mine sites.
  • Purchasing cheap mine assets during favourable points in the cycle and transforming these into favourable profit-sharing arrangements and longer-term mining services contracts.

This is shown in the chart below, which plots the profit Mineral Resources has achieved as a percentage of the capital invested in the business (ROIC) since listing:


FY-20 delivered a record profit result driven by strong commodity prices – particularly iron ore (the profit it achieved from selling iron ore doubled).

The company benefited from both direct exposure (its exposure to two operating iron ore mines) as well as higher mining services revenue (several producers looking to maximise production while iron ore and gold prices are favourable).

Its producing lithium project (Mt Marion) suffered from very weak prices but the company has implemented good cost controls to offset this and reduce costs during the current low pricing environment.

The company expects demand for its mining services to grow strongly next year and significantly higher production of iron ore (as production from Koolyanobbing ramps up).

Mineral Resources has been a standout performer in your Australian Equities Portfolio, having delivered a return greater than 65% return since purchased early this year.

Newcrest FY-20 result (last week) (Mixed)

Newcrest’s underlying profit result was 34% higher than last year, driven by a rising gold price.

It serves as a key exposure to the price of gold and is a low-cost producer.

Despite a positive result, with a slowing production profile, a lot of attention is on its ability to replace existing production. Lower guidance for production from one of its largest mines, therefore, dampened its result.

However, the company has a strong balance sheet, a strong pipeline of assets to develop with not much value attributed to these growth options.

The company is well-positioned to benefit from further price performance of gold and greater portfolio allocations to gold, with Newcrest being the largest, most liquid exposure on the ASX.

Viva Energy: 1H-20 Result (Mixed)

The result from Viva was largely pre-announced, as the has done a good job of regularly updating the market regarding both refining and fuel distribution markets.

The biggest impact of COVID has been on refining margins, which have suffered globally. While the retail fuel volumes have softened considerably during COVID, this has been offset by higher retail fuel margins and margins on fuel sold to commercial customers have remained robust.

Our detailed knowledge of the drivers of profit in this business assisted in gauging the severity of the impact COVID-19 had on profitability. This includes one of the larger impacts on commercial sales in FY-20, a contraction in jet fuel profits, which in line with our expectations.

The company also announced it will return the majority capital from the recent sale of its stake in Viva Energy REIT by way of a capital return ($415m or $0.2146 per share) and special dividend ($114.9 or $0.0594 per share) with a modest continuation of the current share buyback.
While the capital return provides some tax advantages (given the company’s lack of franking credits) this will be more beneficial for shareholders with a higher cost base.

The result has proved the resilience of the business's core non-refining business. The refining business has the potential to generate significant profits in a favourable pricing environment but will likely require recognition of its strategic value in providing domestic fuel security.

Origin FY20 Result (Negative)

Origin’s FY-20 result was largely pre-announced and in line with expectations.

We have reduced the stake in Origin significantly through the year as the stock traded above our long-term valuation. Your exposure to Origin Energy was further reduced by approximately a third leading into its result as we saw downside, particularly to electricity margins in the near term.

As a reminder, Origin has two divisions – Energy Markets (gas and electricity retailing) as well as its stake in the Asia Pacific LNG joint venture APLNG (production and export of natural gas).

In general, the pricing environment for Origin post-COVID has been weak, with lower realised prices for LNG due to weak oil prices and cheap gas and reduced demand flowing through to weak energy prices.

Energy Markets is expected to be less profitable next year as a result of weaker pricing. The company is continuing to take out costs in servicing its Energy Market customers and will seek to take out further costs of $100m+ through integrating the Kraken platform (as part of its partnership with Octopus Energy). While Origin continues to work on bringing down at costs at APLNG, weakness in the oil price will likely also reduce cash distributed next year.

The company has chosen to pay a modest final dividend (25 cents) and is being conservative given the outlook and desire to pursue investments and growth (such as its Beetaloo basin exploration project).

Origin’s APLNG asset still provides exposure to the price of oil and has the potential to generate considerable cash as the oil price recovers, while cost out has the potential to offset some of the margin decline in Energy Markets.

We are comfortable with the size of the current position, and see upside in a post COVID world, and are happy to be patient at these levels.

Here, There, and Everywhere (HT&E): 1H-20 Result (Positive)

The radio advertising market was very soft for the first half of the year (down 30%), with most of the impact coming from advertisers pulling back spending after March.

HT&E weathered these conditions well with revenue declining by less than the broader radio advertising market (-27%) and still managed to produce a net profit during the period.

This was aided by cost-cutting measures and government support measures (although it was still profitable without accounting for government support). The company has also benefited from a healthy balance sheet with no net debt.

While there were concerns about listenership declining during the pandemic (with drive-time radio a key time slot for the industry) industry statics indicate that radio audiences and listenership has grown during the pandemic, particularly in digital formats (such as podcasting).

Despite this, advertising spending is yet to recover, although there has been some positive momentum in radio advertising in July/August driven mainly by retail, finance sector and government sectors.

Management also spent time highlighting what we have long seen as one of its underappreciated assets – Soprano. Soprano is a secure communication platform which HT&E has a 25% stake in. The investment is likely worth many times what it is being valued at on the company’s balance sheet and forms a substantial part of the company’s value.

Our valuation indicates the company remains cheap, as evidenced by the continuing on market buyback the company has in place. The stock has responded since the result, trading +15% higher.

Southern Cross FY-20 Result (Mixed)

Much like HT1, Southern Cross’ FY-20 result was significantly impacted by advertisers pulling back spending as the pandemic hit. Government assistance and cost control supported the company’s profitability during the second half of FY-20.

While the company is in a far better net debt position after raising capital, lower earnings over the current period leave its leverage at relatively high levels.

In reducing its leverage over the past few years, the company has already embarked on a range of cost-cutting measures, which has resulted in relatively higher fixed costs and less scope for further efficiencies.

We see that it has less balance sheet flexibility than HT&E with less valuation upside.

We have been selling your position in since late last year and your position in full this week.


BHP FY-20 Result (Mixed)

BHP’s profit result was slightly below expectations, with the company declaring a smaller dividend than expected.

The result was dominated by strong iron ore prices as a result of reduced output from Brazil (early in 2019 due to a tailing dam failure and more recently supply curtailment due to COVID) and strengthening demand from China.

As highlighted in a previous update, BHP will produce less copper next year (due to COVID-19 related restrictions on production in Chile) and oil (with production and investment being pulled back in a lower price environment). The company also announced it will pare back thermal and lower quality coal exposure as the global energy transition continues.

It will continue to focus on reducing the cost of producing metallurgical coal and iron ore and can grow production if market prices are accommodating.

In the medium term, BHP is looking to grow production of commodities that will form a key part of the energy transition and global growth, including copper, nickel and potash.

Despite the “Big Australian” being seen as a core part of the Australian share market, history cautions against a “set and forget” attitude. BHP is now trading 15%-20% higher than our current valuation, and we have chosen to reduce your holding at these levels

Webjet FY-20 Result (Mixed)

Webjet’s result reflected the challenges the company, and the entire global travel industry has faced, especially in Webjet's European businesses. We remain of the view that the portfolio needs a small exposure to businesses that will dramatically benefit from any progress we make globally at beating this pandemic.

The company has done a good job of reducing its operating costs, which will see it return to profit soon with a recovery in revenue. The update this week presented a timely reminder of the strength and global reach of the business. It also provided clarity concerning the path forward, maintaining the shell of a business whilst demand is negligible, at the same time as one which will be profitable at a fraction of former global travel demand.

The core risk in the business operations in Webjet is working capital, where debtors can't pay, and creditors demand payment, and the market was very apprehensive pre-result. The reported working capital position was pleasing, and when combined with recent capital raising it has built a strong buffer sustain more than a year of close to zero activity.

The stock has responded well, up 22 per cent this month. We believe the risk and reward relationships available in this position is compelling.

Property Portfolio

GDI Property Group

GDI property group is a small, growth-oriented REIT with a mix of commercial and industrial projects, growth-oriented.

Cash collection from tenants was strong through COVID, however COVID has introduced some challenges, with its Botannica 9 development in Swan St Richmond remaining vacant.

The REIT continues to trade at a significant discount to the book value of its assets (NTA) (-14%) and we see that several near-term catalysts can close this gap.

Based on its current share price, the REIT is expected to deliver a 7% yield in FY21, without any improvement in underlying conditions.