Investment Matters

Profit Reporting Season Continues

A turning point for central bank thinking?

Last night in the US Federal Reserve Chair Jerome Powell gave a much-anticipated speech as part of the virtual symposium at Jackson Hole.

What was notable about the speech was the change in tone, which represents a potential turning point in central bank thinking.

The US Federal Reserve will now target an "average" 2% inflation rate (ie. through the cycle) - a relaxation of its inflation mandate. Less rigid inflation targeting means a period of below 2% inflation (as experienced recently) could be followed by a period of above 2% inflation. This flexibility will allow the central bank to focus on its main objective of achieving maximum employment.

This change of policy signals a change in thinking and a realization that targeting employment and supporting jobs is fundamentally more important than keeping inflation within a prescriptive band.

We have been highlighting for many months the increasing importance of thinking about future inflation and will return to this topic in next week’s Investment Matters.

Once again it was a busy week on the reporting front, with over 12 of your companies reporting.


Australian Equities sub-portfolio

Reliance Worldwide FY-20 result (Positive)

Producer of push to connect plumbing fittings (plastic and brass), piping, thermostats and other plumbing supplies.

Reliance’s result beat expectations, with revenue growing despite COVID impacts on demand and supply chain issues the company faced during the second half of the year. The company’s share price ended the week more than 35% higher.

Sales in the US accelerated significantly, with record sales in March and June. This was largely driven by activity in repair and remodelling (with a shift to DIY projects during COVID) as well as the strength of the US housing market in general (as we saw with James Hardie’s result). Critically the company continues to win market share and is having to ramp up production to meet growing demand.

Sales in the UK and Europe were subdued due to lockdown and restrictions put in place during COVID, which led to key distributors running down their inventory and limited restocking. In contrast, sales in Australia were a little better than expected despite a slowdown in construction activity.

The company has seen strong sales momentum in the US over July and August, with volumes in the UK recovering as lockdown measures ease and major customers (retail distributors) begin to restock inventory.
Reliance’s strong portfolio of brands, continued product development and exposure to a growing US housing market will support its growth in the near term.

Cardno FY-20 Result (Positive)

A global infrastructure, environmental and social development company operating in more than 100 countries. Provides a diverse range of services across civil, structural, water, environmental, geotechnical, traffic and transport engineering, energy and resources, land, buildings and management services sectors.

Cardno’s operating profit was ahead of its recent guidance.

COVID minimally impacted business during the period; some projects were brought forward while others were delayed, with the net impact marginally positive for the company.

Its Americas division (primarily based in the US) performed well, with record margins driven by Cardno’s toxicology business.

The company’s Asia Pacific division (primarily based in Australia) underperformed, with weak profitability. However, the company has made strides in returning this division to its former profitability, as evidenced by the quality pipeline of work it has built. We feel that the company now has the right management in place to unlock this divisions potential.

Cardno also demonstrated very strong working capital management over the period. This, coupled with a strong operating result has enabled the company to pay down debt, putting in a position to pursue growth opportunities, particularly in the Americas division.

In our view, it remains undervalued: a business that produces $40m in operating profit per annum that is valued at $136m dollars. This is before considering the (we feel very real) prospect that government spending will be ramped up in the near term and the potential for its Asia Pacific division to generate strong profits.


Intega FY-20 Result (Positive)

Construction materials testing, subsurface utility and quality assurance business

Intega’s result was in line with the company’s more recent update, producing an operating profit that was ahead of last year ($30.9m vs $29.8m).

Work was minimally impacted as many of the services it provides are for projects considered essential in nature.

The company is in a good financial position and its backlog of work has grown by 25%. We were pleased with the company’s strong management of working capital over the period - an area they have been focused on. As with many companies over reporting season, it was reluctant to give forecasts, but at this stage expects next year's profit to be higher.

Pleasingly, the company is ready to return to the pursuing growth, it has the ability to enter new regions through acquisition, leveraging of local relationships and partnering with larger contractors on major infrastructure projects.

We continue to see the company as materially undervalued and well-positioned to benefit from increased infrastructure spending in the US and Australia.

Carbon Revolution FY-20 Result (Mixed)

A producer of single-piece carbon fibre wheels for the world’s leading car manufacturers

As foreshadowed, Carbon Revolution’s ramp-up in production has been slower due to COVID’s impact on the broader automotive industry. However, the company has taken necessary steps to strengthen its position, bolstering its balance sheet and optimising labour costs.

Pleasingly, it continued to win new contracts during the year and has engaged with a major Asian auto manufacturer in recent months which should lead to further demand.

FY-20 was a year where spending was high, as the company looked to improve its manufacturing process (particularly the final finish of its wheels). It is expected that major capital spending will begin to tail off in FY-21 as the company looks to grow.

It expects a material reduction in the cost to produce its wheels next year as it continues to industrialise its manufacturing processes.


Aurelia Metals FY-20 Result (Mixed)

A gold and base metal (zinc, copper, lead) producer based in NSW (Cobar Basin)

Aurelia’s result was largely preannounced, with mining companies typically providing production and costs updates quarterly.

The company’s operating profit was largely in line with last year’s, however, next year’s cost guidance disappointed, particularly at Hera (Aurelia’s secondary, ageing mine).

With gold production at Hera tailing off, the company will look to bolster gold production from surrounding deposits including Federation and Nymagee. The Federation deposit has shown great promise, with initial drilling results indicating areas with very high gold grades, some of the highest seen in the region (in the order of 17-31g/t).      

The company also expanded on its growth ambitions, including acquisitive growth, continued exploration of prospective areas and is positioning itself for an upswing in copper prices over the medium term.

Aurelia is in a healthy net cash position (paying a dividend this year) which provides it with a good foundation from which to grow.


Sandfire Resources FY-20 Result (Neutral)

Gold and copper producer based in WA with development projects in Botswana & USA.

Sandfire’s production numbers and costs were also largely preannounced, with its result in line with expectations. The company has done a good job providing detailed updates throughout the year.

Pleasingly, the company will pay a final dividend of 14c fully franked (which represents a dividend yield of 2.9%).

The result mainly provided an opportunity for the company to update the market on its strategic objectives. There was no real change to this, the company is comfortable with its development pipeline, which they are confident of delivering.

Sandfire remains a core holding, providing exposure to the price of copper (which has strong short and medium drivers) through a producer with options for growth a strong a balance sheet from which to fund these.

Woolworths FY-20 Result (Positive)

Woolworths was successful in embracing a “don’t waste a crisis” ethos this year. Its results were impressive across the board, with positive trading impacts from COVID spurring re-investment in people, online and in-store costs.

Total supermarket sales were up 11.3% in the third quarter (Jan-March) and were up 9.3% in the fourth quarter (March-June), with like for like sales growing similarly. Offsetting this somewhat was the extra costs incurred in providing a safe environment during COVID, which meant a small amount of this uplift in sales fell through to the bottom line (i.e. profits were up less than sales).

The company has made strides with respect to online sales, which are now 6.4% of Food sales ($2bn, and up 40%+) and profitable (in our opinion, likely more profitable than the company infers). COVID has also accelerated investment and capability in this area: the barriers to others entering online grocery are now vast.

BigW saw a massive turnaround and expansion of online – there now appears to be a path to sustainable unwind of the massive store footprint into a combined store/online offer. Previously we assumed BigW would be entirely negative.

The only weakness was the Hotels business (closed due to COVID) which expected to be sold in coming years.

We continue to see the company as being very well positioned, particular in an environment with higher inflation.


Worley FY-20 Result (Positive)

Global engineering company which provides project delivery and consulting services to the resources and energy sectors, and complex process industries

Worley generated significantly more cash than expected this year, despite challenging conditions. Its share price reacted positively to the news, finishing the week more than 8% higher.

Its profit number was complicated by several costs relating to its acquisition of Jacob’s however underlying profitability was pleasing. It has continued to aggressively realise synergies from the acquisition and COVID has presented additional opportunities to reduce operating expenses, leaving the company in a much stronger position. Cash flow also benefited from strong working capital management, which Worley has significantly improved in recent years.

Fundamentally the company has demonstrated a strong ability to cut costs to offset what will likely be a slowdown in activity in the near term (with oil and gas capital expenditure set to decline), with the company now less exposed to more “discretionary” spending than it was in the past. On a longer-term basis, we see value in the company as the sector recovers.

The company is also aggressively positioning itself to be a leader in the energy transition, which will help ensure it continues to play a key role in the energy sector in years to come.


CML Group FY-20 Result (Neutral)

An invoice and equipment financing company, with a history of prudently growing its loan book over many years.

CML Group’s result was largely preannounced a numbers of key operating metrics (invoices funded, profitability) and thus there were few surprises in its result.

The company’s equipment financing book is performing better than expected, with deferred payments falling from 7.2% of customers (by value) to 1%.

There has been some softening in invoice financing during COVID, as reduced economic activity led to lower working capital requirements.

As the economy recovers, the company is focused on expanding into financing small businesses, which will be aided by its recent acquisition of Skippr. It expects to see demand and margins to recover as business activity improves and government support measures begin to roll off. Refinancing of its lending facilities will improve profitability near term.

The company will pay a final dividend (5.7% of its current share price). Its share price has begun to recover, up 37% this financial year, but continues to trade below our fundamental valuation.

Regis Health FY-20 result (mixed)

One of Australia’s leading aged care home providers, with 65 homes around Australia.

Regis is the leading operator in the aged care sector and remained profitable this year, in conditions where 50% of the industry more broadly has not.

Incidences of COVID have been well contained during the period, with only a single major outbreak in one home.

The company was candid about the challenges that face the sector: the growth in government funding has not kept up with an increase in costs across the industry (partly due to successive reforms and implementation of higher standards).

The small holding in Regis part of our COVID recovery portion of the portfolio (4-5% of equities). The companies result provides more evidence of new funding mechanisms and other reforms are needed in the aged care sector. We believe Regis is positioned to benefit from any future changes.