Investment Matters

Reporting season recap: A deeper dive into the numbers

February was one of the best reporting seasons the Australian Equities portfolio has seen in recent years.  

This was exemplified by the portfolio outperforming the market by approximately 1.5% over the month, during what was one of the best profit reporting seasons on record for the broader market.

The ASX-300

Of course, given the challenges over the last 12 months, the prime focus during the period was not the absolute level of profit achieved, but how profits compared to expectations.

And while the profit numbers themselves were heavily impacted by COVID-19 (a handful for the better but a majority for the worse) results generally outperformed expectations.

This was largely driven by the company’s ability to contain costs and spending over the period.

Surprises were therefore largely based on companies achieving higher margins than expected, as opposed to revenue exceeding expectations.

This has led to an upwards revision to expectations for earnings for FY-21 and FY-22, as shown below, a change from the downward revisions we have seen during previous seasons.

 

Analyst’s expectations for this year’s profits have been revised upwards

 Upwards revised profits

Source: Macquarie

 

Pleasingly, companies outperformed as a result of earnings growing faster than expected as well as declining less than expected.

 

Lower costs a big contributor to outperformance

 lower costs contribute to performance

Source: MST Marquee

 

Your portfolio

Cardno was a standout performer for your portfolio during the period. The company posted a strong profit number, and we were particularly pleased that strong cost discipline has resulted in higher profit margins for its Asia Pacific division. Its share price was up over 15% over February.

We were also surprised by Lovisa’s result, with revenue remarkably resilient in Australia despite several months of closure over the half. Its share price also significantly outperformed and was up over 30% during February.

A brief snapshot of the results from the Profit Reporting Season for your portfolio is provided below:

Profit reporting snapshot

 

Two new additions and a farewell to Regis

Two new investments have made their way into the Australian Equities Portfolio: Hastings Technology Metals and Magellan Financial.

We also decided to exit clients’ position in Regis Healthcare over the past two weeks.

Magellan Financial: exploring new opportunities

Magellan is the second new addition to portfolios.

Magellan Financial is an Australian fund manager, who has established an impressive track record since formed in 2006.

The company has over $100 billion in funds under management, with the majority invested in its Global Equities and Global Listed Infrastructure strategies. Its Global Equities strategy is underpinned by an investment philosophy of investing in strong global brands with durable franchises/competitive advantages, such as McDonald's and Starbucks.

Both strategies have an established track record of performance and have outperformed their benchmarks over the last three years.

Fund performance aside, we have been impressed with the company’s ability to scale and grow its funds under management over the past few years.

It has seen strong inflows over several years and has complemented this with product innovation, for example, through the launch of its Magellan Core series and Airlie Active ETF.

Conservative positioning during COVID-19 and a broader rotation away from the style of companies it owns has resulted in muted performance recently, which has impacted its share price.

This has provided an opportunity to invest in the company at what we see as a discount to its potential value.

We see further upside in continued product innovation, particularly in the launch of its touted Retirement Income Fund, which is expected in the near term.

Furthermore, we see upside in several recent principal investments the company has made (investments made with shareholder’s funds, as opposed to investor’s funds) in complementary verticals.

This includes its 40% ownership in Barrenjoey. Barrenjoey is a full services financial firm, which provides corporate and strategic advisory, equity and debt capital market underwritings, cash equities, research, prime brokerage and traditional fixed income services.

We see that the company has assembled a quality team that positions it well to be one of Australia’s leading investment banks – providing significant upside to Magellan shareholders.

Magellan also has a 16% holding in Finclear. Finclear provides the infrastructure for the execution and settlement of trades. We see the potential for Finclear to win a significant market share as it disintermediates the financial plumbing that currently enables the trading of securities.

Hastings Technology Metals: a rare, rare earths opportunity

Last week, First Samuel clients participated in an oversubscribed placement by Hastings Technology Metals.

Hastings Technology Metals is a miner that is engaging in the exploration and development of rare earth deposits in Australia.

The position complements the portfolio’s exposure to rare earths through Lynas – which has generated significant returns for clients to date.

We have sold approximately 60% of our shareholding in Lynas into share price strength and used the proceeds to fund the small exposure in Hastings. The company is a modestly sized position in client Australian Equities portfolios, but one we see as having potential for significant upside.

Its primary interest is the Yagibana rare earths project, a well-advanced project which covers 650 square kilometres in the Gascoyne region of Western Australia.

The deposit

We are excited about the investment for several reasons.

Firstly, the investment provides exposure to rare earth production. Rare earths are minerals that are a critical input in the production of high-performance magnets and electronics.

We have long held the view that the current supply dynamics have resulted in significant fragility. As a reminder, more than 55% of the world’s supply of rare earths originates from China (Source: Roskill). The supply of these critical minerals is therefore coming under-threat as geopolitical tensions escalate.

Secondly, the deposit itself is highly prospective and there are in general few economically viable deposits of rare earths globally outside of China.

The roadmap to production

The company expects to begin production by 2023.

Based on current resources, the mine will have a life of 13 years and has already signed contracts with several large multinationals (including Schaffler and Thyssenkrupp) to supply 65% of its production for the next 10 years.

Based on the company’s estimates, the capital raise sees the project fully funded which includes the construction of the mine, processing plant, tailings facility and associated infrastructure.

Further upside in the future

We see Hastings as an attractive takeover target. Its deposit would complement the infrastructure and capabilities of several larger miners.

Furthermore, the company currently only plans to sell its production in the form of concentrate. There is potential to extract more value through further processing of this concentrate into minerals.

This may be facilitated through the strong support provided by local governments. The “reshoring” of rare earths processing has been a strong focus of governments recently, as highlighted funding recently awarded by the US Department of Defense to Lynas.

This week the Australian government announced a 10-year “roadmap” to facilitate the processing of rare earth minerals in Australia, which will include a potential $1.3 bn in funding, which Hastings or a potential acquirer may be able to take advantage of.

Exiting your position in Regis Healthcare

We have progressively exited clients’ position in Regis Healthcare over the past few weeks.

Our initial investment in Regis was made on the basis that it is a quality operator and that its share price reflected a “doom and gloom” scenario around transmissibility within aged care homes.

We also saw upside from regulatory reform, with potential for further government funding because of the recently concluded Royal Commission into Aged Care.

While the stock fell shortly after our purchase, it rebounded rapidly as the company fielded successive bids for a takeover – the last at $1.85.

The company was successful in limiting the spread of COVID-19 to its residents, however, the impact on occupancy has continued, and may potentially last longer than we anticipated.

Furthermore, the recommendations of the Royal Commission have disappointed, and will likely add further costs to a sector that is already suffering from a lack of funding.

While Regis remains a quality operator, without a clear funding solution we see that the sector may continue to struggle.

We chose to take a small loss on the position – to re-deploy funds elsewhere.