September, 2023
Volatility returned in September as bond market gyrations flowed through to equity markets. With reporting season behind us, the intense focus on macroeconomic drivers was again a feature. Most developed markets closed the month lower, with the biggest drawdowns occurring in the United States (down approximately 5%). The Contact Australian Ex-50 Fund continued its recent history of strong relative performance in September. The Fund declined by 2.8%, however this fared far better than both the S&P/ASX Small Ordinaries Index (-4.0%) and the S&P/ASX Mid-cap 50 Accumulation Index (-4.6%).
We added to our highest conviction positions in September amid negative market sentiment, which allowed us to buy at (what we consider) attractive prices. We have discussed Ampol Ltd in recent months and discuss other key positions below.
We encourage our investorsto read the latest BKI Investment Company Quarterly Report, whereby we discuss the power of recurring revenue streams. In the note, we undertake a deeper dive into IPH Limited (IPH). IPH is a leading intellectual property (“IP”) services firm, specializing in patents and trademarks. IPH operates in over 10 IP jurisdictions and employs over 1,300 people. In FY23, IPH generated almost $500 million in revenue and $170 million EBITDA.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Contact-Australian-Ex-50-Fund-September-2023.pdfAugust, 2023
The Contact Australian Ex-50 Fund continued its recent history of strong relative performance in August. In a busy month dominated by Reporting Season, the Fund returned +0.6% in a declining market. By comparison, the S&P/ASX Small Ordinaries Index (-1.3%) and the S&P/ASX Mid-cap 50 Accumulation Index (-1.3%) closed lower. The Fund has performed particularly well in recent months as our quality businesses have delivered solid results. In the last three months, the Ex50 Fund has increased by 8.7%, outperforming the Small Ordinaries Index (+2.2%), Mid-cap 50 Accumulation Index (+4.2%) and remain focused in achieving a 10% p.a. total return.
We continue to believe that we are in a stock pickers market and a focus on quality companies remains the most sensible strategy. August 2023 provided clear evidence of our entry into a more challenging phase of the economic cycle. While revenues generally exhibited strength, the driving force behind this upturn often stemmed from price escalations rather than volume expansion. Profit margins came under strain, frequently attributed to rising labour costs, albeit alleviated by declining freight rates and energy costs. A notable development is the escalating cost of debt, as interest payments emerged as a formidable challenge for enterprises grappling with stretched Balance Sheets.
A significant portion of the challenges mentioned above had already been anticipated. Consequently, the reporting period exceeded pessimistic expectations. Even the mere notion that earnings might not plummet triggered a substantial upward revision of share prices in several cyclical industries.
August was important for the Fund for more than just the companies that outperformed. Importantly, our focus on quality meant that we avoided any disastrous results. Generally, the companies that dragged on Fund performance had arguably enjoyed too strong a run into the result (Flight Centre and Smartgroup are two examples).
Ampol Limited (ALD) delivered a strong interim result, signalling strong underlying business momentum. We remain optimistic on long-term refining margins given increasing supply constraints, which is complemented by Convenience retail and a robust Balance Sheet. We expect further capital management initiatives in the near-term.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Contact-Australian-Ex-50-Fund-August-2023.pdfJuly, 2023
The Contact Australian Ex-50 Fund gained 4.9% in July. This was a pleasing performance against both the S&P/ASX Small Ordinaries Index (+3.6%) and the S&P/ASX Mid-cap 50 Accumulation Index (+4.4%). The Fund has performed particularly well over the past six months as many quality businesses have reiterated or increased their earnings guidance. We believe that we are in a stock pickers market and that a focus on quality companies remains the most sensible strategy.Global markets moved higher across the board in July. The consensus view now seems to expect that we are very close to the peak in interest rates. Indeed, we may already be there given the moderation in the rate of growth in inflation. The Reserve Bank of Australia seems eager to take a “wait and see” approach in the near term and monitor consumer behaviour and the unemployment rate.
We added Redox Limited (RDX) to the portfolio in early July as the company listed on the ASX. Redox is a traditional Industrial company – it is a leading supplier of chemicals, ingredients and raw materials to a myriad of industries. It was established in 1965 and is still managed by the founding Coneliano family, which owns 46% of the listed company. RDX generates a high proportion of recurring revenue, strong returns on capital and has significant growth opportunities via market share gains. Over time, we expect RDX to generate steady EPS growth and offer a compelling dividend yield. The IPO was priced just under 14x P/E multiple, which we considered attractive.
We wrote about Flight Centre (FLT) last month and the stock was a standout performer in July, increasing by 23%. The company increased its profit guidance for FY23 by approximately 10% at the EBITDA level. Founder and managing Director, Graham Turner said: "Overall, we are pleased with our continued recover as demand has generally rebounded solidly across both our leisure and corporate travel businesses.”
Alliance Aviation Limited (AQZ) also generated strong returns in July following an increase in its profit outlook, which surpassed market expectations. The AQZ announcement suggests that earnings will be almost 15% better than expected. It also disclosed the acquisition of four additional E190 aircraft to satisfy increasing demand. The secondhalf profit upgrade indicates increased wet lease flight hours from additional capacity and higher utilisation. AQZ has invested heavily in expanding its fleet in recent years. As demand increases, we believe that the company is well positioned to drive solid earnings growth. There is also corporate activity bubbling away in the background, with a potential takeover by Qantas. The ACCC has expressed concern on competition grounds, however if the deal does progress, there is likely to be a material AQZ share price increase based on the current bid of $4.75.
GQG Partners (MTS) also delivered a strong update regarding both its Funds Under Management growth and investment performance. Unlike many peers, GQG continues to generate solid net inflows, yet it is being priced by the market as a business in decline. We remain positive on the outlook for GQG and are backing the founder-led management team.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Contact-Australian-Ex-50-Fund-July-2023.pdfJune, 2023
The Australian market (as measured by the S&P/ASX 300 Accumulation Index) increased by 1.7% in June. As has been the case for some time, large caps outperformed small caps. The S&P/ASX 20 increased by 2.3%. The S&P/ASX Small Ordinaries Index was flat. By comparison, the Fund delivered a pleasing 3.0% return for the month.
Given the barrage of negative commentary over the past twelve months, some readers will be surprised by the returns generated by equities markets over fiscal 2023. Notwithstanding an environment of high inflation, a war in Ukraine, wage pressures, slowing earnings growth and unprecedented pace of interest rate rises, the market pushed higher. Quite a bit higher. The S&P/ASX 300 Accumulation Index generated a very robust 14.4% return for the year, yet the Small Ordinaries lagged, delivering 8.4%. The Fund return was 9.4%. The past six months was particularly solid, with a 5.5% return for the Fund against the S&P/ASX Small Ordinaries (+1.3%) and the S&P/ASX Midcap 50 Index (+4.6%). We put this down to a focus on Quality and Valuation.
Metcash Limited (MTS) delivered a solid FY23 result that was ahead of expectations. All pillars (Food, Liquor and Hardware) continued to perform well, with a notably strong performance from the Total Tools business. Revenue increased almost 6% and EBIT up 8% to record levels. The Result Presentation and subsequent Management meeting highlighted the gains that have been made by MTS over the past three years. MTS is now a larger, more diversified and stronger business, which has grown EBIT by 50% (aided by Hardware M&A). Underlying EPS has increased by >40% and Group ROFE exceeds 30%. As we’ve been saying for some time, we find it difficult to comprehend why MTS continues to trade at such a stark PE multiple discount to Coles, Woolworths and Wesfarmers. MTS remains one of our highest conviction positions in the portfolio.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Contact-Australian-Ex-50-Fund-June-2023.pdfMay, 2023
The Australian market declined in May, with the All Ordinaries down 2.6%. The Fund declined by 2.0% during the month, lagging the S&P/ASX Midcap 50 Index, which was flat, yet outperforming the Small Ordinaries Index, which declined 3.3%. IT was the best sector in May, which has been rising with US technology names. Consumer Discretionary lagged the market on the back of trading updates from many retailers that signalled a weakening in consumer spending.
Consumer names were not helped by the RBA, which increased rates by 25 bps in early May, catching the market offguard. Inflation has persisted throughout the month and at the time of writing, the RBA has increased rates yet again in early June to a decade high 4.10%. Lithium stock Allkem Limited (AKE) increased by 21% in May as it agreed to an all stock merger of equals with US Livent Corporation. A large rationale for the merger is synergies. Both companies have brine operations in Argentina and spodumene projects in Quebec. Following the significant jump in the share price, we took the opportunity to take some profits in AKE.
Our investment case was tied to the growth in the Lithium market that was underpinned by AKE’s strong Balance Sheet and cash flow generation. While those characteristics persist, we thought it appropriate to reduce exposure into recent strength. We still have almost 3% of the portfolio in the stock. We also reduced our holding in IGO Limited following a similarly strong run, which sees the stock trade above our valuation.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Contact-Australian-Ex-50-Fund-May-2023.pdfApril, 2023
Equity market managed to eke out gains in April. It was a month of mixed signals. The US quarterly earnings season is generating better than expected results and the Chinese reopening continues to gain momentum. On the other hand, segments of the US regional banking system are fragile and inflation remains stubbornly high across the globe. Most developed equity markets closed the month higher, led by India (+4.2%) and the FTSE (+3.4%). The S&P500 increased by 1.4%.
The Australian market performed relatively well, rising 1.8% for the month (based on the S&P/ASX 300 Accumulation Index). Small and mid-cap Australian shares outperformed their larger counterparts. The Small Ordinaries Accumulation Index increased by 2.8%. By comparison, the Fund increased by 2.2% in March.
Despite initial fears following the March disclosure of a cyber security incident. IPH Limited (IPH) was one of the best performers in April, increasing by 10%. An update from management highlighted a relative immaterial impact to date and that revenue would likely be deferred, not lost. IPH is a leading intellectual property services firm, dealing with patents and trademarks. In Australia, it has a 35% market share. IPH has global growth opportunities. It is a defensive business with a high proportion of recurring revenue and strong cash flow generation. We added to the position recently and remain optimistic on the company.
We are frustrated with the ACCC announcement that it would oppose Qantas’ acquisition of Alliance Aviation Services (AQZ) on competition grounds. Qantas announced that it intends to seek more information from the ACCC regarding the decision, requesting a meeting with the ACCC. Qantas remains adamant that the acquisition would not substantially lessen competition in any market and noted that its competitor Rex’s acquisition of National Jet Express from Cobham Aviation was unopposed, receiving ACCC clearance in 11 days. As a reminder, in May 2022, Qantas proposed a scheme of arrangement to fully acquire the remaining 80% of AQZ at $4.75/share. AQZ closed April at $3.10.
Bank of Queensland (BOQ) delivered a soft interim result that highlighted the intensifying competition in the Australian Banking Industry for both mortgages and deposits. Pressure on net interest margin has intensified. While BOQ is only a small position for the Fund, we intend to be patient for now given the discount to book value that the shares are currently trading at. The ME Bank acquisition is integrating well and should deliver on synergies. Chairman-come-CEO Patrick Allaway is eager to reduce the cost base. We expect to see any sign of good news result in a material re-rating of the stock. With mixed signals from a macroeconomic perspective, we believe that this is a stock pickers market and an environment we thrive in – one where fundamentals and quality matters.
We started to see a mean reversion in small stocks versus large stocks in April and believe this could continue given the extent of dispersion over the past two years. The Fund remains invested in high quality companies that are profitable, generate solid returns and offer an income stream. At a P/E multiple of just 12.6x, we believe that there is inherent value available.
File:March, 2023
The Fund retracted slightly in March in a more volatile Equities market. At a macro level, the failure of several US regional banks weighed on sentiment early in the month before the US Fed provided liquidity support. As fears of contagion of a run on the banks subsided, investors focused on the likely change in policy action by Central Banks. We witnessed the start of a change in behaviour in early April as the RBA paused on its rate hiking.
The Fund declined by 2.6% in March, which was broadly in line with the S&P/ASX Mid-cap 50 Accumulation Index.
After a busy February reporting season, there was less stock specific news in March. Of note for the Fund, Kelsian Limited (KLS) announced the acquisition of All Aboard America! Holdings, a US based bus business providing contract and charter coach passenger services. The purchase price of almost A$500 million will be funded through a combination of debt and equity. We took up our rights under the nonRenounceable rights issue at $5.55.
The transaction opens the door for significant growth in the US for Kelsian. AAAH is the 4th largest motorcoach operator in the US with 1,069 vehicles. For reference, KLS Australian bus segments has ~3,000 buses. The US market is large (over $30 billion) but very fragmented. The business has a high degree of recurring revenue and solid EBITDA margins of 25%. The majority of the management team (including the founders) will remain with the business.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Contact-Australian-Ex-50-Fund-March-2023.pdfFebruary, 2023
The Fund performed well versus the Australian market as investors focused on fundamentals during the February Reporting Season. Quality prevailed. While the Ex-50 Fund declined by 0.7% in a very volatile month, it was pleasing to see significant outperformance of both the S&P/ASX Small Ordinaries Accumulation Index (down 3.7%) and the S&P/ASX Midcap 50 Accumulation Index (down 3.2%). Reporting Season is always an interesting time for bottom-up stock pickers such as Contact Asset Management. Our investment approach involves a robust process whereby we analyse the individual qualitative and quantitative characteristics of companies. At a high level, we noted consistent themes from company results: tight labour supply, rising interest expense, a cautious consumer and ongoing inflation. Top line momentum was strong; however, this was primarily driven by pricing increases rather than volume growth.
Companies with limited pricing power were treated harshly by the market.Despite the cautious tone that has set into market sentiment, there were several pleasing results that give us cause for optimism. After enduring challenging operating conditions over the past two years, Smartgroup Corporation’s (SIQ) operating momentum is improving. Novated leasing leads have been buoyantwhile supply chain pressures on vehicle availability are only just beginning to abate. As the environment normalises, we expect sales to improve (as orders are converted) and costs to drop (as redundant service expenses are removed ) at a better-than-expected trajectory. Growth in EVs is an unappreciated additional boost to activity as are benefits from the recent investment in digital platforms. SIQ has a strong Balance Sheet with near zero debt forecast.
The better-than-expected dividend highlights management’s confidence in the outlook. A forward-looking P/E of 11-12 times suggests excellent value in Contact’s opinion. As noted last month, both Hub24 (HUB) and Netwealth (NWL) are beneficiaries of rising interest rates, which lifted margins on cash balances. Market share gains from the incumbents continues. We added Flight Centre (FLT) to the portfolio recently. Strong momentum is emerging in the corporate business, which now accounts for over 50% of earnings. Leisure is also recovering, yet still has upside with Australian arrivals at c70% pre-Covid levels. The resumption of Chinese tourismwill help drive growth. FLT’s Balance Sheet is in a sound position following the recent raising.
We expect this founder-led business to return to dividend payments next financial year. Kelsian Group (KLS) was another investment that delivered a pleasing result. The earnings stream from the buses business is particularly resilient and has inflation protection mechanisms in place, which are valuable in the current climate. Similar to FLT, KLS noted strong forward bookings in Marine & Tourism, with scope for further price increases. We continue to believe that the Portfolio is well positioned, with attractive Fund metrics offering an enviable combination of Quality, Value and Growth. We seek to deliver a long-term return of 10% p.a. through a disciplined investment process that avoids unprofitable and high-risk companies.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Contact-Australian-Ex-50-Fund-February-2023.pdfJanuary, 2023
Global equities made a solid start to the year, on hopes that inflation has peaked across key developed markets. While policy makers emphasise the tightening cycle is not complete, the probability of a soft landing increased. China’s reopening, robust employment numbers and strong commodity prices added to the more positive sentiment. The Australian market performed strongly, with the S&P/ASX 300 Index increasing by 6.3%. Consumer Discretionary, Materials and Real Estate were the best performing sectors. Utilities was the only sector that finished in the red. Ampol Limited (ALD) reported a solid quarterly update, which highlighted the continued improvement in retail shop and fuels profitability. Importantly, the company continues to generate sound refining margins, which are now less volatile compared to a few years ago. ALD is trading on a single digit P/E multiple and a dividend yield of 6.5%.
We believe the stock is attractively priced. Deterra Royalties (DRR) continues to benefit from strong iron ore prices, notwithstanding the production from Mining Area C was marginally below expectations. The company generates outstanding returns on capital and offers a compelling income stream. Both Hub24 (HUB) and Netwealth (NWL) posted slightly disappointing FUA numbers as volatile equity markets slowed fund flow. On a positive note, rising interest rates have lifted cash margins, which will help underpin earnings growth. We continue to expect momentum from both companies as they take share from the incumbents.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Contact-Australian-Ex-50-Fund-January-2023.pdfDecember, 2022
Global markets were directionless for much of December as investors attempt to determine where interest rates finally settle. The CPI print in the US didn’t provide a lot of clarity either way. China relaxed several Covid measures, which led to a spike in Covid cases. Hence the euphoria of reopening was soon replaced by a large proportion of citizens too scared to venture outside. The Australian market (as measured by the S&P/ASX 300 Accumulation Index) gave up some of the strong gains from November, pulling back 3.3% in December. As has been the story for much of 2022, large stocks outperformed small stocks. This is largely a function of the Large Resources carrying the market.
The S&P/ASX Small Ords Index has given up the last 2 years of gains, closing down 18% in 2022 (when dividends are included). This is a large underperformance to the S&P/ASX Top 20, which increased by 3.6%. Earnings expectations for FY23 have been pared back slightly by the market. Consensus expectations for FY23 EPS growth is now for slightly negative earnings growth. The P/E of the market seems reasonable at 15 times when compared to historical averages. Metcash Limited (MTS), our largest holding, delivered a strong interim result, which was ahead of expectations. Sales increased by 8% and earnings per share by 21%.
The interim dividend was more than 40% higher than this time last year. The IGA stores continue to build market share. As noted by management, the “increased preference for local neighbourhood shopping continues”. The Hardware business performed well and continues to increase in importance. Cash flow was slightly weaker than expected, yet management explained that this was because of inflation and maintaining adequate inventory levels amid ongoing supply chain uncertainty. We remain optimistic on the MTS investment case and struggle to comprehend the enormous PE discount to Coles, Woolworths and Wesfarmers. Nine Entertainment (NEC) underperformed during the month following the downgrade to earnings expectations from Domain Group (DHG). NEC owns 60.1% of DHG and in FY22, it accounted for c.15% of NEC earnings. DHG noted that the property market remained challenging in the final quarter of 2022, which should not be a surprise. While this news will create some headwinds for the broader NEC group, we think this is more than reflected in the current NEC share price.
The P/E multiple, dividend yield and Free Cash flow yield all look very compelling in our view. We exited the position in Monadelphous Group (MND) in December, having done well from the investment. Our research suggests that ongoing challenges with labour costs and weather could negatively impact MND earnings. This has been the case for many of MNDs peers. Given the headwinds, we struggled to justify a P/E multiple of 22 times earnings.
The Fund will pay a semi-annual cash distribution of 1.81 cents in January. We are satisfied with the distribution yield being provided to our co-investors. We are advocates of dividend growth investing and believe that a sustainable dividend is a characteristic of a quality business.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Contact-Australian-Ex-50-Fund-December-2022.pdfNovember, 2022
Global markets were strong in November as investors started to consider the possibility that we are nearing peak inflation. The potential for a China reopening and subsequent stimulus measures was also a factor. The Australian market (as measured by the S&P/ASX 300 Accumulation Index) continued to rally in November, increasing 6.6%. The performance was driven by the Utilities and Big Miners.
The market is now almost back to all-time highs. Several companies held Annual General Meetings or quarterly updates. While some profit forecasts have been tempered, we believe that the tone from most management teams is one of cautious optimism. Several companies are cycling unusual comparable numbers from 2021 (when Covid restrictions complicated events). Yet the level of activity is strong when compared to “normal” levels of activity. Harvey Norman (HVN) held its AGM in November and noted that its stores continue to trade strongly and are well ahead of pre-COVID levels.
The other notable development was the commitment to growth in Malaysia with a long-term target of 80 stores by 2028, from 28 currently. Despite the solid update, the share price reaction was muted. Many investors are convinced that the combination of higher inflation and rate rises curtailing demand over the coming year so feel that current profit levels aren’t sustainable. We think market expectations are too negative. ARB Limited (ARB) provided a trading update at its AGM which noted sales were tracking 10% lower year-on-year and profit declining at a lower rate. The second quarter has started well, with ARB seeing improved supply in key models. Despite low visibility short term, the long-term opportunity remains attractive. Charter Hall Group (CHC) reported its September quarter update. Momentum seems to have slowed over the last six weeks as sale and lease-back and office sector transaction volumes have moderated.
However, FUM growth is tracking ahead of expectations. The potential for short-term upgrades is likely on the back of Property FUM growth. Offshore capital continues to be attracted to Australia. REA Group (REA) provided a 1Q23 trading update, which was in line with expectations. Yield/depth has held up for now, yet listings outlook is softer than expected. REA is managing its cost base as a result. Kelsian (KLS) announced the acquisition of Horizons West buses, providing entry to the education sector. Two bus depots are also being acquired, enhancing KLS’ strategic positioning. KLS is expected to seek bolt on acquisitions, particularly in the bus space. The recurring revenue stream from these contracts is attractive. Elsewhere, KLS retained two Gladstone marine contracts during the month, underpinning the exposure to defensive, inflation protected earnings. The Fund is essentially fully invested with cash of c.5%. We believe that the portfolio is high quality and offers an attractive risk / return proposition given a valuation of only 12 times (P/E).
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Contact-Australian-Ex-50-Fund-November-2022.pdfOctober, 2022
Markets rallied in October as the intense focus on interest rates and real yields continued to dominate investor sentiment. A decline in bond yields was enough to provide valuation support for equities. Domestically, the RBA decision to slow the pace of interest rate increases was welcomed by investors. The Australian market (as measured by the S&P/ASX 300 Accumulation Index) increased by 6.0% in September. The S&P/ASX Mid-cap 50 was strong, rising 7.1% and Small Ordinaries also rallied 6.5%.
The Fund delivered a positive return yet lagged the market as Growth stocks outperformed Quality. The Australian AGM season has commenced, as has the results from the major banks. While results have been solid, the tone of the outlook comments is one of caution. We attended the two-day investor tour hosted by Metcash Limited (MTS) in Adelaide. We remain very positive on the outlook for MTS and the tour increased our conviction. Management communicated a clear and consistent strategy, which is focused on targeted and customised investment to build on recent market share gains. Approximately 90% of the IGA network is being upgraded, which is expected to deliver a 15% sales uplift by 2026. The goal is to replace Aldi as the #3 player by market share. MTS hardware division is impressive. Mitre 10 has delivered double digit earnings growth over the past two years. The more recently acquired Total Tools business is filled with a huge range of leading branded power tools. Management is confident that its rollout plans are sustainable notwithstanding the potential of a cyclical slowdown. All considered, we continue to believe that the large PE discount that MTS trades at relative to its major peers is unjustified. MTS is on a P/E of 13x and offers a grossed-up dividend yield comfortably above 7%.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Contact-Australian-Ex-50-Fund-October-2022.pdfSeptember, 2022
Ongoing concerns around persistent inflation and hawkish Central Banks drove another round of equity market weakness in September. This is not new news. The same themes have been plaguing markets since the start of the calendar year. Nevertheless, it seems that investors are now increasingly concerned that ongoing monetary policy tightening will result in a recession in the near term. The Australian market (as measured by the S&P/ASX 300 Accumulation Index) declined by 6.3% in September. There was also a material outperformance of large stocks versus small stocks. The S&P/ASX Top 20 declined by 4.9%, the S&P/ASX Mid-cap 50 fell 7.5% yet the Small Ordinaries declined by 11.2%. The Fund performed relatively well against the Small and Mid-Cap indices, closing September 6.0% lower. The poor performance of Small Industrials has been a feature of calendar 2022. Over 12 months, the Small Industrials segment of the market has declined by 27.5%.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Contact-Australian-Ex-50-Fund-September2022.pdfAugust, 2022
Global equities were lower in August. After a reasonable rally from midJune lows, investor sentiment struggled against the backdrop of inflation concerns and overly hawkish US Federal Reserve commentary. The broader Australian market (as measured by the S&P/ASX 300 Accumulation Index) outperformed global peers, increasing by 1.2%. The Fund delivered a resilient performance during the busy August reporting season and increased by 3.0%. We discuss some August highlights from our larger holdings below. For more detail, please visit our website (contactam.com.au/insights/), where we expand on our key takeaways from Reporting Season. Early in the month, OZ Minerals Limited (OZL) received an unsolicited bid from BHP Group at $25/share, a 32% premium at the time. The OZL Board rejected the bid, citing it as opportunistic and undervaluing the business. The bid overshadowed an underwhelming result, which was plagued by short-term challenges including conveyer belt outage, weather disruption & absenteeism. Management commentary was very focused on takeover defence, that is OZL’s ability to double production capacity and the attractive fundamentals of copper. Harvey Norman (HVN) delivered a solid result in what was a year of two halves.
After a challenging, COVID impacted first half, HVN delivered steady growth in the second half, which has continued into FY23. The overseas segment now accounts for 25% of earnings. The property segment remains strong with real, tangible property assets exceeding $3.7b. Our investment case is tied to the proposition that HVN is trading on a very attractive valuation for the retail business once the Property assets are stripped out. Whilst we wait for that value to be realised, we are being rewarded by a grossed-up dividend yield of >10%. Nine Entertainment Company (NEC) announced a solid result that was ahead of expectations. Buoyancy in the ad market has continued, leading to excellent Free Cash Flow generation. The growth in BVOD (Broadcast Video on Demand) and other digital assets continues to drive high rates of growth. Given its strong result and Balance Sheet position, NEC announced an on-market buyback (up to 10% of shares). Fund Manager GQG Partners (GQG) reported a pleasing interim result that was ahead of both consensus and prospectus forecasts. Despite significant market volatility in the first half of 2022, GQG’s investment performance has been excellent, which is attracting consistent inflows. The Balance Sheet is net cash. We continue to see material upside in our valuation of GQG, which is founder-led and building its brand. Another founder-led business, Netwealth Group (NWL), posted a result characterised by excellent top line growth offset by higher expenses.
Importantly, NWL continues to generate continued growth in Funds Under Administration (FUA). An underappreciated earnings tailwind is the spread on cash transaction accounts is back to 120bps, from 80bps in the ultra-low interest rate environment. Cash balances on platforms exceeds $4 billion, hence the earnings tailwind is material. After a reasonably pleasing Reporting season, we consider the Fund well placed. We believe that the metrics are compelling for a Fund of quality companies, many of which are founder-led.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Contact-Australian-Ex-50-Fund-August-2022.pdfJuly, 2022
Global equities rallied hard in July following a very weak June quarter. The rise in equities was primarily a function of a decline in bond yields. Expectations for the peak in interest rate hikes has been pared back. Growth stocks outperformed as investors were willing to take on more risk.
The Fund increased by 6.6%. After extensive analysis of the Lithium sector, we added IGO Limited (IGO) and Allkem Limited (AKE) to the portfolio. Share price weakness in recent months piqued our interest, particularly given the industry’s sustainable secular tailwinds. Demand from batteries in electric vehicles (EVs) due to lithium’s uniquely valuable qualities, is expected to grow at a 20% CAGR through to 2030 reaching over 75% of total demand for the commodity. The environmental case provides security around long-term forecasts for consumption. IGO owns 25% of the world’s premier asset (Greenbushes in WA) and 49% of a downstream refinery. While earnings are to become more lithium dependent (~75%), the company is diversified across other commodities less leveraged to the EV dynamic being nickel and copper.
A net cash position and strong cash flows (even if prices come off current levels) ensures growth capex and a dividend yield above 3% can be comfortably funded. AKE is more diversified within the lithium industry, producing multiple products using different extraction methods from locations domestically and in Argentina and Canada. The company also has a net cash balance sheet and is forecast to pay dividends starting in FY23.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Contact-Australian-Ex-50-Fund-July-2022.pdfJune, 2022
Global equities fell hard in June on economic growth concerns. The equity market finally capitulated to the caution evident in the bond market for several months. That is, concerns over rising inflation and the chance of an economic recession. Small and mid-cap Australian equities were not immune. The S&P/ASX Midcap 50 Index fell 10.3% and the S&P/ASX Small Ordinaries Index dropped 13.1%. Small companies have been very weak for the past six months, with the index losing almost one-quarter of its value.
A key issue for investors is the monetary policy tightening underway by Central Banks. There seems to be a “whatever it takes” attitude to combat inflation. It appears that Central Bankers remain convinced that economies are strong enough to handle the perceived rate increases. The pace of rate hikes remains an overhang as does the level at which interest rates settle. As it stands, it appears that market expectations are for rates (i.e. Fed Funds and RBA cash rate) to settle around 3.0- 3.5% in mid-2023. While this is a significant percentage increase from the pandemic low-rate environment, a Central Bank rate of 3.5% is still very accommodative in a historical context.
Metcash Limited (MTS) delivered a strong full year result (April yearend) which was comfortably ahead of expectations across all divisions. The Food business continues to build on the momentum in recent years and EBIT increased by 4%. Liquor sales were up 9% with a 10% increase in EBIT. The Hardware segment also performed strongly with the Total Tools acquisition ahead of expectations. There are still some challenges with the supply chain. MTS trading update for the first seven weeks of FY23 was strong, with the group benefiting from inflation. The stock is currently trading on a P/E of 14 times and remains at a significant discount to its larger Supermarket peers, which we consider unjustified. Smartgroup’s (SIQ) share price declined by 27% in June, following the announcement it had lost a Top 20 contract. The share price move seems extraordinary given the contract was less than 5% of revenue. SIQ is trading on a very low earnings multiple and a compelling yield. The Balance Sheet is strong. We consider the recent weakness to be a buying opportunity.
OZ Minerals (OZL) downgraded its CY22 guidance on lower production and higher costs, particularly at its Carrapateena mine. The operational challenges have coincided with weakness in the Copper price, which has declined by 20%. The stock was weak in June and is likely to be treated with caution in the near term given production disruption, industry cost inflation and uncertainty around commodity prices. Nevertheless, the long-term structural trends for copper remain constructive and the stock is looking attractive from a valuation perspective.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Contact-Australian-Ex-50-Fund-June-2022.pdfMay, 2022
Global markets continued to display a cautious stance in May, as the PE multiple derating of the high growth sectors continued. After a solid performance in April, the Australian market underperformed most global peers during May. The underperformance was most pronounced in the smaller end of the market. The S&P/ASX Mid-cap 50 declined 3.4% and Small Ordinaries declined by 7.0%.
Many of the macro themes from recent months continued to dominate headlines. Primarily, the inflation and interest rates adjustment and the subsequent impact on valuations. Domestically, the RBA increased interest rates for the first time since 2010 in May. At the time of writing, the RBA hiked by a further 50bps in early June to 0.85%.
While the last six months has seen some major moves in equity markets, we think it important to maintain some perspective. Global markets have enjoyed a very buoyant period for several years on the back on cheap money and Government stimulus. Corrections are a normal part of market cycles. It is often in times of uncertaintywhereby the greatest opportunities emerge.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Contact-Australian-Ex-50-Fund-May-2022.pdfApril, 2022
Uncertainty returned to global equity markets in April following a surprisingly strong March. The main driver of the decline in US markets was a more hawkish Federal Reserve, which pushed up real yields and pressured equity valuations.
Tech stocks were hit especially hard since their often-elevated valuations and promise of future growth begin to look less attractive in a rising-rate environment. Chinese markets were also weaker as COVID-linked restrictions hampered activity. By comparison, the Australian market fared much better than global peers. The S&P/ASX Mid-cap 50 and the S&P/ASX Small Ordinaries indices declined by 1.5%.Relative to global peers, we believe that the Australian market looks very attractive. Even in a rising interest rate environment, we think it is highly likely that Australian equities can keep delivering reasonable earnings growth. We base this assumption on a combination of low unemployment, strong household deposits, a re-opened economy and commodity prices which we see as “stronger for longer”
As volatility has intensified in recent weeks, we have been pleased with the resilience of the Fund. Indeed, the recent drawdown has seen the quality companies outperform. We do not invest in unprofitable, non-dividend paying companies trading on eye-watering multiples. As such, we have done relatively well in a tougher market. We prefer companies with strong financials that generate high return on capital and are managed by capable people, ultimately founders. We believe that quality companies will continue to surprise on the upside.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Contact-Australian-Ex-50-Fund-April-2022.pdfMarch, 2022
Given the uncertainty in bond markets and the ongoing geopolitical tension in the Ukraine, global equities markets were remarkably strong in March. Stocks continue to shrug off the ominous signs from the bond markets, even as the widely tracked U.S. 2-year/10-year Treasury yield curve inverted for the first time since September 2019. We remain optimistic that underlying economic growth is strong enough to handle an aggressive pace of rate increases to stave off inflation.
We have received a few questions on commodities exposure recently, hence we thought it useful to discuss the rationale for three of our commodity exposed positions, Deterra Royalties (DRR), Monadelphous Group (MND) and OZ Minerals (OZL).
We consider these three businesses to be higher quality than many of the cyclical mining companies in the Australian small and mid-cap universe and we continued to build on our positions in DRR and OZL during the month. There is a high degree of volatility in the small resources segment and we tend to avoid a lot of companies in the space because of a lack of profitability, an absence of dividends and poor management alignment.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Contact-Australian-Ex-50-Fund-March-2022.pdfFebruary, 2022
The outbreak of war in Ukraine dominated headlines in late February as investors looked to reduce risk. While most global equities markets declined by 3.0% or more, Australian equities weathered the volatility relatively well. The S&P/ASX Small Ordinaries Index was flat and the S&P/ASX Mid-cap 50 Index declined by 0.3%. It is worth noting that the Small Ordinaries Index has declined by 8.0% in the past quarter. By comparison, we were pleased to deliver a 2.1% return for February for the Fund.
The outperformance of the Australian market was due to a higher proportion of Resources and Commodities companies in our index and less Technology stocks relative to offshore peers. In addition, the February reporting season was characterised by generally robust results with more beats than misses. The EPS outlook for the Australian market was upgraded. Valuation and yield metrics now appear more attractive.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Contact-Australian-Ex-50-Fund-February-2022.pdfJanuary, 2022
January proved challenging for global markets and even more difficult for Australian small and mid-cap stocks. The S&P/ASX Midcap 50 Index fell 8.7% and the S&P/ASX Small Ordinaries Index dropped 9.0%. Concerns around the outlook for interest rates was a major focus point in January. Stocks came under pressure as Treasury yields continued an upward trajectory, with companies trading on high-multiple particularly vulnerable. This is understandable as many of these companies are long duration assets in that a higher relative share of their cash flows are derived in the future.
However, several good quality companies in the Portfolio were also caught up in the indiscriminate selling of higher multiple stocks, notwithstanding the fact that the outlook for many of these businesses remains robust. We seek businesses where the returns being generated are strong and that are led by capable and aligned managers. We took the opportunity to add to several positions in the portfolio during the volatility.
The domestic market rallied in the final days of January and, at the time of writing, has stabilised in early February. Nevertheless, there were several stock specific developments worthy of mention.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Contact-Australian-Ex-50-Fund-January-2022.pdfDecember, 2021
Markets finished the year on a bullish note notwithstanding the news of the Omicron virus which added to uncertainty about the path forward. The bulls remain convinced that still easy financial conditions, expanding central bank balance sheets and strong earnings growth will continue in 2022. The vaccination rollout globally has generally been a success, particularly in developed nations. It is hoped that high vaccination rates will create a buffer against lingering normalisation headwinds from Covid variants. The bears remain cautious around central bank policy shift and the heightened potential for a monetary policy mistake given structural headwinds and debt levels.
Charter Hall (CHC) announced upgraded earnings guidance for FY22. CHC now expects post tax operating earnings per security of "no less than $1.05 per security". This is now the second upgrade since the August result. The $1.05 level implies a minimum 72% growth rate over FY21. Funds Under Management is now $61.3 billion (up from $52 billion in June). Later in the month, CHC announced it would acquire 50% of the shares in Paradice Investment Management for $207 million. The price implies 2.3% of FUM or 10x NPAT, and CHC expects the deal to be EPS accretive in FY22. This is an interesting development, albeit not a complete surprise, with CHC having previously considered moving into broad funds management
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Contact-Australian-Ex-50-Fund-December-2021.pdfNovember, 2021
Global markets experienced increased volatility late in the month following the emergence of the more transmissible COVID variant, Omicron. After several buoyant months and solid earnings numbers, global markets became skittish in late November. As a result, most global equities exchanges closed the month lower. Australia's S&P/ASX 300 Accumulation Index decreased by 0.5% for the month. The Fund closed 1.6% higher.
Aside from the macro uncertainty that continues to linger from Covid related events, the month was dominated by Annual General Meetings and associated trading updates. We cover a few highlights below. Reece Limited (REH) was the best performing stock in the portfolio during November, which was driven by a buoyant update at the company’s AGM. Reece is a high-quality business led by an experienced management team that is founder-led and highly aligned with shareholders. REH’s local operations generate high returns on capital and excellent cash flows. Its US operations offer a significant platform for long-term growth.
Charter Hall Group (CHC) announced upgraded earnings guidance for FY22 at its AGM. The company now expects operating earnings per security of 83 cents per share. The previous guidance, which many thought was bullish, was 75 cents per share. The upgrade, which is driven by performance fees and revaluation, implies a minimum 36% growth rate over FY21. Funds Under Management also increased and now amounts to $54 billion.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Contact-Australian-Ex-50-Fund-November-2021.pdfSeptember, 2021
Global markets were volatile in September, with the majority of developed markets closing in the red. It was a topical month for the bond markets and news flow out of China surrounding their property market with embattled developer China Evergrande Group on the brink of default. As there were several reasons for more risk-off trading during the month, long term investors were able to take various opportunities to buy the dips.
After a solid reporting season, the Australian market was impacted by significant moves in commodity markets. The broader S&P/ASX 300 Accumulation Index declined 1.9%.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Contact-Australian-Ex-50-Fund-September-2021.pdfAugust, 2021
The Fund increased by 2.8% in August, roughly in line with the broader market. The month was dominated by Reporting Season, which was characterised by more beats than misses and strong dividend or capital management announcements. However, the return of the virus and several State-wide lockdowns meant that many corporates shied away from providing guidance.
Invocare Limited (IVC) reported a better-than-expected interim result. The good news is that the changes implemented by a new senior management team has resulted in strong operating leverage when the top line has momentum. Operating revenue increased by 13% and EBIT increased by 46% on the first half of 2020, although one needs to keep in mind that 1H20 was significantly COVID impacted. The return to lockdowns in the second half will cause some headwinds. However, IVC pointed to the positive longer-term trends of a growing and aging population, efficiency gains and new growth segments.
PWR Holdings (PWH) is a fast growing, founder-led business selling cutting edge engine cooling products for the motorsports and automotive sector. PWH announced a strong result with EPS up almost 30% and the dividend almost 50% higher than the prior year. The result was characterised by solid revenue growth across all segments. FY21 EBITDA margin expansion to 36.6% (+100bps) was also pleasing as increased manufacturing drove operating leverage. PWH is the market leader, and it continues to extend that position through investment in R&D. The company has no debt, strong returns and outstanding growth prospects
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Contact-Australian-Ex-50-Fund-August-2021.pdfJuly, 2021
The Fund increased by 0.4% in July. It was an unusual month dominated by COVID news in Australia. For now, the market seems unperturbed by the economic impact from another round of COVID-related lockdowns. Additional stimulus will help stem the economic impact to a certain extent as we await an uptick in Australian vaccination rates to allow us to “return to normal”. We continue to generate solid performance from several of our key holdings.
ARB Limited (ARB) announced a very solid trading update, underpinning what has been a very strong run in the stock over the past twelve months. In its unaudited FY21 results, ARB noted sales of $623 million and Profit before Tax to be between A$145-150 million – this was almost 20% better than market expectations. The strength is driven by Australian Aftermarket which is underpinned by robust new vehicle sales in the June quarter. Light commercial vehicle sales were up 33% in the June half and ARB’s backlog of work is over six months long. The offshore business is also performing well; we remain very optimistic on growth arising from the new Ford Bronco collaboration in the US. We discussed Iress Limited (IRE) in our June report and there was more news flow of note in July. IRE held an Investor Strategy Day late in the month where it outlined very ambitious growth plans to double profits by 2025. IRE also announced a $100 million on-market share buyback. The Strategy Day coincided with IRE disclosing that it had received a confidential unsolicited non-binding and indicative proposal from EQT to acquire all of Iress’ shares via a recommended scheme of arrangement at $15.30-15.50/share. This is the second proposal from EQT following an earlier bid at $14.80. At the time of the announcement, IRE shares were trading at $12.51. The IRE Board noted that it had rejected the offer as it does not represent compelling value for shareholders, however it has allowed EQT access to further information.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Contact-Australian-Ex-50-Fund-July-2021.pdfMay, 2021
The Australian market edged higher in May. The month was dominated by the results from the Major Banks and generally positive trading updates from other companies. In addition, the Federal Budget was delivered mid-month and contained few surprises. The Australian Government continues to favour stimulus over austerity in the face of the ongoing pandemic. The Fund increased by 0.7% for the month. We seek to meet with management teams and business owners as often as possible and we had several insightful meetings in May.
Generally, our discussions unveiled that business conditions are robust across most industries. Buoyant demand is creating some supply chain bottlenecks and inflation. We explore this issue in more detail in our monthly Contact Insights piece, which is available on our website. We added Pendal (PDL) to the Fund in May as the Fund Manager raised capital to acquire US-based value-oriented asset manager Thompson, Siegel & Walmsley (TSW) for US$320m (A$413m). The acquisition represents 7.6x EBITDA and is expected to be double digit EPS accretive in first full year. The combined business will have Funds Under Management in excess of $130 billion.
We considered the raising, which was priced at $6.80, to be an attractive entry point. The implied FY22 P/E ratio is approximately 11x for a company that will generate significant near-term earnings growth across a diverse range of products and geographies.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Contact-Insights-May-2021.pdfMarch, 2021
According to Factset, the total amount of dividends paid by S&P/ASX 300 companies was $61 billion, a decline of 24% on 2019.
The timing of the pandemic and the impact on the economy meant that both first half and second half dividends were impacted in calendar 2020. Reflecting on the August 2020 reporting season, Commsec noted that the percentage of reporting companies that elected to pay a dividend was just 68% compared to the average over the previous 20 reporting seasons of 86%.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Contact-Quarterly-Report-March-2021.pdfDecember, 2020
The S&P/ASX Midcap 50 Index built on its November gains, increasing by 3.4% in December. IT stocks again drove the gains. By comparison, the Fund decreased by 0.2%. The index drifted in the second half of December as risks from the Sydney coronavirus outbreak weighed on sentiment. Following several months of negligible community transmission, the outbreak resulted in a localised lock-down of some Sydney suburbs and state border restrictions.
The outbreak potentially presents some downside risk to market expectations of ongoing solid recovery in growth early 2021. However, at the time of writing, the risks look manageable. As has been the case for several months, there appear to be plenty of warning signs for the markets and the broader economy. Many analysts argue that stocks are priced for perfection in 2021, and any deviation from that rosy scenario could lead to a rapid correction or worse for investors. The biggest risks would be if the vaccine rollout stumbles or a new version of the virus emerges. On the flipside, there is a lot of pent-up demand, many businesses are now more efficient than they were pre-COVID and there seems to be a resolute stance to do “whatever it takes” by Governments and Central Banks to avoid a financial meltdown.
We established a position in Nine Entertainment Holdings Group (NEC) in December. NEC is an Australian ASX listed media company with holdings in radio and television broadcasting, newspaper publications and digital media. Over the past five years, NEC has transitioned from a Free to Air television network to a diversified, and increasingly digitized, content company without parallel in the local market. At the core of Nine's business is content - News, Sport and Entertainment. The Group operates through four segments: Broadcasting, Digital and Publishing, Domain Group (59% stake) and Stan. NEC's outlook is supported by its shift to growth assets in Domain, Stan and 9Now. This is complemented by a deep-reaching cost out program to offset headwinds in TV, Radio and Publishing. Stan has the potential to drive significant earnings growth and is Australia's leading local SVOD business. NEC has a solid Balance Sheet and offers an attractive grossed up yield of 4.4% in FY21 which should grow. We are optimistic on the prospects for Ingham’s Group Limited (ING) as we anticipate significant input cost relief. As we know, Australia has experienced significant drought for many years – and last year Australia was forced to finally import wheat. 2021 is set to be very different – ABARE projects Australian wheat production to double to around 31 million tons, with a potential over supply of domestic grain.
This bodes well for Ingham’s margins and Net Profit, with wheat accounting for over 60% of the cost of doing business for Ingham’s. The sensitivity to profit is meaningful – every 5% move in the wheat price has a 6% impact on Net Profit. The price of wheat has dropped significantly from ~$450/tonne in March 2019 to ~$250/tonne. Volumes remain robust. With costs coming down, we anticipate positive operating leverage. In the meantime, we are being rewarded by the likelihood of a compelling dividend yield of over 8% (on a grossed-up basis).
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/Contact-Australian-Ex-50-Fund-December-2020.pdfticker: EVO4741AU
release_schedule: Monthly
commentary_block: Array
factsheet_url:
https://contactam.com.au/ex-50-fund-overview/
Monthly Report
asset_class: Domestic Equity
asset_category: Australian Mid Cap
peer_benchmark: Domestic Equity - Mid Cap Index
broad_market_index: ASX Index MidCap 50 Index
structure: Managed Fund
manager_contact_details: Array
fund_features:
Contact Australian Ex-50 Fund balances growth and income to provide access to a concentrated portfolio of quality Australian companies that sit outside the S&P/ASX 50 Index. This strategy seeks to find long term investments in tomorrow’s leaders.
- Derivatives, short selling and gearing will not be used.
- The strategy applies Contact’s long term focused investment philosophy.
- The Fund seeks to achieve strong relative returns in excess of the benchmark, through a concentrated portfolio of high quality small to medium sized ASX listed companies.
- Typical stock numbers is 20-40 stocks.