June, 2022
To outperform the S&P/ASX 200 Accumulation Index after fees over the medium to long term by investing in a broad range of companies from Australia and New Zealand.
With an established pedigree of investing in Australian equities for over 50 years, the Schroder Australian Equity Fund is an actively managed core Australian equity portfolio with a focus on investing in quality stocks predominantly in Australia characterised by strong returns on capital with a sustainable competitive advantage. The Fund draws on Schroders’ deep research capabilities, with a long term focus on investing, it is suitable as a core portfolio holding over the medium term to long term.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/189090744.pdfJune, 2021
The S&P / ASX 200 Accumulation Index rose by 8.3%, while the Schroder Wholesale Australian Equity Fund (post-fee) rose by 6.4% (post-fee), underperforming by 1.9% (post-fee) for the quarter.
During this period, the overweight exposure to Industrials and an underweight allocation to Energy sectors added value. However, an overweight tilt to Materials along with underweight Real Estate sectors dragged the overall Fund returns into negative territory.
At a stock level, positive contributors included the overweight positions in ALS Limited, Boral and IRESS. The nil holdings in Woodside Petroleum, Sydney Airport and APA Group were also among the top contributors. Conversely, major detractors from performance included overweight positions in Incitec Pivot, Alumina and Lend Lease. The underweight position in the Commonwealth Bank and the nil holdings in Aristocrat were also major detractors from performance.
On the more mundane, but long-dated cashflow front, Telstra announced the sale of a noncontrolling 49% stake in its mobile tower operations to a consortium including the Future
Fund for $2.8bn or 28x EBITDA. As I write, Sydney Airport has announced a proposal from a consortium of infrastructure investors at $8.25 a share or around 23 times EBITDA in the last non pandemic impacted year (2019). Enduring the pain of abysmal returns on low risk assets is clearly becoming too much for many. We quote EBITDA multiples more because they are more readily available. In every case, they offer an overly flattering and unrealistic view of true available cashflow and actual multiples are higher. The $30bn price tag for the same airport for which Macquarie paid $5.6bn in 2002 is a stark illustration of how well highly geared investments in relatively unchanged assets has worked in recent decades. Declining interest rates allowed Sydney Airport to fund virtually all capital expenditure through increased debt, whilst streaming all the cash to equity holders and no tax to the government. Duty-free seems to apply to the shareholder returns as well as the whisky!
Contributors ALS (o/w, +36.3%) As a business with exceptionally strong market positioning in life sciences, commodities and industrial testing across the globe, we continue to see strong appeal in the scale economies and ongoing volume growth potential of well-managed testing businesses. Under CEO Raj Naran the business has worked hard to address pandemic challenges and produce highly creditable results.
Boral (o/w, +33.9%) Efforts by Seven Group to build a more significant ownership and control position in Boral have been frustrated by company efforts to demonstrate higher levels of unrealised value in the business. The sale of the US building product operations into both a strong US housing market and similarly buoyant asset price environment have gone some way to demonstrating this latent value, however, the road to turning this latent potential into earnings remains unrealised. As is the case for many large public companies, we believe
turning the blowtorch on performance impacted by years of accumulated inefficiency and bloat is entirely warranted. Iress (o/w, +40.6%) As a reminder of what technology companies often look like when they grow up, Iress has suffered from being a technology business with solid margins and strong cash generation but limited revenue growth. As is the case for so many businesses, when organic growth gets tough, the tough start acquiring. After a lengthy period in which acquisitions have struggled to deliver the revenues and profits which the investment bank pitch books envisaged (you wouldn’t read about it!) and valuation made little forward progress, rumours of takeover interest saw valuation rise markedly. While we continue to believe the foundations of the Iress business are extremely solid, we are hoping for a period in which simplification, focus and organic growth take the place of fully priced acquisitions. Telstra (o/w, +10.6%) Although we are rarely supportive of financial engineering transactions which seek to accelerate the recognition of market value rather than focus on the delivery of profits and true economic value, we understand the motivation behind the transaction and the benefits of creating clearer lines of accountability in a business which is partially through the incredibly challenging process of turning bloated incumbent into an efficient and simplified telecommunications carrier.
We believe the business has very strong long-term prospects given a market leading infrastructure position in an essential and strong growth industry. Some relief from a regulator whose time might be better spent on industries not characterised by already competitive prices, high levels of investment, no revenue growth and poor returns would also assist.
Detractors Incitec Pivot (o/w, -17.9%) Shakespeare’s ‘A Comedy of Errors’ would be an apt title for the Australian chemicals and explosives industry. Snatching defeat from the jaws of victory has become a habit. A competitive environment in which volume has taken precedence over profit in explosives for some years has coincided with plant outages at highly inopportune times. Production issues at the Waggaman ammonia plant are the latest in the list of issues which has seen shareholders endure extremely poor returns for an extended period. Whilst hope that the worst is over has proven unfounded to date, we continue to believe valuations place almost no probability on explosives serving a purpose other than blowing up shareholder returns.
Lend Lease (o/w, -11.3%) Hopes that growth would extend to profits rather than merely the size of the development book and executive salaries have proven unfounded to date. While Lend Lease has a highly appealing long-dated development pipeline, the propensity to turn any profits into further balance sheet investment or large scale engineering projects which deliver great infrastructure assets for the country but large losses for shareholders has driven abysmal share price outcomes. A future which transitions towards making cash from this large pipeline will hopefully offer shareholders a more rewarding experience. CBA (u/w, +16.0%) An undoubtedly strong franchise and capable management team has seen the valuation of CBA vastly outpace the performance of peers over time.
File: https://commentary.quantreports.net/wp-content/uploads/2021/01/174032316.pdfDecember, 2020
The S&P / ASX 200 Accumulation Index rose by 13.7%, while the Schroder Wholesale Australian Equity Fund (post-fee) rose by 14.6% (post-fee), outperforming by 0.9% (post-fee) for the quarter.
Contributors
Virgin Money UK (Overweight) (+83.0%)
Wild oscillations in the share price remain reflective of equity market conditions rather than rapidly changing business fundamentals. As the UK struggles under a COVID-19 impact significantly more severe than many other jurisdictions, we remain troubled by questions over how credit can be kept flowing, interest rates kept at negligible levels and bank shareholders insulated against the spectre of bad debts should efforts to perpetuate asset price gains regardless of fundamentals ever prove unsuccessful. This question, and the leveraged nature of banks continues to temper our enthusiasm for the sector despite apparently attractive valuation metrics versus history. Whilst there is undoubtedly valuation appeal in the business if the book value proves reliable and the litany of abnormal items which management continue to remove from earnings in order to paint a more appealing picture eventually ceases, we acknowledge the attraction in this investment is more in its apparently cheap valuation than in the quality of the business..
Fletcher Building (Overweight) (+52.8%)
Our attraction to the Fletcher Building business has been its potential and highly attractive valuation rather than historic performance. Strong market positions in hardware and building products, particularly in NZ, provide highly sustainable, albeit cyclical revenues. For many years the business has struggled to convert relatively strong NZ housing conditions into improving profitability at the hands of ill-considered offshore expansion and disappointing cost management. We are hopeful renewed management efforts on this front, continuing strong residential housing activity, limited COVID-19 impact and ongoing attractions of NZ as a market (population growth potential, renewable power, competent and stable political landscape) will offer an improving profit picture. In combination with a valuation which would still be fairly appealing should none of this improvement eventuate, we see the odds strongly in investors favour.
Oil Search (Overweight) (+40.5%)
A highly attractive LNG operation with extremely strong cost positioning and reserves have proven no match for collapsing oil/LNG prices and an over-geared balance sheet in 2020. As has been the case in other commodities, the path of energy stocks is likely to remain anchored in the outlook for underlying commodity prices. History suggests energy prices do not always fall and the dearth of investment which low prices have driven, will sow the seeds of higher prices. Having raised capital earlier in 2020 and rectified the excessive gearing issue, the experience for Oil Search investors is likely to be slightly less volatile in future, however, our expectations of improving cashflows as prices recover see the business offering very attractive returns.
South 32 (Overweight) (+21.1%)
The bulk of the value in South 32 lies in high quality, low cost alumina operations and Australian manganese operations. Smaller elements of value across metallurgical coal, aluminium, nickel and South African thermal coal operations (currently in the process of disposal) have perhaps clouded the outlook for what we believe to be an extremely well-managed business. An ungeared balance sheet and attractive valuation metrics position the business well to take advantage of commodity prices we believe are still depressed versus sustainable levels.
Detractors
Afterpay (Underweight) (+47.5%)
Without detracting from the enormous success which the business has delivered in attracting users of its buy now pay later service and the undoubted consumer appeal of foisting costs on retailers rather than consumers, we find the more than $30bn valuation attributed to the business difficult to fathom. As a relatively small revenue business with global potential, a simple story and a customer base which overlaps with the most eager new participants in the equity market frenzy, the ducks have lined up for a stratospheric valuation. Management are obliging with regular and judicious business updates to fuel the adrenaline. Our longer-term concerns remain the already intensifying competitive landscape and the lack of scale economics. Whilst the world remains awash with countless billions seeking to finance technology businesses of any shape and form without regard for profit, we would expect this landscape to depress rather than augment the outlook for future sector profitability
Aurizon (Overweight) (-8.2%)
The hard work navigating the haphazard and often unfathomable approach to regulation in Australia which sees its regulated assets priced to deliver lower returns than many other regulated assets despite at least comparable risk, has created headaches of recent years. As a necessary infrastructure provider to a still essential industry, we have adopted a pragmatic, rather than emotional approach to the business. Even assuming the achievement of aggressive targets in reduction of thermal coal usage (which we wholly embrace), the high quality of the operations which Aurizon services and the logic of prioritising higher quality coal sources as the world finds emission solutions leaves Aurizon’s rail network valuable into the distant future.
ASX (Overweight) (-11.1%)
Software issues which caused a trading outage in November have, perhaps predictably, seen regulators and connected parties raise concerns over the operation of ASX while expressing no such concern over their own (the regulator’s prerogative). Years of relatively flawless operation combined with trading and market plumbing which operate at least as effectively as global counterparts are generally lost in the emotional reaction of participants who endured the trauma of being unable to trade shares for a day or so. They should perhaps speak to a few tourism or hospitality based small businesses for some perspective on what constitutes a real problem. We continue to believe ASX is a well-run business currently rectifying periods of technology underinvestment in years past. This unfortunately takes time and sometimes encounters issues. While we harbour some concerns over the longer-term impact of perversion of fixed income markets from intervention and the unfathomable desire in political circles to continue driving consolidation rather than fragmentation of equity ownership and capital provision, we expect the ASX franchise will endure.
CBA (Underweight) (+29.1%)
Major banks in Australia have far greater similarities than differences; balance sheets which predominantly send deposits and wholesale funding out the other side as housing loans to support the Australian love affair with overpriced property and far lower proportions as business and personal lending. Long history and benign operating conditions have seen the costs of performing this function grow incessantly. While CBA performs these operations at least as well as other major banks and with good technology, the eroding value of a large deposit base in a zero interest rate environment and intense competition for the remaining creditworthy borrowers, make it difficult to sustain its profit and return on equity advantage over peers. Valuation continues to reflect a large and sustainable advantage over peers.
ticker: SCH0101AU
release_schedule: Quarterly
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asset_class: Domestic Equity
asset_category: Australia Large Blend - Core / Style Neutral
peer_benchmark: Domestic Equity - Large Cap Neutral Index
broad_market_index: ASX Index 200 Index
structure: Managed Fund
manager_contact_details: Array
fund_features:
Schroder WS Australian Equity Fund – WC aims to outperform the S&P/ASX 200 Accumulation Index after fees over the medium to long term by investing in a broad range of companies from Australia and New Zealand. Schroders is a bottom-up, fundamental, active manager of Australian Equities, with an emphasis on stocks that are able to grow shareholder value in the long term. We would describe our style as Quality Growth. Unlike most competitors, our definition of growth (‘Quality Growth’) focuses on the long-term quality of the business and the average returns achieved through a full business cycle, not the near term earnings momentum. This long term focus normally results in a relatively low momentum bias in either direction as the process is largely ambivalent to short term earnings direction.