Reporting season wrap up

It was a very strong month of our performance across all our large cap strategies. We’ve been talking in recent months about the significant polarization in the market. There’s been a small number of large cap industrials trading at very extreme valuations. So we started to see that begin to unravel this reporting season. A lot of that more extreme valuations has been driven by a lot of index buying as a lot of those larger cap positions get beat up, not really on fundamentals, but more forced buying as people move to those index positions. So we always felt there was a fairly strong opportunity, so it was quite pleasing to see that start to play out. Where we saw that play out during reporting season was firstly some of those large cap sectors like banks and consumer stocks, which were negatively impacted by the soften consumer, the weakness in housing that’s flowing through.

Second area was some of the quality industrial stocks that have been lagging. There’s been a number of stocks that had difficult past couple of years, stocks like CSL, James Hardie, which we’ll talk to, and the market started to revisit those stocks after some better results. And then finally, the resource sector continues to see quite good support driven by strong demand for commodities across gold, lithium, copper in particular. That’s partly driven by demand from AI perspective. Also, I think some concerns around potential debasement of US currency saw people seek hard assets. So from our perspective, our positioning was very strong coming into reporting season and this was reflected in good outperformance.

It was a fairly strong reporting season with 32% of companies beating expectations and that resulted in earnings per share being lifted by 1.5%. But as always, there was the winners and losers. The losers tended to be those companies more exposed to the consumer and housing, and particularly with regards to their outlook statements. We saw companies more exposed from the resources side or the construction side look a little better through reporting season. And we also saw an increased willingness of the market to buy some of those companies that delivered better than feared type results. We thought it was a win for price discovery. It was only six months ago, people were wondering whether value was dead and then people were buying stocks based more on momentum and direction rather than whether there was any value on offer. And we saw an increased willingness of the market to find good opportunities, to find good quality companies at attractive prices, which is at the end of the day, what you’re always looking for when it comes to buying good companies.

And as a result, the key factor that worked through the month was that intersection between value and quality, which is obviously where we play pretty significantly. So I think that was one of the things that really helped our performance through the month was that markets refocusing on value through the month.

So CSL delivered a result which was 2% better than very low expectations. And as a result saw a lot of interest return. Now CSL has had a very difficult 18 months and was trading as if it was a little broken. Market had lost confidence in its Behring plasma business, which has always been the flagship. It’s a very strong business that’s got global dominance and it’s fairly concentrated industry that grows at good rates of growth, but people had lost confidence in their ability to keep up with that market growth rate. So a return to growth in the second half in that business was much appreciated by the market as was the outlook statement for high single digit growth in that core bearing business, reminded people of the qualities of that business and allowed the market to regain interest in what was a cheap, very cheap stock after 18 months of disappointment.

The highlight of the reporting season from my perspective was James Hardie. They delivered a very strong result which demonstrated their execution of their much maligned acquisition of AZEK. You saw good cost synergies come through, you saw good market share gains coming through, and this was in a very difficult macro environment, so it was very pleasing to see. They also announced some new distribution agreements, which should set them up for further market share gains in coming quarters. And that’s on top of some new product launches as they push to try to penetrate into the northeast corner of the US. The macro environment’s still challenging for Hardee’s however, and new housing starts remain soft, but we see this as a potential tailwind for them into the future. Not precisely sure when that macro is going to turn, but inevitably it will as given demand for new houses typically follow cycles.

So we’re at a bit of a low point at present. So you’ve got good execution, good product innovation, good market share gains with the potential for market share to turn at some point into the future, which provides good support for the stock. The other stock we’d like to talk to is Cleanaway, which received a bid through the month. It didn’t deliver the strongest result, but it’s in the midst of a takeover from a private equity group. What I think that did highlight was the scarcity value of its assets, which are very difficult to replicate given that the national footprint that they’ve developed over many decades and the value that was on offer. And we have seen private equity and other bidders emerge in the market over the last six months. And we’ve seen a number of bids emerge. And I think that’s a bit of a reflection of that bifurcation that I mentioned at the beginning. There is some value in the market as well as some expensive parts and the bids are coming for some of those stocks that have been trading cheap and Cleanaway is a good example of that.

The stock which was weakest for us through the month was the Lotto Corporation. It’s a very defensive business, delivered a good result in a difficult year. The past year was a one in 45 year for jackpots. When they don’t have many jackpots, they tend to not get as many sales. So it was a soft year. But for us, we think that’s the opportunity because that’s in the rear view mirror now. And as you look forward, you’d think mathematically you’ll return to averages which will present a tailwind for the company. The thing we like about Lottos is it has very long licenses. Its next license doesn’t have to be signed for 30 years, doesn’t have to spend any capital or much capital on its business in the meantime.

So it produces a lot of cash flow. I think the market tends to look at the PE. The headline PE looks a little high, but that’s because you’re not spending any CapEx. So if you look at the free cash flow yields, it yields about over 5% with high single digit growth for the next 30 years before you have to pay for your next license. We think that’s a very attractive, defensive business that makes a really good anchor for the portfolio. Then in terms of the sectors that we avoided that struggled through the month, key highlight was banks. Banks have been impacted by the budget and the slowdown in housing that’s affecting their volumes. We’re also seeing increased competition for deposits and mortgages as well as slight deterioration in bad debts. And so while there’s no substantial deterioration in earnings, it’s an incremental deterioration in stocks that are very expensive from a historical perspective.

So we saw some weakness across that sector. Don’t really see any reason to close that out yet. It still feels like that’s in the very early stage of underperformance. From a consumer sector, it was a mixed bag, but some of the bellwether stocks like Westfarmers and JB Hi-Fi struggled through the month. It was mostly in their outlook statements, a bit like the banks. It wasn’t like disastrous. It’s just a slight deterioration in stocks that had been trading relatively high, particularly Westfarmers trading quite expensive valuations. So we saw some softness in those stocks and being underway and trying to position ourselves in some quality names and more attractive valuations supported the performance through the month.

So in summary, it’s been a good calendar year after a couple of challenging years for us. I think the reporting season was very strong, sort of reinforced from our perspective, the focus in on quality and value and that’s where we saw the opportunities. It was also pleasing to see price discovery reemerge through the month. We think it’s still early in that phase and given that we see a number of sectors trading well north of their long-term valuation ranges and some other high quality names trading at discounts and that’s where the opportunity lies and we’re continuing to try to exploit that. We’re still finding some good opportunities emerge in some good quality companies that have been trading cheap and we’re continuing to try to exploit those opportunities.