Reporting season wrap up

I think there’s two reasons. I mean, we’ve just gone through reporting season and reporting seasons these days can often be quite volatile, particularly when expectations have been quite high Going in to the reporting season, we’ve had very strong 18 months in markets, so stocks needed to deliver. What we saw was probably the most volatile reporting season we’ve seen in our experience. And when we look at the market overall and we look through reporting season, it’s sort of clear to us that there’s a bit of lack of growth in some areas, banks, insurance companies, and then some of the companies with good structural growth to trading a pretty big premium so that they needed to perform exceptionally well to justify those share prices. So often the stocks that did well were an eclectic group of companies that were perhaps surprising to the upside. So I think that’s been one of the key reasons for the volatility.

The other reason is Trump, people describing the Trump bump to markets turning into the Trump dump over the last little while, and when you look at Trump’s policies, the things the market slight was reduction in regulation, reduction in government spending. Those things promised lower inflation and improvements in productivity, but at the same time, that comes with a fair bit of chaos. There’s just a lot of policies out there at the moment. All the tariffs on, again, off again, creating confusion to the market. Ukraine, I think the market’s struggling to get their setting right and this is undermining business confidence at present. So we’ve seen a reduction in bond yields potential for interest rate cuts to start emerging. Once again, and this is just playing once again into this volatility. We’ve seen a number of times over the past year where the market’s unsure about the shape of a recovery or whether it’s a harder landing or a softer landing, and we’re back into the case of expecting interest rate cuts once again.

Yeah, the key things I wanted to talk about was our biggest overweight stock in our portfolio and our biggest underweight stock, and that’s CBA versus CSL took two Cs if you like, and they’re little like twins, but opposites. Over the last five years, CBA has recovered strongly post covid where CSL has tended to lag. CBA is trading at a record multiple, whereas CSL is trading at its slowest multiple for many years, probably about 15 years. So we like to compare and contrast them. We look at both of them. They’re both market leading businesses, very strong Australian businesses. CBA is the strongest bank in Australia. It has a competitive advantage in that those old mite accounts, it’s got a lot of young customers who initiate those deposit accounts, so it gives them a lower cost of funding, which is a competitive advantage in the market. However, banking is competitive.

Mortgages are very competitive. You’ve got about 70% of the mortgage market is dominated by mortgage brokers these days and it just keeps pricing very tight. The ability for banks to earn really big returns on their capital have gone, and CBA is the best returning bank, but it’s still only earning slightly above ITSs cost of capital. It’s still only barely grows the growth over the next couple of years, we think three 4% per annum. So it’s very modest single digit growth, a little bit better than the other banks, but not a whole lot better. So now perspective, there’s only so much you should pay for a company that’s growing at three or 4% yet CBA is trading at 26 27 times earnings. The highest multiple it’s traded at in its history. If we go back for the last 10 years, the average multiple, including the most recent history where it’s been very high, the average multiple is about 16 times.

Even if we assume that there was no bad debts into the future, so zero bad debts next year and use that 16 times earnings, we still see the stock is about 30% expensive. So it’s trading at a very big premium and it’s really an unsustainable sort of number that ultimately I don’t think you get much of a return investing in CBA. Whereas we compare that to CSL CSLs involved in three key businesses across the globe. The most important one for it is its bearing business. That’s a plasma related business that provides healthcare solutions for a range of rare diseases. Very important business globally, a market leading. It’s growing its top line at 10% per annum and it’s got a very strong margin improvement story as it recovers margins to what they’re earning pre covid. And they’re doing this through a range of efficiency processes, including improving their manufacturing processes.

Second business is a V four business. This was a business they bought a couple of years ago, probably hasn’t had the success they would’ve liked, but we’re starting to see a little bit of growth emerge. I mean that business is involved in iron deficiency and kidney dialysis are important businesses, but some of their products have been coming off patent, so there’s a bit of a recovery story going on there. They still delivered 6% revenue growth in the half, so was still quite strong. The business had struggled a bit during the half was their flu vaccine business in the US there’s a lot of vaccine hesitancy post covid and the amount of people taking flu has really dropped quite substantially. However, there’s a natural limit we think, to the amount that it can retreat given that we’re seeing hospitalizations and a nasty flu season this year in the us.

So if you have a lot of people get flu one year, usually you see the number of people taking the vaccine increased the following year. But even if it doesn’t, I don’t think it really matters because it’s only a really small part of the CSL business. The main game is that is the bearing business, which is market leader and growing strongly. So same maths as CBA, if we took a discount on what this stock used to trade at, on average it’s traded about 35 times over the last decade. If we just used 30 times, then this is 30% cheap as of today. So it’s pretty big contrast to CBA and in a pretty expensive market it looks pretty attractive and it’s very defensive. So regardless of what’s going on with the macro environment in the US I think people are going to need those lifesaving drugs. So we think even though it didn’t react that strongly in reporting season, we’re pretty happy with the underlying thesis and how it’s tracking.

I think the market’s been overdue at pullback. It’s been a very strong market for 18 months and a bit of heat needed to come out of markets. There was a lot of optimism about Trump, there was a lot of optimism about Magnificent Seven. There’s a lot of optimism about AI and some of that’s coming out of markets and that’s probably a good thing, a healthy thing for markets. It can also mean that there’s some opportunities that present themselves some good quality companies which potentially offer growth that will start to trade a bit cheaper and that can present us with opportunities. There’s also opportunities that can emerge if interest rates start getting cut, because there’s a range of companies that have probably been struggling a little bit as interest rates have been higher. Things like James Hardy, which is involved in US housing market. The US housing market will start to look better if interest rates are getting cut. So we can select some of those companies that can do better in this environment. And we embrace the volatility because it gives us that opportunity to buy some good companies at better prices.