Hear the latest from DNR Capital Chief Investment Officer, Jamie Nicol as he unpacks the recent reporting season, including the outperformance of banks, the impact of AI on market sentiment, and the increasing volatility beneath the surface. We also hear from Portfolio Manager, Scott Bender and Associate Portfolio Manager Brendan Mowry and share our perspective on where value is emerging and how we are positioning portfolios in response.

 

Over the past month, the market’s really been dominated by fears around potential AI disruption. That saw a sell off in companies like software, classified businesses, and even companies like insurance. It really started spreading across a range of sectors. The market then rotated into perceived safe havens and banks enjoyed a good run as a result, and they had pretty solid results. Now we think this perception of safety for the banks is overstated. The banks are trading at a very expensive levels by historical standards. In fact, as high as I can remember over the past 30 years, and very expensive compared to global banks as well. And they’re not without risk. Now, they’ve enjoyed a good couple of quarters, but they’re still delivering very modest growth. Historically, as you can see on this chart, when interest rates start rising, the multiples on banks start compressing. And they do that because you start seeing lending growth begin to slow and potential for bad debts.

So that’s obviously one risk. The second thing is we think competition is rising, particularly in deposits. Deposits is such a crucial component of a bank’s strength. And I think across the major banks is about 285 billion in deposits that they’re not paying any interest on. It’s hard for me to conceive that over the next five, six, seven years, that they continue to be able to not pay any interest on those deposits, on those transaction accounts. And competition is coming by Macquarie Bank who are growing their deposits about 40% per annum. But it’s also coming from other areas. And even if you think about AI potential to enable a bit of churn across different banks, I mean, that’s something that’s being discussed in Europe at present. I think with these concerns about AI top of mind, and I know there’s a lot of really extreme examples being floated about, and people are concerned about what it means for employment, et cetera.

If you are concerned about those, well, you shouldn’t be buying banks because ultimately banks lend people in a lot of good jobs, a lot of money, and if there’s any sort of employment concerns, then that’s going to go to banks. Now I’m not really worried about that at present, but it’s just highlighting that when you’re paying a very full price, there’s a whole range of risks that should be considered and should be factored into the stock.

When it comes to AI risk, the market’s been really grappling with the threat and it’s been a shoot first ask questions later scenario. When we look at the companies getting affected, I mentioned classifieds, I mentioned software companies. These are some of the better quality companies in the market historically, and we’re not seeing their earnings get affected, but of course it goes to the potential terminal value of these companies. What earnings will they be making 10, 20 years in the future? So it’s understandable that there’s been somewhat of a selloff. The question is, it seems to have got a little indiscriminate. You’ve seen very aggressive selling off a whole range of sectors, and sometimes it’s been very reactionary, reacting to articles on Twitter, which are very fear-based, often very self-interested, those articles. So it potentially opens up opportunities amongst these companies, which have got some points of difference.

When we’re looking at the moats behind these businesses, particularly the classifieds and the software, we think about things like the quality of the data. So a company like CarSales has got all its private car sales information, which isn’t available in the broader market. Also, when you look at something like Xero, requires accurate data. It’s compliance led. You need to be very specific about the data. It needs to be reliable. And when you’re providing sort of tax information accounts, financial information that businesses are relying on, accuracy is important. And with AI, it tends to be probabilistic as opposed to deterministic, which is needed. You also need to think about the go- to-market. Many of these businesses have existing business models with millions of customers. That’s hard to replicate. There’s often network effects. These existing businesses are also investing in AI. And into the future, you’re going to see, or you’re already seeing some revenues come off some of their AI initiatives that they’ve been investing in for some time, and that’s going to accelerate.

So will Zero provide that AI services into their small customer base, their three million small customer base, and help those small customers deliver accounting in a much more efficient manner. We think they’ll be very much a part of that story, and hence the very aggressive selloff, which has seen this stock trade at very discounted levels by historical standards presents an opportunity. Now, there’s a lot of other opportunities outside of AI impacted stocks. There’s a whole range of good quality stocks trading at discounted levels. And I think what we’re trying to do is really contrast that to some of those pockets of the market, trading at elevated levels like the banks that I mentioned. I’m going to get Scott and Brendan to highlight a couple of these key areas that we think look really attractive.

So I might just start off running through the resource sector. It has had a really strong run, and that really started in the middle of last year and accelerated through the start first few months of 26. Despite the run up in prices, reporting season really did highlight that at current spot commodity prices, valuations don’t look stretched at all. Free cash flow yields are strong, multiples don’t look challenging, and most of the major miners actually had really strong operational updates, so they are executing particularly well at the moment, but the concern with resources is always around the longevity of the cycle. And from these levels, we are giving a lot of thought to the dynamics around supply and demand from a medium term point of view. On the demand side of things, it’s pretty well acknowledged that Chinese economy looks to be bouncing along the bottom, sort of not getting any better, but not getting any worse.

While there are other sort of secular drivers that look … Things like data center build out from AI as well as defense spending and more of just a general focus around the strategic value of commodities. And that’s been really supported from a demand point of view. And we think the market’s pretty much across that. Where we think the market’s maybe been a little bit too optimistic is just on how quickly supply can come in to respond to these higher prices. So to date, we haven’t really seen any new material supply come in across the commodity complex, maybe excluding iron ore where you have seen Simondu come up and start running. We think the market’s going to be able to absorb that extra volume out of Simon do, but generally the supply across the rest of the commodities that’s looking to come on is going to be very long dated.

Just given how hard it is to find high quality, large scale projects means that any new supply is going to take a long time to come in, particularly by the time you get permitting and the cost to get this new supply up is going to be very high. And so all that’s good news for existing producers. So we think the resource space remains to look really interesting opportunity over the medium term and we remain overweight the sector.

So we think there are a few really interesting bottom up opportunities that have come out of reporting season. Firstly, I’d just like to highlight Clean Away, very defensive business that continues to grow earnings, does have a very strong position in post collection space, and that’s a very asset heavy part of the market and extremely hard to replicate, just given the hurdles around getting new post collection facilities up and running. The stock’s currently trading as significantly cheaper than it has for a long period of time, and that’s despite the positive outlook. So that’s a position we’ve been adding to and continue to add through this month as well. Secondly, Cochlear, which is a very high quality business, but a position we had actually been selling down through the back half of last year. We only had a very small active position going into the result, and we were concerned that the new product launch would see surgeries being delayed as people waited for the new process and the implant to become available.

Look, to be honest, the impact of the delay and procedures was probably towards the top end of our expectations, and you did see the stock trade down quite heavily on the soft first half result. Look, overall, we don’t think the business is broken, and while it’s disappointing, the launch of the new product has taken longer than we in the market had hoped, the rollout’s now over 80% complete, and the feedback we’ve been getting on the new implant from both doctors and the recipients has been really positive. So yeah, we think this pullback on the soft first half result is giving us a good opportunity to build that position in what’s a very high quality business trading and a really attractive valuation. And now I’ll just pass over to Brendan, who’s going to run through some other opportunities we’re seeing at the moment.

At the current share price, we view Aristocrat leisure as particularly compelling. The company is a global leader in the design development manufacturer of gaming machines, probably better known as Pokies. Ongoing market share gains in their core gaming segment, incremental growth via their interactive segment, which houses the online lotteries and gaming assets. In addition to ongoing share market buybacks supported by a conservative balance sheet, enables the company to deliver high single digit to low double digit earnings growth over the medium term. More recently, the shares have been sold off in response to the appreciation of the Australian dollar relative to the US dollar, which depresses near terms earnings growth on a headline basis. Concerns around the pace of growth in the online gaming business, which is somewhat constrained by regulatory approvals, albeit the overall direction remains favorable, and perhaps some contagion from the AI risk trade.

Ultimately, we view these concerns as short term in nature, presenting an opportunity to buy shares in a quality compounder with resilient earning extremes, a fortress balance sheet, and it valuations as cheap relative to the market as we’ve seen in the last decade. In summary, the reporting season saw a number of key themes. While we originally saw the threat of AI disruption and subsequent selloff contained within the software and online classified space, we’re now starting to see this broaden out metastasize into second, third, and fourth derivatives. In many cases, we believe this fear has led to indiscriminate selling, which really presents compelling opportunities for active investors. While we would concede that the results from the big four banks were highlighted the reporting season, this is typical of the early phase of a new rate hiking cycle, and likely to represent a bit of as good as it gets moment.

We maintain a high conviction underway to the sector, given more compelling risk reward opportunities elsewhere. One of those opportunities is the resources sector where we remain attracted to the fundamental setup, with the years of regulatory burden and underinvestment crystallizing and attractive supply side dynamics. So as the dust settles on a highly volatile reporting season, we remain focused on capitalizing on opportunities to purchase shares in quality companies at attractive valuations.

 

This video has been prepared and issued by DNR Capital Pty Ltd, AFS Representative – 294844 of DNR AFSL Pty Ltd ABN 39 118 946 400, AFSL 301658  as  the investment manager of the DNR Capital Funds. The Trust Company (RE Services) Limited ABN 45 003 278 831 AFSL No 235150 (as part of the Perpetual Limited group of companies) is the responsible entity and issuer of units in DNR Capital Funds.  It is general information only and is not intended to provide you with financial advice and has been prepared without taking into account your objectives, financial situation or needs. You should consider the product disclosure statement (PDS) for the relevant DNR Capital Fund, prior to making any investment decisions. The PDS and target market determination (TMD) can be obtained for free by calling DNR Capital on 07 3229 5531 or by visiting the Fund website dnrcapital.com.au/invest. If you require financial advice that takes into account your personal objectives, financial situation or needs, you should consult your licensed or authorised financial adviser. This information is only as current as the date indicated and may be superseded by subsequent market events or for other reasons. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information. All investments contain risk and may lose value. Neither DNR Capital nor any company in the Perpetual Group (Perpetual Limited ABN 86 000 431 827 and its subsidiaries) guarantees the performance of any fund or the return of an investor’s capital. Neither DNR Capital nor Perpetual give any representation or warranty as to the reliability or accuracy of the information contained in this video. Total returns shown for the DNR Capital Funds are calculated using exit prices after considering all of Perpetual’s ongoing fees and assuming reinvestment of distributions. No allowance has been made for taxation. Past performance is not indicative of future performance.