Hear from Scott Kelly, Portfolio Manager for the DNR Capital Australian Equities Income Strategy as he discusses the current market and the opportunities for income seeking investors.



Well, the market’s rallied hard following the Fed’s pivot last year. And to put the collective move in perspective since the end of October, 2023, the income strategies benchmark, which is the A SX 200 industrials index, is up over 20% over those four months. And it’s ended February, 2024 on a 12 month forward PE of around 19 times now, well above the long-term average. So the income strategy is underperformed over this period, and that’s primarily due to portfolio positioning, which is accounted for well over half. And there’s a few reasons for that. Firstly, the income strategy has a defensive tilt and that’s evidenced by its portfolio beta, which is currently around 0.81. And since investor optimism for the Goldilocks scenario IE, the soft landing and low interest rates, that’s really seen defensives lag over that market rally and portfolio holdings and traditional defensives like Amcor, Endeavor, the Lottery Corporation, Telstra, Cash, they’ve all been drags on performance over this period despite no real fundamental change in operating performance or investment thesis.

The second reason is that banks have also outperformed over this period, which has been a headwind for our double digit underweight position, despite falling net interest margins, slowing credit growth, robust competition in both mortgages and deposits, cost pressures, and rising mortgage delinquencies. The sectors now trading on all time high PEs with CBA in particular now on a whopping 22 times 12 month forward pe. So with no growth and no credit cycle in consensus, we remain comfortable with our underweight position in the big four banks and that really represents our non holding in CBA, which is due to valuation and our preferred bank remains nab. Finally, the sharp fall and bond yields has also seen long duration and growth stocks outperform in particular tech stocks, which the strategy is, is underweight. Well, in our view, current market pricing is akin to a Goldilocks scenario with expectations that the economy is not hot enough to see a resurgence in inflation nor cold enough to see economic distress and earnings downgrades,

But such a narrow path of outcome being price leaves us cautious with a view that at least one of these assumptions could be wrong. And despite moderating inflation protections, the top down picture remains highly uncertain, particularly given Middle East instability, casting a shadow over markets. So we are concerned that the pricing and equity markets has become overly optimistic, leaving market multiples stretched and vulnerable to compression, especially in a year where we think investors need compensation for these risks I’ve just outlined. So we continue to add to existing portfolio positions in resilient quality companies that have underperformed the market despite delivering operationally good results and presenting good value, we believe on risk reward metrics. So a few examples of these include firstly, Auckland Airport. It’s a high quality asset with a unique position as New Zealand’s largest airport operator. And that’s seen it generate meaningful returns over a sustained period. And we think as passenger volumes continue to recover towards pre covid levels with attractive regulatory pricing, airport development opportunities and non-air nautical opportunities as well, these all provide operating leverage for investors over the next decade. Secondly, cube Logistics. It’s well managed, well positioned, and well diversified as it navigates the challenging and volatile operating environment. It’s return on investor capital is expected to expand over 10% very soon, and free cashflow generation should also improve as CapEx normalizes. We also believe the market’s underestimating the likelihood of more organic contract wins, investment opportunities and m and a. And although it trades on a reasonably high PE of around 20 times FY 25, we don’t think this accurately reflects the earnings contribution from its Patrick investment nor almost half a billion of capital that’s been deployed into assets that currently aren’t generating income. For example, it’s IMEX terminal. So that’s a stock that we continue to like over the medium term. Thirdly, Scentre Group presented a solid first half result on the back of strong Instore sales. And whilst the market remains focused on the potential impact of a consumer slowdown, we think this misses the upside from management driving more value from an improved tenant mix and medium term focus on developments capital partnering and refinancing its debt. We see an easy path to mid to high single digit earnings. It’s trading on 11% discount to NTA and is paying a 6% dividend yield. So we certainly see further scope for our performance in that name. And then lastly, the lottery corporation. It’s a high quality, well-managed highly cash generative business with an economically resilient exclusive license market. Its momentum has turned from negative to positive over the last quarter as jackpot Fing has mean reverted after a light 23 highly recurring and predictable revenues, greater operating leverage, and a high dividend and payout ratio. It’s all likely to drive shareholder value in the medium term. So these are just a few examples of resilient quality companies that we expect we’ll deliver regardless of the economic environment overall, we remain comfortable with the defensive tilt of the strategy, particularly given market expectations and the overlay of the macro and geopolitical environment. And we are also conscious that income seeking investors are typically retirees and vulnerable to sequencing risk, particularly at this point in the market cycle.

Well, in terms of the dividend outlook for 2024, we think company balance sheets remain under geared relative to history, and with the market seemingly more confident that the interest rate cycle has peaked, we think the market will start to expect to see more capital management initiatives. Payout ratios are also still well below pre pandemic levels, which should allow the corporates to gain greater confidence to return cash to shareholders. So the income strategy is well positioned, we expect it. We’ll deliver a gross dividend yield for calendar year 2024 of over 5%.