This week we look at one of the most overlooked but stellar results of the 2020 reporting season. This company has grown earnings at a compound rate of 44% p.a. for the last four years and requires little capital to grow. The business is benefitting from structural tailwinds and, we believe, is on track to potentially hit the $100M net profit milestone in 2021 yet is only being valued at $550M or a PE of 6x by the market.
Authors: Ron Shamgar
Resimac (RMC.ASX) is one of the largest non-bank mortgage originators in the country. Over the last four years, RMC has grown AUM from $8.9bn to $14.9bn, a CAGR of 14%. Over that same period NPAT has grown from $13m to $56m, or 44% CAGR, demonstrating the strong operating leverage in their business model. This was driven by strong net interest margin (NIM) improvement to 190 bps, compared to 153 bps last year, and a significant improvement in their cost to income ratio, now 37.9% compared to 56.6% in FY19. Return on equity (RoE) increased from 17.3% to 25.5%, given the capital light nature of the business. The final dividend was raised from 1 cent to 1.8 cents while the net cash balance rose to $23m.
Source: RMC company filings
More importantly, RMC is benefitting from favourable cost of funding while its banking peers are seeing deposit margin pressure. RMC is growing at 7x system growth by offering quick turnaround time for brokers and an excellent service proposition and positioning itself as more of a digital non-bank with a strong direct to consumer digital brand in homeloans.com.au.
Source: RMC company filings
RMC has the most extensive funding of any Australian non-bank both through their international RMBS issuance program and their seven warehouse facilities. This is a key competitive advantage while other lenders have struggled. This was demonstrated by RMC’s AUM growth over the Covid period, where their rate of growth was maintained despite a significant dip in the market. Other non-banks were forced to reduce volume over funding and capitalisation concerns.
Also important is the fact that RMC’s profit is driven not just by NIM but also strong volume growth and a tightly managed cost structure. Their AUM base is 22% higher as a starting point so, in the absence of any further growth in the loan book, RMC could still grow profit in FY21. Dissecting the NIM movement further, NIM increased from 153 bps to 190 bps in FY20, noting that NIM was 183 bps in the 1H FY20 and 197 bps in 2H. The increase was driven by a reduction in the spread between the BBSW and the Cash Rate and RMC only passing on three of the four rate cuts in FY20 (noting that 1 bps is worth $1.3M of PBT).
Source: RMC company filings
If conditions remain as they are today, we believe RMC could deliver a NIM result in excess of 204 bps. If this is the case, RMC could see NPAT in the range of $74m to $105m or a PE multiple of 5-7.5x based on a range of scenarios. Another way to look at the FY20 result is that in spite of the $16m special Covid provision, RMC were still able to grow 2H NPAT to $28.8m. This absorbed 100% of the incremental provision which gives a potential $90m profit start for FY21 plus additional growth.
We are forecasting potential for $100m net profit in FY21, which should then see the stock valued at around $3.00, more than double its current price.
Disclaimer: RMC is currently held in TAMIM portfolios.
Sid Ruttala once again delves into the top end of the market, working his way down the larger companies on the ASX. This week we look at Goodman Group (GMG), Newcrest Mining (NCM) and Woodside Petroleum (WPL).
Goodman has put out some interesting results, the most surprising of which was the WIP (Work-in-Progress) increasing to $6.5bn, a sign of future earnings growth. Although the headline does require a little more nuance given that much of this was a result of low completions over Q4 ($100m AUD vs. the $1.3bn expected in the previous 9-month period). Covid-19, as expected, did impact the business in that it has, for one thing, decreased the payout ratio, a positive sign of good balance sheet management. The downside being slower completion of the WIP through much of this year and the first half next year. Earnings are thus likely to stay muted until Q4 of next year especially curtailed if we see further lockdowns across the jurisdictions the firm operates in.
Earnings-wise, operating profit came in at $1.06bn, an increase of 12.5%. EPS was 57.5c, an increase of close to 11.5% and above guidance of 9%. They also reported an increase in AUM, increasing to $51.6bn AUD. Of this approximately $2.9bn AUD came from revaluation (mark-to-market) gains across the Group and Partnerships.
An overall solid result delivered from management who have shown both balance-sheet and strategic discipline. Management’s commentary and guidance remained bullish throughout the reporting, pointing to strong occupier and investor demand as well as a focus on logistics assets (though commercial has been the big red-flag). Looking at the business overall, we remain of the view that Goodman has maintained the right focus across the industrial and multi-tenant warehousing assets that will see both secular growth as well as increased profitability from the digitalisation trends that were catalysed post-Covid, a trend rewarded by its share price returning 34% CYTD, a clear outperformer in the ASX20.
“Scarcity of land is driving increased intensity of use including multi-storey logistics, data centres, and other commercial uses, providing potential value add opportunities – Continued transition to fewer, higher value and longer lead times of development projects.”
- GMG Full Year Results Presentation
Red Flags & Risks: GMG operates in the right segments of the property market going forward, which should not only sustain them from an underlying valuation standpoint but will likely see continued growth. That said, much will be contingent upon the impact of Covid on WIP. Going into next year we are likely to see delays further impact the balance sheet and put downward pressure on the payout ratio as management seeks to maintain working capital, a big risk for the dividend and yield-starved investor.
Gearing also remains a big issue to us. Although management has indicated that it will seek to cap gearing to below 10%, I think it highly unlikely that this expectation will be met or management will seek to use partnership leverage in an effort to supplement an increased development throughput (somewhat hiding this aspect from the parent company’s balance sheet). That said, with rates as low as they are and unlikely to head higher across Australia, North America or the UK, this might not necessarily be a bad thing.
My Expectations: Personally, I remain optimistic about Goodman. The company has the ingredients to make up a stellar anchor for any portfolio. Management’s focus on the Logistics business as well as land scarcity being a major issue across every jurisdiction it operates in, including the UK and China, they are playing within the right sectors and at the right time to benefit from the move toward digital and the advent of e-commerce. Their promotion of Carbon Neutrality and playing to ESG frameworks should allow the securities to trade at a consistent premium to their peers. Overall, a solid business and well-capitalised.
Dividend Yield: A dividend yield of 1.6%, assuming a share price of 18 AUD.
We expect this to stay consistent through much of next year with further growth likely to be in 2022 on a nominal basis. This may be unattractive for many, but I would say look at it like a bond proxy (i.e. a substitute for investment-grade bonds with nominal upside even without inflation) and things get interesting, especially with a WALE of 15 years. It remains a buy for me.
Newcrest Mining (NCM.ASX)
Solid results from Newcrest, nothing to write home about though. Production stood at 2.2 Moz (million ounces) of gold and 138 Kt (thousand tonnes) of copper at an AISC (All-In Sustaining Costs) of $862/oz, showing that Newcrest remains a relatively low-cost producer. Given the continued upside in the price of gold, underlying profit increased to $750m, an increase of 34% on the previous year, with FCF (Free Cash Flow) of $647m.
The Lihir project was a disappointment with production only coming in at 776 Koz and is beset with issues around clay content, ore mix and the grade. Breaking down the AISC, Lihir (Newcrest’s largest project by resource) stands at approximately $1,204/oz. The Telfer and Red Chris projects come in at $1281/oz and $1703/oz respectively. The outlier is the Cadia project, at $160/oz, which enables the company to drag down the cost base massively.
Numbers-wise, EBITDA at $1.3bn USD is in line with my expectations and net debt stands at $624m. The firm maintained a 30% payout ratio.
Red Flags & Risks: Newcrest remains an outlier from other gold majors from a risk perspective. I say this because their main projects retain a reserve life of 21 years, astounding in that this is significantly higher (by about 50%) than their nearest competitors, Barrick and Newmont. However, the biggest risk remains the cost of production once Cadia the outlier is stripped out, with the average set to then rise above $1200/oz. Management has been prudent in keeping debt limited and rolling over existing debt onto a new rate given the interest rate environment.
From a valuation perspective and for a gold play, the company remains at a reasonable valuation. In saying that, there will likely be continued issues with production, especially at Lihir. The company will have to keep growth in mind along with jurisdictional risks, especially across Ecuador and the PNG.
My Expectations: I remain optimistic about the price of gold given the global monetary and fiscal policy environment. That said, we are likely to continue to see volatility as much of the selling in the short-run will be the result of covering losses across other asset classes. Assuming that we sustain prices at current levels, much of Newcrest’s future will be contingent upon curtailing costs that seem to have gotten ahead of the company.
The growth catalysts are likely to come from Wafi-Golpu, Hevieron and Red Chris which could double the output over the coming decade if executed correctly. I remain of the opinion that much better plays for gold exposure exist, so not yet a buy for me.
Dividend Yield: Assuming a share price of $13.50 AUD, then the current yield stands at about 1.1%.
On a nominal basis, my expectations are that this will go up at a double digit rate over the coming decade or so, despite the cost of production and assuming the payout ratio stays put at 30%.
Woodside Petroleum (WPL.ASX)
For those of you unaware, this author is a particularly long-term bull when it comes to oil. This isn’t necessarily in the hopes of V-shaped recovery but rather a consideration of the supply-side of the equation, with the contention that much of the high-cost production across the Permian is unlikely to recover back to pre-Covid levels. This, taken in conjunction with the fact that low-cost producers in the case of Saudi Arabia and Russia, have break-even budgets (i.e. budgetary break break-even as opposed to cost of production) above $80 USD p/barrel (please refer to my previous articles for a breakdown of this thesis).
WPL has been interesting to watch, especially given the upside of many of the junior gas players following Morrison’s rhetoric around a gas led recovery. Even based upon this thematic one would’ve expected one of this nation’s largest producers of LNG to have benefitted, but investors seem to think otherwise. Numbers-wise the company continues to meet expectations with production and expenditure guidance largely unchanged. 2020 came in at approximately 100MMBOE (million barrels of oil equivalent) and total expenditure was flat at $2.4bn. With investment expenditure down, this shows that most of this was a result of FX and Covid-related oil mess (i.e. a positive, indicating that the actual cost of production is in line with expectations).
The company remains well-capitalised with $7.5bn in liquidity, making it likely to target M&A activity going forward and being a prime beneficiary as the global supply chain continues to consolidate. Recent key catalysts have included the outright bid for Sangomar (Senegal) in competition with Lukoil, a bid that I would personally applaud given the fact that it was, for one thing, at a palatable price (something that was perhaps enabled by US sanctions on Russia, who said politics wasn’t good for business?).
Red Flags & Risks: The company remains well-capitalised and is a cash cow with current free cash flow yield coming in at approximately 11.6% at 2021 guidance. The big risk will be the short-term volatility in the price of oil, though the company remains well hedged with over 13m barrels through to December 2020 (so any upward swing in the price before then is a disadvantage, though there were call options purchased for 7.9m barrels), potentially expensive but prudent.
My Expectations: I have conviction that management will remain disciplined and that they will continue to scout for deals, providing good catalysts into the future. The underlying security will be volatile, given the procyclicality of oil, but remains a consistent provider of income. The discussions with regards to Pluto and Scarborough are ongoing and provide short-term catalysts (Exxon out). Personally, I would look to accumulate from weak hands at anything below $20 per share. Long-term price target, assuming an oil price of $50 USD/barrel, is $36.
Dividend Yield: The yield is a solid 7.2% assuming a share price of 18 AUD.
On a nominal basis, this is likely to stay consistent for the next 12-24 months and there is potential for significant upside thereafter.
Sid Ruttala continues his exploration of the top end of the market, this time moving just past the surface of the ASX and going outside the Top Ten. This week we look at Macquarie Group (MQG), Telstra Corporation (TLS) and Rio Tinto (RIO).
Author: Sid Ruttala
This week we continuing publishing my notes on individual companies. At the beginning of this particular series, we were going to limit ourselves to the Top Ten but due to significant interest from readers, we’ve decided to continue down the list by market capitalization. Next on the list for this week are: Macquarie Group (MQG), Telstra Corporation (TLS) and Rio Tinto (RIO).
MQG is one security that held up relatively well through the Covid selloff, the twelve-month number coming in at -8.3%, a stellar achievement given the performance of financials on the ASX broadly. Numbers-wise, overall operating income was down -3% for FY2020, to $12.3bn AUD, with profit coming in at $2.7bn AUD, an 8% decline on the previous year. The more important metric in my opinion was the EPS. At $7.91 AUD per share, it represents a 10% decline from the previous year.
Breaking it down by division, MAM (Asset Management) and CGM (Commodities & Global Markets) were the performers in terms of income. The Asset Management division printed higher than expected (my expectations at least) management and performance fees, while commodities and global markets have held up relatively well with particularly higher business in the commodities lending business (thank you, iron ore). As expected MacCap has seen lower DCM (Debt Capital Markets) revenue partially offset by M&A activities and, for the foreseeable future, this will be the silver-lining if management continues to get themselves onto deals which we can certainly expect (given their track record).
Looking to the future, recent HY21 guidance suggests that NPAT will be down 35% YoY. Management has taken a conservative and prudent approach by increasing provisioning for Covid-19. Also problematic is the higher Australian Dollar, given that 69% of MQG’s income is now global. Numbers-wise, a 5% swing in the spot rate will result in a 3.5% swing in the NPAT (either way). For the number-crunchers among you, happy to share the TWI (Trade Weighted Index) calculations.
Red Flags & Risks: The biggest risk comes from Covid. One saviour for Macquarie Capital has been M&A activity and unless we see a marked improvement in the overall economy we will continue to see stress (including increased provisioning) across BFS (Banking and Financial Services). There is downward pressure on EPS and management will need to be diligent in increasing AUM for MAM in order to circumvent these headwinds. On the upside, however, the continued decline in AUM for AMP has meant that it has been receiving flows (including to its Macquarie Wrap platform). The key will be reaching enough scale in terms of inflows to offset the margins on the annuities like business (i.e. infrastructure and green assets).
My Expectations: A fair substitute for the Big Four. Messy short-term outlook with headwinds across the investment divisions and likely increases to provisioning going forward. We will see increased M&A activity but it will probably not be big enough to offset the declines across DCM. The Asset Management division is likely to be the knight in shining armour given the illiquidity and stickiness of the underlying assets, including renewables and infrastructure. That said, the business has a proven track-record of close to 51 years of profitability, one can probably trust that track record. A long-term hold.
Dividend Yield: The current dividend yield stands at an exceptional 3.6%, assuming a price of $118.69 AUD.
Though on a nominal basis we don’t expect this to stay put through the next FY due to increased provisioning and short-term declines in NPAT. Over the long run, we expect the company to maintain a consistent payout ratio (above 50%).
Telstra Corporation (TLS.ASX)
Telstra is one Australian company that never ceases to disappoint. Every time it starts to look cheap, it surprises investors by getting even cheaper (eventually it becomes a habit). With that in mind, I can’t say I was overly surprised by a rather disappointing FY20 result. NPAT was down 12.6% to $1.8bn AUD with the biggest declines by segment across Fixed (-11%) and, more concerningly, Mobile (-4.4%). Greater than expected decline, in my opinion, in ARPU (Average Revenue per User) even factoring in less roaming charges (i.e. no international travel). What was more disheartening was the DATA and IP segment declining close to 13% due to increased competition. This is while we live in a Covid world where consumers don’t do much other than use the internet; everything was online for at least a few months there.
On the positive side, the one bright spot is the value (longer-term) of its infrastructure with close $1bn p.a. in recurring payments from NBN. InfraCo has a lot of untapped potential and should create a buffer for the company.
Much will be contingent on management. One trend we have seen is that TLS has taken the lead in raising prices higher, especially 5G, and others will likely follow suit. Until now the play has been to increase usership at all costs, but a rationalisation might be in order. Especially targeting premium customers and increasing margins per customer. Its main competitors, Optus and TPG, are also likely to follow suit with TPG also indicating that its discounts are not going to become a permanent fixture. The accelerated digitisation as a result of Covid could become a tailwind for the largest telco in the country (though they do have a track record of not taking advantage of such things…).
Red Flags & Risks: Simply put, competition is the biggest risk for the company. Until now, telecommunications has been a race to the bottom (granted, beneficial for the consumer). What we are likely to see is a consolidation and rationalisation, with market shares becoming stable. TLS will have to focus less on the acquisition of customers and more on the monetisation of its existing infrastructure and user base.
What has been frustrating to watch has been the lack of willingness to look at alternative revenues and diversifying the business. It took the company until last year to even think about rationalising its product line. Looking at their global counterparts in the States, AT&T acquired Time Warner, Verizon made multiple acquisitions across cloud security and more recently drone tech company Skyward, and Singtel (Optus) is buying up broadcast rights to sports left, right and center. It will be key for TLS to move into the 21st century and shake off its public sector roots. Vision 2022, which includes a move to digital and IoT, at this stage remains all flash and no fire. They’ve talked the talk, time to walk the walk.
My Expectations: While at current valuations it does look cheap, especially when one considers the true value of its infrastructure assets, there is too much up in the air and it relies on flawless execution by management. Even with regards to InfraCo, there has been no clear outline of how it will be monetised.
The company needs to modernise, ARPU will get higher but this is probably contingent on international travel being opened up again. One thing I did like was the Capex brought forward despite Covid,
Personally, I am a fan of Andy Penn but he is fighting an uphill battle. If you hadn’t picked up on it by now, to put it bluntly, still not a buy for me.
Dividend Yield: The current dividend yield stands at an exceptional 5.7% assuming a price of $2.82 AUD.
On a nominal basis we expect this to stay put, though the yield might keep going higher if past performance is anything to go by.
Rio Tinto (RIO.ASX)
Before getting onto the recent events that culminated in the ousting of CEO Jean-Sebastian Jacque and several other top executives, let’s go through the numbers. The company has certainly put out some stellar results buoyed by iron ore prices, NPAT was at $4.8bn USD while EPS was at $2.94 USD per share which represents a slight decline of -3%, a positive given the environment. What is immediately evident was that the impact on the firm from Covid was minimal, only showing up in terms of slightly lower cash conversion.
Division and commodities wise, iron ore was, as expected, the outperformer. What was rather surprising to me was the aluminium and bauxite numbers, driven primarily by prudent cost management and margins despite the prices tumbling. Corporate cost cuts were also evident across Escondida. Projects-wise and in terms of growth catalysts, fieldwork across the assets in Guinea is to commence this year, despite my expectations of it being pushed into next year (another positive). The Oyu Tolgoi copper/gold project has been facing some hurdles in terms of a slower than expected ramp-up (this one is a negative).
It was exciting to see the maiden resource for the Winu project coming in at 500m tonnes at a grade of 0.45% CuEq (copper equivalent), Australia’s newest tier-1 project. Though still in its infancy this could be the next catalyst for Rio, especially given the likely upward trajectory in Copper spot prices.
Red Flags & Risks: The biggest risks currently are related to the uncertainty around management going forward. Whatever the market may say about the previous CEO, he has been interesting for shareholders from a pure numbers perspective, putting steady dividends into our pockets. That being said, the rather blasé attitude to corporate and social responsibility has done some irreparable damage to the company’s brand. Blowing up a 46,000-year-old site of immense cultural importance and then trying to assume plausible deniability in a parliamentary inquiry will do that. You would hope they have learned their lesson.
Scalps have been taken. These include the CEO, the Head of Iron Ore division and the group executive for corporate relations, all by mutual consent of course. Though the consent did cost a tidy $80m AUD. The new CEO, whoever that might be, faces a decent challenge. This includes but is not limited to dealing with the Mongolian government in putting the Oyu Tolgoi copper mine in order and ramping up production, hitting the ground running with the Guinea assets (i.e. Simandou Iron Ore project) and placating a wide group of rather aggrieved stakeholders due to the aforementioned PR disaster.
Risks also include project execution and keeping Capex in line, to meet the expectations of now rather spoilt shareholders (this will include the Oyu Tolgoi, Amrun and Koodaideri projects).
Currency wise, Rio’s revenues are inversely correlated to the AUD and a higher AUD will create a rather messy P&L.
My Expectations: I tend to be contrarian when it comes to the price of iron ore, though many have said it is toppy, and my expectation is that, while volatile, there are catalysts that will apply upward pressure in the medium to long-term, including higher infrastructure spending around the planet. Copper will remain an interesting buffer for the company and Winu creates the potential for stellar upside.
That said, there is a lot of uncertainty concerning the leadership of the company and what this means for the existing strategy, including the cost-cutting measures. Simply put, environmental and ethical concerns aside, a great business. I would hold if I already owned but wouldn’t be adding to the position with great conviction.
Dividend Yield: The current dividend yield stands at an exceptional 5.9% (approx.) assuming a price of $103.740 AUD.
On a nominal basis we expect this to stay put with potential upside on the underlying security if management gets its act together and doesn’t decide to ignite a museum or look for ore under the Pyramids.
Firstly, credit where it’s due, the CEO (Elizabeth Gaines) has done a stellar job in turning around the business, cutting debt and costs. From a numbers perspective, a record EBITDA of $8.38bn USD ($10.99bn AUD) and NPAT of $4.25bn USD ($5.85bn AUD). More importantly, the free cash flow continued to grow in double digits. From a yield perspective, the company’s 100c p/s was certainly above the market expectations and represents a 77% payout ratio.
In terms of capex and additional projects, the two majors in the pipeline are Eliwana and Ironbridge. This is in addition to Pilbara Energy Connect which aims to decrease the firm’s carbon footprint by investing in hybrid solar-gas transmission infrastructure. Currently, capex stands at approximately $1.96bn USD for 2020 with guidance of $3.4bn USD in 2021. Although this does represent a substantial increase, it puts the company in a strong position for the future with my expectations being a substantial decrease (i.e. 50-60%) post-2021.
Red Flags & Risks: The biggest red flag is the current share price at $18.25 AUD per share, this represents a substantial premium to NAV and even small fluctuations in the price of ore could lead to amplified downside risk from a valuation perspective. That said, from a cost-discipline and management perspective, I could not find fault (not for lack of trying). The biggest metrics to watch going forward will be steel production in China (and thus the trade relationship that underpins it) and the infrastructure pipeline both domestically and abroad. We would guess that there will be a fair amount of infrastructure spending in the coming years given the need for stimulus globally.
My Expectations: Personally, I remain bullish about iron-ore spot prices, even with the possibility of Brazil coming back online, due to the amount of fiscal stimulus that is being touted across the planet as mentioned above. This is pure-play on exposure to that growth trend. Though the security remains overvalued from a historic perspective, Fortescue is one great Australian business that fits well into a portfolio despite the downside risk (mainly due to the substantial run in the share price).
Dividend Yield: The current dividend yield stands at an exceptional 9.6% assuming a price of $18.37 AUD.
On a nominal basis we don’t expect this to stay put through the next FY due to the upcoming elevated capex. Over the long run, we expect the company to maintain a consistent payout ratio (above 70%).
Woolworths (WOW.ASX)
Not surprisingly, Woolworths was one security that effectively behaved as a hedge during the Covid-19 market sell-off. That being said, it remained consistently volatile calendar year to date, the share price returning 2.29% since January. Amidst the lockdowns and stay at home trends, there has been a spike in home consumption increasing the volumes but reducing the frequency (i.e. large bulk orders and less frequency in orders).
This is one security that has been on my radar ever since Amazon’s entry into the market in 2017. Despite the doom-and-gloom type hype associated with the move, WOW has been adapting and growing it’s business consistently. Online sales growth came in at 69%, a stellar result that equated to 100% of the sales growth which stood at 8.1%. Normalised EBIT came in at 8.8% (assuming the exclusion of the hotels since this was an exogenous event, we would exclude this particular metric in assessing management). Australian Food continues to grow in the high single digits with the NZ business growing at a double-digit rate.
What has been pleasantly surprising was the inventory turnover which was pushed down to 37 days and indicates that management has been forecasting in a reasonable manner. The lower than expected capex was surprising and, though taken well by shareholders, is not a positive (in this author’s opinion at least).
Red Flags & Risks: Management seems to be disciplined when it comes to cost management and balance sheet discipline but there is uncertainty around the divestment of Endeavour and the profitability of same-store sales. If the Endeavour divestment is done at a reasonable valuation, it could put some cash in the pockets of shareholders though. Big W somewhat surprisingly beat my expectations, though I believe it would be better off sold rather than remaining a part of the broader group.
The competition from pure-play online retailers could put downward pressure on profit margins (including price deflation). The competition could also come in the form of convenience stores. The key will again be in the delivery, turning existing stores into effective distribution centers (DCs). What caught my eye in this instance was the partnerships with Sherpa, Uber and Drive Yellow for last-mile delivery, a problem that remains the single biggest headache for retailers both in Australia and globally.
Woolworths Fairfield Heights, a TAMIM property
My Expectations: Not a growth play but rather a play on the balance sheet (bottom line as opposed to top-line). Much will be dependent on continuing to increase inventory turnover, reinvestment in IT and last-mile delivery. The business’s competitive advantage could also come from regional areas where existing store-presence gives them a head-start on online retailers (i.e. stores as DCs). The divestment of Big W along with Endeavour would make the business much more manageable and focused in my view.
Dividend Yield: The current yield stands at 2.5% assuming a share price of $37 AUD.
This is likely to stay consistent at around $1 AUD per share (give or take 0.2c) for the foreseeable future as the business continues to reinvest in order to keep up with competition and margin pressure.
Transurban (TCL.ASX)
Transurban is one company that sits on the frontline for the Covid economy and not in a good way. Government lockdowns and policy responses have meant that all major markets have been impacted including Montreal, Melbourne, Sydney and to a greater extent Washington. Numbers-wise, EBITDA stood at $1.89bn AUD, representing a decrease of 6%, while revenues were down approximately 3%, coming in at $2.492bn AUD. Of this, the North American operations represented a less than stellar figure of $154m AUD. Traffic restrictions across key regions, including Melbourne, are likely to take a further toll on the company. July traffic declined more than 25% in fact with the biggest negative coming from Citylink being down close to -48%.
That said, while the current situation does seem rather gloomy, TCL remains relatively well-capitalised though debt and gearing has continued to increase to 35%. What is more interesting is the pipeline of additional projects, the more attractive of these being the M6 extension, M12 Motorway, in Washington (with the announcement of the Capital Beltway Accord) and Montreal set for a toll increase of 14% (A25).
Red Flags & Risks: Much of the businesses immediate future will be contingent upon the whims and vagaries of government policy as well as economic conditions, mostly Covid-19 related. What was been surprising is the resilience of commercial and large trucking haulage. It will be incumbent upon management to win additional business in North America where the groups best prospects for sustained growth are likely to come. From a macroeconomic perspective, the business depends upon the urbanisation of populations which, from a long-term secular growth perspective, could start to decline or at the very least slow somewhat as a result of the pandemic. We have seen signs, especially in North America and to a lesser extent Australia, of a move out of the city for opportunities in regional or suburban areas or, in a pandemic-accelerated trend, even the same opportunities but with the option to work from home. For those interested please feel free to look at the dislocations in the San Francisco property market, with increasing movements of populations away from the main city.
In the shorter term, the bigger concern for me was the slight but still telling increase in costs, of 2.3%, despite the fall in earnings. I would have liked to see this remain flat.
My Expectations: The business will focus on expanding its North American footprint going forward, especially with the likelihood of fiscal stimulus being directed toward the upgrading of existing infrastructure as well as build out of new projects. Similar trends are likely in Australia as governments are forced to stimulate growth. TCL, while currently seeing some short-term pain, will benefit substantially from these catalysts as long as they win net-new contracts. Management does have a proven and consistent track record when it comes to this.
Earnings growth will remain less than stellar in the short-run unless we see traffic levels revert to something near pre-covid levels, which in my opinion may take longer (at least eighteen months) than many seem to expect. Over the medium-to-long run, given the likely additional infrastructure pipelines across all the geographies that the group operates, there are catalysts in the form of net-new wins or contracts. So, for the more patient long-term investors it might pay to stay invested as long as the expectation is not for a quick turnaround.
Dividend Yield: 3.6% assuming a share price of $13.97 AUD.
I expect the payout ratio to be consistent and the nominal dividend to remain around 50c p/s for the foreseeable future. Over the long-run (I’m talking 3+ years) I would expect to see this grow in the mid-to-high single digits. This is based on my assumption that traffic volumes won’t return to a normal or pre-covid level for at least the next eighteen months and the fact that any additional contracts would require capex and put upward pressure on the cost base.
As promised, this week we continue to look through some of the key highlights, and my notes on the top end of the market (by market capitalisation). The securities this week are CSL, BHP, and Wesfarmers.
CSL Ltd (CSL.ASX)
This is one company with which we’re sure the vast majority of our readership has had a pleasant experience with through their investment careers. Despite the volatility, it continues to be one of the few consistent performers in the ASX50. The company and management has once again managed to surprise in releasing yet another round of stellar results. Numbers wise, revenue continued to grow by 11% and Covid, while impacting the supply chain in regards to the collection of Plasma, has not materially impacted revenues.
The company remains well-capitalised with over $750m USD cash on the balance and available liquidity of close to $3.1bn USD. What was perhaps missing in the reporting, was an indication of how the Vitaeris Inc. acquisition was coming along. Although this seemed to be a small acquisition given the broader portfolio, it was interesting in that Vitaeris was conducting phase III clinical trials for a treatment for organ rejection within kidney transplant patients. Another niche but highly promising and potentially lucrative market. Perhaps not in the same way as haemophilia but arguably on par, with existing treatments in that particular instance ranging from anywhere between $300,000-$500,000 USD per patient (more than compensating for the small market size).
Red Flags & Risks: Covid-19 has undoubtedly cost the supply chain in terms of plasma collection, something that remains central to CSL’s business model. While the company controls around 30% of collection centers globally, the current lockdowns and health concerns have inevitably led to supply constraints. The flip-side of this is that the economic damage caused as a result might force more people, especially from lower socio-economic stratas (in the US that is, you don’t receive compensation here), to give more blood.
In terms of the competitive environment, the vast majority of the portfolio including the immunoglobulins and Seqirus related products are plasma based and, although CSL has a marked advantage in this area given the highly consolidated nature (oligopolistic structure with the closest competitor being Grifols), there is also potential for competition from recombinants (see below). The next phase of growth will very much rely on the Asian markets where cost will play a greater and more significant role. In other words they have to compete with recombinants in the developed world (i.e. recombinants being more expensive) and cost in the east. The product pipeline, including the acquisition of Vitaeris, is potentially a way to diversify the portfolio but this remains in its infancy.
“…recombinant product versions of plasma derived products are also available. These are manufactured by the expression of equivalent proteins from genetically engineered cell lines.“
Forgive the Wikipedia definition, but: “Recombinant DNA (rDNA) molecules are DNA molecules formed by laboratory methods of genetic recombination (such as molecular cloning) to bring together genetic material from multiple sources, creating sequences that would not otherwise be found in the genome.”
That is all to say, plasma synthesised in a lab as opposed to collected from donations.
My Expectations: Management continues to deliver, with consistent expenditure on R&D. The haemophilia B market remains lucrative for the company with further expansion into the European markets providing long-term revenue growth. Covid, while having an impact on the supply-chain for plasma, will also potentially be beneficial as the company would be part of the equation for the distribution and commercialisation of Covid-related vaccines at least in Australia. The R&D pipeline looks solid with my bets on the transplant and hematology related aspects to deliver.
Dividend Yield: Current yield of 1% (assuming share price at $281 AUD).
We would expect the payout ratio to remain the same but on an absolute basis for dividends to grow at double digits over a long term horizon.
BHP Group Ltd (BHP.ASX)
Stellar results from BHP with FY20 NPAT of $9.1bn USD, EBITDA margin of 53% and, most importantly for the yield hunters, a 55c US p/s dividend, lower than expected but in my opinion prudent and a number which still represents a 72% payout ratio. As expected, the laggards were the petroleum and coal divisions. What was exciting (in my view) was the potential divestment of half of BHP’s coal production, especially thermal and PCI assets (didn’t necessarily expect the Bass Strait Gas assets to be included). But any demerger via a trade sale, especially a demerger when trying to get rid of thermal assets, would have to be sweetened.
The company continues to look for oil acquisitions, in which they would of course be joining their global counterparts (Exxon et al.). My expectation is bolt-on acquisitions of juniors (maybe the Gulf of Mexico or, even more interesting, Horizon’s P&G interests which lie on the pipeline route of ExxonMobil and Oil Search).
What was rather disappointing, however, was the copper division especially in a time of stellar copper prices. Underlying EBITDA of $4.35bn USD was less than impressive due to higher costs in Antamina and Olympic dam. This, I feel, is one division to which management could allocate some much needed resources, the existing pipeline of Tier-1 assets look less than stellar especially when compared with Rio’s Winu (this includes the LATAM assets where costs have been kept reasonably within range).
Red Flags & Risks: While BHP has a diversified base in terms of commodities, the name of the game is pro-cyclicality. Weakening demand for steel production in China could hamper future growth and much will be contingent on maintaining cost discipline and hedging. Further delays in restarting Samarco and any weaknesses on project execution can be painful for shareholders. The divestment of coal assets could see some much needed focus, in my opinion, better allocated by getting a hold of copper assets which should have a longer runway and lessen the cyclicality of earnings (copper being central to electric vehicles as well as having a long-term secular growth story to it).
My Expectations: Management has delivered some stellar results and navigated the Covid mess in a better then expected manner. The business has to be streamlined somewhat however with the riddance of legacy assets as soon as possible, here I am thinking of thermal coal. The shifting of focus towards copper, rare-earths and oil will put the company in a better place over the long-run. Not a growth story but a yield story.
Dividend Yield: Assuming a share price of $37.5 AUD, then BHP has a great 4.5% dividend yield.
BHP remains a credible substitute for the banks from an income perspective.
Wesfarmers (WES.ASX)
Wesfarmers results showcased fantastic performance across the retail segments. Bunnings was the standout with same store sales growing by 14% through FY20 and delivering an overall EBIT of $1.8bn AUD (17.6% growth). Target remains the outlier (on the downside) continuing to be loss making while Kmart remains profitable. Revenues were cushioned primarily via strong online sales growth( coming in at close to 34%), with the major impact of Covid coming from supply-chain constraints (stock-outs).
Officeworks, with an EBIT of $190m AUD, represented double digit growth (13.8%). What was surprising to me was the chemical, energy and fertilizer divisions which beat on expectations. Volumes continued to grow for both chemicals and fertilizers, though LPG was weaker within expectations. Overall this segment still delivered an EBIT of $450m AUD (not Bunnings type growth but nothing to cause concern).
Red Flags & Risks: Though the company has maintained market share within an increasingly competitive environment (especially in online retail), the flip-side of this will be the margins. Unlike pure-play online retail, the existing store-footprint means that the cost base is substantially higher and uncertainty around Covid-19 as well as the impact on supply chains remains uncertain. It will be incumbent on management to deliver an omnichannel experience to customers whereby the stores are effectively turned into distribution centres. That said, credit where it’s due, the spin-off of Coles was a solid play and gives the company ammunition to go hunting for deals. For the moment, consumer sentiment and overall outlook will be the biggest factors impacting the business going forward.
My Expectations: Management has delivered for shareholders and remains a business that has consistency in terms of managing expectations as well as payout ratios for its shareholders. A lot of the reporting was however quite tactical and backward looking to do with the retail division and how the business was coping with Covid. No clear outline was given about where it was heading from here. In my view, a focus on their chemicals business will be interesting and the play for Lynas last year was an indication to me of where they were looking in terms of the future (though one wouldn’t have known it from the commentary).
Dividend Yield: Assuming a share price of $47 AUD, then WES has a stellar 3.6% dividend yield.
With a proven consistency in terms of payout, a good yield for the income hunters.
Disclaimer
BHP is currently owned by the author of this article, Sid Ruttala. TAMIM has no current exposure to the three stocks mentioned in this article.
