As mentioned last month, with reporting season in full swing, we will address the trading outlooks and our expectations around the upcoming results for some of our core holdings. Last month, we discussed Pioneer Credit, Fiducian and Zenitas, whilst this month we will focus on Apollo Tourism and Leisure, Elanor Investors and Konekt.
ATL is a leading integrated, global player in the RV (recreational vehicle market) – manufacturing, importing, retailing and renting RVs in Australia, NZ, United States and Canada.
The company was recently profiled in the Australian.
In early May, ATL provided a strong trading update, expecting FY17 NPAT to be between 5% and 10% above its forecasts. Management commented that forward rental bookings were ‘looking positive’ in all geographies, with bookings for the upcoming USA season tracking ahead of last year. In relation to ATL’s retail operations, Management noted that continued growth in new vehicle sales was expected in Australia and New Zealand, particularly for the Adria and Winnebago brands.
We believe beating the company’s prospectus forecasts will give the market increased confidence in the ATL strategy. Growth into FY18 for ATL will be supported by earnings contributions from its recently acquired Australian caravan and motorhome retail operations and its new wholly-owned Canadian RV subsidiary, CanaDream Corporation – one of the largest RV rental and sales companies in Canada. Both acquisitions are expected to be earnings accretive in FY18. Ongoing tourism growth from ATL’s key markets, particularly Europe, and increased RV fleet utilisation is expected to result in strong profit growth for ATL in FY18.
During FY18, to support its Australian retail RV footprint, management expects to relocate it Brisbane manufacturing facility to larger premises, resulting in an incremental ~$1m operating cost in FY18. This incremental cost will diminish in future years when the existing facility is fully exited. Notwithstanding this additional FY18 expense, ATL continues to trade on an undemanding multiple for a growing global company of ~12x FY18 earnings.
Konekt provides workplace health solutions, helping organisations prevent workplace injuries and minimise the impact of workplace injury costs by assisting injured employees return to work. KKT is an Australian market leader (~11-12% market share) in a very fragmented market.
In May, Konekt confirmed its revenue guidance in the range of $51.0 to $53.5m and EBITDA margin in the range of 10.5% to 11.5% (of revenue).
In H117 KKT recorded revenue of $26.3m at 11.3% margin and noted it was well positioned going into 2HFY17 with some good momentum across the business. We would expect a result at the top end of guidance which implies earnings per share of c. 5 cents. This places KKT on a price/earnings multiple of c. ~11x FY17 earnings.
We do not think that is demanding pricing for a market leading national business, very well led by Damian Banks, and with a strong track record of very high earnings growth (EPS was just 1.4 cents in FY14). The business has the potential to take further market share in a fragmented market and/or expand its range of service offerings to become a diversified corporate health provider. To drive organic growth, KKT continues to open new offices (to add to its existing network of 40+ services) and to offer to existing clients a wider range of services (ie workplace mental health).
Notwithstanding a significant CAPEX program undertaken for FY17 (approximately $1.8m), KKT’s free cash flow and acquisition funding facility of up to $10m positions it nicely to take part in industry consolidation and provides further potential upside to organic growth. Given the sector consolidation, KKT also may be seen as an attractive takeover target itself at some stage.
Elanors Investors (ENN.ASX)
ENN guidance: not provided
TAESC estimate of core earnings: $12.3m
(FY16 Earnings: $11.6m)
Property and hotel fund manager and investment company, Elanor Investors, is a portfolio holding where we are expecting a small increase in earnings for the year, but a weaker earnings per share result relative to the prior year due to share issues during the year. While ordinarily this would be concerning, for the reasons set out below, we believe ENN now represents compelling value for investors.
After a strong first half where ENN delivered a record result on the back of significant performance and acquisitions fee, ENN’s second half will be softer with reduced contributions from performance and acquisition fees.
However, based on a market update in June, as a result of recent valuation uplifts to its hotel and tourism assets and the mark to market of a development asset, ENN’s underlying net asset value is now approximately $2.00 per share, almost equal to its current share price.
What this means is that the market is essentially valuing ENN based only on the value of its hard assets (its hotels and property investments and some minor non-core assets) and is attributing almost no value for ENN’s actual ‘operating business’ – its highly regarded fund management operations.
This fund management business currently has $700m funds under management, and generated segment EBITDA of $8m in FY16 and $7.8m in H117 (driven by $5m in performance and acquisition fees), and has significant leverage to ongoing FUM growth and significant potential performance fees. ENN management are optimistic about converting their strong pipeline of new fund initiatives which should support growth into FY18 after a relatively quiet last 6 months in terms of FUM initiatives and divestments.
As value investors, we believe that this represents a compelling value opportunity, and we like the ability to buy a share of a high quality funds management business with a top class management team for next to nothing. Catalysts to potentially unlock this value include the sale of non-core assets, new fund initiatives and asset realisation / generation of performance fees.
Note: All three stocks mentioned here are currently held in the TAMIM Australian Equity Small Cap IMA portfolio.
Australia has a love affair with property, however you can’t go a week without seeing a newspaper headline proclaiming the next property crash. The low level of global and local interest rates over the last 9 years has caused property prices to go up significantly due to low financing rates and investors searching for an investment vehicle to provide them with a better yield then they are able to receive from the banks. The apparent benefits of property are good long term return potential.
Generally property is an asset class with lower levels of volatility and when added to an existing portfolio of shares and bonds it is an excellent diversifier of overall portfolio risk. Headlines, as always, are dangerous as they are designed to sell newspapers and don’t provide the full picture. With property (as with equities) there are a large number of factors to consider. This includes the ever important location, location, location as well as the yield on the property. You also need to consider which sector of the property market you are looking at, is it residential housing? Commercial buildings? Industrial factory space? Or retail shopping centres to name a few. At TAMIM we are constantly researching investment markets for opportunities to deliver returns to clients and over the next few months we will be sharing our thoughts on investing into the various property sectors starting with retail.
There are a lot of significant factors that impact the performance of a shopping centre be it regional or metropolitan.
Anchor tenant:
One thing that is noticeable is that the performance of the anchor tenant be it a supermarket or discount department store has a very strong bearing on the overall returns of a shopping centre. The anchor tenant can, amongst other things, be impacted greatly by opening hours, the range of goods on offer, the price point, and the ratio of car parking. This, logically, can impact the performance of the adjoining specialty stores. If customers visit the centre for their staples then the surrounding stores will, in turn, benefit from increased foot traffic.
Catchment Areas:
As can be expected, the retail sector will always face cyclical and structural economic issues. Several cyclical issues are beginning to move in the sectors favour. With strong growth in four or five sectors and dwindling numbers in four or five other sectors, employment is a cyclical issue significantly impacting the performance of any given shopping centre. The jobs gained and lost are not necessarily in the same locations. It follows that certain catchment areas are doing better than others.
The catchment area for the shopping centre impacts the performance of the centre. Accessibility (i.e. the surrounding road system and the actual points of access to the centre) is a factor while location in relation to competing centres is also important when projecting performance. As you can imagine, the size and demographic (age etc.) of the population as well as the potential for its growth in the long term can have a material and critical impact on performance. In today’s world, with greater fluidity of the global population and increased levels of immigration, ethnic factors are increasingly playing a role in determining the performance of shopping centres too.
Demographics:
Continuing this discussion around employment and catchment areas, the size and shape of the workforce has a weighty influence on retail property. Wages dictate spending and jobs roughly delineate catchment areas. Australia is one of a small number of countries that have enlarged their workforce over the last ten years. The Australian workforce continues to grow in size while unemployment creeps lower. This has occurred in part because growth in wages has been borderline stagnant allowing for the hiring of more workers than may otherwise have been the case. Inflation in asset prices has boosted household wealth despite household income growth being restrained. Growth in household disposable income remains below average despite positive contributions to household spending capacity coming in the form of increasingly low interest rates, depressed petrol prices and increased comfort regarding job security.
Spending patterns:
It appears that changes in consumer spending patterns in the last decade have had a negative effect on apparel, department store, and discretionary retailing turnover in general. This has affected tenants in many regional and some sub-regional centres. Many sub-regional shopping centres have been immune from this though. The turnover statistics from ABS in the table below show robust growth over the long term in many of the significant retail categories found in your average shopping centre. Supermarkets have been seeing solid turnover growth as have the liquor stores that come under their stable. Discount department stores dealing in discount clothing, electronics, and household goods including furniture have also been experiencing decent turnover growth. Specialty shops associated with shopping centres such as bakeries, chemists, newsagencies, take away food stores, and other local service providers such as dry cleaners may be in the tenancy mix too.
Source: Savills
The Amazon factor:
In addition to these broader issues, there is the imminent arrival of Amazon on our shores to consider when looking at retail property. There is no doubt that Amazon arriving here will have a significant impact on retail. Having said that, there will be a grace period of sorts before the impact is truly seen. Amazon will need to set up the infrastructure they need to properly compete with shopping centres and follow that by winning over the trust of the Australian public before taking significant market share. In looking at the entry of Amazon to the Australian market one must also consider that regional and sub-regional shopping centres will unlikely be affected anywhere near as quickly or as much as those located in the major cities as Amazon will look to establish itself and win over major population centres like Sydney and Melbourne ahead of places like Newcastle or Ballarat. To this point, Amazon recently confirmed it will open a 24,000 sq metre warehouse in Melbourne’s Dandenong South.
The Trend for 2017:
Smaller stores are in; larger stores are out.
Changing consumer preferences will push more and more “big box” retailers to focus their attentions on smaller-format stores. Less is more in 2017 when it comes to store size. Retail giants such as Target, Best Buy, and Ikea are already adjusting to this trend by increasingly spending on smaller-format stores instead of their traditional borderline-warehouses. The importance of convenience and accessibility in todays world of instant gratification is key to understanding why shoppers are moving away from larger stores. People just don’t want to waste their valuable time roving the never-ending aisles of huge stores these days. They want things to be made easy for them with smaller stores offering specialised selections. Additionally, smaller stores cost less to establish and run. They also take up less space in urban environments which allows retailers to capitalise on the potential of more densely populated areas.
“Retailtainment”, as may be evident from the name, is the combination of retail and entertainment. The concept is a concerted effort by retailers to offer shoppers a fun or unique experience that incorporates lifestyle elements into their stores. Things like boutique coffee offerings or reality experiences that are more likely to engage retailers and keep them coming back for the shopping experience. For an international example one can look at Fortnum and Masons, a department store in Piccadilly in London. The 3rd floor has been transformed from menswear (which is offered in overabundance in other local outlets) to a cocktail bar.
The opportunity:
The structural issues facing retail property can be formidable but certainly not insurmountable. TAMIM anticipates that the retail sector will evolve to take advantage of these structural issues rather than be over-whelmed by them. An ageing population will not stop creating challenges for the retail space as they compete for the all-important spending of retirees. Retirees can usually be expected to show preference for services over goods and will not necessarily continue to dwell in their traditional catchment areas. Online shopping has already had a great impact on retailing for certain categories of goods and, with the imminent arrival of Amazon, it will no doubt continue to present challenges for the sector. Retail has already been forced to begin adapting without the world’s biggest player arriving and will continue to do so. Certain areas, notably regional and sub-regional centres, will likely hold out longer and more effectively than their metropolitan counterparts.
Every six months in Australia, reporting season comes around. It’s an important time for investors as it gives us a chance to see in detail how companies are travelling and, in some cases, what their outlook is for the year ahead. As a result, February and August become important times for shaping portfolios and generating investment ideas. Whilst every result will be scrutinised, we believe this reporting season there are a number of major questions outstanding for which we will receive further clarification.
Reporting Season: The unanswered questions Guy Carson
1) Will Telstra cut its dividend?
Back in February, we wrote that “we expect that Telstra will be forced to cut their dividend sooner rather than later.” That was on the basis that Telstra was paying out more in dividends than it was earning as can be seen below.
Source: Thomson Reuters, company filings
From the above we can see that historically Telstra has paid out close to, if not all of their earnings in dividends. However, going forward we believe this needs to change. The Telstra of today is a very different company to ten years ago. What was once a national monopoly now faces competition on all fronts. As a result, the company will need to invest in their networks and in other growth initiatives to stay ahead of the pack. Previously, due to their natural advantages the company could pay out earnings and then use to capital markets to facilitate investment. With the increase of competition and the potential decline in margins and market share ahead, we believe this capital allocation strategy needs to be revised. As a result, we expect Telstra to cut their dividend. Whether it happens at this result or they provide guidance for next year, we believe we should get some clarity at this result.
2) Will the end of the residential construction boom factor into the guidance for residential REITs?
The leading indicators for the residential construction industry are pointing down. Building approvals have peaked, commencements have followed and completions typically follow 6-9 months after.
In an economic sense, this has been one of the major drivers of the Australian transition from the mining boom in recent years. With the RBA cutting interest rates from 4.75% to 1.5%, they have sparked the biggest building boom in Australian history. With the downturn upon us the only question that remains is whether we have a hard or soft landing. How the major developers react will be interesting.
The building boom has been kind to some of the major listed players in recent years. Mirvac, for example, has seen residential earnings grow by 51% last year and potentially by another 45% this year.
Source: Company filings
The focus though will quickly turn to next year and the expected amount of settlements as well as the level of presales. If volumes start to decline, earnings will follow.
3) Which companies are shaping up to be the major beneficiaries of an East Coast infrastructure boom?
With the residential construction boom potentially coming to an end, one of the most compelling stories from a top down perspective is the coming infrastructure boom set to take place predominately on the East Coast. The chart below looks at the major construction projects across Australia and their planned timing.
Source: CImic Company filings, Macromonitors
The vast majority of projects are taking place in New South Wales (Bruce Highway, NorthConnex, WestConnex, Western Sydney Roads, Sydney Metro, Sydney Light Rail) and Victoria (West Gate Tunnel, City Link – Tulla Widening, Melbourne Metro Rail, Regional Rail Revival). Both state governments have seen significant cashflows from stamp duty in recent years and are now in the process of spending the proceeds. The focus is very much on roads, which seems a little short-sighted particularly in Sydney where there is a definite need for a legitimate metro/rail system.
There will be some significant winners from this increase in infrastructure work, the question investors have to ask is who they will be and is it already in the price. Obvious beneficiaries such as Cimic have seen their prices run hard but there is one value opportunity that we have initiated a position in recently, which is Veris.
Veris is a Western Australian based surveying company that has expanded into the East Coast via acquisition. The surveying market is highly fragmented and as the first mover with a roll up strategy, Veris has a good opportunity to grow strongly over the coming years.
4) Will WA arrears start to hit the profit line of the banks?
The only one of the big four with a June balance date is Commonwealth Bank. Whilst the other three have quarterly updates around the same time, the focus will be very much on the details of the CBA result. To that end, one area of risk we have identified in recent times is the rising arrears within the Western Australian property book. The rise in arrears started in 2015 (coinciding with the peak in the residential construction market in WA) and has continued steadily in recent periods.
Source: Company filings
If arrears persist, they move to stressed and eventually become impaired. A large increase in impairment expense as well as a stagnating top line saw Bankwest’s cash NPAT fall by 12% in the first half of the financial year. High volume growth within the Retail Bank saved them as they grow their asset book by 8% in total over the half. The question is will slowing volume start to reveal some cracks.
Source: Company filings
The volume growth from the first half will continue to benefit earnings in this half but we’d expect the rate of operating income growth to slow in coming halves.
Ultimately, these are some of the issues will dictate the direction of the Australian Equity market over the next six months. Of course, there will be other stories that will catch us by surprise and the ongoing movements of commodity prices and the level of the currency will have an impact. Portfolio management is a 365 days a year job and we need to absorb and process information at all times, it’s just in the next month we will see a large amount hit us at once.
This week Robert Swift takes a look at the currency debate that has been raging recently. Robert takes a look at what has happened so far and how he expects equities to react accordingly. Is it time to increase or decrease your weighting towards international investments?
Investing internationally can expose you to currency risk. If the AUD$ falls against other currencies then you benefit to the extent that the value of your investment rises when translated back into AUD$. On the other hand if the AUD$ rises then the value of your investment is reduced by the extent of the decrease in the foreign currency. It is important to note that you haven’t lost money if you do not sell the position. It is only a “loss’ or ‘gain’ on the basis of adjusting prices to current market values.
Currencies fluctuate and in the short run can do so for random and illogical reasons. In the long run (5 years +) they tend to follow a more logical path which is determined by relative competitiveness in traded goods. Countries with more debt, more inflation, and less capital investment tend to have currencies which structurally decline in value.
The AUD$ has recently risen by about 5% against the US$ and the global equity portfolio has about 50% of its assets in US$ denominated stocks. This has reduced the value of the portfolio.
We consider below the reason for the increase and, more importantly, if it will it continue. Are we going to see a repeat of the commodity boom from China which drove the AUD$ over parity, and at the time caused all sorts of currency experts to predict that the AUD$ would remain there! As we said – currencies fluctuate in the short run and are notoriously hard to predict.
While equity prices could be said to behave in a predictably irrational fashion, currencies tend to behave in an unpredictability irrational fashion.
So what happened and why do we think this is nothing to worry about? You shouldn’t sell international equities nor be afraid of owning many foreign currencies.
The RBA’s Deputy Governor successfully (sort of) arrested the Australian dollar’s ascent last Friday, but while it has at least stopped rising for now, its recent surge has not been reversed as it laps at 80 US cents and 5.4 Chinese renminbi (yuan).
The US$ was faltering after a strong run as part of the ‘Trump trade’. Political gridlock in Washington (aka chaos) has removed some of the lure of the US$ and the big increase in infrastructure debt issuance at higher interest rates, now looks less likely.
The Federal Reserve is once again signalling a slow exit from zero interest rate policy and only gradual increases in interest rates. The Federal Reserve, like all central banks, is keen to keep hinting to the market what they will do and is consequently causing the volatility.
As economic news varies between a faltering USA economy and a strengthening USA economy, the US$ rises and falls with expectations of interest rate changes. In the Northern Hemisphere Summer, USA economic activity tends to be softer. Although seasonal adjustments are made in the measurement of these statistics, they are imprecise.
The RBA Board meeting minutes released recently indicated the Board viewed the neutral cash rate as around 3½% compared to a current rate of 1.5%. This was (incorrectly) taken as a hint that rates would shortly be on their way there.
The iron pre price in US$ has bounced which helps the AUD$.
Why do we think this is a temporary surge and one should remain invested in unhedged international equities?
The last thing the RBA wants is a rising AUD$. it continues to acknowledge that …“An appreciating exchange rate would complicate” the transition of the national economy away from its earlier heavy reliance on the construction of big-ticket resource projects.
USA inflation, or many components of the index, remains well-contained, and so the RBA’s capacity to switch back to a tightening bias, much less actually raise the cash rate, is limited by the extent to which they want Australian interest rates to be a lot higher than USA interest rates. We show the spread in the chart below. We are at an extreme now and a wider spread is not helpful to a smooth economic transition.
Source: Bankwest
Export item prices other than iron ore are still subdued. Note also that Chinese GDP composition will be different in the next 15 years from the last 15 years. In the last 15 years there was a lot of construction and basic infrastructure. As the economy matures there will be more services and less physical construction. To view Chinese GDP as being a predictor of commodity demand may no longer be quite as easy and analysts will have to be cognisant of this changing shift rather than simply measure the rate of Chinese GDP.
Most importantly the AUD$ is not a cheap currency. The OECD calculation of the PPP fair value of the A$, an anchor price around which news flow drives it up and down, is about $0.71. We attach that chart below.
Source: Thomson Reuters
Consequently the AUD$ at a little above fair value is not likely to rise much more. With the Australian dollar at levels above 80c, one should be investing more into international equities to attain better portfolio diversification and to gain exposure to sectors and themes not present in Australia.
As is traditional, with reporting season fast approaching TAMIM have asked our mangers to provide a quick preview of what they expect and hope to see over this always interesting period. This week the Small Cap team review Zenitas Healthcare, Fiducian Group and Pioneer Credit.
ZNT’s share price weakness of late has been a key contributor to the fund’s recent underperformance. We have written previously about our thesis for investing in ZNT.
This recent interview with Justin Walters, ZNT CEO, provides an up-to-date summary of the ZNT strategy and opportunity.
As noted in this interview, ZNT has, as of late June, re-affirmed its previous EBITDA guidance and we would expect to see ZNT report in August an EBITDA profit in excess of $6.6m.
More importantly, the outlook for FY18 would appear positive, with 14 new clinics set to open early in FY18 which are expected to contribute to FY18 earnings, together with other organic growth initiatives that ZNT are pursuing. ZNT’s management are confident of capturing further market share, in a market that is growing at ~5% annually.
We see the current share price weakness as a reflection of the market’s impatience regarding delays in ZNT announcing an earnings accretive acquisition, rather than a sell down based on any fundamental aspect. That reaffirmation of guidance and positive industry and company outlook suggests that the thesis for investing in ZNT remains very much intact.
We have recently met with ZNT’s CEO and understand that a number of potential acquisitions are being progressed, and we are confident that these will add further scale to ZNT’s GP and homecare footprint* (ZNT already owns the largest network of allied healthcare/physiotherapy clinics in Australia). Irrespective of any acquisitions, the company continues to grow organically.
With a market cap at 30 June 2017 of $42m, cash of $9.7m (31 March 2017), undrawn debt funding for acquisitions of $10m and reaffirmed FY17 EBITDA of $6.6m, we continue to see ZNT as a highly compelling and undervalued investment, with material upside.
An increasing focus on 1) the benefits of community/home care as opposed to high cost hospital care, and 2) the potential for integrative health care to assist in the management of chronic disease will support the ongoing growth of ZNT.
*on 3 July 2017 ZNT announced an investment into an established homecare company with a large presence (800+ staff) across the east coast of Australia.
Diversified wealth management group FID does not provide earnings guidance; however, it has outlined a double-digit target for earnings growth. FID has achieved double digit annual EPS growth in 13 out of 17 years since it listed on the ASX.
FID appears to be positioned well for a strong full year result:
As at 30 April 2017, FID’s total funds under administration, advice and management (FUMAA) was $5.6b versus $4.7b at 30 June 2016 – an 18% increase over 10 months, with 2 of the strongest months of the financial year for inflows remaining.
As at 31 May 2017, FID’s reported funds under management was $1.8b, up from $1.47b at 30 June 2016 (23% increase for year to date).
In the second half of the financial year FID has acquired $52m in funds under advice through the acquisition of 2 financial planning networks.
FID’s operating model benefits from significant operating leverage, so these positive developments in relation to FID’s asset management base are supportive of strong earnings growth. In its half year result, FID noted the reduction of its Cost to Income ratio as a result of the scalability of operations. FID’s reported operating cash flows as at 31 March 2017 are strongly up on the same period for last year.
For the first half of FY17, FID delivered EPS growth of 22% with underlying NPAT of $4m. Based on a continuation of strong asset flows in the second half, FID is on track to deliver underlying NPAT for FY17 of approximately $8.5m (~22% increase).
Pioneer Credit (PNC.ASX)
PNC NPAT guidance: $10.5m
TAESC estimate: $10.5m
Financial services company Pioneer Credit re-affirmed its FY17 guidance and provided FY18 guidance in early April.
Since then, we understand that collections have remained steady and average payment terms are steady, underpinned by low unemployment rates across Australia and New Zealand.
Pioneer continues to build out its analytics focus, with a team of 12 now working on more sophisticated analysis, new business initiatives and predictive modelling.
PNC has also been busy recruiting staff for its anticipated growth, and while labor intensive, its success rate in recruiting staff has been improving. PNC’s staff retention is assisted by a strong culture installed by its impressive management team.
Due to the significant investment in training, it takes 5 months before new staff are profitable. All head count increases in back office, finance, risk, analytics, have been factored into Management’s forecasts.
We understand that Management remain comfortable with its disclosed forecasts. Despite a strong share price performance in recent months, PNC’s FY18 guidance of EPS of ~27 cents puts it on a multiple of under 9x, yielding 6% fully franked based on a 50% payout ratio. We believe this remains compelling for a business with a very strong management team, which is growing earnings at a double digit rate.
Note: All three stocks mentioned here are currently held in the TAMIM Australian Equity Small Cap IMA portfolio.
