Markets are always made up of at least 2 opposing views. This is what makes markets what they are. Trying to come to a price through the discovery of existing and new information and factoring all of this into future cash flow projections is what makes financial markets. That is why the team at TAMIM is passionate about what we do, we love the intellectual pursuit of finding out information that perhaps the market has not yet figured out. We use this knowledge in putting portfolios together. Because we know that different investment methodologies will work in different market environments, we work with a number of managers across a number of investment styles and asset classes, this allows us to always have a solution for the current investment environment.
European banks are in free-fall. The Stoxx 600 Bank index is down 42.5% from its high on the 20th of July 2015 to the low on 11 February 2016. This is largely driven by concerns over the ability of Central Banks to support markets globally. Mario Draghi’s policy of more and more quantitative easing is not working. Europe’s banking system is fundamentally weak. There is not enough capital supporting the mountain of debt on the banks’ balance sheets. In addition to this the ongoing weakness in oil prices causing worry about banks exposure to oil and gas corporates and the weakness in emerging market debt emanating from China continues to make the situation worse.
source: www.stoxx.com
On the surface, Australia’s banks are much stronger. But our love affair with residential property has resulted in housing dominating the asset side of banks’ balance sheets (as we all know, house prices never fall!). On the liability side of the balance sheet, it is believed that banks have a large reliance on offshore borrowing which to be fair is partially offset by a large and stable domestic funding base. The liquidity pressures on the global banking system mean that the cost of financing these liabilities will rise. The ASX Financials ex A-REITs index has fallen 24.9% since its peak on the 20th of March 2015 to the low on 12 February 2016. Is there more weakness to come. It is interesting to note that there is divergence in this index with CBA down 27.1% at is low (it has since recovered) while for example ANZ is down 41.3% from its high.
source: au.yahoo.com
Given the above global and local movements there has been a lot of commentary on the banks recently so TAMIM has done its research and has the following Bull and Bear summary of the issues for you to consider.
The Bear View
Dependence on offshore wholesale funding is what’s having most impact on local bank share prices in the short-term. Despite a strong local deposit base funding pool there is still a reliance on offshore wholesale funding. With concerns around European banks and financial markets at present there are concerns on the Australian banks ability to continue to raise funding offshore in the short term.
The risk of a recession in Australia has increased over the past year especially with the global resource led slow down. A recession and a resultant increase in unemployment would have a negative impact on the banks. Australian banks are highly exposed to lending to the household sector (over 50% of their loan books). Australia has the highest levels of household debt to income globally at 185% and any significant increase in unemployment would see the Australian banks profitability levels impacted.
Concerns that bad debt provisioning especially that focused on residential house lending is low and bad debts in these areas are likely to increase in the face of a possible recession.
Banks are increasingly being required to hold higher levels of capital to strengthen their balance sheets. The increased capital requirements are hurting returns on equity and earnings per share. As their share prices fall, the cost of raising this equity increases. This will suppress future returns from the sector.
Negative fallout from the financial planning review which could result in class actions for the banks’ wealth management and financial planning arms.
There is concern that the banks will not be able to sustain dividend levels especially NAB and ANZ.
The Bull View
Domestic funding capability continues to be strong with deposit funding in the 4 majors between 50% to 64% of total funding. Interestingly it seems that the banks have been able to extend the funding tenor for wholesale debt to longer terms. For example, the average wholesale funding tenor for CBA has been maintained at 3.9 years while liquidity coverage further improved to 123% of total net cash outflows. We wait with interest to see the results from the other 3 majors.
Valuations on ANZ and NAB are at the best levels since the GFC when taking price to book values into account. Book value is the value of the tangible and intangible assets on a bank’s balance sheet. If you are willing to pay more than book, you are signalling that you expect ROE’s that are greater than the cost of equity required to fund those assets. In the first half of 2009, ANZ and NAB’s price-to-book multiples were 1.1x. While CBA was 1.3x and Westpac was 1.4x. Six years later CBA had bounced back to 3x, Westpac was 2.5x and NAB and ANZ touched 2 times. The last 12 month of regulatory-enforced de-leveraging and a string of global shocks have reduced ANZ and NAB’s price-to-book multiples to 1.2x and 1.4x, respectively. This would seem to suggest that on this measure ANZ and NAB are of interest.
The sale by NAB of the Clydesdale business and ANZ retreating from its riskier Asian businesses are both credit positives.
The current generation of bank bosses seem to be superior risk managers than their predecessors which will be required in this ongoing global debt deleveraging cycle.
Dividend yields for the banks are now high (between 5.7 and 8.2% on a 12m forward yield) given the recent share rice falls which will bring buying from the retiree sector. This will provide a level of support to bank share prices.
Credit exposure to energy is 1.1% for the CBA while the other Australian banks have exposures up to 2%. The exposure of Australian banks to this sector is about half of their global counterparts.
Mortgage repricing on investment loan books took place in November and has not fully flowed through to the Net Interest Margins of the banks. This will be a positive for the bank’s profitability on a forward looking basis.
Source: CBA company filings
Should you own, buy or even sell the banks. The case can be made for all 3 situations and we believe the answer will largely be impacted by your circumstances and especially your time frame of investment. The recent correction in banks has vividly illustrated the risks of running portfolio’s that have a high level of concentration to 1 sector. In this case, the banks. It is even more important to be aware of this concentration risk when holding the banks because as Australians we are also highly leveraged in most cases to the property market. As always, consider both side of the argument, safe investing from the team at TAMIM.
The Wellcom story starts with industry doyen and patriarch Wayne Sidwell. One of the Wellcom non-executive directors remarked Wayne Sidwell is Wayne Sidwell, nothing more need be said”. When James first met with Wayne, he immediately recognised the business had a very astute, experienced and engaged leader. Subsequent due diligence, including feedback from competitors, confirmed Wayne’s reputation as a fierce competitor but at the same time an honest and honourable man.
While WLL may only have a 10 year track record as a listed entity on the ASX and 15 years as an incorporated company, the history with the Sidwell family in the industry runs for over 8 decades. Wayne’s father Bill entered the industry in 1932 as an apprentice and eventually built up a family business. In 1968 Wayne joined the family business Show Ads / Omega as an apprentice. Fast forward to 1993, Show Ads/ Omega is floated on the ASX and becomes Shomega Limited. Shomega Limited was subsequently acquired by PMP Limited in 1996 where Wayne took over the role as CEO of the pre-press division. In 1999, Wayne resigned from PMP and started Wellcom a year later with 14 hand-selected employees. Incidentally out of the original staff, seven are still with the company in senior roles within the business. In 2005 it was obvious to Wayne that the industry was changing and the business required substantial investment in technology and for future international growth. Hence, the business was floated to raise capital in the same year.
2016 overview from Wellcom group from 2015 AGM presentation
Before articulating the unique Wellcom business model, it is worthwhile adding a little background on the industry to provide context. Years ago, advertising agencies were a one stop shop for clients; they would come up with the ideas, produce and then place them (known as media buying). When media buying was taken out of agencies, they lost control over where and how their idea would be viewed by the consumer. The next big change is taking place right now and relates to the separation of production of the idea from the advertising agency, referred to as decoupling. Enter the few global businesses like WLL who at their core are more akin to technology companies with their sophisticated software programmes, which enable them to offer the full spectrum of services relating to creating, managing and distributing content at a lower cost with faster turnaround times than the traditional incumbents. WLL is at the forefront of disrupting the industry status quo.
Wellcom 3 year share price chart source: Commsec
Today WLL is a truly global company with around 500 staff and 750 clients, with offices and 50 odd Hub’s (internal graphic studios) operating in Australia, New Zealand, USA, UK, Singapore, Kuala Lumpur and Hong Kong. The Hub model is unique to WLL and contributes around 70% of the Group’s revenue. This service involves installation of WLL technology and the placement of staff in the client’s offices, providing a range of sticky services “on-site”. Importantly, they are also an essential marketing resource; new products and services can easily be marketed and deployed to the client managed facility.
As an investor, you feel like you have hit the jack pot when you find a small listed company that is largely misunderstood by the investor community with world leading products and services on the cusp of rapid international profit growth. In 2015, Australia and New Zealand contributed around 75% of Group earnings, with clients including the largest local banks and retailers. To give you an idea of the rapid international expansion, recent global business wins include BASF, UK Trade & Investment, Canon, Patek Philippe, Simon Malls and Tesco. WLL now has global expertise to manage any corporation’s brand management, brand consistency and communications delivery across the globe, including adapting content for local markets.
WLL’s partnership with BBH is worth individual attention. Bartle Bogle Hearty is a leading international advertising agency and have shared a partnership with WLL for many years. It began as a hub/studio in London and then extended into Singapore and New York. 2015 was a year of consolidation for the WLL London office (which was noticeable in the financial accounts) as considerable time, investment and resourcing was deployed in preparation for the on boarding of Tesco business. Tesco is the size of Woolworths and Coles combined. We believe the London office will be a significant contributor to the Group in future years and we expect continued rapid growth from the US and further expansion in Asia.
Wellcom campaign images
To conclude, we own a meaningful position in WLL, a small listed business that is a world leading global production company capable of offering around the clock services connecting industry leaders with customers. The Executive Chairman, Wayne Sidwell, has almost five decades of experience and remains as passionate about the industry as ever. We have a penchant for well-managed, risk adverse (especially when it comes to debt) listed companies generating good cash flow with a strong family business alignment and pedigree. Wayne controls ~ 50% of the company and, as recently as September 2015, increased his holding by acquiring more shares on market. In 2015 the international profit contribution to the Group was still small (especially in absolute terms); there is enormous potential for this company to grow in a large global profit pool from a low base.
Over the next few weeks my good friend and highly skilled investment strategist Jonathan Pain has agreed to share his views on what he is seeing in global investment markets with readers of the TAMIM weekly newsletter. The only thing better then reading a Pain report is listening to Jonathan present. Enjoy the reading.
The Pain Report will provide you with a weekly independent and objective commentary on the global economy, in an attempt to help you identify the key forces which will shape the world in the years ahead. For example, I believe that the most significant and defining economic phenomenon of our time is the rise of the Asian middle classes. I urge you to beware the prism through which you view the world, and to be aware that much of the western media’s negative and sensationalist coverage is biased against the so-called emerging nations. In my view, the decades ahead will see an era of prosperity, enlightenment and opportunity that very few today are predicting. If any of the above resonates with you then please read “The Pain Report”.
“Humpty Dumpty sat on a wall. Humpty Dumpty had a great fall. All the King’s horses and all the King’s men couldn’t put Humpty together again.”Before I move on please read the following article by Kyle Bass, or you can read it later at Corona time.
That the market has had a great fall, there is no doubt. The question therefore is how do we put the Humpty Dumpty market back together again? Can the world’s central banks and governments do it this time, as they did in 2008?
That the world has a lot of debt, there is no doubt. Does the world have too much debt…that is the question. And if you accept the premise of the question, has the great global credit bubble just burst? I can hear the hissing sound, but many can’t. The RBA Governor, Glenn Stevens, can’t hear it, but then again he didn’t hear it in 2007..the RBA actually RAISED rates in March 2008.
Indeed, many argue that the markets have become detached from reality, and that the economic fundamentals just simply do not justify the crash we have seen in equity markets across the world. Only time will tell.
But surely there is a reason for a chart, like the one below. (TOPIX Japanese Banks Index) Please note the ‘great fall’ since the BOJ announced negative rates on 28 January. Oh horror of horrors banks don’t like a negative deposit rate on excess reserves and flat yield curves. (Think net interest income!) What do all the King’s horses and all the King’s men do next time?
What about this chart of European bank stocks?
Or closer to home? The S&P/ASX 200 Financial excluding A-REIT Index.
Is all this noise just simply to be ignored?! I think not. For many months now I have argued that we are witnessing the deflation of a global credit cycle and bank stocks around the world are screaming that message out LOUD. I am not going to talk about China today and leave you to read the Kyle Bass article instead.
Last week I suggested you buy gold.
This week I have no bright ideas and to be honest I want to get out of here because I have a very busy day ahead. It’s a beautiful day here in Sydney and I’ve been sitting at my computer since before dawn…yes I know that’s sad. So to make you and I feel a lot better I’ll show you the ‘Mother of all Indices’…the S&P 500, which bounced off a very critical level, namely 1810.
The other good news is that oil rallied hard and if you believe the UAE there is rumour of a cut in production..we shall see. And in even more good news the Middle Eastern sovereign wealth funds have been HUGE sellers of equities, which helps explain the rather dramatic decline in stock markets and the numerous ‘dead cat’ bounces that we have seen. Also, it is noteworthy that, like many others, they were overweight Japan and Europe, hence these two markets bearing the brunt of the global sell off over the last 3 months. They would appear to have sold rather a lot, and perhaps they are nearer the end of the liquidation programme. This may enable markets to bounce quite nicely but will, alas, not change the BIG issue, which remains the deflation of the global credit cycle and that the central banks have lost their ability to influence/control markets.
Then we face the reality that the PBOC will have to devalue the YUAN…it’s only a matter of time. In the meantime forget about all of this and have a great weekend wherever you are in the world…it’s nearly Corona time!
“Ladies and gentlemen, the captain has now turned on the seatbelt sign. Please return to your seats and fasten your seatbelts.” When we’re passengers, turbulence often catches us by surprise; it may even evoke fear and anxiety. The pilots and frequent flyers are usually more sanguine. They understand that more often than not, turbulence isn’t dangerous and only rarely requires a significant divergence or emergency landing. Instead, they stay focused on the task at hand, adjusting the flight path to make the plane more comfortable while relying on their well-tested systems and procedures to mitigate discomfort and risk.
“Ladies and gentlemen, the captain has now turned on the seatbelt sign. Please return to your seats and fasten your seatbelts.” When we’re passengers, turbulence often catches us by surprise; it may even evoke fear and anxiety. The pilots are usually more sanguine. They understand that more often than not, turbulence isn’t dangerous and only rarely requires a significant divergence or emergency landing. Instead, they stay focused on the task at hand, adjusting the flight path to make the plane more comfortable while relying on their well-tested systems and procedures to mitigate discomfort and risk.
Often, market volatility can evoke the same emotions of fear and concern in investors. But typically, the best course is to stay focused, not fearful. As would an experienced pilot, we rely on our rigorous and time-tested processes to manage known risks and prepare for those that may be approaching on the horizon—all while maintaining our long-term course.
During these periods of volatility it is important to remind ourselves of our long term views. In this instance our long terms views remain unchanged:
Global deflationary pressures remain.
The world is still in a period of lower economic growth.
Supportive central bank monetary policies will continue for an extended period.
Government debt levels are still excessive and will need to be worked out over the next decade.
Global demographic shifts continue and we believe the biggest risk to market volatility remains at a geo-political level.
A growing global middle class, can continue to provide economic tailwinds.
As it relates to the near term, many of our “fasten seatbelt” indicators have been flashing. Key market indicators to be monitoring include:
volatility,
credit spreads,
commodity prices,
inflation expectations
We believe we are well-equipped to navigate this turbulence and see considerable opportunities for investors who can stay calm and buckled in during this period of elevated choppiness.
The below table details the sector returns for the S&P 500 over the last 12 years since 2003. The key take out for us in managing the risk of portfolios while continuing to try and deliver returns is the following. Markets will deliver you a set of returns however within the market there will always be brilliant opportunities to make or lose money. Take 2015 as an example. While the S&P 500 was up 1.4% in US dollar terms, through the year there was significant divergence in the sectors making up the market. Consumer discretionary stocks were up 10.1% while Energy stocks were down 21.1%, if your portfolio consisted of largely consumer discretionary stock versus a portfolio of oil companies your 2015 experience would have been remarkably different.
Source: Standard and Poors. Past performance does not guarantee future returns. The historical performance is meant to show changes in market trends across the different S&P 500 sectors over the past twelve years. Returns represent total annual returns (reinvestment of all distributions) and does not include fees and expenses. All data are as of 12/31/15.
Looking at the averages over the last 12 years, the annualised returns over each sector are relatively consistent but it masks the fact that there is huge divergence each year between the best and worst performances of each sector. This can be highlighted in the extreme by looking at the best return for the IT sector at 61.7% versus its worst return at -43.1%.
Source: Standard and Poors. Past performance does not guarantee future returns. The historical performance is meant to show changes in market trends across the different S&P 500 sectors over the past twelve years. Returns represent total annual returns (reinvestment of all distributions) and does not include fees and expenses. All data are as of 12/31/15.
While we’d like to say that the “fasten seatbelt” sign will be turned off momentarily, we believe investors should be prepared to stay buckled in their seats for a while longer. In the meantime, we believe it is of paramount importance to be invested with professional money managers that select stocks and not markets. Managers who have the discretion not to be fully invested and the ability to select stocks independently of markets should outperform in this volatile environment.
Your choice of pilot to guide you through the turbulence is extremely important. You can choose a pilot who is telling you not to fly because of the turbulence or you can choose a pilot who understands his plane, understands the flying environment and a pilot who is confident in his systems and processes.
James Williamson of Wentworth Williamson and manager of the TAMIM Australian Equity Value IMA looks at Collins Food and how it is possible to beat private equity at it’s own game.
Source: Commsec
With the very public dumping of Dick Smith by the equity market over the last month, TAMIM thought it timely to remind investors how to play private equity listings profitably. We have been holders of Collins Foods Ltd (ASX:CKF) since 2013 and have recently seen the stock rerated by the market. Here is the story of Collins Food and how and why we held it for our clients.
KFC landed in Australia in 1968 when the first store was opened in Guildford, Sydney. Today, KFC serves 2 million customers every week through over 600 stores and is one of the most recognised food brands in the country. Collins Foods Limited is the largest franchisee of KFC restaurants in Australia, operating 171 outlets in Queensland, northern New South Wales, Western Australia and the Northern Territory. Collins Foods also has investments in Sizzler (Australia), Sizzler (South East Asia) and Snag Stand, but the collective profit contribution of these businesses is not meaningful to the Group.
Collins Foods listed on the ASX in late 2011 at $2.50 per share, proceeds were used to pay back the vendor, private equity firm Pacific Equity Partners, and reduce gearing levels. Collins Foods is a good defensive business, but it is normally not a good idea buying from a private equity firm in an initial public offering widely promoted by large investment banks! Three months after listing, the company issued a profit warning citing fragile consumer confidence. Disillusioned investors sold the stock down to an intra-day low point of $1.00 on the 9th of May 2012, 60% below the initial listing price. Only now in 2015 has the NPAT (pre-exceptional items) come into the range of the 2012 earnings forecast in the prospectus.
Generally the best time to invest is when uncertainty or an element of fear dominates the thinking of investors and market commentators towards a stock; the sell down of Collins Foods in late 2011 and 2012 was totally out of proportion to the earnings downgrade. We acquired Collins Foods in 2013 when our trust started operating at prices from $1.60 to $1.80.
Our investment thesis for Collins Food cited:
an excellent underlying business;
trading on an undemanding multiple;
good cash flow generation;
low earnings expectations from the investment community.
The acquisition of 44 KFC restaurants from Jack Cowin in late 2013 on an undemanding multiple (probably partly due to his long standing disagreement with KFC brand owner, Yum! Brands) was a natural fit to the existing business, boosting the growth trajectory of the Group. As it turns out, not only have the original core KFC franchises performed better than expectations, the Group stands to benefit from bolting on other KFC operators in Australia, leading to further scale economies over time.
At the most recent reporting period for the half year October 2015, revenue rose 5.1% to $269.7 million as same store sales at its KFC fast-food restaurants lifted 5.2%. Sizzler’s fell 12% as it continues to remain an orphan asset. Earnings before interest, tax, depreciation and amortisation was also up 19.8% to $35.3 million, reflecting strong growth earnings and profit growth. CEO Graham Maxwell said the KFC businesses continued to perform in Queensland, Western Australia and the Northern Territory. The company opened three new KFC restaurants during the half year, two of them were in Western Australia. Sixteen store revamps were completed during the half. The Sizzler Australia business is now managed as a non-core business segment with no further growth capital been allocated. Three stores were closed during the period and the company said earnings before interest, tax, depreciation and amortisation remains positive. The group lifted its fully franked interim dividend by one cent (20%) to six cents a share.
Collins Foods is no longer trading at bargain prices of 2012 and 2013. Net operating cash flow is up 43.4% to $23.8m. In addition, it was pleasing to see the Group report a lower net leverage ratio of 1.62. Assuming no further corporate activity, the trajectory for net debt remains on a declining trend (whilst still paying out a healthy dividend stream). With the Friday close at $4.72 TAMIM has shown its managers will not be caught out like other investment professionals by the games of private equity investors.
Source: Commsec