This week we look at two junior banks that currently sit within select income-oriented individually managed accounts at TAMIM. That is the Bank of Queensland (BOQ.ASX) and Bendigo and Adelaide Bank (BEN.ASX). This is a timely review given the RBA’s flip-flopping around the potential timing of rate hikes.
Author: Sid Ruttala
I personally continue to believe that a rate hike will be 2024 at the very earliest given the emphasis on wage growth as a policy metric. If that is the case then the property market is likely set to continue on its trajectory for a good 24-months yet with that being reflected in an expanding mortgage book across the banks.
Given the above context, why look at these two particular institutions? For one thing, both have a disproportionate exposure to residential mortgages as a percentage of the balance sheet; BEN the highest at 72% and BOQ close at 66%. The only close peer to this metric in the Big 4 is Westpac (WBC.ASX) at 63%.
Bank of Queensland (BOQ.ASX)
BOQ is perhaps one of the most unique models in Australian banking, perhaps even globally. Their owner operated franchise bank model is supposed to help the business deliver better customer service as well as build better flexibility. Whether the bank is able to sustain this in an environment characterised by shrinking physical footprints in favour of online business channels is a question for the future. The bank does seem to have a coherent digital strategy however and time will tell how they manage to integrate the existing footprint of ‘owner managers’ into this context. However, for the longstanding shareholder it has been a rather painful experience to date in comparison to her peers (i.e. the opportunity cost of owning BOQ as opposed to holding one of the Big 4).
Nevertheless, it does seem the business is changing for the better. The most recent indicator of which has been the acquisition of ME Bank at a palatable price tag and which has received approval from the Treasurer. This adds a great compliment to the existing mortgage footprint. It has also maintained strong housing loan growth at 1.6x system. This compares well with its peers with the highest amongst the Big 4 being CBA at 1.2x. Numbers wise, statutory NPAT came in at $154m AUD – up 66% compared to 1H20 – and cash earnings grew at 9% to $165m. Perhaps the most important metric for us however was the fact that the business continued to maintain its NIMs despite the falling cash rate (this was predominantly driven by flexibility in deposit pricing). EPS came in at 35.5c per share (up 3%) and with the addition of ME we should see this number grow 30% by FY22.
On the negative side, some of the positive numbers were made possible entirely as a result of reversing Covid provisioning with the bank releasing $75m AUD from its group provisioning as well as a loan impairment benefit of $20m AUD. Despite this, I remain of the conviction that the bank remains a good buy.
Their continued focus on deposit growth and concentration into the residential housing market looks set to continue on par with the broader property market. In addition, despite the significant loan growth, the continued low interest rate environment effectively ensures credit stress will continue to remain benign.
Red Flags & Risks: This investment is almost entirely predicated upon continued growth in the residential property market. Intense competition in the space also creates an environment ripe for the deterioration of credit quality along with pricing pressure. The additional risk of increased costs following the ME acquisition and integration remains.
My Expectations: There is significant upside in line with the broader property market at least till 2023 when the market should begin to price in the possibility of rate hikes; potentially a share price of $13 AUD by end of 2022. This is effectively exposure to the residential property market without having to go through the process of taking out a mortgage and sustaining a reasonable dividend yield for the hassle of doing so.
Dividend Yield: 4.2% assuming a share price of $8.99 AUD, expecting this to grow on a nominal basis over the next Financial Year.
Bendigo and Adelaide Bank (BEN.ASX)
BEN is another bank with a markedly different business model to the traditional banking houses. They operate a community branch model alongside the traditional corporate branches. While this has helped them gain greater scale than would otherwise be the case, this has unfortunately not been reflected in total returns or ROE (as long standing shareholders are probably well aware). So the question remains, why do I believe BEN.ASX seems attractive at this point in time? Again, it effectively remains a play on headline cash rates and the continued growth of the Australian housing market. Along with my soft spot for the fact that it has a significant footprint within regional Australia and Agribusiness (but that’s neither here nor there).
Looking at the outlook for the next 24-months, with 75% of the bank’s book in the residential housing space and continued expansion of the economy along with low unemployment figures, the bank is in a good position to show some decent results. During the last announcements for 1H21, the headline earnings increased 156% compared to 2H20 and 2% compared to 1H20. Cash earnings per share continued to normalise, though they still remained down in comparison to 1H20 (-6%). Similar to BOQ, we should see some decent revisions upwards given that the bank will release somewhere between $30-40m AUD from Covid-related loan impairment provisions and has seen their NIMs stabilize. However, CET1 stands slightly lower than BOQ and the broader banking system at 9.36% but this isn’t a significant cause for concern.
The bank does have a strategy to streamline the process of loan approval and bring down the cost/income ratio. The strategy of trying to attract and retail to younger customers is interesting and it will be worth watching how their digital offering and metrics compare with their competitors. This has so far paid off across most of the business and agribusiness divisions while the consumer division (which remains the bread butter) has seen some progress (Opex coming down by 1.6% in 1H21).
Red Flags & Risks: Like BOQ (and much of the financial services sector in this country) the business has significant concentration risk towards the housing market (more so in this instance as it has the highest percentage of the balance sheet allocated to the space). We are likely to see continued pressure and deterioration of credit quality as players compete for growth.
My Expectations: Again, this is a valid and more liquid alternative to residential property investment with the advantage of a considerably higher yield and, given that the business currently trades at a PE of 12x earnings, a much better risk-reward. That being said, there is better upside with BOQ.
Dividend Yield: 4.5% assuming a share price of $10.18 AUD.
Final Caveat & Biggest Risk
This is again a play on residential property growth. At this point there is a marked incentive for policy makers to reign in the market, perhaps not through the cash rate mechanism but rather through alternatives (e.g. lending standards).
Disclaimer: Both BOQ and BEN are held in select individually managed accounts (IMAs) run by TAMIM.
Three weeks ago Ron Shamgar was on the business channel Ausbiz discussing a number of companies we own with takeover appeal. One of them was rhipe (RHP.ASX). Last week RHP received a takeover bid at a 35% premium to when TAMIM bought in. This week we explain why we believe RHP is still undervalued and explore two other potential targets we like.
rhipe (RHP.ASX)
rhipe is a software reseller and is a strategic asset with 3,000+ resellers across ten countries in the APAC region. They predominantly sell Microsoft products (70% of sales) which provides other acquirers an opportunity to offer other vendor solutions – think Google, AWS, Symantec etc – to its product range.
Source: RHP 1H FY21 Results Presentation
RHP have been expanding in the APAC region, including a Japan JV in 2019, while also growing their portfolio of vendors to offer more solutions. Additionally, RHP have been focusing on building their own IP so they can offer their own software products as a standalone or in bundles with their resale products.
Authors: Ron Shamgar
Returning to the takeover offer, the bidder, a company called Crayon (CRAYN.OL) – is listed in Stockholm and has a very similar business model to RHP in Europe. CRAYN has already raised the funds for the deal through a bond offering so they are fully funded and ready to go. The due diligence and the Scheme Implementation agreement took only three days to complete once the offer was announced.
CRAYN has made this bid for RHP at a cyclical low given their exposure to South East Asia which has been heavily affected by Covid. This impacted their share price; RHP was trading at around $2.40 pre-Covid and has traded roughly in the $1.50 – $2 range since. As touched upon above, RHP has been investing significantly in Japan and Korea of late. Japan is the largest Microsoft market outside of the US and the upside of the 2019 transaction is yet to impact earnings for RHP.
We estimate significant synergies (approximately $10m p.a.) for CRAYN from the acquisition. RHP is cashed up with $54m on the balance sheet and no debt. Based on FY22 forecasts, the RHP bid values it at 15.5x EV/EBITDA but with synergies the multiple is closer to 11x. Other recent software deals have seen multiples range from 18x for Hansen (HSN.ASX) to 49x for Altium (ALU.ASX).
Given the timing of this acquisition and the strategic value RHP offers, we see a high likelihood of competing bids emerging from either an ASX listed company like Data3 (DTL.ASX) or another global player. The bid (with franking credit) is worth $2.56 but we think a price of $3.00+ is more reasonable.
Watch this space.
Capitol Health (CAJ.ASX)
Capitol Health is one of the largest providers of diagnostic imaging and specialist radiology services in Victoria, they currently own and operate 63 radiology businesses around Australia. CAJ is a defensive business with their revenue coming from essential services such as X-rays, MRI’s and ultrasounds. The fact that 77% of their revenue mix is bulk billed is another great defensive indicator, meaning customers pay very little out of their own pocket for Capitol’s services. The newly appointed management team has turned the business around in the last eighteen months with improved margins, organic growth and a strong balance sheet. Their operating EBITDA was up 50% for HY21, improving their operating EBITDA margin from 22% to 31%. CAJ have grown their business by upgrading/expanding their clinics to maximise their revenue potential for each clinic, accretive acquisitions (most recently Direct Radiology) and a focus on customer referrals.
The sector has been consolidating with several deals coming through recently. This includes the likes of Sonic Healthcare (SHL.ASX) buying Canberra Imaging Group at approximately 9x EBITDA and Quadrant selling Qscan to Infratil (IFT.ASX & .NZ). We believe that this corporate action in the sector not only makes Capitol Health look cheap but also makes them an attractive takeover target.
Listed peer Integral Diagnostic (IDX.ASX) is trading on 13.5x EBITDA while CAJ, currently sitting on a market cap of $390m, is trading on 7.5X EBITDA.
The metrics above show how compelling CAJ looks as a takeover target.
Looking at the corporate activity in the sector and the comparison with IDX, we think any takeover premium should see at least a multiple of 12-13x EBITDA and there is also the possibility of CAJ making further acquisitions this year.
Uniti Group (UWL.ASX)
Unita Group is a telco fibre provider to the residential sector and the only competitor of scale to the NBN. We estimate that UWL is currently winning a 25-30% share of all new greenfield developments against the NBN. UWL is currently annualising $130m of EBITDA and has a contracted pipeline of over 250,000 lots to connect fibre over the next 3-4 years.
At full rollout, we estimate that the group will have a run rate of $200m EBITDA. We like companies like Uniti as the majority of this EBITDA is recurring, long-life defensive core infrastructure earnings. Their sustainable cash flows also enable UWL to access cheap credit to expand the business through acquisitions, as we have seen through Opticomm and, more recently, Telstra Velocity, Telstra’s fibre business.
UWL are starting to see some structural tailwinds as demand for data consumption and connectivity rises. This has been accelerated by the pandemic and the general shift towards digitisation, something UWL are looking capitalise on through their Communications platform as a service (Cpaas) which is proving to be a very profitable business for UWL, accounting for 47% of their free cash flow. UWL will also benefit from a variety of emerging thematics such as 5G, IoT and data centres (a theme we spoke about the past fortnight). With a strengthened property market UWL will also have an opportunity to win market share from the NBN on the back of their acquisition of Opticomm who have a big presence in the residential market. Also of note is the fact that UWL recently got admitted to the ASX200 index. This usually provides a bit of momentum in the share price as UWL’s stock would be bought by rebalancing index funds.
Source: UWL 1H FY21 Results Investor Presentation
We have seen significant deals for these types of infrastructure assets here in Australia recently. Super Funds are managing so much money that they are running out of places to invest it all and, in order to achieve their 7%+ p.a. returns, infrastructure assets have become a hot commodity. For example, Telstra (TLS.ASX) has sold half of their mobile towers for 28x EBITDA while Sydney Airport only this week received a bid on 25x pre-covid earnings from Qsuper. It was evident again in Aware Super’s takeover battle against UWL for Opticom last year. UWL are currently sitting on a $2.2bn market cap which puts them at about 17x EBITDA, We wouldn’t be surprised to see Aware or someone else come back and bid for UWL in the near term. We estimate that any bid will be $5.00+.
Disclaimer: RHP, CAJ and UWL are all currently held in TAMIM portfolios.
In order to achieve full autonomy in driverless cars we will need to see much more then just advanced tech in-vehicle, we will also need a significant step up in infrastructure in the cities and spaces around the vehicles. Over the next two weeks we will be talking about two stocks that are well positioned to benefit from the rollout of 5G and the need for connectivity in infrastructure to support the emerging autonomous driving sector.
Author: Adam Wolf
With rising inflation expectations and the Fed outlining their plan to hike rates before the end of 2023, markets have begun to favour value oriented stocks and brick and mortar businesses as opposed to the high growth infotech companies. As expectations of interest rate increases get priced in, it’s the companies at the high growth end, those trading at high PE multiples, that will suffer the most as their cash flows are further into the future. They are worth a lot less now with an increased discount rate as opposed to the brick-and-mortar businesses who have predictable and sustainable cash flows in the much nearer future. Another theme we have seen in the markets is the transition from covid winners to covid losers, a lot of the stocks that benefited during the pandemic lock-downs are now starting to suffer as economies open up. TAMIM’s Global Mobility fund is a long short strategy and benefits from this by seeking out pandemic losers such as delivery services and home fitness/gym equipment providers and selling them short. In turn it can take long positions in those stocks which will benefit from expectations of increasing interest rates.
Crown Castle (CCI.NYSE)
Crown Castle is a leading operator of wireless communication towers in the US and is the nation’s largest provider of towers, small cells and fibre. Crown Castle owns, operates and leases more than 40k towers and has 80k miles of fibre supporting 80k small cells across key markets in the US. In 2014 they transformed into a REIT structure which reduced their corporate tax and increased their distributions to shareholders as per requirements. Crown Castle is similar to other shared infrastructure businesses in the sense that they develope and operate highly capital intensive assets that are utilised over long periods of time and shared among multiple customers. By sharing these assets between multiple tenants customers are able to lower their costs. Crown Castle’s customers include the big four wireless carriers – AT&T, Verizon, T-mobile and Sprint – who account for the majority of their rental revenue .
Source: Crown Castle Company Overview, April 2021
Q1 2021 Key Figures
Market Cap
Q1 Rev
Div yield
Q1 EBITDA
Q1 EBITDA Margin
Net Debt
Crown Castle
$84bn
$1.48bn
2.74%
900m
60.8%
$19bn
Source: Crown Castle First Quarter 2021 Earnings presentation, April 2021
5G Rollout
The rollout of the new generation of a mobile network requires significant investment in cell infrastructure and will need a denser web of transmitters as the demands of the new network are much higher. In simple terms, the biggest difference between 4G and 5G is the speed. 5G networks will be up to 100x faster than 4G. Whilst 5G doesn’t offer the same coverage capabilities, it offers far more channels for transmitting data which delivers higher bandwidth and lower latency. Each generational upgrade demands more data which is ultimately enabled by cell towers and small cells. Crown Castle’s customers are all looking to roll out 5G at scale and are investing heavily to improve and densify their networks. This is starting to drive demand in activity and leasing of Crown Castle assets. The shift from 3G to 4G was fairly stock standard as they were similar networks but the shift from 4G to 5G will be very different and a lot more complicated. It will require a lot more towers and small cells to provide this network. The biggest issue is that there currently isn’t enough infrastructure in place to do so.
Source: Ericsson Mobility Report, June 2021
How will Crown Castle perform in a high inflation environment?
When looking for companies that will outperform in inflationary periods it is important to look for companies that have considerable pricing power and a favourable debt structure. Without pricing power, companies’ margins will suffer as their cost base increases. This is likely to happen to companies that are operating in crowded markets with no competitive advantage. Another factor to look out for is the company’s debt structure, whether it’s fixed or variable. This is important as the company’s cost of capital will rise and, if their debt is on a variable rate, their interest expenses will jump. With the rollout of 5G networks there simply won’t be enough towers to distribute 5G nationwide which not only provides Crown Castle an opportunity to develop more infrastructure but also provides them with significant pricing power in terms of the rates they charge their customers for leasing those towers. Crown Castle effectively operates in an oligopoly with few competitors and high barriers to entry. Management have been actively mitigating the risk of inflation and have embedded escalators in the majority of their contracted revenue. Crown Castle have an inflation-friendly debt structure with 91% being fixed. This will protect them from rising rates as well as benefit them if high inflation occurs as they will be paying their creditors back with money that is worth less, meaning their debt will get inflated away.
Growth Strategy
Crown Castle is at the forefront of a significant opportunity to capitalise on the rollout of 5G networks across the US. CCI’s plan to capture this market is through the development of small cells. Small cells boost coverage in a specific area and are attached to existing infrastructure such as traffic lights or street lamps through fibre optic cables. They also relieve congestion to networks, essential given the increased data usage we have seen in the US.
Source: Crown Castle Company Overview, April 2021
With wireless data consumption increasing exponentially there is a need for denser networks of small cells that will enable wireless carriers to deploy additional coverage and capacity on their networks; this will see small cells become a much bigger part of the network. CCI are currently deploying around 10,000 small cells a year and have invested significantly in fibre as a dual offering to customers; management can see this number increasing with demand. CCI is the only company to offer towers alongside fibre and small cells, making them best positioned to benefit from this opportunity as they can leverage their existing client base of wireless carriers.
Source: Crown Castle Company Overview, April 2021
In November 2020 Crown Castle announced a long term agreement with DISH Network Corporation which will see DISH’s network deployed across 20,000 of Crown Castle’s towers. The revenue from this deal will start to come in from the second half of this year.
Thesis
Infrastructure companies like Crown Castle are considered by some as bond proxies, providing a steady yield supported by their real assets (towers, fibre and small cells). However, Crown Castle is offering a unique opportunity to investors, a bond proxy with equities-like upside. Crown Castle are aiming to grow their dividend by 7-8% annually and, given their opportunity to benefit from the incoming rollout of 5G, this is more than achievable. Crown Castle’s revenue is largely recurring and most of that revenue is from the top carriers in the US. Crown Castle’s contracts are typically between 5-15 years and currently have $27bn in contracted customer receivables. Given that their tenants include AT&T, Verizon, T-mobile and Sprint it makes for a resilient company with sustainable cash flow from creditworthy customers. This also allows Crown Castle to access cheap credit. They have $255m in cash and $4.4bn in undrawn debt facility on their balance sheet, giving them plenty of liquidity to execute their strategy of implementing more small cells and fibre assets to roll out 5G. Given the dynamics of the cell tower industry and the limited infrastructure available, Crown Castle is also well positioned in an inflationary environment as they have sufficient pricing power and a favourable debt structure. Crown Castle will also be a winner of the ongoing emergence of autonomous vehicles with the increased need for 5G and connectivity to ensure driverless cars operate efficiently. We will delve deeper into this next week with our discussion on, Ericsson (ERIC-B.STO).
Disclaimer: Crown Castle is held as a long position in TAMIM’s Global Mobility portfolio. The TAMIM Global Mobility strategy seeks to to capitalise on the ongoing $7 trillion autonomous and electric vehicle revolution.
EML Payments provided an unexpected update in May. This announcement was regarding the Central Bank of Ireland (CBI) and their regulatory concerns around EML’s Prepaid Financial Services (PFS) subsidiary; concerns centred on potential anti-money laundering and counter terrorism breaches. Investors took the worst case scenario approach and wiped almost 50% from the EML’s valuation. We took a different approach. We spoke to management, industry insiders, other Irish regulated fintechs and examined the historic actions of the CBI when dealing with similar breaches.
We came to the conclusion that, rather than EML being in the wrong, this was a broad crackdown by the CBI and other European regulators, enforcing tighter regulations to prevent other financial services collapses and frauds like the Wirecard fiasco last year. We believe that the CBI and EML management will end up working collaboratively to improve any compliance concerns around the PFS programs.
We see the chance of a fine greater than $2-3m as very unlikely while the possibility of losing PFS’ money license is almost non-existent. We do believe that EML will have an additional compliance cost to bare and, in the worst case, they will have to relocate some programs the CBI is uncomfortable with to another regulator elsewhere in Europe.
Overall, this was an unexpected development that not many could have foreseen. We took the opportunity to double up our position around the $3.00 mark. We expect the stock to regain most of its lost value (it was trading at $5.00+ prior) once the matter is resolved over the coming weeks. On the flip side, we believe all additional costs borne by EML will reduce the earn out component of the PFS acquisition which is currently sitting at $110m. Our views and valuations have not materially changed on EML nor our views on its long-term prospects.
Smartpay (SMP.ASX)
Smartpay provides merchant terminals to small businesses in Australia and NZ. The company has a March year-end and, as such, they reported their FY21 results. Revenue was up 20% to $33.8m while EBITDA was slightly up, coming in at $7.6m. More importantly, run rate EBITDA to the end of March was $9.8m. The key growth pillar for SMP is the Australian acquiring business, as opposed to to the NZ terminals business for example, which is growing fast. Revenues for this segment of the business were up 80% to $17m and run rate revenue at the end of March sitting at $27m+ as it adds 4-5k new terminals annually.
We estimate that the company will add a further $20m+ of revenue during FY22, with about half of that dropping to the bottom line. We see EBITDA coming in at around $18m this year, which places the stock on an 11x EV/EBITDA multiple. We think 18x is a more appropriate multiple considering their growth rates, comparable peer valuations and the huge runway of growth next few years. Unfortunately, management doesn’t focus too much on investor relations. This means that the stock is very much under the radar, but hopefully not for long. We value SMP at $1.30.
Money3 (MNY.ASX)
Money3 provided a profit upgrade due to continued strong growth in loan originations in 2H. NPAT is now expected to come in at $38m, up from the $36m it was previously. MNY is benefitting from a buoyant domestic economy and consumer demand for both used and new vehicles. We don’t see this thematic changing much in the near term as international borders broadly remain closed, meaning consumer demand for domestic holiday and travel will remain. Management remains confident in its FY24 $1bn loan book target, an achievement we estimate will yield $80m NPAT.
Spirit Technology Solutions (ST1.ASX)
Spirit Technology provided a four month trading update to the end of April. Overall the update was positive; highlighting the foundation that management has built through acquisitions over the last eighteen months. These include a national brand which encompasses telco and internet solutions, cyber security, and IT services to over 10,500 businesses. In addition, the company now has 150 sales staff who are also supplemented by 350 national resellers.
The focus now is on completing the integration of all their recent acquisitions alongside proving to investors the organic growth potential in the business and their ability to win larger corporate and government deals. We estimate that ST1 is on a run rate for $150m of revenues and about $20m of EBITDA. Management is currently busy divesting ST1’s residential internet customer base and their wireless infrastructure network. We believe both asset sales will move the company into a positive net cash position which will enable larger acquisitions or merger opportunities to be explored. Our valuation is 50 cents.
RPM Group (RPM.ASX)
The RPM Group provided a Q3 trading update and Q4 forecast. For the quarter, revenues were up 59% to $14.5m while EBITDA was up 87% to $1.28m. The balance sheet has a net cash position of $4.5m. The company is focused on further acquisitions in a number of divisions; Wheels and Tyres, Mechanical Repair and Roadside. More importantly, the Q4 forecasts of $15.2m revenue and $1.5m EBITDA are on track. We believe the group is now annualising $60m in revenue and $6m of EBITDA. We expect further acquisitions to take the company to in excess of $100m revenues next year. Based on the achieving of this target, we would value RPM at $1.00.
Ive Group (IGL.ASX)
IVE provided a trading update alongside FY21 guidance of $100m underlying EBITDA and net debt of just under 1x EBITDA. The company highlighted that it continues to win and renew major customer contracts. That being said, a number of the Group’s revenue segments – travel, catalogues, exhibitions and events – continue to be at reduced levels from last year.
We expect that the company can continue to pay fully franked dividends of 14-16 cents of per annum on EPS of 20-22 cents p.a. Prior to Covid, IGL shares traded in the $2.00-$2.40 range and, on current business conditions, we believe the shares should trade at $1.80-$2.00. We bought the stock at 70 cents and, going forward, we are happy to receive our double digit return via dividends.
Earlypay (EPY.ASX)
Earlypay provided a trading update with record transaction volume of $199m in March, up 34% on the same time last year. Management reconfirmed full year guidance of $21m+ EBITDA, NPATA of $8.5m+, and a final dividend of 1.3cps+ fully-franked (2.3cps total for FY21). In addition, there have been improvements to all three warehouse facilities. This provides cost savings, greater flexibility and increased headroom which will support continued growth of EPY’s loan book.
Based on company guidance we see 2H momentum and the 2H NPATA estimate of $5m translating to a material increase in earnings for FY22; NPATA of $14m. EPY is a beneficiary of a buoyant domestic economy and demand for finance solutions from small businesses as government stimulus is no longer available. EPY’s recent capability to onboard clients online is driving growth in a larger market opportunity now more than ever alongside an ability to scale quicker with invoice financed volumes now at a run rate of $2.2bn. Our valuation of EPY is 75 cents.
Disclaimer: All stocks discussed above are owned in TAMIM portfolios.
Ron Shamgar is the portfolio manager for both the Australia All Cap and Small Cap Income unit classes of the TAMIM Fund. Both strategies utilise a combination of growth and value investing principles to achieve their objectives. Ron has been actively investing in Australia for over fifteen years.
Doing this exercise last year, we had mentioned the vulnerability of TCL to the Covid economy. While lockdowns and policy responses have made an impact, what has been pleasing was the recovery across most of the firm’s markets with perhaps the exception of Melbourne. Sydney, Montreal and Washington have seen some recovery. Importantly though, the numbers across major markets, with the exception of NSW, are still below pre-Covid (i.e. 2019) levels. Management guidance has indicated that traffic and volume is returning. This is despite changes to flexible working arrangements and the increased use of online retail (both long-term headwinds to the business). One interesting trend that we saw was that 59% of GWA (Greater Washington Area) commuters were likely to use their cars on a daily basis, a higher number by 5% from pre-pandemic levels. Combine this with record high vehicle sales and there might be more to this story than meets the eye. That is to say, are users less likely to use public transport as a result of the pandemic?
Numbers-wise, EBITDA for 1H21 continued to decline to $840m with margins also continuing to see a decline, from 75.7% to 69.0%. Revenue came in at $1.21bn, compared to $1.445bn in the same half last year. On top of this, substantial changes to the AUD have hit the bottom line quite hard with net financing costs increasing by $313m overall. However, the company has been busy with cleaning up the balance sheet and taking advantage of the low interest rate environment while it’s available (as is evident by the refinancing of WestConnex, still yet to see the reduction in net interest costs going forward). It is also good to see the potential to take on additional projects, including the expansion into Maryland. With the Biden Administration’s focus on upgrading the ailing US infrastructure system, the company is well placed to take advantage, this is likely where the next spurt of growth is to come from).
Despite TCL being, in my view, a great reflation trade especially with the recent refinancing’s taking place (where inflation would effectively act as a transfer of returns mechanism from debt holders to equity holders), the situation remains rather messy. We are not likely to see a return to profitability until mid-next year at the earliest. Would’ve liked to see more focus on the new projects in the pipeline as opposed to traffic and volume metrics which we believe the market has already priced in. That said, we are likely to see increased numbers through next year and over the next five years with dividends (assuming pre-covid payout ratios) likely to double as vaccinations are rolled out across North America and Australia. The company, while well capitalised, will also likely require further equity injections as it bids for new projects and finishes off the existing pipeline particularly in North America and especially Maryland, though some of it will be funded by further debt and prudent sale of at least half of the existing US assets.
Red Flags & Risks: Government policy across major markets, including vaccine uptake and rollout, remains the biggest risk in the near term for the company. Heavy and large trucking haulage still remains pleasantly surprising though and this should continue to grow as economies release some of the pent-up demand. Longer term, the increased use of flexible-work arrangements and de-urbanisation across the more developed markets (something which touched on last time) remains a headwind.
My Expectations: The business will focus on expanding its North American footprint going forward, the Biden Administration’s focus on infrastructure does create some tailwinds alongside increased spending in Australia. Not a buy yet as we believe the company will have to do a cap raise in the medium term in order to progress some of their more ambitious projects. This would be the time to get in.
Dividend Yield: 2.6%, assuming a share price of $14 AUD.
I personally remain of the view that the payout ratio will be consistent, the nominal dividend will remain around 40c p/s for now and should head back above 50c by 2022. Over the long-run I am quite bullish given the tailwinds and assuming leadership are prudent in their balance sheet management.
Goodman Group (GMG.ASX)
Goodman continues to interest me with its result. WIP (Work-in-Progress), which surprised me last time I undertook this exercise, came through at $8.4bn AUD for 1H21 (compared to $6.5bn last year). The more recent quarterly gave it an increase to $9.6bn (as of March). Again, a sign of future earnings growth. However, rather less pleasing was that, although development starts were significantly above long-run average levels, my expectation is that completions are substantially below (a bold move but does add some risk). Profitability-wise, the average yield of development WIP is expected to be around 6.8%, a slight but significant increase from the 6.6% previously reported.
Numbers-wise, operating profit was up 16% to $614.9m, gearing reduced to 4.5% from 7.5% and importantly a WALE of 14 years (a stellar outcome). Net debt continued to decline to $800m; a strong balance sheet with $2.3bn in available liquidity. Occupancy rates across owned property remained about 97%. Overall, Goodman has surprised on the upside, I was expecting earnings to stay muted. Granted I did not foresee a bullish property market that saw the business make revaluation gains of close to $1.3bn and the payout ratio back to pre-covid levels quicker than expected.
The company has demonstrated a great degree of resilience through Covid with over 140 transactions globally. There is no doubt that they were pushed along by a resurgent real estate market not only in Australia but across all of the markets in which they operate.
Red Flags & Risks: My biggest risk when we last visited GMG was the likely impact of Covid, this (somewhat surprisingly) appears to have been misplaced. Revaluations have been a tailwind for the business but herein lies the biggest risk going forward. That is, even though we have seen the business benefit from the segments it plays in, a change in monetary policy could be the biggest risk for the long-term investor.
My Expectations: Personally, I remain optimistic about Goodman. Management has delivered according to expectations and their portfolio looks fantastic, including the logistics business.
Dividend Yield: 1.5%, assuming a share price of $19.79 AUD.
We expect this to stay consistent through much of next year with further growth on a nominal basis likely to be in 2022. 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). In that context, it remains a buy for me.
BOQ is perhaps one of the most unique models in Australian banking, perhaps even globally. Their owner operated franchise bank model is supposed to help the business deliver better customer service as well as build better flexibility. Whether the bank is able to sustain this in an environment characterised by shrinking physical footprints in favour of online business channels is a question for the future. The bank does seem to have a coherent digital strategy however and time will tell how they manage to integrate the existing footprint of ‘owner managers’ into this context. However, for the longstanding shareholder it has been a rather painful experience to date in comparison to her peers (i.e. the opportunity cost of owning BOQ as opposed to holding one of the Big 4).
BEN is another bank with a markedly different business model to the traditional banking houses. They operate a community branch model alongside the traditional corporate branches. While this has helped them gain greater scale than would otherwise be the case, this has unfortunately not been reflected in total returns or ROE (as long standing shareholders are probably well aware). So the question remains, why do I believe BEN.ASX seems attractive at this point in time? Again, it effectively remains a play on headline cash rates and the continued growth of the Australian housing market. Along with my soft spot for the fact that it has a significant footprint within regional Australia and Agribusiness (but that’s neither here nor there).
rhipe is a software reseller and is a strategic asset with 3,000+ resellers across ten countries in the APAC region. They predominantly sell Microsoft products (70% of sales) which provides other acquirers an opportunity to offer other vendor solutions – think Google, AWS, Symantec etc – to its product range.
Capitol Health is one of the largest providers of diagnostic imaging and specialist radiology services in Victoria, they currently own and operate 63 radiology businesses around Australia. CAJ is a defensive business with their revenue coming from essential services such as X-rays, MRI’s and ultrasounds. The fact that 77% of their revenue mix is bulk billed is another great defensive indicator, meaning customers pay very little out of their own pocket for Capitol’s services. The newly appointed management team has turned the business around in the last eighteen months with improved margins, organic growth and a strong balance sheet. Their operating EBITDA was up 50% for HY21, improving their operating EBITDA margin from 22% to 31%. CAJ have grown their business by upgrading/expanding their clinics to maximise their revenue potential for each clinic, accretive acquisitions (most recently Direct Radiology) and a focus on customer referrals.
Unita Group is a telco fibre provider to the residential sector and the only competitor of scale to the NBN. We estimate that UWL is currently winning a 25-30% share of all new greenfield developments against the NBN. UWL is currently annualising $130m of EBITDA and has a contracted pipeline of over 250,000 lots to connect fibre over the next 3-4 years.
