Portfolio Performance

As I didn’t do a 6 month portfolio review I’ve decided to do something a little different and do a 9 month review (of my performance) instead.

My Personal Account (PA) which I refer to as my “Growth Value Fund” posted returns of 6.3% after transaction costs for the 9 months (to date). This takes my annualised return since inception to 12.3% p.a. (post all costs - which are quite high given my transaction costs as a % of transaction value is high. Performance before this cost is about 15%). Over the most recent 9 months, major detractors included WDS Limited (ASX:WDS), Slater & Gordon (ASX:SGH) and Arrium (ASX:ARI).  I have sold out of all of these positions except for WDS. Although these stocks fell significantly, the impact was subdued due to their small weightings – I held small positions relative to my other, high conviction calls. On the other hand, major contributors were Sirtex Medical (ASX:SRX), RCG Corporation (ASX:RCG) and Molopo Energy (ASX:MPO). These three stocks have done the majority of the lifting in both performance and dollar gains. I sold out of Molopo Energy realising a c. 26% capital gain (104% annualised).

Over the most recent quarter I added significantly to my Mineral Resources (ASX:MIN) holding and bought into MNF Group (ASX:MNF) which is now my largest holding. While both are only up c. 2-4%, the dollar gains are substantial as they are big holdings of mine (about 50% of my portfolio in fact – a serious level of concentration). People question why I have bought into Mineral Resources and I’d like to offer some insight. Many have ditched the company and there has been immense short selling pressure. My best guess would be because of the impact of the iron price on the business. However, what many don’t talk about is its extremely high quality iron ore crushing business which operates at a 29% EBIT margin and has a high level of contractual (recurring) revenue. Furthermore, the revenues are generated on a volume basis, and so are not as responsive to price as many believe – the majors are still pushing volume through via MIN.Yes, the earnings have re based downward, but the share price depreciation has been too aggressive and not justifiable in my opinion.  

Brief Market Review

As financial markets continue their wild gyrations, the most recent quarter was not easy with the MSCI AC World ex-Australia falling about 9.2% (USD) but this was offset by changes in the Aussie dollar.  Growth concerns over China and the rising expectations of the US interest rate hike were key themes shaking markets.

Domestically, the ASX200 Accumulation Index fell 6.6% in the most recent quarter – mostly driven by a sell-off in the banks and materials.  More specifically, the resource sector came under immense pressure as the iron ore price and oil price continue to set new lows. On the other hand, investors rewarded the industrials sector.

Brief Market Outlook

The Australian economy continues to shift away from the mining sector. With the AUD coming off we have seen tourism and services reduce the unemployment rates for these sectors. With the RBA cash rate at 2.00%, it remains expansionary. There is also a growing concern over the Australian GDP growth rate in the medium term. In one of my recent posts titled “General Commentary” I talked about how each RBA rate cut is having less of an impact on investment. I’d like to add to this. What’s happening is that with each RBA rate cut, you’re seeing more money pour into equity markets, driving up prices. Companies are using the lower rates to pay higher dividends to attract this new money, driving their share prices higher at the cost of investment into the future. This, I believe is a serious issue which needs a solution. It has come to my attention that many of the beloved blue-chips are operating at unsustainable payout ratios which I believe will come under threat.

In terms of the market outlook over the short term I cannot add much value here as quite frankly I have no idea. However, while many are focused on the daily moves of markets, I am confident that the ASX will continue to grind up over time as the economy continues to grow.

I will attempt a more elaborate post at my yearly review covering most of the year which may see some overlap with the material posted in this review.  

I hope you all enjoy your Christmas & New Year.

IPOs In The Pipeline

Some “hot” companies are getting ready to list on the Australian Stock Exchange - namely, Link, McGrah Real Estate and Baby Bunting.

When investing in IPOs it is imperative that you identify the motivations (from the business owners perspective) for doing so. Is it a firm that actually needs money to grow and the managers are retaining a substantial shareholding or is it a private equity flip? I don’t think there’s any question that Link is a great business that have a competitive edge in their market (and a clear strategy for growth going forward) which has helped them sustain healthy margins, good cash flow generation and >90% recurring revenues. However, I question the multiple attached to this business.

The other two companies I won’t make a comment on for various reasons – it would be wise not to infer from this.

The main reason for writing this post is to say that it is with great pleasure that I’m preparing an exciting post about my experience at a small investment firm. Titled “memoirs of an aspiring fund manager” (don’t laugh!) it will detail what I have learnt thus far working in the investment management industry. It is targeted towards younger, relatively inexperienced individuals (such as myself) who might want some insight into the industry and some lessons I’ve learned along the way. Watch this space!

Reporting Season With A Twist

This post is a short summary of a great experience I’ve had over the past few weeks.

This reporting season was very different for me in the sense that I was fortunate enough to get to personally meet various CEO’s & CFO’s from all over Australia and across a wide range of industries.

The structure of the meetings is straightforward, you essentially gather around in a boardroom at a brokerage firm and the company presenting will talk over their results in a closed environment. By this, I mean that it’s generally not recorded and publicised. Followed by the presentation is a Q&A session.

Although I had never heard of some of the firms that spoke, it was a great experience which broadened my understanding of different industries and their key drivers. These drivers are extremely important because they feed into valuation models. My aim was to walk away with a deeper understanding of what exactly were driving these companies and industries more broadly. I believe I achieved this to a satisfactory extent (I’m by no means an expert though).

Some companies and their respective managers which I was lucky enough to meet were: MNF, SDA, PME, BLA, VOC, DWS, RXP, SKI, VTG, RFG and PFL to name a few. 

General Commentary

Global markets are going through a rough ride. Not in my entire investing lifetime have I witnessed such wild vicissitudes in equity markets. While this is probably more of a reflection of my youth rather than anything else, it is still interesting times where our equanimity and rational thought are being tested.

We are experiencing  multifaceted problems in major economies such as China, Greece, America and Australia. Domestically, it is in my view that we have been shielded away from the GFC given our commodity boom. However, it has been apparent for an extended time that the good times are disappearing. The downturn in mining is having a multitudinous effect on our economy. For example, it is having adverse impacts on income, tax revenue and jobs.

Recent studies have shown that wage inflation is going nowhere. Our real incomes, as consumers aren’t appreciating. So what implications may this have? Well, for one, I believe that consumer demand will be weak and this is what I think we are seeing now with the most recent reporting season. A common theme among many companies is that growth in revenue is not transparent. While cost cutting has been a theme for some time, as well as restructuring, we are seeing the implications when these measures are exhausted – margins are contracting. Importers are even more vulnerable to gross margin contraction as the lower $A (predominantly driven by the rapid decline in the demand for Australian commodities) lifts their costs of goods sold.

To overcome this problem, many companies, both domestically and internationally are turning to M&A activity to boost revenues rather than anything else. And boy is the time ripe for that! In this low interest rate environment, companies are definitely taking advantage of cheap credit to help pick up the slack. However, what happens when interest rates begin to rise- especially in the US?

Given the aforementioned, I believe it’s fairly evident that the Australian market is in a tough time for the foreseeable future. Given the lust for yield as a result of the historically low interest rates globally, riskier assets are appreciating while global economic growth is decelerating. Moreover, benefits from the RBA rate cuts are having fewer impacts with each subsequent cut.

I believe the reasons mentioned above are key to the issues Australian companies are facing, namely revenue growth and margin contraction. By extension, I would argue that profitability will be sub-par in at least the near term. Moreover, as I mentioned earlier, the lust for yield have pushed these exact companies to prices which may be unjustifiable. Do you see the spiral effect I’m trying to achieve here? The low interest rate environment is evident of a weak economy; however, this is pushing investors into riskier assets – such as shares. These companies, given the weak economy and lack of consumer demand aren’t delivering. This problem is enhanced by the premium some investors are willing to pay to own a piece of a company which is able to pay dividends. So what’s the outcome? Investors are paying more and more for less and less. Not only that, but they are increasingly becoming vulnerable to stocks de-rating - which has become more apparent with some companies which have come out in the FY15 reporting season. Over the long term, it sometimes pays to arrest our inherent rapacious actions which may do more worse than good.

A prevalent theme of the FY14 reporting season was a lack of EPS growth on a broad level. Interest rates we’re still historically low back then and investors demanded dividends. As a result of the latter overpowering the former, (on a broad scale) payout ratios unambiguously rose at the cost of investing for future growth. As the labour market continues to weaken it will be interesting to see where the growth will come from. I believe technology will no doubt have a big role in this.

Despite the relatively bearish atmosphere i may be depicting, I wholeheartedly believe that the astute manager can still generate outsized returns in this environment. Why? Because if history is any guide, then it is definitely possible. Returns may not be as easy as they were previously, but this is only a guess at best. Unfortunately, i wasn't blessed as a Seer and so i cannot detect what the future holds.

Downgrades left right and centre

High quality Australian businesses have recently been slogged amid profit downgrades. Companies which have flagged downgrades include Seek (ASX: SEK), Flight Centre (ASX: FLT) and others such as Nine Entertainment (ASX: NEC) and Qube Holdings (ASX: QUB).

A recurring theme is that revenue growth has been an issue. They have been expanding bottom lines via cost cutting but this will only go so far. It is worrying to see companies which are not only deeply intertwined with the economy, but also, are of high quality see problems at the top line. Other companies such as IOOF have been dumped by the market amid "rumours" of a whilseblower who told Fairfax Media that IOOF have engaged in activities such as insider trading and front-running.

While some may argue the market has overreacted, it pays to think independently. When companies such as Seek and FLT come out with profit downgrades, this doesn't paint a bright picture for me going into reporting season. I believe more downgrades are imminent given the not before seen shift in the global economy and the repercussions we are seeing.

Companies which can display growth in earnings irrespective of where we are in the economic cycle are ones which should be constantly on the radar. Something that i do to check this at times, is to see how the particular company went during the GFC and compare their performance among peers. This won't work for every company and is much better suited for countries other than Australia (as the GFC had little relative impact on our domestic economy).