Innovate or Die

Australian manufacturing’s obituary has been written many times over the past decade. However, we believe these reports are greatly exaggerated. There are attractive investment opportunities in Australian manufacturing, particularly where companies are innovating in this space. This is the first of a series of articles that will highlight where we see such opportunities.
Australia has struggled to compete with high volume, low value-add manufacturing due to our high relative wages, strict regulatory controls and the tyranny of distance. Historically our weak currency protected manufacturers from these cost imposts. However, a prolonged period of at or near USD/AUD parity through to early 2015 rang the death knell for many of our “widget” producers. Since the Global Financial Crisis, Australia has lost around 200,000 manufacturing jobs and with the imminent closure of the remaining car manufacturers in Victoria and South Australia, this number may worsen.

To put the state of general manufacturing into perspective, 30 years ago, 16% of Australians with a job worked in the manufacturing sector. Today, this number is 7%. Why would Acorn Capital invest in Australian manufacturing?

Innovative manufacturing

General manufacturing may have been a wrecking ground for capital in Australia in recent years. However, the key differentiator for investors in the sector is innovation. Innovate or die. Our focus in the industrials sectors is on what is termed “Innovative Manufacturing”. In this context, we regard innovation as new ways to do old things better or more efficiently.
Clearly, Australian manufacturing is going through a transition. However, through innovation there are exciting green shoots. The dire state of the manufacturing sector over the past 20 years has forced change, as has the highly skilled nature of Australia’s workforce, both white and blue collar. This innovative approach to manufacturing has encouraged the development of niche, low volume, highly technical products for world markets. Our portfolio includes a number of innovative manufacturers who specialize in niche products or markets, where technical smarts enable Australian businesses to compete in global markets.

A carbon driven revolution

A high profile innovative manufacturing investment of Acorn Capital is Carbon Revolution (“CR”), a Geelong-based private company that manufactures light-weight, single-piece carbon fibre wheels for the automotive industry. CR expects to expand into aerospace in coming years. The genesis of CR came about when Deakin University student engineers and their mentors developed a lightweight wheel from composite materials for the University’s entry into the Formula SAE racing competition. Following the success of the initial prototypes additional engineers, scientists and Research & Development (R&D) specialists joined the development program and CR was born. The R&D background of the CR founders has been complemented by a number of car manufacturing specialists, who have joined the business from the likes Bosch/PBR, Ford, Toyota and Holden, as these businesses exit the Australian market.

Carbon wheel demand is a result of the quest of automotive manufacturers to lower the weight of cars, due to increasingly stringent global carbon emissions standards. Carbon fibre wheels are approximately half the weight of comparable alloy wheels and reduce the unsprung mass of vehicles. Consequently, carbon fibre wheels permit weight savings in other areas including vehicle suspension systems. The result is a car with lower fuel consumption. Approximately 425 million steel and aluminium wheels are produced annually—and if CR can capture a small proportion of this, the opportunity is very, very significant. CR has secured Original Equipment Manufacturers (OEM) supply contracts with Ford Detroit and at least one other global OEM, confirming the market share gains have begun.

The Geelong region in Victoria has become a recognised location for advanced materials commercialisation and CR enjoys support from CSIRO as well as Deakin University’s carbon fibre research centre (Carbon Nexus), ensuring CR is at the forefront of composite materials engineering and manufacturing globally. In fact, CR’s head office and manufacturing facility are located within the grounds of Deakin University and within walking distance of CSIRO’s composite materials research facility.

It’s not all about fast cars

CR is also active in the aerospace sector, with potentially significant weight savings (and therefore fuel savings) for aircraft by switching from aluminium to carbon fibre wheels. The first phase of development work has been completed, with material assessment and selection and initial engineering feasibility work finished. Over the next 12-18 months CR expects that prototype parts will be engineered, produced and ready for testing in North America. Whilst a longer-term driver of growth, the potential opportunity is significant and will further support valuation upside for our investment in CR.

What attracted Acorn Capital to Carbon Revolution?

CR is a world-class R&D and engineering firm that has commercialised its product and is now rapidly scaling to meet the demands of OEM car manufacturers globally. Whilst the high initial cost of the CR wheels means that they are currently best suited to performance sports cars, such as the top of the range Ford GT and Mustang GT350R, CR has recently signed other OEM contracts with global manufacturers that will deliver scale benefits to manufacturing costs.

As CR continues to improve its manufacturing processes through innovation and automation, the cost of the wheels should reduce substantially, making them available to a much more diverse range of vehicles (and consumers). Evidence of these scale benefits can be seen in CR’s recent 25% price cut for its aftermarket, non-OEM wheels. Economic theory suggests as CR moves down the cost-curve, demand for its products will increase as prices reduce. CR appears to be 2-3 years ahead of the competition with its single piece product, giving it a significant competitive advantage in the market. Additional contract wins should drive volume growth and therefore top-line revenue growth over the coming 5 years and this will support a material improvement in profitability as scale benefits are enjoyed and manufacturing costs fall.

Acorn Capital’s investment in Carbon Revolution is driven by a belief that as the business scales up with additional volume from new contract wins, manufacturing costs will continue to fall and gross margin increase. This will take time, but the business is well progressed in automating its manufacturing process and it continues to innovate ways to make its wheels more competitive. This margin improvement will be supported by strong top line revenue growth as vehicle manufacturers chase weight reductions in their cars to meet increasingly stringent environmental standards.
Find out more about investing in emerging Australian companies through Acorn Capital Investment Fund Limited.

Important information
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Beneath Driver Lane

When Melbournians’ boast of the most livable city in the world, the historic winding laneways and hidden bars are almost guaranteed a mention. Melbourne’s newest late night venue strikes at the heart of that nostalgia, slotting seamlessly in to the classic Melbourne narrative. Hidden behind the iconic GPO building, down Driver Lane, a light above the doorway is all that identifies this underground hideaway. Descend beneath the laneway to another world of deep strumming blues, martinis, reimagined classic cocktails, and French-inspired bar food that will continue through to 3am, 7 days a week.

The venue and renovation

Our research indicates that the building was constructed in the early 19th century as the Money Order Office; a secure underground vault that was affiliated with the General Post Office, used to store the money. Throughout the renovation we have kept this rich history in mind, bringing the render and painted white walls back to the original beauty that once was. This has revealed beautiful red brick arches and structural columns which you simply can’t create from scratch.

The Bar

“I’ve always believed that walking into a bar should be an empowering experience. When you sit at the bar you should feel like a kid in a candy shop, able to have anything you please. The outside world is forgotten and the worries of the day are washed away.” Says owner Hamish. The bar itself is a shrine to great products, highlighting the hard work and many hours that have put in to creating a plethora of spirits. There are no optical illusions or mirrors, just understated timber shelves that let the bottles do the talking.

The Team:

The newest venture by Hamish Goonetilleke (Rum Diary Bar, Rum Diary Spiced Rum) is unashamedly a tribute to deep driving blues and a love of dark spirits. Boasting a 400-bottle back bar, a solid and respectable wine list sourced from Australia and Europe and 4 tap products on rotation, including a guest tap that will be reserved for showcasing independent and limited edition beers. The cocktail list is the brain child of global cocktail finalist, Jonathan Minihan (The Toff in Town), whose took inspiration from over a decade of experience, producing cocktails that walk the line of classic and contemporary. From a deconstructed Charlie Chaplan to a modern take on a Bees Knees, this cocktail list has something for everyone. Joining Jon is Venue Manager and backbone of the team, Reuben Powley (Melbourne Pub Group). Bringing nearly a decade of experience across Australia and New Zealand, Reuben’s strong work ethic and focus shines through immediately. A man of few words, Reuben says his driving ambition is ‘to make sure every person, whether it be the customer through to Hamish, walks away from the venue having had a great time’. Accompanying the epic cocktail and spirit collection will be a selection of casual, yet refined, French-inspired bar snacks by well-known Chef Danielle Rensonnet. The menu provides a selection of all the things you love to eat when enjoying a drink; cheese and charcuterie, parfait, a classic reuben sandwich, and consistently well-priced Oysters all night long. Danielle brings with her a wealth of knowledge and experience (Bellota wine bar, Three One Two (by Andrew McConnel), and St Jude’s Cellars). The goal is to create a space where you can come and enjoy a high-quality drink and snack whenever it takes your fancy, from post work drinks through to 3am. Overall, there is no doubting that Beneath Driver Lane is the new kid on a block.

Contact Details:
Address: Basement Driver Lane, Melbourne Hours: Mon to Thur 4pm-3am / Fri 2pm-3am / Sat & Sun 4pm-3am
Website: www.driverlanebar.com
Email: drink@driverlanebar.com

Advancing Australia

There is a growing chorus of market experts predicting lower sharemarket returns for the years ahead based on the current record highs and seemingly stretched valuations of most major sharemarkets. This is a sentiment that we agree with, as we believe monumental changes lie ahead for the global economy. We are in the midst of a synchronised normalisation of interest rates from all-time lows, unwinding of inflated balance sheets, slowing commodity demand, increasing inequality, protectionist trade policies and volatile currency markets.

So as investment advisers, what should we do in this situation?

In an increasing interest rate environment, we are simply not comfortable ‘buying the index’ via an exchange traded fund, as these investments are always fully invested and perform the worst during market downturns. What we seek to do at Wattle Partners, is to identify emerging themes that can generate long-term outperformance for investors even in poor markets. Rather than looking globally for growth, which has been our preference in recent years, we thought it worth considering where the future lies for the Australian economy.

Australia – Today

In order to understand where the future is for the Australian economy, it is important to consider where we are today. Whilst the general views of economic commentators and ‘expert’ forecasters remain positive, with trend growth and inflation to return soon; the data suggests all is not as rosy as it seems. The S&P/ASX 200, which is a leading indicator of the strength of the economy, has actually lost ground over the last decade, to the tune of -1.33% per annum in price terms. When all dividends are reinvested, the return is marginally better at 3.20% per annum; not quite the 10% per annum most of us expect from sharemarkets. Interestingly, the growth in the ASX 200 has closely mirrored the growth of Australia’s GDP per capita, or person. In 2006, our GDP per capita was $50,952, in 2016 it had increased to $55,670. That’s an improvement of just 10% over the same 10-year period. Whilst we remain among the richest countries in the world, it seems the last decade of ‘GDP Growth’ has actually come from increasing the size of our population, and has not resulted in any improvement of the wealth of the population. Interesting, given we experienced both a commodity export and property construction boom for the ages.

In our view, Australian’s have become far too infatuated with investing into residential property, supported by various tax benefits, and this is having negative implications on the economy. Recent statistics indicate that property now makes up close to 60% of the value of the assets of Australian’s and the property market is substantially larger than the sharemarket, which includes businesses that employ the majority of Australians. When you combine the preference for property with retiree’s obsession for franking credits, the result is a corporate sector starved of capital for investment into research and development, expansion and innovation. We believe it is these reasons that are now seeing wage growth at its lowest level in 20 years, at just 1.9% in 2017, and three consecutive months of negative or zero growth in retail sales.

Australia’s trend growth for the period 1992 to 2016, was close to 3.3% per annum, yet we now sit at just 1.8%, slower than Europe, 2.5%, and the US, 2.3%. Consumption continues to be the primary driver of Australia’s growth, representing 56%, however, the threat of increasing interest rates is putting pressure on household budgets and may see us experience the first recession in two and half decades. We are seeing the end of an era in Australia as the final remnants of our past, including smelting plants, vehicle and basic manufacturing are closed down, replaced by cheaper overseas imports. The performers of the last decade, our commodity producers, are beginning to recover, yet they remain cyclical and profitability is determined by the whim of the Chinese Government and their fiscal spending. This is certainly not a sector we should be banking on to improve the wealth of Australian’s for the years to come.

It isn’t all bad news…….

There are definitely reasons to be negative on the future of the Australian economy; but there are also plenty of reasons to be positive on the outlook for Australian businesses. Australia has consistently fought above its class to the benefit of the population, with our ranking as the 13th largest economy, just behind Russia, but ahead of Spain, and its 46 million people. Australia has just recently achieved its 26th year of consecutive economic growth, albeit at a slowing pace, and remains a successful service driven economy with a history of being ahead of our competitors in a number of specialised areas, which will be discussed below.

Australia – Tomorrow

Yes, it’s true that the companies of yesterday are closing down or leaving our shores. To be honest, this probably should have happened earlier given the borderless, globalised world we live in. The concept of competitive advantage suggests that in a connected world, countries should focus on producing what they are best at, or that which they can deliver at a lower cost than their trading partners; as one of the wealthiest countries in the world there is simply no chance we can compete with the likes of Asia or Africa for basic manufacturing. So, where will the growth come from? Where should we invest?

It isn’t all doom and gloom, at this juncture Australia has two options, to move along the advanced or value added manufacturing path of Germany and Japan, or transition towards an even more service driven economy. Given the multi-decade head start already afforded to Germany and Japan, we believe our future is in the latter. And more specifically, the increasing export of our services, expertise and experience to our closest neighbours in the north; Asia, China and India. Over many decades, Australia has built a reputation of world leading knowledge and success in several key areas (Why Australia? Benchmark Report 2017) that we believe have the potential to benefit investors in the future. They are:

  • Resources and energy – including renewables;
  • Agribusiness – including land and technology;
  • Financial services – including insurance, pension and investment management;
  • Education – including tertiary and vocational; and Tourism.

In addition to these, we also see opportunities both domestically and globally in the following:

  • Technology and digital media;
  • Health and aged care; and
  • Infrastructure.

In the sections that follow, we will quickly touch on what we believe to be the opportunities for investors in each of these sectors and a number of implementable ideas. In addition, there are a number of additional articles within this issue, including an analysis of opportunities in the advanced manufacturing space, by microcap investors, Acorn Capital, and a look at Australian success in the online application space, courtesy of Roger Montgomery.

Resources and Energy

Australia was blessed with an abundance of easily accessible commodities that form the basis of the today’s world. In terms of our future, we do not believe it lies in the iron ore, coal or oil sectors, but rather in cleaner energy, mining technology and power storage. We think investors should be seeking exposure to cleaner energy sources, such as natural gas, solar, and uranium. Companies involved in these sectors include, Santos (STO) and Origin Energy (ORG), or Energy Resources of Australia (ERA) for those seeking an exposure to uranium production ahead of a possible approval in Australia. In terms of the future, which we believe will be based around power storage and renewable energy, Australia is well positioned to benefit from both of these booms. Australia has an enviable number of commodity producers specialises in lithium, which at this stage appears to be the core component of most battery technologies. Australian lithium producers are only minnows on a global scale, but given the well highlighted shortage of supply likely to occur as petrol powered cars are banned in various countries, the likes of Orocobre (ORE), Galaxy Resources (GXY) and Mineral Resources (MIN) stand to benefit exponentially.

Infrastructure

It is increasingly evident for anyone that commutes into the CBD’s of Melbourne or Sydney, that following years of steady immigration, there has been an inadequate level of investment in our infrastructure. The daily commute seemingly gets longer every year, whether by public transport or car, contributing to an inefficient economy and disgruntled workforce. The continued sprawl of our cities has yet to be met with similar expansion or infrastructure, yet the tide appears to be turning; with Government’s showing some bipartisanship and improving an increasing slate of infrastructure projects. These include new roads andfreeways, schools, hospitals and telecommunication networks, as well as bridges, public transport expansions, level crossing removals and tunnels. There is an extensive selection of companies and sectors that will benefit from this trend, some more than others. They include contracted construction companies, like Cimic (previously Leighton Holdings) and Lend Lease or raw material input producers, like cement and gravel (Adelaide Brighton, Boral and Brickworks). Our picks for this burgeoning sector are Lend Lease, given its globally renowned brand, and Boral, which has less exposure to the cyclical mining sector than Adelaide Brighton.

Tourism

In 2016, Australia was the 11th largest market for international tourism, generating $29bn in associated receipts which represented some 23% of GDP. International tourists remains infatuated with the natural beauties of our country, from the diverse and rare flora and fauna to world-class travel destinations in every state. An increasing number of tourists are choosing Australia over the likes of Europe and the US, with 1.2m Chinese visiting Australia in 2016 and that number expected to hit 3.3m in 2026, as the country’s wealth continues to grow.
Unfortunately, there isn’t a great selection of opportunities to access this exploding trend, with most airports, outside of Sydney, privately owned or held by institutions. Embattled theme park operator, Ardent Leisure (AAD), and Event Hospitality and Entertainment (EVT), which owns cinemas and hotels offers exposure to the younger generations, whilst casino and resort owners, Star Entertainment (SGR) and Crown Resorts, to the wealthier groups. One for the risk seekers is Experience Co Ltd (EXP) which provides adventure experiences like sky-diving, ballooning and white water rafting. Our exposure of choice remains Sydney Airport (SYD) which essentially has a monopoly over arrivals due its proximity to the Opera House, Harbour Bridge making it the first port of call for most international travellers. The airport stands to benefit from increasing capacity, efficiency improvements and continued growth in Asian tourists.

Education

As it stands, Australia is the third most popular destination for students choosing to study overseas, attracting more students than the likes of France, Germany and Japan or 6.2% of the global total. Education services are one of Australia’s leading exports, whether in the form of accepting international students, offering online education, or using our expertise to expand offshore. Interestingly, the increasing unrest in the countries like the United Kingdom and the US, are expected to benefit Australia by attracting more students to our comparatively stable and safe economies. There are a number of listed education investments, including Navitas which has expanded globally and teaches some 80,000 students and IDP Education, which provides international student placements and has been expanding into the operation of English language schools in Asia. An alternative option to access the exponential growth in students, maybe to invest into one of Blue Sky Asset Management’s Student Accommodation Property Syndicates, which either manage or develop properties focused on attracting international students.

Financial Services

As a small country in terms of population, Australia has seemingly done something right when it comes to the provision of pensions and retirement benefits. Australia’s $2tn pension system is the fourth largest in the world and a major driver behind our globally recognised funds management industry; this is expected to at least double to $4tn in the next 10 years.
Australia houses some of the world’s most successful professional equity investors, with the likes of Kerr Neilson, of Platinum Asset Management (PTM), and Hamish Douglass, of Magellan Financial Group (MFG), building businesses from scratch and increasing attracting investment capital from offshore. These are two of our preferred exposures to the world-class funds management sector. At the other end of the spectrum are ANZ Banking Group (ANZ) and AMP (AMP), both of which have been expanding aggressively into China and the Asian region. ANZ has sought to diversify its risk away from the Australian property market by continuing its institutional and corporate banking operations through Asia, whilst AMP has entered several joint ventures in China and Japan that are focused on sharing their expertise with superannuation, pension and annuity management. It’s not surprising that financial services make up close to 10% of our $1.6tn services sector when you consider the quality of the businesses we have just identified.

Agribusiness

One of the most important sectors, in our view, for the future of Australia, is agricultural and the production of food. We continue to be viewed as a high quality producer of food, with a commitment to safety, animal welfare and security of supply, however, this can quickly change. Our largest agricultural exports in recent years have been beef, other meat, wheat milk and barley. At Wattle Partners, we believe an investment in agriculture can be in two ways; the lowest risk ownership of producing property, or the ownership of the production or distribution companies.
In terms of production companies, we prefer those with the ability to differentiate and charge a premium for their products for one reason or another. A2 Milk (A2M) has been a market darling in recent years, however, in our view the growth trajectory could easily be reversed with an improvement in Chinese dairy and milk production in the years ahead. Bega Cheese (BGA) stands to benefit from the changing diets of the Asian region, with its spread of both milk, cheese and other dairy products likely to benefit. Select Harvests (SHV), as one of the only listed almond producers in the world, is likely to see continued growth as healthy eating spreads from the developed to the emerging markets. Costa Group (CGC) is the largest horticultural company in Australia, producing berries, mushrooms, tomatoes, citrus and avocadoes among others. It has substantial market share in the majority of its sectors. The company is also investing into global expansion by entering joint venture to grow its various commodities in Asia and the Middle East, a positive in terms of reducing the cyclicality of their Australian business.

Technology

Australia has an enviable track record in inventing technologies or software that become ubiquitous in the modern age; it all began with the CSIRO discovering wifi in the 90’s. Unfortunately, we haven’t always been good at monetising these opportunities. The future of the global economy, as proven by the likes of Google, Amazon, Facebook and Alphabet, lies in digital media and data services. Fortunately, there are no barriers to entry for global competitors and Australia houses some of the world’s best programmers and designers. The Australian Government has been a strong supporter of venture capital investment, providing research and development incentives to Australian companies, which bodes well for the future. These are a few of the more interesting opportunities today:

  • Afterpay (APT) – Which is growing substantial market share offering a ‘lay-by’ arrangement for the digital age.
  • Altium – Which provides design software for the construction of circuit boards central to increasing computing power;
  • Freelancer – (FLN) – Which is a crowdsourcing marketplace allowing people to post jobs and collate quotes for consideration in various service sectors;
  • Aconex (ACX) – Which has revolutionised the construction industry via its web-based project management platform.

Health and aged care

As a major beneficiary of the 40’s and 50’s baby boom, Australia’s population will become increasingly tilted towards the older generations in the years ahead. The continued improvements in modern medicine will mean people are living longer and surviving with chronic pain as they may not have been able to in the past. We believe two key sectors will benefit from the ageing population, private hospitals and aged care homes. It is becoming increasingly difficult to improve healthcare outcomes via increased Government funding, as a result we expect a transition to more efficient providers and the outsourcing of additional tasks to the private sector. Healthscope (HSO) and Ramsay Healthcare (RHC) stand to benefit from the increasing regularity and severity of illnesses. On the other hand, the likes of Estia Health (EHE), Regis Healthcare (REG) and Japara Health (JHC) are well positioned to benefit from a boom in older Australians transitioning into some level of assisted living. These companies have been exposed in recent years due to some inappropriate policies and the gaming of Government funding, however, the future is clear. The Federal and State Government’s simply cannot be relied upon to fund the sector as demand continues to grow, and these represent just a few of the companies that have the ability to raise capital and provide services more suited to the expectations of the Baby Boomer generation.

Conclusion

We hope this article has gone some way to provide you with an insight into the many opportunities in the future Australian economy; something that will be important for investors as well as the employees of tomorrow. Australia has a strong history in world changing technologies, from the invention of wifi and the Black Box recorder on every plane, to the technology supporting Google Maps, Spray on Skin and cervical cancer vaccine, Gardasil. We suggest investors keep this in mind when times get tough in the years ahead, as they typically do.

Money Habits from Drew

Drew is one of the original founders of Wattle Partners, an independently owned and licensed financial advisory firm. He has a decade of experience and is a Certified Financial Planner. Drew was drawn to financial advice due to the poor experiences of his parents during the GFC and seeks to implement a more tailored approach.

Persistence

  • Most people fail because they don’t make the simplest parts of their business strategy or finances a habit!
  • Whether it is paying off your credit card on time and in full every month, following up potential customers/clients or taking the time to review your spending against your budget once a month; the key is putting in place a process and making it part of your routine. This breeds consistency and undoubtedly success.

Be patient

  • As a financial adviser we see first-hand people taking incredibly short-term views or trying to micro-manage performance. Whether it’s in business or investing, wealth and success are not built overnight.
  • A lot of people make snap judgements based on short-term trends, rather than taking an objective long-term view. It’s been proven consistently that the key to building wealth is to put in place a strategy suited to your objectives and managing to a long-term goal.
  • Short term changes of strategy, in business and investing, are generally a waste of time.

 Outsource

  • As much as we tend to think we are the best at everything, there comes a point where your time is simply better used focusing on what you are good at. In our experience, the most successful people are the ones that learn early the need to outsource and the value in paying professionals.
  • This can apply to every aspect of your life, whether it is using a painter rather than doing it yourself, engaging an accountant to prepare your tax returns, employing a marketing or social-media specialist to grow your business.
  • In our experience, outsourcing specialised tasks to professionals can save substantial time, money and stress. As a bonus, a lot of their fees can be tax deductible!