Under the Microscope – Boral Ltd

The Australian residential property market has been a major talking point in recent months, as the long awaited correction gathered pace. As many readers will be aware, a great deal of the economy relies on the residential property sector, from construction and building supplies companies, to entertainment and retail stores who benefit from the ‘wealth effect’ higher property values provides. The recent weakness has seen many associated sectors fall off heavily on the back of investors expecting lower profit growth; yet know that these corrections don’t impact all companies the same way and some can become oversold. In this edition of Under the Microscope, we try to determine whether Boral Ltd (BLD) is good value or has further to fall. As a note, Boral’s share price has fallen from a 12-month high of $8.22 to just $5.10, or 38%.

What is Boral?

The company was founded in 1946 as a group of investors sort to manufacture bitumen for the expanding Australian economy. Boral is an international building products and construction materials group with three divisions; Boral Australia, a construction material and building supplies business; USG Boral, an interior linings joint venture in Asia, Australia and the Middle East; and Boral North America, a growing building product and fly ash business in the US. The company acquired the US-based Headwaters for US$2.6bn in FY2017 as it attempts to expand its international footprint and reduce its reliance on the Australian building cycle.

Why Boral? 

Boral is among a handful of dominant building material players in Australia and has benefited from the recovering US economy through its acquisition of Headwaters. Management have been diversifying the business in recent years with revenue spread across Boral Australia ($3.59bn), USG Boral ($1.58bn) and Boral North America ($2.14bn). The Boral Australia business is Australia’s largest construction material and building product supplier focused around concrete, asphalt, cement, roof tiles and timber. Road, highways, subdivisions and bridges (RHS&B) represent 36% of revenue, following by non-residential and detached dwellings at 16% each; meaning the business is well diversified and not as reliant on residential property as the share price fall suggests. The USG Boral JV is a growing international business focused on the supply of plasterboard and internal linings across the growth economies Asia, with most revenue coming from Australia (37%) and South Korea (23%). The Boral North American business offers direct exposure to the US housing cycle, with around 80% of revenue coming from new and existing residential property, but a growing portion (13%) being sourced from infrastructure spending. It is the North America business that has been the key source of recent weakness, with a recent earning downgrade blamed on poor weather in the US.

Which Bucket does it fit in? 

We believe BLD meets the requirements of the Value Bucket as it offers substantial earnings growth and currently trades at a heavily discounted valuation compared to this potential. The company has been sold off by close to 40% on the back of poor weather, but more so, concerns about their exposure to the US and Australian housing cycle. Yet, a closer look at Boral’s financials indicates that less than 50% of their total revenue comes form Australian and US residential housing construction, and they are in fact more directly exposed to the infrastructure spending boom than any company in Australia. The company has an oligopolistic position in the Australian concrete and infrastructure market but trades on a price-earnings ratio of just 12x and offers a 50% franked yield of 5.4% (6.6%). As a comparison, similar but less attractive competitors, Adelaide Brighton (16x) and Wagner’s (22x), trade on premium valuations but offer less exposure to the announced increases in infrastructure spending and more to the volatile residential property sector.

How do the financials look?

Boral announced a strong result for 2-18, with EBITDA up 47% on the previous year to $1.056bn and net profit up 38% to $473m. This result was supported by a full year of contributions from the Headwater’s business and hence appears stronger than it otherwise may be. Looking more closely, revenue in the Boral Australia division increased 9%, with scale supporting a 15% increase in division profit to $433m. From a macro view, further strength is supported by a 15% increase in the RHS&B building that occurred in 2018 and 13% in non-residential construction that is expected to continue. USG Boral detracted from performance in 2018, with income from the JV falling 9% and EBIT 10% down to $194m, as higher input costs and competitive pricing in Asia impacted on returns for the business. That being said, the business continues to grow from its small beginnings with EBIT now up 80% from day 1. The Boral North America delivered ahead of proforma expectations, reporting EBITDA of $368m compared to expectations of $345m and synergies from the acquisition are 10% ahead of their stated target. The result would have been stronger if not for adverse weather conditions impacting on construction projects. The strong results across the board resulting in a 20% increase in earnings per share and 10% to the dividend for the financial year.

Broker views

The broker views on Boral are quite strong, with five buys and two holds from those who cover the stock and most have a target price in the $7’s suggesting upside of around 40% from its current level.

Wattle Partners view

The view of the Investment Committee is that BLD has been oversold due primarily to a misunderstanding of their revenue exposure. As all investors would know, mis-pricings can occur from time to time continue for extended periods, offering patient investors excellent opportunities. In Boral’s case, it appears that investors have assumed the company is more reliant on the Australian residential property sector, and subsequently that they have extrapolated a short period of US housing weakness into the future. US home building rebounded late in 2018, with November housing starts up 3.2% and building permits up 5.0%, with indications that rate hikes may be on hold likely to support further growth. As part of their ‘downgrade’ management reported expected growth in the North American business to be 20% in 2019, high single digits in the Australian business and 10% in the USG Boral joint venture.

In our view, BLD offers investors exposure to a company expected to continue growing earnings at a high single digit rate over the years ahead. The company is supported by three major tailwinds, firstly, the substantial pipeline of approved and funded infrastructure projects that require their concrete, bitumen and other material inputs (see the chart) as well as a renewed recovery of the US housing market and continued growth in Asian construction.

The companies US divisions are well placed to benefit from the stronger US economy and higher wages growth, which will contribute to higher property prices and greater spending on renovations. Management noted in 2018 that the supply of concrete and cement is likely to come under pressure in 2019 offering the potential for higher prices and greater profits. The US operations have benefitted from the announced corporate tax cuts whilst the future sale of land around existing quarries and operations in Australia may result in the payment of special dividends or other capital management initiatives. The property division has consistently delivered incremental profits to the business through a combination of rezoning and selling previous property assets or buying and redeveloping properties for their own use.  Importantly, in a competitive sector Boral has committed $425m to capital expenditure focused around upgrades at their various plants and quarries around Australia and North America. Finally, the merger of Boral’s US JV partner, USG with Knauf, has triggered Boral’s option to buy 100% of this business, which will be determined based on the fair value which is expected in early 2019.

To summarise, in a world of overvalued, high growth, low profit technology companies, Boral may provide the complete opposite to investors; a profitable, diversified and growing business leveraged to the infrastructure cycle, that trades at a substantial discount to its fair value.

TSB – What does it mean to me?

We’re sure you will be sick of acronyms by now, but there is one more important one that should be covered, TSB, or your Total Superannuation Balance. This measure and the associated cap of $1.6m was introduced at the same time as the Transfer Balance Cap but has a much different purpose. The TSB has been established to determine your eligibility to various strategies, but most importantly it determines whether you can make any further contributions to superannaution.

Your total superannuaiton balance is calculated by combining the following as at 30 June each year:

  1. The accumulation phase value of all superannuation accounts that you own;
  2. The retirement phase value of all superannuation accounts that you own, i.e. the balance of your transfer balance account;
  3. The amount of any rollover not already reflected in either balance listed

For those where it is relevant, any personal injury or structured settlement claim is desregarded.

Accumulation balance

Your accumulation balance is equal to the amount that would be payable if you were to withdrawal your entire balance, therefore, it is adjusted each year depending on market movements and drawdowns. It includes certain deferred benefit income streams, transition to retirement income streams and those that do not comply with the normal pension standards such as where a breach has occured (which is quite rare).

Retirement balance

The retirement balance value is calculated by using your transfer balance account at 30 June with modifications only if you have a certain account based income stream or a structured insurance settlement contribution was received.

For account-based income streams, which make up 90%+ of those in existence, your transfer balance is modified to include the current value of the interest that supports your pension at the end of 30 June. What this means is that for the purposes of your total super balance calculation, both pension payments and investment earnings or losses are relevant and can either reduce your increase your assessed balance. This is obviously quite confusing given they are excldued form the TBC calculation.

What is your Total Super Balance used for?

The TSB calculation is used to calculate your entitlement to five key strategies or benefits:

  1. Carry forward concessional contributions – From 1 July 2019, if your total super balance is less than $500,000 you may be eligible to increase your concessional (or deductible) contributions cap by utilising previous years unused
  2. Non-concessional contribution bring-forward – From 1 July 2017 if your total super balance is below $1.6m you are eligible to make a non- concessional contribution; if it is above this amount, you are no longer eligible to make these non-deductible contributions. Importantly, the total super balance is also used to determine if you can utilise the bring-forward rule and contribute more than one year’s worth of the cap at any given time;
  3. Government Co-Contribution – From 1 July 2017 you are eligible for the co-contribution if your total super balance is below $1.6m in the previous year;
  4. Spouse tax offset – From 2017-18 your spouse must have a total superannuation balance less than the general transfer balance cap of $1.6m to be eligble to receive a spouse
  5. Segregated assets method – From 2017-18, SMSFs and other regulated super fund will not be able to use the segregated assets method where a member has a total super balance exceeding $1.6m in the fund.

What’s a TBAR?

We aren’t talking about a type of construction material, rather some much more relevant to retirees and in particular those who have chosen to be trustees of their own super funds. The TBAR (or transfer balance account reporting) legislation was introduced in 2017 as part of the commencement of the $1.6m pension cap.

What is the impact of the change?

As most readers are likely aware, from 1 July 2017, the Government has placed a cap on the amount of your superannuation that can be held in the tax-exempt pension, retirement or drawdown phase of superannuation. This limit was set at $1.6m per person and is known as the Transfer Balance Cap or TBC.

For clarification, only pension accounts that are in the retirement phase of superannuation, where you have retired or attained aged 65, are included in the cap. This means transition to retirement or TRIS pensions, that occur when you continue to work and have not yet met a full condition of release, can exceed this amount and not require any reporting to the ATO. The TBC does, however, include death benefit or reversionary pensions as well as defined benefit income streams, which must be multiplied by 16x to determine the cap figure.

Importantly, accumulation phase superannuation balances, as they are not tax exempt, are excluded from this cap and the associated reporting.

What is the TBA?

The TBA is the account that the ATO uses to track the transactions and amounts in retirement phase across all your superannuation accounts, not just your SMSF. Your TBA reporting requirements either commenced on 1 July 2017, if you were already receiving a retirement pension, or when you commence a pension in the future.

How does the TBC work?

The TBA operates like any other account with the ATO, in that certain transactions result in credits and debits to its balance. Generally, the credits to your TBA occur when you transfer funds into pension or retirement phase and these must be immediately reported to the ATO by your super fund. If your pension balance exceeded $1.6m on 30 June, it would have been reduced to meet the cap.

The primary debits from the cap are amounts that are commuted or withdrawn from retirement phase, such as lump sum withdrawals, moving your pension balance back to accumulation for any reason or should you rollover to another superannuation provide.

Importantly, earnings and losses on your superannuation investments do not affect the balance, so if your portfolio grows over time to exceed $1.6m you will not be impacted. Similarly, you cannot top up your balance if it falls due to pension drawdowns or investment losses.

The transfer balance cap is proportionally indexed, meaning if you are under the cap your limit will be increased as the cap increases. However, if you have ever met or breached the $1.6m cap, you will not gain the benefit of indexing in the future.

What if you exceed the TBC?

If your balance exceeds the cap, you will be notified by the ATO that you have an excess transfer balance. They will require you to remove the excess immediately, along with any ‘notional earnings’ calculated using the ATO’s default earnings rate. You will also be liable to pay tax on the notional earnings on the excess transfer balance for the period of time the funds remain in superannuation. These amounts will be calculated by the ATO and a notice issued to you, with subsequent breaches increasing the notional earnings tax rate to 30%.

An important strategy consideration…..

With the imposition of this new limit, more importance is placed on the appropriate treatment of lump sum versus regular pension payments. Regular pension payments have no impact on your TBC, however, if the payments from superannuation exceed your minimum and are not being drawn regularly, it may be benefit to threat these as lump sum draw downs, reducing the amount of cap that is used at any given time.

Thinking differently about income

Whilst the threat of the removal of franking credit refunds is still some time away, and faces the brunt of a crossbench filled with minor parties, we thought it worth looking at some opportunities to add a more focused income producing strategy to your portfolio. The Investor’s Mutual Equity Income Fund has an interesting strategy, often employed by stock brokers for major clients, that is utilised to produce more income for investors.

For some background, Investors Mutual was established by the highly regarded Anton Tagliaferro in May 1998 and has built a reputation as one of Australia’s most consistent Australian equity managers. They now offer seven different Australian equity funds with around

$10bn managed by three portfolio managers (Tagliaferro, Hugh Giddy and Simon Conn) with in excess of 20 years of direct investment experience each, supported by a team in excess of 30 staff. Investors Mutual is partly owned and supported by Natixis Global Asset Management, a specialist investor in funds management companies, who take care of distribution.

Why Investors Mutual?

The team have built a reputation as one of the more astute and disciplined value investors in Australia by outperforming their objectives over a long period of time. This focus is built around fundamental analysis with a focus on company quality and gaining access to management rather than focusing on financial statements. The entire team focuses solely on analysing Australian equities, across both the large and small cap sectors, which means there are limited distractions and a fairly select universe from which to choose. This fund differs from the majority of its competitors via its flexibility to use options strategies in order to improve the income produced by the fund. These options strategies are used to improve the income delivered to investors and reduce the volatility of the fund. Very few specialist income managers venture into the use of options, preferring to remain exposed to the day-to-day volatility, however, for those with experience the strategy can add materially to returns.

Why the Income Bucket?

The fund meets the requirements of the Income Bucket by seeking to generate an income that exceeds the dividend yield of the ASX 300 by at least 2% and experiences lower volatility than the market over rolling four-year periods. The fund has consistently achieved both these targets having delivered an income of 8.9% per annum since inception in 2011. The fund offers diversification within the Income Bucket through its more diversified portfolio and willingness to avoid or overweight any sector (including the banks) rather than follow the benchmark as most competitors, listed investment companies and exchange traded funds operating in this sector seem to do. This has meant investors have benefitted from higher weightings to energy and utilities in recent times and an under weighting to financials. The fund currently holds 80% in ASX shares and 20% in cash which is required to fund the net 5% position in exchange traded options.

Performance & Top Holdings:

The fund has performed well over the long-term, adding 9% compared to the benchmark of just 6.7% per annum. Importantly, of this return 8.9% was delivered in the form of income. The fundamental value approach of the fund saw it underperform in 2018 as high growth technology companies drove the benchmark ASX 300 index higher, the result being a net return of -4.3% compared to the index of -3.1% for the 12 months to December. This should be expected from time to time as the managers are seeking a high quality, less volatile portfolio that supports a quarterly distribution for investors, rather than chasing momentum and hot companies. At present the fund is substantially overweight Utilities companies and underweight materials, consumer staples, financials and healthcare compared to the index. The fund holds 44 individual stocks with key holdings being: Transurban, Caltex, Spark Infrastructure and Crown Resorts, with the major banks and Telstra recently making a return to the portfolio.

Should you invest?

We believe this fund offers and attractive diversification opportunity within the Income Bucket and expect the

Lunch with Octopus Investments

Our boardroom lunch series continued in February as we welcome Sam Reynolds, Managing Director of Octopus Investments Australia. As we highlighted previously, Octopus is a European fund manager, with around $15bn in assets under management, who implement an ethical focus for their investment decisions. They have a preference to supporting positive business in the areas of healthcare, renewable energy and venture capital. When it comes to renewable energy, their experience is unheard of in Australia with over $4.6bn in assets under management and having constructed or operated over 250 individual sites, primarily in solar and wind.

We invited Sam to present as we believe the renewable energy thematic is a potentially hugely profitable investment opportunity over the next few decades. Whilst our major political parties may continue to disagree on the appropriate action, businesses around the world and now in Australia, are talking with their wallets, entering landmark Power Purchase Agreements with renewable energy operators to appease the wishes of their customers.

The boardroom lunch was a deliberately relaxed affair, with Sam taking questions throughout, whilst explaining the core facets of his approach and clearing up a few fallacies impacting the sector.

Why Australia?

As one of the most experienced and successful renewable energy investors in the world, the first question asked of Sam, is why Australia? According to Octopus, Australia today looks like the UK and Europe over 10 years ago, when there was a lack of political will to move towards renewables. As part of the decision to bring their full team of 10 analysts and experts to Australia, Octopus reviewed the opportunities available in the US and parts of Asia, but decided Australia offered the best opportunity to replicate their current model and deliver outsized returns.

Further, Sam suggested that any expectation that the move to renewables from coal will be smooth, as many bureaucrats expect, may be delusional. Approximately 80% of Australia’s energy currently comes from oil and gas, however, forecasts suggest that 50% should be sourced from renewables by 2030. In 2030, 50% of Australia’s coal plants will be over 40 years old, with many projects actually being mothballed well in advance of this date, as Hazelwood was in Victoria recently.

One of the biggest reasons for Australia, is our expanding cohort of Generation Y and Millenials, who increasingly want action taken on climate change and are forcing business through their tweets or buying decisions to make the change.

What about costs?

Sam explained that there is a common misconception that new solar sites actually cost more than coal plants but that this is completely untrue. According to analysis, new solar is cheaper than both new and life extending coal fired plants even without the benefit of renewable energy subsidies that are provided.

Is Australia too different to Europe?

Sam noted during the presentation that the UK powered its entire country without coal energy for 2 full days in 2018. Whilst a portion was supported by nuclear energy, the reduced reliance on coal is obvious and it is actually estimated to be removed from the energy mix from 2025. Whilst it would be an important step for Australia to consider the benefits of nuclear energy, it doesn’t appear likely for the time being.

On the positive side for renewables in Australia, the team indicated that we actually have a more favourable climate than the likes of the UK. In the UK the peak demand for energy comes overnight, due to the cold and snowy nights, meaning heating is turned on throughout the country at the same time that most renewable energy sources cease production. This is opposed to Australia, where peak demand occurs in the middle of the day, when the temperature is at its hottest, which happens to be when solar and wind can produce the most power for the grid.

Is there any issue with our grid?

A number of questions were raised around both the quality of our electricity grid and the ability to gain access from the likes of Australian Super and Transgrid. Sam confirmed that a major part of their extensive due diligence into any project is in the fact assessing and reviewing the quality of the grid infrastructure in the area, noting that their recent $450m project, required around $25m in self paid upgrades to the local grid to ensure the project was as efficient as possible and energy loss was minimised. One attendee noted the issue of the interconnected grid in Europe, compared to our straight line grid on the East Coast, hence the importance of locating any sites in the most effective area.

There was some concern about accessing the grid given it is basically monopoly owned by a number of large institutions, with Sam indicating his is well versed in the negotiating tactics required to work with grid owners, and the importance of the demand-pull for clean energy that is occurring from consumers. Importantly, Octopus’ reputation and experience means they have extensive networks within Government and the power industry both here and around the world that can assist with connection and any other issues.

What to watch for?

With over 250 projects built in Europe in the last decade, Octopus has a unique understanding of the issues facing both the industry and new projects that seek to enter the market. Sam discussed a number of issues that concern him throughout the sector and which should be front of mind for investors seeking to add an exposure to the sector.

His first point was that subsidies do not always end up being in the best interests of the sector, as evidenced several years ago, when Government funding saw many inexperienced providers enter the sector and the quality of work reduce substantially.

Sam highlighted the now bankrupt RCR Tomlinson as a case in point for new entrants in the industry, as the engineering and construction group simply took on too many projects at the same time and did so without any real experience in the sector.

Sam warned against working with any engineering company, developer or investor that is only making its entry into the sector, as he has seen and experienced the issues come with misunderstandings and poor pricing models. He noted that even some of the world’s most experienced renewable consulting business can include poor assumptions in their models, hence Octopus undertake their own due diligence, including of the local electricity grid, for every project. They do not rely solely on an independent report, but noted many other investors do, which can cause substantially worse outcomes than expected should the real world be different to the assumptions (as it typically is).

Another issues the smaller players face is the lack of scale in both construction and energy generation. In some cases, a smaller solar farm may need to sign off its entire annual generation to a single business, effectively making it a price taker, or not be able to access the debt required to fund the projects. There is no such issue for Octopus and in fact they have been requested as preferential builder/operators by the lenders on various occasions.

Other questions

There were a number of other questions from the audience, including around improving technology in the solar panel sector, the importance of baseload power and whether Octopus had given any consideration to adding storage to their solar farms. Sam noted that the Snowy Hydro 2.0 proposal, which sees water pumped upstream using solar panel, to produce baseload power overnight, made sense for Australia and has been used overseas for some time. He noted that at this point battery storage, like that in South Australia, which combined millions of small batteries, is simply not cost effective enough for solar farms in this or any other country, hence they would continue to work on the basis of direct connections to the grid. That being said, Octopus were always seeking new opportunities and would add said storage capacity if and when it became both reliable and more appropriately priced.

What are the investments?

The Octopus investments are restricted to wholesale investors only at this point, meaning investors need to have at least $2.5m in assets to access any of these opportunities. Octopus is offering two options, one directly for wholesale investors, with a minimum of $300,000 per investor, and one for institutions and pension funds, with a minimum of $5.0m per investor. We are currently seeking expressions of interest for the second option at investment levels of at least $250,000, with the potential for these investments to be pooled together to access the asset.

The first option is the Early Stage Innovation Company (ESIC), with the fund aiming to raise $35m to construct 1 to 2 solar farms and on sell them within a 2 year period. Under the ESIC Fund, the unit trust will own the underlying property, construct and operate the assets for a short period of time. The forecast return is around 8% per annum over the holding period, however, similar strategies in Europe resulting in returns of closer to 10-12% with minimal volatility. The added benefit of this option for those not investing through superannuation is a 20% tax offset for the value of the investment and capital gains tax exemption which has been afforded by the managers obtaining a Private Binding Ruling from the ATO based on the use of new technology in the project. Of course, this investment must stack up without the need for a tax offset, which we believe it does. If you would like a copy of the Information Memorandum, please contact one of our advisory team.

The second option, is the $150m OASIS Fund, which is restricted to a total of 49 investors and a minimum investment of $5.0m. The fund is targeting an annual return of 9-10% over a three to five year holding period, with minimal income expected in the early years. They intend to sell the underlying assets via private sale or IPO at the end of the five year term. This fund will be diversified across states and in our view represents the more attractive long-term option. Given the minimum investment size, any investment would need to be pooled via a separate unit trust, which we are in the process of reviewing with a number of legal and accounting experts.

Thinking differently about income part 2

As the threat of the removal of franking credit refunds increases, we thought it worthwhile once again touching on specialist fund managers who may be able to supplement your own, franking credit focused portfolio. We recently met with the team at Legg Mason, who offer and vouch for the Martin Currie Equity Income Fund.

Who is Legg Mason? Legg Mason was founded in 1899 making it one of the longest standing asset management firms in the world. The company managed some $100tn in assets across the world through their multi-affiliate model, whereby they partner with specialists in each sector to deliver active managed strategies to their clients. The company has 39 offices across the world, employs 3,300. This fund is managed by Martin Currie, a global manager who first established a presence in Australia in 1954. The core of Martin Currie’s proposition is effective stewardship which is assessed through a differentiated ESG and responsible investment analytical process.

Why Martin Currie? Martin Currie is one of the most successful long-term Australian investors having managed institutional capital for several decades until 2011. This meant the firm does not have the profile of a Platinum or Magellan. The fund itself is managed by Reece Birtles and Michael Slack who each have over two decades of experience across global sharemarkets. The fund has differentiated itself by building a benchmark unaware portfolio of high yielding companies, but most importantly investing in those businesses that are increasing their dividends, not just on their payout ratios. The managers understand the impact that constantly paying out earnings as dividends can have as well as how important sound management is to drive long-term returns. Their investment process is fairly straightforward, focusing on Valuation, Quality, the Direction of Earnings and Sustainability of their dividend, but it is their experience and access to quantitative information that sets them apart.

Why Income Bucket? The fund’s dual objectives are to provide an after-tax yield in excess of the ASX 200 whilst growing their dividend stream above inflation. This is in line with the requirement of the Income Bucket to seek the majority of the CPI + 5.0% targeted return in the form of dividends. The fund is benchmark unaware and will hold between 40 and 60 individual investments at any given time. The managers seek to construct a portfolio that can be held over the long-term, by investing with growing businesses, which means the portfolio turnover is typically around 25% per annum. They are what is known as ‘actual investors’ who seek to buy shares in businesses, rather than stocks. They are also aware of the taxation benefit that franking credits can provide to Australian investors and include this in their internal assessments of investments.

Performance & Top Holdings: The fund has performed well over the long-term, delivering a return of 6.98% over the five years to January 2019. At present the fund has 48 individual holdings, of which the top 10 represent 39% of the fund. These include Wesfarmers, ANZ, Insurance Australia Group, Telstra and JB HiFi; making the portfolio markedly different from the index. The overall allocation of the fund is around 9% to energy, 16% to non-bank financials, 12% to utilities and 14% to consumer discretionary with over half of the fund invested in businesses with market capitalisations of over $10bn. The fund may underperform the ASX 200 in the short-term as it seeks to reduce the underlying volatility of the portfolio and exhibit a risk level below the market. The fund currently offers a forecast yield of 5.90% plus franking and will be exposed to those companies announcing both special dividends and off-market buy backs in the lead up to the election.

Reasoning: We believe that Martin Currie’s low turnover fundamental value focused approach can complement well with other income focused holdings that generally make up portfolios. In what is becoming an increasingly volatile and difficult market for income investors, their benchmark unaware approach provides a lower risk and more flexible option. This is ensured through the both the ASX sector limit of 22% and an individual security limit of 6%, meaning you will never see the fund hold 60% in just two sectors like an ETF. Martin Currie’s approach stood out to the Investment Committee as being repeatable for two reason; firstly, they are major proponents of aligning with high quality management, with a particular focus on Environment, Social and Governance (ESG) issues; which increasingly lead to positive results. Secondly, they seek to find companies whose earnings are moving in the right direction and which are paying sustainable dividends that can be increased each year regardless of the economic conditions. The managers charge a flat management fee of 0.85% which is competitive with no performance fee.

A few head scratchers

As with every reporting season, there were quite a few headscratchers on both the analyst and management side for investors to deal with.

Bingo Industries (BIN): Fund manager darling Bingo Industries shocked the market by announcing a substantial downgrade to profit guidance of $108-112m, or 20% growth from its rubbish collection business. The share price was punished as a result, but after being pitched the IPO some time ago, we couldn’t quite understand how this type of business could manage to consistently deliver 20% profit growth every year. Management indicated that softening residential construction, following house price falls, and a slowdown in developments had hit profits heavily, after suggesting they were immune just a few months ago.

Bank of Queensland (BOQ): As predicted by most in the industry, it has been the smaller banks more impacted by the Royal Commission and APRA prudential measures, as BOQ reported a substantial higher cost of capital and profit falling to $165m from $182m in 2018. Their net interest marhin fell to 1.93% from 1.97%, one of the lowest in Australia, and CET 1 capital is just 9.1% in what must be a concern for the regulator.

IOOF Ltd (IFL): We cant’s quite work out what’s happening at IOOF, after seeing several staff members facing criminal charges, the company that has acquired one financial advisory business after another (including Shadforths) announced remediation provisions of just $5-10m. This pales in comparison to the banks and AMP. They highlighted that the cost to review all their advice will be around $30m but that only 10% of revenue produced by their adviser network comes from grandfathered commissions. We struggle to believe this is accurate and suggest some further negative news is coming in the future. At the same time, the company reporting NPAT of $100.1m, up 5.8% on the first half, and confirmed it would proceed with the purchase of ANZ’s Pension and Investments business.

Afterpay Touch Ltd (APT): APT delivered another solid headline result, with underlying sales on their platform increasing 147% to $2.3bn, yet the company failed to deliver a profit. The company appears to be the buy now pay later provider of choice for retailers, however, the quality of its customers may leave something to be desired. Some 17.6% of income is presently being sourced from late fees and the company continues to avoid the use of credit ratings checks. The strength of the business model appears to be driven by offering credit to those who are unable to control their spending, hence the huge levels of growth and increasingly lower quality of their retail partners. Yet following recent political questioning the company has now indicated it will seek to improve its lending standards; is it giving up growth?