Model Portfolio Update


The month of August saw the majority of Australia’s largest companies report full year earnings, as a result it was quite a busy period for the Investment Committee. An update on the major holdings within the Model Portfolio now follows:

AMP Ltd: AMP announced a better than expected underlying profit of $309m, driven by strength in the AMP Capital and AMP Bank divisions, but fell to a loss due to $2.35bn in write-downs on their wealth management and insurance. Earnings within wealth management division fell 49% to $103m for the first half of 2019, whilst AMP Capital increased 27.7% to $120m making it the largest contributor to profits. The wealth management divisions’ assets under management increased 8% to $132.7bn with just $3.1bn in net outflows, a much better result than expected by analysts. The result was accompanied by a $650m capital raising and cancellation of the interim dividend. An announcement was made on the strategic review undertaken by the new CEO, Francesco De Ferrari, which was received positively by institutions. He announced a change in the strategic direction of the business, seeking to cut its adviser numbers substantially and continue the evolution of their financial advice unit to interact directly with their customers via the increased use of technology. AMP announced it would no longer be paying a market-leading price of 4 times revenue for buying back AMP Financial Planning firms, which is a sound decision. The sale of AMP Life to Resolution Life was renegotiated, albeit at a 10% discount, allowing the company to focus their capital on areas that offer substantially better growth. AMP represents a contrarian investment opportunity with the latest earnings announcements seemingly providing a circuit breaker against the negative sentiment and selling pressure of the last 6 months.

Orora Ltd: Glass and cardboard box manufacturer, delivered a weaker than expected result, with profit up 4.0% on the previous year with expectations substantially higher. The share price was sold off heavily as a result, and in our view has been oversold. The company delivered top line revenue growth of 12.1%, to $4.7bn and EBIT came in at $335m some 3.7% improvement on the previous year. Management blamed higher electricity prices and input costs in Australia, which offset the c$8m gain from the translation of their USD earnings. The North American point-of-purchase marketing business, which is being constructed through acquisitions, is still in its early stages but struggled as margins were reduced amid lower than forecast sales volumes. Orora remains a defensive money generator, with 56% cash flow conversion from earnings, which is impressive for a company with significant capital expenditure. The Australian business continued to drive performance with fresh food and drinks both growing in the mid-single figures, offsetting the weather, trade war and weak retail sentiment in the US that saw earnings fall 11% to just $83m in USD terms. With that being said, the company once again increased their dividend to 6.5 cents per share, up 4% on the previous year.

Telstra Corporation Ltd: Telstra delivered its heavily flagged earnings result, with total income falling 3.6% and EBITDA down 21.7% to $8.0bn as the rollout of the NBN continued to hit the bottom line. Management noted that the impact is around 50% complete and has cost around $1.7bn in earnings since 2016. These results were within guidance and sufficient to warrant the c60% returns delivered over the last 12 months. The highlight was TLS’s continued dominance in the mobile subscriber base, adding 11k and 139k in pre and post-paid plans in the six months to June and continue to outpace Optus, having attracted 60% of all sign ups. The company offered positive guidance for the year ahead, of EBITDA between $8.9bn and $9.8bn, and confirmed the dividend of 8cps, keeping the 12 month total at 16cps. Importantly, Telstra’s 2022 strategy which includes asset monetisation, a structural separation of infrastructure and technology assets, cost cutting and simplification continued apace delivering another $300m in cost reductions for the second half. The company announced the sale of 49% of their exchange owning property trusts to Charter Hall, releasing $700m to the business for future investment. CEO Andy Penn has remained on the front foot along with the other telco heads as they pressure the Government for a writedown in the NBN which could eventually see Telstra acquire the monopoly asset.

Commonwealth Bank of Australia Ltd: CBA delivered a weaker than expected profit for the 2019 financial year, with cash NPAT falling 5% to $8.5bn below consensus forecasts. The pressure came primarily from increased remediation costs, which reflect potential payments to customers impacted by poor financial advice and sales practices; these total around $714m. More generally, the company is facing a number of industry wide headwinds including slowing credit growth following some publicised responsible lending court cases, a weakening property market, lower interest rates pressuring net interest margins (NIM) and the disruption of selling non-core businesses. On a positive note, CBA delivered industry leading loan growth at 3.9% and a flat NIM for the second half of 2.10% as there huge staff and cost cutting process reduces operating costs. Once again, CBA’s capital ratio was above the minimum requirement at 10.7% with the sale of CFS GAM likely to see this further increase to 11.8% unless the capital is returned to shareholders. The company is proceeding with the sale of their external mortgage broking and financial advice businesses, including Count, Financial Wisdom and Aussie Home Loans, which management appear happy to be give away for free to avoid further reputational damage. They intend to continue operating the in-house Commonwealth Financial Planning unit. Most importantly for investors, the dividend was retained at the same level, albeit pushing the payout ratio over 90%.

CSL Ltd: Investors had been growing increasingly nervous about CSL’s growth prospects in light of their Chinese expansion and increasing competition; yet once again the company delivered on it lofty expectations seeing it once again reach all-time highs. Management reported revenue was 11% higher than FY18 leveraging this into a profit increase of 17% to $1.9bn. Every major business unit is now performing well with Privigen and Hizentra growing sales 23% and 22% respectively and the troublesome influenza vaccine business, Seqirus, completing its turnaround with 19% growth on the previous year. Experts were disappointed with the fall in free cash flow, but given it was a result of increasing investment in plasma collection centres to further solidify its dominant position, should be viewed as a positive for long-term investors. The other major impact was the short-term cash flow reduction as CSL begins to export directly to China, rather than through intermediaries, which requires higher inventories and production before launch. The strong result saw management increase the dividend once again, to $1.85 per share, an 8% improvement on the previous year. In a sign real strength of CSL CEO Paul Perrault welcomed further supply and competition in their core immunoglobulin sector as demand continues to outpace investment. In an environment where all investments are effectively split into unprofitable high growth companies and profitable slow growth companies, CSL seems to see right in the middle.

Qube Holdings Ltd (QUB): Qube’s diversification strategy continued to pay dividends in the second half of the financial year with management announcing a 3.9% increase in operating revenue to $1.84bn and underlying profit growth of 15.4% to $123.2m. It’s important to note that this excludes the impact of non-operating write-downs The highlight was the operating division, which includes their port logistics operations and ports and bulk commodity shipments. The logistics division actually saw revenue reduce following the end of rail terminal contracts with Aurizon, but deliver higher earnings due to previous years investments. The ports division was able to offset weakness in vehicle imports and general cargo volumes with a stronger than normal period for oil, gas and forestry products. Bulk commodities saw volume growth amongst most commodities and a recent specialist lithium storage facility adding to revenue. The logistics division which represents 35% of revenue saw growth in every capital city port, however there was a substantial decline in agricultural exports due to the worsening drought conditions in NSW and QLD. Thankfully, this was offset by improving mining revenues as key commodity prices remained robust. The company is moving forward from the messy financials following the huge Patrick acquisition, and has been able to reduce their leverage to just 32.5% in a short period of time. As highlighted previously, we believe the growth opportunity lies in the need for increasing investment in supply chain efficiency, where Qube’s intermodal terminals stand out. The Infrastructure and Property division remains in its infancy but delivered 8.8% growth in revenue to $103m and 18.4% growth in earnings to $39.2m, with around $265m dedicated to capital expenditure during the period. The strong results across the board resulted in a 3.6% increase to the dividend to 2.9 cents per share with management indicated the outlook for FY20 should be similar to that just completed with the potential tailwind of acquisitions and further progress at Moorebank.

Santos Ltd: Santos’ remarkable recovery from the depths of oil price crash continues at pace with management announcing another record half year profit of $411m an increase of 89% on 2018. Of course, the percentage growth must be taken with a grain of salt given this is coming off a very low base and a $30 oil price. Most importantly for investors was a 74% increase in free cash flow to US$638m which means the business is actually turning profit into cash available for investment or distribution. The result was a 71% increase in the dividend to 6.0 cents. The company continued to reduce its cost base with free cash flow breakeven now as low as US$31 per barrel, meaning the business would remain profitable in the worst case scenario. A major driver behind the improving performance was the 2018 acquisition of Quadrant Energy’s high quality producing assets that are no expected to add a further $50m-$60m in cost synergies. Santos’ turnaround is a story for the patient investors, as after drowning in debt whilst constructing the PNG and Gladstone LNG plants the company has now reduced its leverage ratio to 31%. This freeing up of capital has allowed Santos to increase its capital investment into existing assets, to around $1bn, spread across WA, the Cooper Basin and Queensland; bucking the trend of other miners who seem to be pulling back. Interestingly, their portfolio sales volumes are not split 35% to CPI-linked gas contracts, and 65% to oil-linked liquid and gas contracts.

Boral Ltd: The cement and building materials producer delivered a solid result for the financial year, with its diverse operations across Australia, the US and Asia offering some earnings stability. The company beat expectations announcing revenue was up 4% to $5.8bn and EBITDA increasing 2% to $1.03bn. The strong result and completion of a number of divestments in FY18 meant cash flow was substantially stronger, at $712m compared to just $235m, however, management retained the dividend at current levels. Management highlighted that non-residential and infrastructure activity remains solid, but that cyclical housing slowdowns in both the US and Australia where housing starts dropped 2% and 15% on the previous year are pressuring margins. Boral Australia stagnated with revenue flat and earnings down 6%, primarily due to the windfall property sales that occurred in FY18 and which facilitated the higher dividend. Boral North America was substantially stronger, growing revenue by 12% in AUD terms and earnings by 19% to $415m, with the company able to offset the wettest period on record via the synergies from their recent Headwaters acquisition which now total $71m. One of the highlights of the result was the announcement that Boral would be repurchasing 50% of the domestic joint venture with USG/Knauf, who are the world’s leading plasterboard manufacturers, whilst also expanding the joint venture in Asia via a further $241m investment. It’s obvious that management are seeking greater diversification into the faster growing economic region after announcing that net profit for the group would be 5-15% lower in 2020. The investment will be funded through existing debt facilities and proceeds from the sale of Midland Brick ($86m) and Texas Block ($127m). Boral continues to offer exposure to a high quality, defensive and well run business with global diversification and expanding operations in the under invested infrastructure sector.

Ramsay Healthcare Ltd: The globally diversified private hospital and medical centre operator delivered a result in line with guidance, with revenue increasing 24.4% to $11.4bn on the back of the Capio acquisition. Earnings also improved 10% to $1.1bn. The Capio acquisition which includes operations in Sweden, Norway, Germany and Denmark has allowed Ramsay to diversify away from Australia and benefit from similarly ageing demographics in Europe as well as offering a more diverse range of services including aged care support. When the benefits of the acquisition are excluded revenue remained strong at $9.6bn at 5.3% increase on the prior year and EBIT up 6.2% with the company continuing to benefit from currency translation into AUD. The Australian operations were the highlight with earnings increasing 6% to $950m on the back of a 4.1% increase in revenue over the previous year. Importantly Ramsay’s volume and patient growth is above the industry average which is evidence of the high quality and preference for their facilities. The Australian division added a further 216 beds but management noted short-term conditions remain difficult with a more positive long-term outlook. The European business showed growth, albeit weaker, with revenue up 2.6% and earnings a more muted 1.8% to $453m when Capio was excluded. The size of the acquisition is such that the growth levels increase to 51.7% and 32.6% respectively, however, they do have a negative impact on profit, rather than earnings, in FY19. Importantly, FY19 only included a small portion of the announced tariff increase in France, suggesting FY20 will be an even stronger result and NHS volumes only began to improve in the second half.  The company guided to lower than normal growth in earnings of 2-4% with additional benefits to be drawn from synergies associated with their growing global scale. Ramsay surprised the market by announcing a 6% increase in their interim dividend to 91.5 cents per share.

Woolworths Ltd: Woolworth’s return to market dominance continued in FY19 with the company delivering revenue growth of 3.4% ($59.9bn) and a subsequent increase in net profit of 7.2% to $1.7bn. The immediate result was a 9.7% increase in the total dividend to $1.02 per share. Of great significance was the strength of WOW’s second half, delivering 3.6% comparable store sales growth compared to Coles’ 2.2% performance. The launch of the Lion King figurines appears to have shut the door on Coles’ minis promotion and seen a surge in sales of 7.5% in the first 7 weeks of FY20. The company’s transformation continued during the year with the sale of the Petrol business adding $1.7bn in cash and both the merger of ALH and Endeavour Drinks and subsequent demerger or separate listing to be completed in FY20. Interestingly, online sales continued to grow strongly, +45% in the fourth quarter, and whilst it remains a tiny portion of overall sales at $1.4bn it is profitable and well ahead of Coles. It appears BIG W may finally be turning the corner, as sales increased 5.2% on FY18 and the loss reduced substantially to just $5m. The brand is benefitting from a more refined product selection and a rationalisation of poor performing stores.

Model Portfolio Update

Looking around the markets, the Model Portfolio’s large and growing exposure to global share markets ensured investors benefited from the significant upside delivered around the world. Whilst the performance of the ASX was strong, it was usurped by the US and Asia.

Within Australia the highlights remained the mining and materials sector as the likes of BHP and Rio Tinto benefitted from well publicised iron ore supply issues even as export volumes stagnated. The Plato Fund has an exposure to both companies whilst both Boral and Orora fall into this group.

The other performers were driven by the aftermath of the Federal Election and subsequent rate cut with those businesses offering defensive income streams and exposed to the right sectors performing strongly. This month they were financials and banking (3.49%), healthcare (4.20%) like Ramsay and CSL, Consumer Staples (3.02%) including Woolworths and Industrials (4.47%) which includes both technology and operational companies like Qube.

Gold bullion: Gold bullion remained one of the best performing asset classes of 2019, reaching all-time highs above $2,000 in Australian dollar terms and delivering a return of 7% for the month. Gold is a much-maligned investments with traditional stock pickers, brokers and the likes of Warren Buffet unable (or unwilling) to properly value the asset due to its lack of cashflows. What we know is that gold acts as an alternative currency in times of volatility and most importantly for Australian’s offers a direct hedge against the biggest risk to our economy; China. In the month gold benefitted from geopolitical escalation in Iran and China, as well as the rate cut delivered by the Reserve Bank of Australia. Major central banks outside the US and Australia continue to buy substantial amounts of gold to hedge against the USD.

Qube Holdings (QUB): Qube continued to deliver during the month, moving to an all-time high as the integration of the Patrick and Asciano businesses continued. The company continues to expand its service offering and has been gaining market share as its competitors decided to increase their prices at an less than opportune time. The strength has been driven by the companies strong Bulk Commodity volumes, as South American iron ore struggled in light of the Vale dam collapse. This offset weakness in car and soft commodity volumes impacted by the drought and flooding in various parts of Australia. Management recently announced the Moorebank Intermodal Terminal will be ready to receive trains from the Port of Botany in the third quarter of this year, with the Target site complete prior to this. The company has been investing heavily into solar energy and the automation of on-site logistics at Moorebank making it one of the more innovative businesses in Australia.

Hybrids and Preference Shares: Whilst we don’t typically focus on the Capital Stable Bucket investments in this report, the performance of the sector was such that it couldn’t be ignored. According to the Solactive Australian Hybrid Securities Index, the sector was up around 2.5% since the start of May and 1.8% in the month of June alone. The preference share sector fell out of favour in the lead up to the Federal Election due to the fact that most pay a fully franked distribution which was likely to be impacted by the Labor Party’s policies. As outlined previously, it is important not to assume that the expected will occur. The result has been the mass selling of preference shares by stockbrokers and short-term investors missing out on the re-pricing of these securities following the election. As mentioned previously, the lack of interest from retail investors has opened the market to the likes of the industry super funds, which are supporting greater liquidity and demand in the sector.

Telstra Corporation (TLS): Telstra continued its upward march during June after announcing higher than expected impairment in May on the back of its substantial business restructure. The company continued to benefit from the ACCC’s decision to block the merger between TPG and Vodafone and the subsequent commencement of an appeal process, which will act to distract both competitors in the short-term. This combined with the banning of Huawei’s technology, used by Telstra’s competitors, from the Australian 5G network is seeing the sentiment towards the company finally turn. A number of brokers upgraded their recommendations during the month, noting that Optus has begun increasing it mobile pricing reducing the gap to Telstra’s more expensive but higher quality service. They also note that the NBN rollout is now 70% complete and believe the market is undervaluing Telstra dominance in technology and investment to deliver the best 5G network.

Boral Ltd (BLD): Boral’s recovery slowed during the month but the company reaffirmed guidance for the financial year and indicated weather conditions were conducive to a strong finish for the year. The company also announced a multi-billion-dollar project with Mirvac that would involve the redevelopment of its Scoresby site in Eastern Victoria. Boral expects this to deliver $66m in earnings through to 2026.

Magellan Infrastructure Fund: The Magellan Fund continued to deliver for investors increasing 4% in the lead up to the end of the financial year. The performance was driven by a further deterioration in bond rates around the world, with some 50% of European bonds now trading on negative yields. This is leaving investors with few opportunities to find low risk income and increasing the attractiveness of Magellan’s key infrastructure assets. Transurban performed strongly as news filtered through of their sweet heart deal with the Victorian Government should the construction of the new western freeway be delayed, whilst Crown Castle, which owns telecommunications towers in the US benefitted from the capitulation of China Tower due to its use of Huawei technology that is banned in many developed countries.

Model Portfolio Update

It was a mixed month for the Wattle Model Portfolio, as the core domestic holdings benefitted from a Liberal National Party election victory, but the global managed fund exposures were impacted by increasing trade war concerns towards the end of the month. The ASX outperformed it’s global peers for the month, bucking the correction trend due primarily to many income seeking investors returning to the market following the positive result on franking credits and the expectation of several rate cuts to come. Whilst we don’t believe that rate cuts should be the first point of action, it seems inevitable they will be moved, offering opportunities in markets for at least the next 6 to 12months.

The Model Portfolio bucked the trend of most benchmarks, including both union funds and corporate super, delivering a positive return in a generally negative market. This was due to our focus on undervalued, defensive but profitable companies exposed to the few growing sectors in the economy, including the Boral, Ramsay and Telstra. The strongest sectors in the quarter were Communications, as the TPG-Vodafone merger was denied, and Telstra announced further progress in its transformation. Materials benefitted from Fortescue’s special dividend and continued strength in iron ore prices, whilst Energy was hit by weakness in the oil price. Healthcare and Financials both benefitted from the election result, as the potential cap on health insurance premium increases supported the continued volume growth in private hospital admissions. Unfortunately, the global technology stocks and anything exposed to the China-US trade war were hit, yet we remain confident of a final positive outcome before the end of 2019.

Orora Ltd (ORA): The bottle and cardboard box manufacturer had experienced a poor start to 2019, as signs of a slowing US economy impacted the outlook for their growing US business. The share price began to turn as the Federal Reserve put rates on hold and both consumer sentiment and retail sales in the US showed signs of improving. The company has been acquiring numerous business in the retail marketing space in the US and spending substantial amounts on both innovation and energy efficiency within their business. Management announced that they expect earnings to be above FY18 but highlighted a slightly slower than expected start to 2019. They noted the US operations were improving in March/April which bodes well for the close of the financial year. Input costs continue to place pressure on the bottom line, however, purchase agreements for renewable energy supply are offsetting the increased cost of Kraft paper and starch. The company will benefit from the weakening in the AUD and the extraction of synergies from the purchase of Pollock and Bronco Packaging in Texas, which fit the same business model as Australia.

Ramsay Healthcare Ltd (RHC): Ramsay was one of the immediate beneficiaries of the election result, as the business relies on private insurance premiums to fund some 80% of their domestic procedures. The Labor Party had proposed a 2% annual cap on insurance premium increases which the market had assumed would lead to lower revenues for RHC. Right or wrong, the policy was not successful and no cap has been applied. After finalising the acquisition of Capio in Northern Europe, the company now manages some 480 global facilities in 11 countries and employs 77,000 people. Recent data from the UK’s NHS indicated Ramsay’s volume growth is on the improve with operations further supported by the first increase in tariffs in both the UK and Europe in many years. The companies deal with Baxter Healthcare for the bulk purchase of infusion pumps whilst small on its own, indicates the purchase power and cost benefits afforded by its scale. At the end of the month, long-time CFO Bruce Soden made the decision to step down after 31 years.

Qube Holdings Ltd (QUB): The integrated logistics and transport business, Qube, announced the acquisition of mining services business LCR Group during the month. The acquisition was made to allow Qube’s other operating divisions to deliver additional services, including existing customers in heavy transport, mining and mobile crane businesses, with an increasing focus on renewable energy. The business came at a cost of $135m and was funded from undrawn debt facilities, it is unlikely to have a material impact on profits in the short term.

GAM Absolute Return Bond Fund (AFM0002AU): GAM announced the payment of a further 9% of the remaining capital at the beginning of May, taking the total capital return to 80% of that invested. We understand that management have also agreed to sell the remaining assets to an external party at their cost price with the deal expected to be settled in July/August of 2019.

Plato Australian Shares Income Fund (WHT0039AU): The Plato fund was recommended to provide an overweighting to high yielding, fully franked dividend paying Australian companies in the lead up to the Federal Election. In May, investors benefitted from both the announcement and completion of a number of special dividends and buy backs as well as the success of the Liberal Party. The fund benefitted from the Woolworth’s and Caltex buy backs, renewed strength in the banking sector and special dividends from Rio Tinto, Fortescue and BHP. The fund delivered an income of 15.1%, that’s correct, for the 12 months to 30 April, losing 0.8% in capital, but still outperforming the ASX 300 by 2.1%. Whilst the flow of special dividends and buy backs is likely to slow, we continue to see substantial value in this specialist income and franking due to the exposure it provides to the less volatile, more defensive businesses in the Australian economy.