Speaker 1:
Before we begin this Bennelong Funds Management podcast, we would like to acknowledge the traditional custodians of the land on which we are recording and pay our respects to Elders past, present, and emerging. We celebrate the stories, culture and traditions of Aboriginal and Torres Strait Islander communities who work and live on this land, and we commit to an ongoing journey of reconciliation and respect.
Jonas Daly:
Hello and welcome to our podcast for December 2023. My name is Jonas Daly, Head of Distribution at Bennelong Funds Management, and today I'm joined by the BAEP investment team, including Mark East, Chief Investment Officer and founder of the firm; Neale Goldston-Morris, Senior Investment Analyst in Economics and Market Strategy; and Brad Clibborn, Portfolio Manager and Senior Analyst. Gentlemen, welcome today.
We've seen some good performance bouncing back, with the relative performance, for example, in the ex-20 portfolio up 9.2% ahead of its benchmark for the calendar year to date. And again, look we’d like to thank all of our investors for the continued support over the last couple of years. It has been a volatile environment. Today's podcast will focus on the macro impacts. It has been driving a lot of returns recently in the last few months. Then we'll focus on some of the current stocks in the portfolio. So Neale, I might just kick off with yourself. Bond markets have obviously been pushing markets around on the equity side as well. A few comments there'd be great.
Neale Goldston-Morris:
Yes, they certainly have been pushing equity markets around. Just a bit of retrospect, '22 saw the worst drawdown in returns for bonds in over two centuries. Very difficult time for everyone. Things are starting to turn, and they're starting to turn because the US in particular is managing its transition very effectively. In other words, it's achieving the dual goal of maintaining economic growth at the same time as steadily reducing inflation. And that's starting to feed through to bond yields. Bond yields have now been falling pretty usefully. That is then a clear tailwind to equities compared with the headwind that it was in '22. Particularly as it applies to our style of portfolios, which are high quality, long duration growth stocks. And the correlation between bond yields and equity prices has been remarkably high. I would anticipate over the next year that will reduce because the pressures from bond yields falls away and the underlying individual fundamentals of each stock will then take hold.
And as we've said before with our stocks, the underlying driver has been companies that are willing to reinvest in themselves to improve their product or service to generate the long-term earnings growth. And we believe that'll be a dominant driver in the next 12 months. Our portfolios remain very overweight to the US, stocks like James Hardie, ARB, Aristocrat, Goodman, etc etc, because of that successful transition the US is achieving. And it's achieving it because government is working hand in hand with the private sector to achieve optimal outcomes. By contrast, in Australia, the government is doing everything it can to attack the private sector at every turn and generating suboptimal policies on the back of that. One of the reasons our portfolios have very low exposure to domestic Australia. Our inflation rate remains high, it'll come down more slowly than US and other countries. And hence that is a relative headwind at least, as far as that's concerned. The good news is, as the pressure from bond yields retreats, then much more positive overall equity returns should eventuate and you can see a taste of that as Jonas mentioned in the returns as far as the ex-20 is concerned.
Jonas Daly:
Great, thanks Neale. And Brad, we've just come through a number of annual general meetings and November results season. A couple of stocks you'd like to highlight, James Hardie, congratulations on a good result there. So, maybe kick off with James Hardie and some comments there.
Brad Clibborn:
Yeah, thanks Jonas. We've spoken about James Hardie a lot on this podcast this year, so I'll be brief, but it's definitely worth touching on again because they reported their September quarter results last month and it was another very strong performance from the company, and that's continued to drive really strong returns for the funds. It's a top contributor to returns for the funds this year and had another good performance on the back of their results. So the net profit for the September quarter was in line with the guidance they'd provided three months earlier, but the guidance that they provided for the December quarter ahead was 25% ahead of consensus expectations, with profit growth expected to be 30 to 40% year over year. So really strong growth that they're showing.
So if we pull back and just have a little bit of a reflection back on the last 12 months for the stock and where expectations were sitting earlier this year. At the start of calendar 2023, consensus expectation was for James Hardie's earnings to decline by 15% over the next 12 months as a softer US housing market became a headwind for their volumes. Where we sit today, in actuality, Hardie is on track to grow their earnings by 15% despite the US housing market contracting by 9 to 10%. So that's an excess of a 30% upgrade to consensus expectations we've seen over the last six months.
Importantly, we've continued to see really strong and actually accelerating market share growth by James Hardie. Their volumes are tracking about 9% ahead of the market index this year in terms of their growth rate. They've had disciplined cost control, it's delivering record margins. And what they're really doing now, which is an important part of our investment thesis across all our portfolio companies, is they're reinvesting that strong revenue performance back into the business. They're investing in more marketing, they're adding more technical salespeople into the field to really grow their distribution and continue to accelerate their market share gains. And given their scale, that level of investment is something we think their competitors will really struggle to keep up with. So we continue to see that strong market share growth outlook, which will support the long-term earnings growth and strong shareholder returns in our view from the company.
Jonas Daly:
And just as far as Aristocrat goes, just some results there or any highlights.
Brad Clibborn:
Yeah, so Aristocrat reported its financial year 2023 results in November. They'd had earnings grow 22% over the financial year and landed earnings slightly ahead of consensus expectations. The gaming business in the US and Australia performed well ahead of consensus expectations. However, what we saw from management was a decision to actually reinvest some of that back into what they call their design and development investment, which is all the game designers and content investment. Essentially, that's the R&D engine of the Aristocrat business. And if we look back over the last 10 years, Aristocrat's disciplined approach to design and development spend has really been a strong driver of shareholder returns. They've grown that D&D spend from $120 million 10 years ago to $820 million in the latest financial year and are now spending over two times their nearest competitor. And if we look at what that's delivered for shareholders, it's been a 26% compound EPS growth over that 10 years and 23% compound share price return for shareholders as well. So that decision to increase the design and development spend in this last year, we're going to back management that historically has delivered strong returns for shareholders. And if we look at operationally what's that delivered, they now have 19 of the top 25 premium lease games in the US casino market. They perform at two and a half times the casino house average, so they're a must have product for US casino customers. And that's seen them double their market share in their US premium lease businesses over the last five years and grown their in-store base of lease machines in the US by another 17% this last year.
So if we look ahead from here, the next driver for Aristocrat is really the legalisation of online casino in the US. We think that'll be an important driver of growth for the next 5 to 10 years. They've invested heavily in R&D around that over the last 12 months, over a hundred million dollars of R&D spend into that alone. And they've launched their first products with their popular Buffalo slot game, achieving 5% market share in its first month for one title, which is a very impressive outcome. We'll see them close their acquisition of the NeoGames business that they've committed to buy recently, which will expand their distribution into online casino and online lotteries as well. The balance sheet's strong, we continue to see that disciplined reinvestment and the strong growth in earnings for the company over the medium to long term.
Jonas Daly:
Thanks Brad. And just with the growth in AI and quantum computing, obviously, data centres are kicking off and could be the picks and shovels for that area. Goodman Group, is that something Goodman, an opportunity for Goodman and how did they go on the latest results?
Brad Clibborn:
Yeah, so Goodman, it's an interesting point you make there. It's an owner, developer, and asset management of industrial property with historically a focus on logistics assets. They've got a really long and strong track record of earnings growth, having delivered an 11% earnings per share growth over the last 10 years. They've got a large pipeline of strategically located land assets for future development and a really strong balance sheet to take advantage of further land acquisition opportunities. But to your point, Jonas, over the last three to six months they have articulated a bit of a diversification in their strategy to expand into developing data centres for large cloud companies like Amazon and Microsoft. The locations of these data centres have a lot of similarities with their traditional industrial business, and Goodman does actually have a long track record of developing these data centre sites. With the strong growth in demand we're seeing from cloud and AI, that opportunity around data centres is accelerating.
So what we saw over the last six months is Goodman have disclosed a significant land bank across Asia, Europe, Australia and the US that can be developed into 3.7 gigawatts of data centres for development over the next 5 to 10 years. To put that in context, the total data centre market today is about 50 gigawatts, so it's a substantial pipeline that they have. The value add that Goodman bring to the table is not just the land that they have in their portfolio that they can repurpose to these data centre sites, it's also their experience around local and state planning processes. The challenging part is getting access to power and it's that expertise that Goodman brings and that's their core skillset that is not necessarily the core skillset of a Microsoft or Amazon that ultimately need these data centre sites.
Means that the returns are very attractive – the yield on development costs that you get out of these data centre sites is 8 to 12% versus 7% for their traditional industrial assets. So by repurposing sites into data centres, there's quite substantial value uplift for Goodman shareholders. So we think that's going to underpin continued strong earnings growth for the next 5 to 10 years for Goodman. And that's contributed to some good share price performance as they've articulated that strategy over the last three to six months.
Jonas Daly:
Great. Sounds like a good opportunity. Now we might just move over to Mark East on the REA. They just recently gave a quarterly update. Any comments there on how they're positioned and a few highlights?
Mark East:
Yeah, thanks Jonas. REA owns the leading property portal in Australia, realestate.com.au, it's probably one of the highest quality businesses in Australia with number one market position, an attractive two-player industry structure and has strong pricing power. As you mentioned, they reported their September quarter results last month and after listing volumes fell 12% last year, volumes are now starting to recover. The September quarter saw volumes up 1% and October volumes were up 16%. Pricing or yield trends have also been very strong, largely driven by a 13% price increase this year and the successful rollout of a new product, their new Premiere Plus premium listing product. And this saw average revenue per listing up 9% in the September quarter. Good cost control by management also, that helped protect margins last year when volumes softened. And this is now paying off this year with strong operating leverage forecast for the current financial year.
So the outlook for REA in Australia is attractive. Today, REA's listing fee is only 0.2 of a percent of the average property value. That's well below what the seller would pay the agent, yet REA are driving the majority of the buyer audience to the property, and this has enabled REA to guide to double-digit growth in average revenue per listing or yield over the next few years. Importantly, REA's competitive position versus Domain has got stronger over the last year, which further supports that sort of strong pricing power. So yeah, REA is a high quality company with a good runway of double-digit earnings growth ahead.
Jonas Daly:
Sounds good. And a big one, CSL, plenty of news on this stock throughout the press. You guys have held it for a long time in the portfolio. In fact, I think you held it when it was outside of the top 50, so you know the stock well and we've seen these impacts before by news coming out on other drugs entering the market. Any updates there that you could provide and your current positioning?
Mark East:
Yeah, sure. Look, CSL's got a lot of the attributes that we look for in a company. Strong balance sheet, high quality management team, and invest a lot in R&D and its manufacturing processes to develop new products and drive long-term growth in the business. But in June, management provided guidance on FY24 earnings, which was a bit lower than market expectations. And this miss was due to slower than expected recovery in gross margins in the CSL bearings business. Post that, CSL's provided broad guidance on the recovery of gross margins over the next few years, and that provides some relative certainty about the outlook and the recovery and earnings in CSL.
The recovery in gross margins, that's driven by a drop in donor fees, an increase in collection volumes and the rollout of CSL's new Rika device into its collection centres in the US. And this device will lead to CSL being able to collect more blood from each patient in a shorter amount of time. And this increased efficiency will be an important driver of margins for the business over the next few years.
CSL has several new products coming to market over the next couple of years, which should help to drive revenue for the company. One of these is HEMGENIX, which is the first gene therapy drug ever approved in hemophilia B. One concern with CSL has been threat to its Ig franchise in CIDP from Argenx’s drug. But we think this has been overplayed. This view is based on a number of factors. Firstly, CIDP represents less than 10% of CSL's revenues. Argenx’s drug, it was no more effective than Ig in the trials and is expected to cost two to three times more. And also patients tend to be very sticky on existing treatments when that treatment is working. We also believe there's significant unmet need in other indications to support high single-digit growth in Ig demand over the next few years. So yeah, we expect CSL to deliver strong double-digit earnings growth over the next few years and that supports the valuation of the stock. Yeah, a core holding for the funds.
Jonas Daly:
Thanks Easty, that's great. And look, thanks everyone for the updates today. It really is showing that, obviously, and Neale mentioned earlier, there's a lot of volatility around with bond markets, that we've continued to obviously stay focused on quality and remain true to label. The portfolios have bounced back in performance and holding that through the cycle with good quality companies that have strong pricing power, and you heard that with some of the examples that the guys gave today. Thanks again for everyone's support and have a great Christmas.
Speaker 1:
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