Jonas Daly:
Hello and welcome to our podcast from Bennelong Australian Equity Partners. My name is Jonas Daly, head of distribution at Bennelong Funds Management, and today I'm joined by Mark East, Chief Investment Officer, Neale Goldston Morris, Senior Investment Analyst, focusing on economics and market strategy, and Brad Clipborn, Senior Investment Analyst. Today's podcast we'll focus on the relative performance of our portfolios, recent reporting, the current positioning, and then an outlook on both the opportunities and the risks that lie ahead for Australian equities. Neale, we'll kick off with you, but obviously a lot going on on the macro side and some comments around obviously interest rate and obviously a big focus on earnings for this year. So I might just pass over to you first.
Neale Goldston Morris:
Thank you, Jonas. Last year, calendar '22 was an unusual year. It's one of those years where central banks were forced to make a major adjustment to interest rates. It occurs about once every decade. When that occurs, and they only do it because they actually initially judged inflation wrongly. They thought it was transitory. It wasn't, just like it wasn't back in 2007 and '91 and '81 and '74. When that occurs, in other words, the whole yield curve moves up from short end right through to 10 year bonds. The market derates, PEs come down, particularly PEs above average come down regardless of earnings delivery. In other words, it's a broad based shedding evaluation if you like. Stepping forward from that, the tightening cycle is now largely done. We might get one or two more rate rises, but in the scheme of things, that's very small compared to what has being done at 10 rate rises so far.
So whereas last year was the year of PE derating, where particularly higher PEs got derated. This year it'll be about earnings delivery. And in this environment that's in an environment of a slowing economies, not necessarily recession, but slowing economies, your low PE deep cyclical stocks will fade away because they are very sensitive to the earning cycle. These are the ones that held up last year because of their low PE, but your high quality growth stocks should actually start to outperform because they're the ones that actually can deliver the earnings. That's why I trade on a high PE to start with. So coming then to our investment approach, and let us emphasize this. Our approach has not changed. It's always been about investing in high quality companies that generate high returns on capital, have really strong lowly geared balance sheets, so they can weather the storm when economy goes awry, and they differentiate themselves because of the quality of the product or service they deliver.
They deliver that by constantly reinvesting in the business through R and D, a research and development, constant series of improvements. In addition to that, in most cases they have some sort of global footprint, a niche market share maybe, but still a global particularly into North America and Europe. That means the addressable market is far larger than just a 25 million people in Australia. That means by implication, if they have a superior product or service, they can grow that market share extensively over the long run and grow the stock extraordinarily. That's why CSL, for example, has gone from a dollar back in the early nineties to $300 today. Its ability to grow long term into large addressable markets. So from that perspective, our portfolio is very, very still true to label, very full of those sort of stocks, CSL, ResMed, James Hardie, Aristocrats, RDP, pipe PEs of this world, very much similar in characteristic but quite different sectors. It's ambivalent to sector if you like.
We don't have the low growth domestic exposed cyclical stocks, which we believe will fall away again this year and have over the long run basically gone nowhere. The Westpacs and ANZ of this world are still the same share price as they were 20 years ago. So we believe the earnings performance this year will start to differentiate again just like it does in most years. The big interest rate changes of last year are, if you like the aberration, yes, they occur and they occur about once every decade if you like.
Jonas Daly:
Thanks, Neale. That's great. And obviously not changing your spots on process or philosophy there or compromising on quality. So great update there. Thank you. We will get into the portfolio now with Mark East and Brad, but just before we do, yeah, I think just against the peer group of growth managers, obviously that quality relates to growth as well. We are in line with those managers in that peer group. It's been a tough year for growth and obviously we don't want to compromise on quality. So we will dig into some of the attribution, some of the main contributors, some of the main detractors. So we might just kick off, pass over to yourself, Mark if we can, just on a couple of stocks that's contributed over the year.
Mark East:
Thanks, Jonas. One stock that I'll talk about is ARB, which is the four-wheel drive accessories business that we've owned for a fair while now. Company reported its first half result in February. This result was a little bit below expectations. That was driven by a number of factors. Firstly, there was a lack of vehicle supply into Australia and the UK where ARB has operations. It's also a lack of skilled labor or fitters in Australia. And the US business of ARB, it was impacted by change of ownership of their largest customer and this customer basically stopped placing orders for a few months. Importantly, over the half ARB sales trends did improve, so a better December quarter versus September quarter. We still like the outlook for ARB and the company made a number of announcements in their result, which supports the sort of long-term growth prospects of the company.
This included the announcement that they'll be opening their first retail store in the US and once they're happy with how that store is operating, they'll look to roll out more stores. So they're also talked about releasing a number of new products over the next sort of three to six months, which should be positive for the sales outlook and also talked about their relationship with Ford in Australia and the US and that relationship's progressing well and expanding into other countries and also updated the market on their relationship with Toyota US, which is also progressing well. So yeah, still comfortable with the long-term outlook for ARB. One other key holding is Breville. They announced their first half result in February also. It was largely in line with market expectations. The US business was the star performer with double digit sales growth while Europe and APAC was slightly below expectations.
The main issue for Breville at the moment is Europe, where the Ukraine war has created significant inflation and economic uncertainty, and that's resulted in nervousness amongst Breville's retail customers pulled back on their ordering. This economic uncertainty will clear at some point and Breville's European business should reserve strong growth trajectory, which is growing very strongly prior to Ukraine. And again, we still like the long term growth outlook for Breville supported by a number of things. One being the strong new product pipeline the company has. There should be an increasing number of new product coming out over the next few years. And also they're continued geographic expansion. So it's mainly centered around Asia, but it's also the maturing of recently entered countries like Mexico, Korea, France, and Spain. So again, still comfortable with the long term outlook for Breville.
Jonas Daly:
Great, thanks, Easty. That's great. And Brad, a couple of stocks from your side.
Brad Clibborn:
Yeah, I guess one of the sort of positive contributors through February results period was HUB, the financial platform. They had a good result sort of earnings, 4% ahead of consensus, so good platform revenue margins which grew over year over year. Rising interest rates, they benefit from that with their cash admin fees and a pretty stable competitive environment supported their base platform fees being fairly steady as well. That's dropped through to consistent margin expansion with their EBITDA margins hitting over 40% while still investing heavily into new product and their operations as well. From a flows point of view, they had strong flows at 5.8 billion despite the ongoing sort of market volatility over the last six months and they outperformed industry flows as well. They've reaffirmed their FY 24 funds under administration guidance of 80 to 89 billion dollars, which is above the consensus expectations at about $79 billion, so they continue to see some strong growth in fewer heading forward. So we did see sort of earnings upgrades on the back of that good result sort of load to mid single digit earnings revisions.
Jonas Daly:
Thanks, Brad. So just also I note that BHP and Mineral Resources were two of the main detractors there as well. Can you provide some comments there on that mining sector and those positions?
Brad Clibborn:
Yes. So BHP and Mineral Resources did subtract in that December period in particular. We were rebuilding exposure to BHP and added Mineral Resources in that November, December period in anticipation that the authorities in China would change direction and announce a reopening after the COVID lockdowns. They did. The Chinese economy is now starting to respond and BHP and Mineral Resources are assigned to respond as far as their share prices as well. We expect that to continue and particularly through iron ore in the second half of this year should continue to strengthen. In addition to that, the COVID reopening strategy, if you like, is also held through IDP Education, the students coming down from China to Australia, Flight Center and Corporate Travel on our travel side, and Aristocrat just outside entertainment if you like. So those are all consistent with that China reopening story and they're all in the quality space as well.
Jonas Daly:
Great. And the March quarter has been a positive one for the fund, which has been great, it's a good start to the year. So just wanted to talk through, you talked about obviously RES coming in, some of the current positioning. Any other new stocks that have entered the portfolio? Maybe Brad, if you could comment on those?
Brad Clibborn:
One of the recent additions to the portfolio this quarter's been Flight Center. It's a stock we've followed closely for many years, but not one we've owned for quite a long time now. Just prior to COVID, Flight Center had been in a very tough position to rising costs in their leisure business, eroding profitability. Management did a strategic review around that leisure business model and had formulated a plan to reduce the cost base and pivot their leisure business model over the following three years or so, but a few months after that COVID happened and Flight Center was forced to pivot aggressively in a short space of time cutting their global leisure store network by over 50%, reducing headcount substantially and generally pulling back on operating costs to conserve cash burn through those early stages of COVID. This has given Flight Center the luxury of being able to actually choose where and how they add back costs into the business now as travel activity starts to return.
So we've been meeting consistently with Flight Center management through COVID tracking their progress and a few things that have stood out to us in terms of the business and management's approach. We think they've held their disciplining costs. We think COVID has forced a fundamental change around cost management within the business and management have reaffirmed this by putting out a 2% PBT margin target for FY 25. Flight Center has also doubled down on their investment in the corporate business through this period despite being cash constrained and they've actually delivered significant market share gains in their corporate business. You might not know, but Flight Center's one of the top five travel management companies for corporates globally, and their volumes are now back to near a hundred percent of pre COVID levels when the market's only recovered to 65 to 70%. So they're clearly taking market share.
And finally, management also continued to invest in technology. They've rolled out new booking systems for their leisure agents. That's driven productivity to be 50% ahead of pre COVID levels in leisure. They've rolled out new client facing tech platforms for their corporate business and generally invested in their E-commerce offerings as well. So we see the ongoing tailwinds of reopening of travel as a tailwind for Flight Center over the next 12 months or so. Additional airline capacity coming back into the market, especially with China reopening should support lower airfares and better remuneration for travel agency. So that sort of leads us to believe that Flight Center has a pretty positive structural earnings growth store in the next three years ahead of it, driven by strong corporate travel offering, taking market share globally and a leaner repositioned leisure business.
Jonas Daly:
And just on that, trying to reopening another stock in particular IDP Education. We have mentioned it, but just some comments on that.
Mark East:
Yeah, thanks, Jonas. IDP is a key sort of portfolio holding known for a fair while. They announced their results in February. It was slightly below expectations. Led to some small low single digit earnings downgrades for the company's earnings forecast. The company's student placement business had a very strong result following the reopening of Australia's borders plus continued growth into the UK and Canada. The other main division, the English language testing business or IELTS, they reported results slightly below expectations due to some visa processing issues in Canada, but we view this as a short-term issue.
Still like the long-term growth story for IDP, I mean that's driven by a number of factors. Firstly, an increasing pool of international students. There's also favorable post-study work rights settings across Australia, the UK and Canada. And there's a number of IDP driven initiatives as well, including expansion of their offices in India and Southeast Asia, investment in their digital offering and new products. One interesting new product is the one skill retake test, which is offered by their IELTS English language testing business that was launched in December and with India to go live in the next few months. And we think this could lead to some market share gains for for IDP's business. So the IDP key holding and one we're still comfortable with.
Jonas Daly:
Great. Thanks, Mark. And back to you, Brad. Just on James Hardie if you had any comments there you wanted to make?
Brad Clibborn:
Yeah, I guess Hardie's been a sort of positive contributor for the March quarter to date. The end of calendar '22 saw some significant headwinds for US housing in particular, which is where the majority of Hardie's earnings rests. Higher mortgage rates through the fall. In the US mortgage rates moving from five and a half to 7% was a headwind, particularly in new construction, which is about 35% of Hardie's business. So that did see a slowdown in the back end of last year and a downgrade to earnings guidance for Hardie.
As we've come into calendar '23, the builders in the US are seeing a positive bounce in terms of home sales for the first few months of the year. This has led to some optimism in the building materials and home building stocks as well and seen a healthy bounce for Hardie. Importantly, all our channel checks continue to indicate that Hardie is still taking market share. We believe that's ultimately the key driver of earnings growth for Hardie over the medium to longer term is their ability to continue to grow market share in the US through penetrating new markets and launching new products and that all looks intact. So remains a core portfolio holding as well.
Jonas Daly:
Thanks, Brad. That's great. We might just wrap up the stock commentary there, but that's been some excellent insights from everyone in the team there and we will finish on Neale. Just in regards to your outlook, there's a bit of fear out there. There's a negative news around the banks, we've had zero exposure to, so great call there. But just any outlook in terms of give us some optimism but also identify some of the risks.
Neale Goldston Morris:
So the key plus is the central banks have just about finished their tightening cycle. That will settle 10 year bonds, the discount rate if you like, that settles valuations. It then comes down to earnings delivery. Yes, economies will be slowing, particularly North America and Europe. In that case, because of that, we have no banks. There will be some more problems in the overseas banks. So we have no exposure to banks. We have no exposure to the domestic retailers. In other words, deep cyclical stocks that will be slowing with their earnings this year. But quality earnings delivery from quality stocks should be the standout this year is that earnings differential widens between the good and the weak. It won't be in an easy environment, it will be volatile. There will be shocks along the way, but we've been through the big interest rate adjustment so that pain has passed us.
Jonas Daly:
Thank you very much, gentlemen, for your insights today to the various portfolios that you manage, but also Neale, your insights on the macro side. Thanks everyone for joining the podcast today. Thank you.
