Quarterly report. Prepared for Antares Dividend Builder Model Portfolio December 2014

Transcription

1 Quarterly report Prepared for Antares Dividend Builder Model Portfolio December 2014

2 Table of contents Quarter in review... 3 Portfolio performance... 4 Quarterly attribution analysis... 5 Major factors contributing to performance... 6 Stock activity... 7 Outlook and strategy Contact Details Investor Services Phone: Fax: investorservices@antaresequities.com.au Quarterly Report prepared for Antares Dividend Builder Model Portfolio December

3 Quarter in review The Australian sharemarket performed well in the December quarter, with the S&P/ASX 200 Accumulation Index rising 3.1% and ending the calendar year with a total return of 5.6%. The market was constrained by weakness in the resource sector (-13.0%), in response to lower iron ore prices and the sharp fall in the oil price. Energy stocks were hit particularly hard, with the sector ending down 17.8%. The Australian dollar ($A) fell 6.5% against the US dollar and is now down almost 15% from its peak in July. Weak iron ore and oil prices were the main drivers of the currency s move, although comments from Reserve Bank Governor Glenn Stevens suggesting that the $A would be better off around 75 US cents also affected sentiment. The weaker Australian dollar supported stocks that generate earnings from offshore such as healthcare (+13.9%), selected industrial companies and Westfield Corporation in the REIT sector. Defensive, yield focused sectors, such as telecoms (+11.9%) and REITs (+11.5%), also outperformed, supported by a 74 basis point fall in domestic 10-year bond yields. In company news: Medibank Private was floated in November, generating proceeds of $5.68 billion for the Federal Government. Orica announced that it was selling its chemicals division to private equity group, Blackstone, for $750 million. Santos had its credit rating downgraded by Standard & Poors due to the weak oil price and deferred its hybrid note issue due to weak demand for its shares. Rio Tinto announced that it had been approached by Glencore regarding a merger but talks had ceased in August. Westpac CEO, Gail Kelly, announced her retirement after leading the company for the past seven years. Woodside Petroleum paid $2.75 billion for the non-us assets of Apache Corp. BHP Billiton announced plans to spin-off its non-core assets into a new company called South32. Quarterly Report prepared for Antares Dividend Builder Model Portfolio December

4 Portfolio performance The following table shows the performance of the Dividend Builder Model Portfolio relative to its benchmark. Period Net fund return 1 % Gross fund return % Benchmark return 2 % Net excess return % Gross excess return % 3 months months year years p.a Since Inception p.a. (22/11/2010) Net returns are calculated using exit to exit prices, assume that all distributions are reinvested and are net of ongoing fees and expenses. No allowance has been made for entry fees. 2 S&P/ASX200 Accumulation Index. Quarterly Report prepared for Antares Dividend Builder Model Portfolio December

5 Quarterly attribution analysis The major factors positively contributing to performance were: Stocks Positioning Basis point contribution 3 Woolworths Underweight 71 Telstra Corporation Overweight 25 QBE Insurance Group Not owned 16 Sydney Airport Overweight 13 Charter Hall Retail REIT Overweight 11 Tatt s Group Overweight 10 Metcash Not owned 8 Crown Resorts Not owned 7 Flight Centre Not owned 7 Macquarie Group Not owned 6 The major factors negatively contributing to performance were: Stocks Positioning Basis point contribution 3 CSL Not owned -33 Commonwealth Bank Underweight -28 Cash Overweight -25 Asaleo Care Overweight -21 Qantas Airways Not owned -20 Westfield Corporation Not owned -19 DUET Group Overweight -18 Amcor Not owned -17 Suncorp Group Overweight -16 AMP Overweight Approximate basis point contributions and are not additive. Quarterly Report prepared for Antares Dividend Builder Model Portfolio December

6 Major factors contributing to performance Contributions to performance December 2014 Positive Negative Woolworths (WOW, not owned) The Fund benefited from not owning Woolworths that experienced weak performance. Although WOW reaffirmed its full year guidance at its AGM, the company released its 1Q15 sales update that showed sales up 3% which was weaker than expected. This was mainly due to slowing momentum in the Food & Liquor division. WOW is also being investigated by the ACCC over allegations that it is billing suppliers for accounting mistakes that occurred more than five years ago. Telstra Corporation (TLS, overweight) TLS performed strongly as it is a defensive, yield play that benefited from the 74 basis point fall in domestic 10- year bond yields during the quarter. TLS also announced a revised Definitive Agreement between NBN Co and the Federal Government which has a similar net present value to the old agreement but with the added benefit of more protection for Telstra shareholders. Sydney Airport (SYD, overweight) - SYD is also a defensive, yield focused stock that was supported by falling bond yields. SYD released data showing strong growth in passenger numbers in November, particularly for international travel. Domestic passenger numbers are now the highest they have been in three years. CSL (not owned) The Fund does not hold a position in CSL given its low yield status and this detracted from performance as CSL performed well. CSL produced a result that was in line to perhaps slightly better than expected in August which caused the share price to perform very strongly. That momentum continued in the December quarter, with the stock also benefiting from the falling Australian dollar as it has significant US dollar denominated revenues. Commonwealth Bank (CBA, underweight) Being underweight Commonwealth Bank detracted from performance as the bank sector performed relatively well, underpinned by investor demand for yield. CBA also has dividend seasonality working in its favour as it is the next large bank to go ex dividend. Qantas Airways (QAN, not owned) The Fund does not hold a position in QAN and this detracted from performance as the stock performed well. QAN announced better than expected traffic and capacity results and benefited from the fall in the oil price as oil is a significant component of Qantas cost base. QAN also delivered a favourable trading update and announced that it now expects to deliver an underlying profit before tax of $ million in 1H15, largely due to rapid progress being made by QAN s $2 billion transformation programme that was announced last year. Quarterly Report prepared for Antares Dividend Builder Model Portfolio December

7 Stock activity During the quarter we added to our positions in three key Dividend Builder stocks: Toll Holdings, National Australia Bank and Tatts Group. Toll Holdings (TOL) is a diversified logistics company operating in Australia and overseas markets such as Singapore and Japan. The group s businesses include mining services, freight forwarding and contract logistics. The chart below from TOL s most recent results presentation gives a snapshot of the various TOL businesses. Chart 1: Toll Holdings divisional structure Source: TOL FY14 Results Presentation We own TOL in the Dividend Builder portfolio based on its attractive valuation and dividend yield as well as the diversified exposure it gives the portfolio. TOL offers cyclical exposure to economic conditions in Australia and Asia, and we expect the company should be well placed to benefit from any improvement in economic growth in its key markets. This differs from a number of other holdings in Dividend Builder, which are typically either interest rate sensitive stocks - such as banks, infrastructure and property trusts (REITs) - or more defensive businesses such as supermarkets, energy utilities and gaming companies. We forecast modest top line growth over the medium term, with the majority of profit growth to come from the stated cost cutting programs. So any improvement in economic activity would be a bonus for TOL s profit growth. We also expect the company s return on capital to improve through a focus on organic revenue growth rather than acquisition-led growth, as well as further divestments of low returning businesses that were acquired prior to the appointment of current CEO Brian Kroger. We think management s stated strategy appears sensible, being based on a mix of revenue growth and cost cutting opportunities (see Chart 2). Quarterly Report prepared for Antares Dividend Builder Model Portfolio December

8 Chart 2: Toll Holdings growth strategy Source: TOL FY14 Results Presentation Our investment case for TOL includes no major ESG concerns, and we see the balance sheet as reasonably geared, with a sensible dividend payout ratio in place. For Financial Year 2014, TOL paid a fully franked dividend of $0.28 out of Adjusted Earnings per Share of $0.42, which equates to a dividend payout ratio of 67%. We consider this to be an appropriate level for a business such as TOL. For Financial Year 2015, the average market estimate for TOL s dividend is $0.29, which is 4% above the FY2014 dividend. Our buying of TOL shares for Dividend Builder was done in late November at prices between $5.44 and $5.64. This equates to a yield of %, or 7.3%-7.6% including the franking credits. Quarterly Report prepared for Antares Dividend Builder Model Portfolio December

9 National Australia Bank (NAB) has clearly been the worst performer in the bank sector over the past 10 years. To highlight the starkness of the poor performance, Charts 3 and 4 show NAB s share price relative to Commonwealth Bank (CBA). Within the bank sector, the divergence in price between NAB and CBA looks extreme. Chart 3: NAB and CBA share prices Source: Bloomberg Chart 4: CBA share price minus NAB share price Source: Bloomberg It is hard to believe that NAB s share price was higher than CBA in Whilst NAB management have made some poor investments resulting in permanent losses that will not be recovered, we think NAB s new CEO and CFO are attempting to deal with these legacy problems and become a more traditional bank, which could unlock additional value. Quarterly Report prepared for Antares Dividend Builder Model Portfolio December

10 NAB is now trading on a forward PE of 11.3 times compared with CBA which is on 14.5 times. NAB is also on a forward yield of 6.5%, fully franked. Whilst this not as high as the dark days in and during the sovereign debt crises in , in the current environment it is an extremely attractive level of income. So, to summarise why we have changed our opinion on the future potential performance of NAB: 1. New MD and CFO - We rate both the MD and CFO as high achievers, with strong banking experience. From a general market conceptual perspective, one of the strongest signals for a performance turnaround in a company is when a long term underperformer gets new management. 2. Fundamental metrics Measures such as PE and yield favour NAB over the other three major banks. 3. The rebound in the UK banking sector This makes the sale of NAB s UK business a possibility, although we would expect a sale to be quite painful as it will likely occur below book value. We believe that NAB will rerate once the UK is sold. 4. The new management team are focused on improving ROE - We expect all low ROE businesses to be scrutinised and either improved/restructured or capital released in some way. Over the years, many broking analysts have pointed the finger at MLC as a low returning business, which has negatively impacted NAB s share market rating. 5. Management experience - The new NAB executive leadership team is heavy with banking experience. 6. Business banking - Even at this early stage, a competitor, who has previously been very critical of NAB s business bank performance, has seen NAB improve in this most important area. This provides a data point that the new management team know what they are doing. 7. Murray Review - The Murray review recommendations into bank capital suggest that the major retail banks will have higher capital requirements imposed on them than the business banks (although clearly all will be affected). 8. Valuation - NAB is cheap based on its historical PE multiple relative to the Industrial market (see Chart 5). Chart 5: NAB PE relative to the Industrial Index Source: Bloomberg Quarterly Report prepared for Antares Dividend Builder Model Portfolio December

11 9. Antares valuation - NAB currently trades at around an 18% discount to Antares target price based on a dividend discount model. 10. Economic climate - Australia s current poor economic performance makes it more likely that cash rates will fall rather than rise early in the new year. This traditionally benefits high yielding stocks. Clearly the risks to our position are regulatory, ineffective execution of strategy, and a continuation of the current very low business credit growth environment. Tatts Group - During the quarter, the Fund added to its position in Tatts Group (TTS). Formerly known as Tattersall s, TTS is Australia s leading lottery operator. It also has a wagering arm (Tattsbett) and a number of other gaming-related businesses. TTS is characterised by a relatively defensive earnings stream and an above average dividend yield, both of which are underpinned by the lottery business (which accounted for 67% and 58% of TTS s overall revenue and earnings before interest and tax (EBIT) during FY2014, respectively). Lotteries TTS s Lottery business is one of the world s largest in terms of sales, and accounts for most of the lottery sales in Australia. It is licensed to sell lottery products in all states and territories except Western Australia (where the lottery is still government owned). Sales are conducted via a franchise and agency network of around 4,250 retail outlets and venues, as well as via online channels. Lottery earnings are driven by lottery ticket prices, ticket sales volume, regulatory requirements around prize pool sizes (as a percentage of sales), state lottery taxes, agent commissions payable to the retail distribution channels and TTS own operating expenses. The Australian lottery sector is mature and characterised by steady underlying demand (influenced by changes in population and disposable household income), and Australian spending on lottery is amongst the highest in the world (on a per capita basis). The chart below shows the growth in Australian lottery turnover over the years. Chart 6: Australian lottery turnover Source: Queensland Government Statistician s Office, data not yet available. Note there was a gap in the NSW data for FY2010 (only 3 months of data available, from April to June 2010). NSW data for the full FY2010 was estimated by annualising the 3 months worth of data. Compared to other forms of gambling, lottery has relatively low regulatory risks (due to lower perceived risk of problem gambling), faces very low competition within its sector (given the monopoly operating rights bestowed by the state based licences) and is also less economically exposed. However, it also Quarterly Report prepared for Antares Dividend Builder Model Portfolio December

12 has lower organic growth than other forms of gambling. Licence renewal risk is considered low for TTS, given the cost involved to replicate its lottery infrastructure and the scale advantages it enjoys. Currently around 80% of TTS s Lottery EBIT is linked to licences with at least 35 years remaining. Lottery sales are relatively immune to economic conditions and while underlying demand trends are stable, sales can fluctuate between years due to jackpot outcomes. For example, after experiencing record revenue and a stellar jackpot sequence during FY2013 (more frequent larger size jackpots and also bigger average jackpot size), TTS reported a 4.3% drop in its Lottery revenue for FY2014 as it was not able to replicate the exceptional lottery outcomes of the prior year. TTS seeks to organically grow its Lottery revenue by introducing new games, expanding existing games into new jurisdictions, restructuring existing games to stimulate further demand (e.g. the 2013 Powerball restructure which was designed to create more regular jackpots and grow the number of winners with an extra prize division) and regular product price increases (often linked to game changes). Going forward it will also be growing its distribution network via sales at petrol station convenience stores in select states. One area of rapid growth is TTS online lottery sales. From FY2010 to FY2014, online sales (as percentage of total lottery sales) grew from 5.1% to 9.4%. As well as data suggesting that average transaction values for online sales are higher than those of the bricks and mortar retail channel, online sales have the added benefit of generating higher margins for TTS. Unlike sales via physical outlets like newsagencies, sales conducted via TTS web-based platforms do not incur agent commissions. As online lottery sales grow as a proportion of total sales (driven by the convenience factor), TTS should see a margin expansion from this shift. In February 2015 TTS will further expand its lottery business in Victoria when it takes over the lottery (scratchies) operations of its competitor, Intralot. Having lost a rumoured $63m from its Victorian lottery business, Intralot announced its exit from the market in 2015, with TTS to regain its monopoly in Victoria for a small consideration payable to Intralot. The exit of a competitor should place TTS in a stronger position when it renegotiates its Victorian licence renewal (which expires in 2018). Wagering TTS s wagering division TattsBett (to be rebranded to UBET) has an estimated 6% share of Australia s wagering market, and holds exclusive retail licences in Queensland, South Australia, Tasmania and the Northern Territory. It is also the monopoly operator of the racing totalisator pools in those states. This division contributed 22% and 31% to TTS overall revenue and EBIT during FY2014, respectively. Due to underinvestment, TattsBett has recently underperformed its competitors with below industryaverage growth. Revenue and earnings fell in FY2014, whereas competitors reported positive growth. TTS has begun addressing this issue, and has been re-investing more into this business (e.g. expansion of its bookmaking, marketing and digital teams). Earnings margins for the next few years could remain compressed as the re-investment continues. During FY2014 TattsBet encountered two challenges from Racing Queensland in relation to TTS s race field fee arrangement with the latter and TTS s wagering retail exclusivity in Queensland. Both matters dragged down TTS share price, but were ultimately concluded in TTS favour when it agreed a new wagering licencing framework with the Queensland Government and Racing Queensland in June TTS not only extended its retail exclusivity for 30 more years, it also received a 61-year extension to its sports wagering licence in the state and a reduction to its wagering tax rates. In exchange TTS agreed to pay additional product fees to Racing Queensland and also a $150m licence fee (payable in 4 instalments to 2023). Overall TTS is expected to be better off financially under this new framework. TTS also previously ran a gaming machine business in Victoria (Tatts Pokies). This business ended in 2012, when the Victorian Government allowed hotels and clubs to bid for gaming machine entitlements Quarterly Report prepared for Antares Dividend Builder Model Portfolio December

13 and operate the machines directly. In response, TTS initiated legal action against the Victorian Government to seek compensation for the adverse business changes. In June 2014 the court ruled in favour of TTS, awarding it $451.1m in damages plus interest and costs. The decision was upheld in December 2014 after the Victorian Government appealed the initial outcome. The Victorian Government is currently seeking leave to appeal in the High Court of Australia. Should TTS be ultimately successful on this matter, it may return the proceeds to shareholders via capital management. Recent share price performance and outlook The following chart shows TTS share price performance over the last 18 months. In addition to aforementioned events, TTS also reported FY2014 earnings which were below expectations and highlighted the earnings challenges faced by the Wagering division. TTS also declared a lower than expected final dividend, which raised concerns that it was reducing its payout ratio (despite the payout based on statutory profits being within policy range). Company management has confirmed there is no change to its dividend policy, and that FY2014 dividends were affected by a significant item which reduced statutory profits and which will not repeat (health benefit levy to the Victorian Government which TTS no longer pays). Chart 7: Tatts Group share price Source: Bloomberg Despite the challenges faced by its Wagering business and question marks over its ability to regain market share with a major revamp, we believe TTS offered an attractive risk-return balance at the time we added to the position. While it is not expected to produce strong growth, we are very comfortable with TTS Lottery business, with its steady earnings, strong monopoly positions in most states and low regulatory risks. We also view positively TTS various initiatives to organically grow its Lottery earnings. We expect the Lottery division to report markedly stronger earnings for the first half of FY2015 versus the previous corresponding period (due to better jackpot outcomes), but anticipate earnings from Wagering to remain weak. TTS had strongly outperformed the S&P/ASX100 index during the December 2014 quarter, likely supported by the favourable outcome of its legal case against the Victorian Government, news of strong Lottery sales so far this year and general preference by the market towards more yield oriented stocks. (NB: commentary may not be provided on some positions where we have an imminent intention of buying or selling). Quarterly Report prepared for Antares Dividend Builder Model Portfolio December

14 Outlook and strategy Outlook Australian industrial stocks put in a third year of strong returns for investors, with the S&P/ASX 200 Industrials Accumulation Index producing a total return of 11.5% for calendar year This was substantially better than the headline S&P/ASX 200 Accumulation Index, which only returned 5.7% given it was weighed down by the poorly performing resources sector. Industrials stock ended the year with a forecast dividend for Financial Year 2015 of 4.8%. As shown in Chart 1 below, this yield is a material premium to that available on 10-year Australian government bonds, and a wider spread than was the case at the start of the year. Chart 1: Australian dividend yields vs bond yields Source: Bloomberg So the case for owning industrial stocks based on the yield premium relative to bond yields and term deposit rates still holds. We would caution however that our analysis of a number of interest rate sensitive sectors namely banks, property trusts (REIT s), infrastructure stocks and utility companies suggests they are looking fully valued to mildly expensive. Naturally, the big risk for the share prices of companies in these sectors is a reversal in bond yields. While we unfortunately aren t able to precisely pick the point at which this may occur, we do formulate our portfolio strategy with scenarios like this in mind. The investment process for Dividend Builder has always considered our proprietary stock valuations as a key input into our stock selection criteria, alongside other important factors such as expected dividend yield, balance sheet strength, management quality (including ESG) and overall portfolio diversification. Given Dividend Builder s objective of delivering a higher yield than the benchmark, we will naturally have a large amount of the portfolio invested in high yielding stocks, many of which are in the interest rate sensitive sectors listed above. But we also try as much as possible to construct a balanced portfolio, which is a key reason for owning stocks like Toll Holdings, Coca Cola Amatil and JB Hi-Fi. One part of the market that we are effectively restricted from owning due to the Fund s objective of delivering a higher yield than the ASX 200 Industrials index - is Australian listed companies that earn the Quarterly Report prepared for Antares Dividend Builder Model Portfolio December

15 majority of their profits from offshore. A number of these stocks including Amcor, Westfield Corporation and CSL have performed extremely well lately, largely due to the steep fall in the Australian dollar. Unfortunately, the Dividend Builder portfolio has not participated in this rally as these companies tend to have low dividend yields and lack of franking credits. The table below should give investors a snapshot of the current Dividend Builder portfolio. It lists the ten largest active positions (portfolio weight relative to benchmark weight) with some key current metrics. Stock Share Price Sector Dividend yield Market Capitalisation ($b) Telstra Corporation 5.97 Telecoms 5.4% 73.0 National Australia Bank Banks 6.1% 81.2 Tatts Group 3.46 Gaming 4.6% 5.0 Toll Holdings 5.89 Transport 5.0% 4.2 Stockland 4.12 REITs 5.8% 9.8 DUET Group 2.41 Utilities 7.3% 3.6 Sydney Airport 4.71 Infrastructure 5.0% 10.5 AMP 5.50 Financials 4.7% 16.4 Coca-Cola Amatil 9.32 Food and beverage 4.7% 7.1 Charter Hall Retail REIT 4.12 REITs 6.6% 1.6 Source: Bloomberg, Antares Quarterly Report prepared for Antares Dividend Builder Model Portfolio December

16 Contact Address Antares Capital Partners Limited Level 20, 8 Exhibition Street, Melbourne, Vic 3000 Postal address GPO Box 2007, Melbourne, Vic 3001 P F antarescapital.com.au Important information: Antares Capital Partners Ltd ABN , AFSL ( ACP ), is the Responsible Entity of the Antares Direct Separately Managed Accounts ARSN ( DSMA ). An investor should consider the current Product Disclosure Statement ( PDS ) when deciding whether to acquire, or continue to hold, an investment in the DSMA, whether an investment in the DSMA is an appropriate investment for the investor and also consider the risks associated with any investment. This report has been prepared in good faith, where applicable, using information from sources believed to be reliable and accurate as at the time of preparation. However, no representation or warranty (express or implied) is given as to its accuracy, reliability or completeness (which may change without notice). This communication contains general information and may constitute general advice. This report does not take account of an investor s particular objectives, financial situation or needs. Investors should therefore, before acting on information in this report, consider its appropriateness, having regard to the investor s particular own objectives, financial situation or needs. We recommend investors obtain financial advice specific to their situation. Past performance is not a reliable indicator of future performance. Returns are not guaranteed and actual returns may vary from any target returns described in this document. Any projection or other forward looking statement ( Projection ) in this report is provided for information purposes only. No representation is made as to the accuracy or reasonableness of any such Projection or that it will be met. Actual events may vary materially. Any opinions expressed by ACP constitute ACP s judgement at the time of writing and may change without notice. An investment in the DSMA is not a deposit with or liability of National Australia Bank Limited ( NAB ) or any other member of the NAB group of companies ( NAB Group ) and is subject to investment risk, including possible delays in repayment and loss of income and capital invested. Quarterly Neither Report ACP prepared nor any other for Antares member Dividend of the NAB Builder Group Model guarantees Portfolio the December repayment 2014 of your capital, payment of income 16 or the performance of your investment. NAB does not provide a guarantee or assurance in respect of the obligations of ACP.