Yarra Emerging Leaders Fund (Direct)

Transcription

1 Investment Commentary Quarter to 31 March 2018 Yarra Emerging Leaders Fund (Direct) Total returns as at 31 March month 3 months 1 year 3 years p.a. 5 years p.a. 10 years p.a. Since inception^ p.a. Yarra Emerging Leaders Fund (Direct) Emerging Leaders Combined Benchmark Excess return Past performance is not a reliable indicator of future performance. Taxes payable by investors have not been taken into account. The figures shown have been provided for illustrative purposes they are unaudited and subject to change. The total returns shown are prepared on an exit to exit basis they include all ongoing fees and expenses and assume reinvestment of all distributions. ^ Inception date Yarra Emerging Leaders Fund (Direct): November 1994 Comprising 50 S&P/ASX Midcap 50 Accumulation Index and 50 S&P/ASX Small Ordinaries Accumulation Index Excess return: The difference between the Fund s return and the benchmark return. Market review Australian small and mid-caps endured their worst quarterly return in almost three years in 1Q18, but outperformed large caps during the period. The Emerging Leaders Benchmark declined 2.5 in the three months to 31 March 2018, outperforming the S&P/ASX 200 Accumulation Index which fell 3.9. Globally, the MSCI World Index declined 2.1 amid fears about a trade war after US President Trump announced a series of tariffs: 25 on steel imports, 10 on aluminium imports and 25 on $US50bn of Chinese imports. In January and February, Australian equities outperformed international equities as earnings generally exceeded expectations. Around 39 of companies beat expectations while 30 missed across the S&P/ASX Earnings expectations for FY18 held steady (normally they are revised downwards). However, the Emerging Leaders Benchmark fell 2.6 in March, with negative sentiment from the Banking Royal Commission weighing on Financials and Metals & Mining declining amid weaker commodity prices. On a quarterly basis Financials (-10.8) was the largest detractor from the benchmark s return, followed by Consumer Discretionary (-4.5) and Metals & Mining (-2.5). Telecommunications Services declined the most in value (- 14.9), as the sector continued to face significant competitive pressure. Only four out of 11 sectors generated positive returns in the quarter: Consumer Staples (+11.1), Health Care (+4.9), Energy (+1.2) and Information Technology (+0.3). Outperformance was concentrated in a few stocks, with A2 Milk (A2M, +55.5) and Bellamy s (+89.7) companies exposed to the Chinese consumer driving the outperformance in Consumer Staples. In Health Care, ResMed (RMD, +12.9), Sirtex Medical (SRX, +67.9) and Cochlear (COH, +6.8) were largely responsible. Portfolio review Key contributors Sirtex Medical (SRX, overweight) the liver cancer treatment company outperformed after receiving a $1.6bn takeover offer from US giant Varian Medical Systems at a 49 premium to its last traded share price. We believe the takeover which has been recommended by SRX s Board has a high probability of success, with the Foreign Investment Review Board (FIRB) clearing the takeover and intervention from the Australian Competition and Consumer Commission (ACCC) unlikely. As a result, we have subsequently exited the position. NextDC (NXT, overweight) the data centre operator outperformed following a better-than-expected 1H18 result. The company reported strong revenue growth (up 17), margin expansion, record new contract sales and pricing power, with prices up 8 per megawatt. Furthermore, the implied 2H18 earnings guidance appears conservative in our view. We remain overweight NXT, as we believe the company is structurally set to benefit from increasing cloud technology adoption. NXT is accelerating its expansion to meet the demands of larger clients, including building three new data centres, which will support significant medium to longer term earnings growth. The outlook for NXT appears attractive given the company s growth profile and infrastructure-like characteristics at maturity. Tabcorp (TAH, underweight) the gambling services provider underperformed following a worse-than-expected 1H18 result. Net profit after tax declined 20 to $82mn, below consensus forecasts for $89mn, primarily due to the Wagering & Media division where wagering yields declined and costs increased. We remain underweight the stock due to our negative view 1 Source: JPMorgan NO LONGER AVAILABLE FOR NEW INVESTMENT

2 towards the conventional wagering business, which operates in a low growth industry and with high levels of competition, placing intense pressure on its traditional retail distribution strategy. ResMed (RMD, overweight) the sleep apnoea device maker outperformed after delivering better-than-expected secondquarter results. Strong sales of both its airflow generators and masks supported revenue, with operating earnings coming in 3 above consensus. While the market is beginning to capture RMD s appealing growth characteristics, we see further upside as earnings growth rates accelerate over the next one to two years, with benefits accruing from a positive product cycle in the flow generator segment. While the US tax reform bill has created a number of one-off charges to net profit, we view the reform bill as neutral to positive for RMD s earnings going forward. CSR (CSR, overweight) the building materials company outperformed in the quarter in response to housing construction activity holding up better than expected and higher aluminium prices. Key competitors, which reported in the quarter, indicated strong demand for building materials and gave upbeat outlooks. We remain overweight the stock based on three factors: a more positive outlook on the Building Products division compared to consensus as a result of an improved competitive landscape and market structure in bricks, management s strong operational expertise across all divisions (including the Aluminium division where earnings are being optimised through proactive hedging strategies and efficiency measures) and the company s strong balance sheet which enables the pursuit of selective bolt-on acquisitions and capital management initiatives. Key detractors A2 Milk (A2M, underweight) the company outperformed after its 1H18 result beat market expectations, prompting double-digit consensus earnings upgrades to FY18 and FY19 as Chinese demand for its infant formula drives strong revenue growth. 1H18 EBITDA grew 123 to $NZ143mn, with direct sales to Asia up 204 to $114mn. We remain underweight the stock, with its valuation (at a forecast P/E of 33.7 times) fully capturing the company s positive outlook. While China infant formula sales have grown significantly, we are cautious to capitalise this earnings momentum given questions regarding the sustainability of the current distribution channels (particularly via daigous), an increasing competitor presence and the fickle nature of the Chinese consumer. Vocus (VOC, overweight) shares in the telecommunications company declined after management downgraded EBITDA guidance by 2 and net profit guidance by 10 for FY18. While 1H18 EBITDA beat guidance by 2.4 due to growth from Enterprise & Wholesale (+11.2 year-on-year), VOC said this included large one-off contracts that won t be repeated in the second-half. Further, the Consumer business continues to face competitive pressure from the NBN and Energy. Subsequent to the result VOC announced the exit of its chief executive. Notwithstanding VOC s short-term challenges, we continue to believe the longer-term revenue and margin opportunities remain and that the share price (at 10.8 times forward earnings) currently capitalises limited future growth. VOC remains focused on integrating and simplifying its various acquired businesses, unifying its product offering and increasing customer product penetration. TPG Telecom (TPM, overweight) the telecommunications company underperformed despite announcing a 1H18 result above expectations. EBITDA came in 2 ahead of consensus due to faster-than-expected cost reductions, a delay in the NBN roll-out and improved margins from the new NBN 50 plan. That being said, operationally the result was more negative. Gross profit in the consumer division declined, broadband subscribers fell by 8,000 (driven by iinet) and the corporate division grew by 3.4 when expectations were for The stock remains a high-conviction holding in the portfolio, offering compelling value relative to its peers (at a forward P/E of 15.1 times) when considering its defensive characteristics and disruptive growth opportunities from its entry into the Mobile market. Furthermore, in our view consensus forecasts now capture a lower contribution from iinet which we believe will be offset by material cost synergies and the detrimental impact of the NBN roll-out on margins. isentia (ISD, overweight) shares in the media aggregation company declined after announcing its 1H18 result, with EBITDA declining 30 to $15.7mn reflective of ongoing pricing pressure, and confirming the resignation of its chief executive. We believe the share price fall is an overreaction as revenue should now stabilise and, in the longer-term, has the potential to grow by 3-4. Furthermore, EBITDA margins now appear to be at sustainable levels. We expect ISD to sustain its dominant position in the ANZ media monitoring landscape through a more appropriate pricing and product strategy, while the Asian business is gaining market share as ISD leverages its technology and content investment. Super Retail (SUL, overweight) the retailer underperformed after delivering a disappointing 1H18 result and announcing the acquisition of outdoor adventure retailer Macpac for $A135mn. EBITDA declined 1 year-on-year to $149mn in the period. At the division level, Leisure EBIT declined 20 year-onyear due to weakness from BCF and Rays, Auto growth EBIT slowed to 4 year-on-year amid margin weakness and Sport EBIT growth slowed to 2 year-on-year as the conversion from Amart to Rebel branded stores increased costs and impacted revenues. For FY18, the result and outlook commentary implied consensus earnings downgrades of 6. While SUL expects Macpac to generate mid-single digit EPS accretion in FY19 before synergies, the market took a negative view of this acquisition given historical underperformance of the division from both an organic and acquisition perspective. We remain overweight SUL, as we believe the market has overreacted to both Amazon s arrival and the Macpac acquisition. SUL provides a diversified discretionary retail exposure (across Auto, Sport and Leisure) which should support medium to long term mid to high single-digit earnings growth from both sales and margin opportunities. The stock now trades at 9.2 times

3 earnings on a 12-month forward basis a steep discount to its discretionary retail peers. Key purchases CSR (CSR) we increased our holdings in CSR during the quarter. We are more optimistic than consensus expectations concerning the company s Building Products division: we expect EBIT growth in FY18 as a result of an improved competitive landscape and market structure in bricks, while consensus is currently forecasting a mid-single digit decline. CSR demonstrates strong operational expertise across its divisions, including the Aluminium division where management continues to optimise earnings from its Tomago plant through proactive hedging strategies and efficiency measures to drive down costs. Lastly, the company s strong balance sheet it is effectively debt free leaves it well placed to pursue selective bolt-on acquisitions or capital management initiatives. Primary Health Care (PRY) we established a position in the health care services provider prior to the release of its 1H18 result. With a new management team in place, we believe the earnings outlook for PRY will improve across its key business lines of medical centres, pathology and diagnostic imaging. The company s medical centres will benefit from improving GP recruitment while the pathology division will be aided by lower rents. Furthermore, recent Medicare data indicates positive volume trends, with a 13.5 rise in benefits in Pathology and an 8.1 rise in diagnostic imaging for the first half of FY18. New Century Resources (NCZ) we established a position in the zinc developer during the quarter. NCZ has commenced capital works to restart production at its Century Mine in Queensland, a project which was operated most recently by MMG in early The company s Restart Feasibility Study (RFS), completed in November 2017, revealed a mine life of 6.3 years with first production expected in the third quarter of NCZ will leverage MMG s former infrastructure on the site, which is in excellent condition leading to low capital requirements. We view the stock s valuation metrics as highly attractive based on its expected production profile with EV/EBITDA multiples below 3.0 times based on a range of scenarios, providing a significant margin of safety. Key sales Sirtex Medical (SRX) we exited the position in the quarter to reallocate funds to better opportunities. We believe the takeover by Varian Medical Systems which has been recommended by SRX s Board has a high probability of success, with the Foreign Investment Review Board (FIRB) clearing the takeover and intervention from the Australian Competition and Consumer Commission (ACCC) unlikely. We also see the probability of further competing bids as very low. Charter Hall Long WALE REIT (CLW) we exited the position in the REIT during the quarter. We believe the stock, which currently trades at 0.9 times NTA with a 7.0 forecast dividend yield, will continue to trade below Net Tangible Asset value (NTA) due to a deteriorating outlook for the cash backing of its dividend, limited levers to offset increasing borrowing costs and seemingly limited capacity to consider a share buyback. Crown Resorts (CWN) we trimmed the position size following recent outperformance as our investment thesis plays out. We believe CWN is emerging as a simpler, more focused and more disciplined company. We remain attracted to the stock based on its core Melbourne and Perth businesses two defensive monopoly assets that support a high dividend payout ratio. Furthermore, VIP gaming activity is rebounding globally, with Australia a clear beneficiary. Key active overweights NextDC (NXT) the data centre operator is structurally set to benefit from increasing adoption of cloud technology and is accelerating its expansion to meet the demands of its larger clients. The company is currently building three new data centres which will support significant medium to longer term earnings growth. The outlook for NXT appears attractive given the company s growth profile and infrastructure-like characteristics at maturity. Macquarie Atlas Roads (MQA) we maintain a favourable view towards MQA based on its steep discount to intrinsic value and attractive, long-dated assets. MQA trades at an FY18 EV/EBITDA ratio of around 11 times, well below comparable asset transactions, which in part reflects the external management structure of the vehicle. MQA recently announced plans to internalise management, a change we believe will be highly value accretive. Not only have large fees leaked significant value over time, but the external structure and MQG s ownership stake which was sold in December represented a roadblock for any potential acquirer and, in our view, had prevented MQA s assets from being appropriately valued. Ansell (ANN) our positive view is based on ANN generating operating leverage and market share growth above expectations, enabling the company to grow earnings above consensus. Drivers include lower raw material costs, internal programs to improve operational efficiency, improved margins from new distributor agreements and a shift towards highervalue products. ANN s relative valuation remains attractive, trading on a 12-month forward P/E of 17.7 times a significant discount to its domestic peer group. CSR (CSR) we are overweight the stock because we are more optimistic than consensus expectations concerning the company s Building Products division. We expect EBIT growth in FY18 as a result of an improved competitive landscape and market structure in bricks, while consensus is currently forecasting a mid-single digit decline. CSR demonstrates strong operational expertise across its divisions, including the Aluminium division where management continues to optimise earnings from its Tomago plant through proactive hedging strategies and efficiency measures to drive down costs. Lastly, the company s strong balance sheet it is effectively debt free leaves it well placed to pursue selective bolt-on acquisitions or capital management initiatives.

4 TPG Telecom (TPM) we believe TPG offers compelling value relative to its peers (at a forward P/E of 15.1 times) when considering its defensive characteristics and long-term growth opportunities, particularly from its disruptive entry into the Australian mobile market following the purchase of the 700Mhz spectrum in April Furthermore, in our view consensus forecasts now capture a lower contribution from iinet (which we believe will be offset by material cost synergies) and the detrimental impact of the NBN roll-out on margins (which we believe will be offset by growth in both market share and its Fibre-to-the-Building broadband product). Key active underweights Cochlear (COH) our underweight COH position reflects our view that the current share price is efficiently capturing the growth characteristics of the company and its market leadership position. In the near term, the processor upgrade cycle is likely to provide additional earnings momentum, which we believe is appropriately captured in high earnings growth and multiple expectations at this time. Tabcorp (TAH) we are underweight the gambling services provider because we believe earnings expectations are too optimistic and the market s valuation, at 21.5 times 12-month forward P/E, is stretched. Our key concern is the outlook for the conventional wagering business, which operates in a low growth industry and with high levels of competition, placing intense pressure on its traditional retail distribution strategy. The merger of TAH and Tatts Group (TTS) doesn t alter our view of the structural headwinds in wagering, with the high acquisition price and high gearing more than offsetting targeted cost synergies in our view. Market outlook We believe fundamentals point to a strengthening earnings cycle for the Australian equity market, with upgrades to FY18 consensus estimates likely. Consensus sees Resources delivering high-single digit growth, with Industrials at midsingle digits and Financials at low-single digits. Australian equities are priced modestly above their long-term averages based on forward earnings estimates, though valuations remain attractive relative to alternatives such as fixed interest. The S&P/ASX 200 Index yields 4.7 on a 12- month forward basis versus 2.6 from the Australian 10-year government bond yield. At a global level, while an economic recovery and excitement about political change is driving valuations to elevated levels, we remain alert to economic and geopolitical risks, including surging interest rates and China s real rate of growth. We see significant value in certain sectors but believe others to be overvalued based on our earnings and cash flow expectations. We are overweight the Information Technology, Telecommunications Services and Consumer Discretionary sectors, but are underweight Real Estate, Energy and Materials. Boral (BLD) our underweight position is premised on the company s exposure to moderating domestic construction material markets, including new housing demand in Australia where we believe activity is likely to soften in the medium term. We also believe management paid a full price for the recent acquisition of US asset Headwaters and question the earnings sustainability of the US business and BLD s ability to extricate synergies to meet stated targets. While BLD s valuation of around 9.4 times EV/EBITDA appears undemanding relative to historic valuations, we do not believe it fully factors in these risks at present. Bluescope Steel (BSL) while our view towards the stock has recently improved, we currently maintain an underweight position. BSL s earnings remain subject to volatile commodity prices, though its recent cost-reduction programs and ongoing shift in business mix means that its earnings appear more resilient than in previous cycles. A2 Milk (A2M) we believe the stock s current valuation trading at a forecast P/E of 33.7 times fully captures the company s positive outlook. A2M s earnings growth over recent years has been underpinned by China infant formula sales which have grown significantly, however we are cautious to capitalise this earnings momentum given questions regarding the sustainability of the current distribution channels (in particular via daigous), an increasing competitor presence and the fickle nature of the Chinese consumer.

5 Sector allocation Portfolio Benchmark Active Consumer Discretionary Consumer Staples Energy Financials Health Care Industrials Information Technology Materials Real Estate Telecommunication Services Utilities Top 5 holdings Portfolio Benchmark Active NextDC Features Investment objective Recommended investment time frame To achieve medium-to-long term capital growth through exposure to small and medium sized Australian companies that are considered to possess strong capital growth potential. In doing so, the aim is to outperform the benchmark over rolling 3-year periods years Fund inception November 1994 Fund size APIR codes Estimated management cost Pooled Fund A$ mn as at 31 March 2018 JBW0007AU 2.25 p.a. Buy/sell spread +/ The Yarra Emerging Leaders Fund (Direct) is not available for new investment. Where existing reinvestment instructions are in place, distributions may be reinvested. Macquarie Atlas Roads Ansell Resmed CSR Key active positions Overweights Portfolio Benchmark Active NextDC Macquarie Atlas Roads Ansell Underweights Cochlear Tabcorp Holdings Boral Portfolio holdings may not be representative of current or future investments. The securities discussed may not represent all of the portfolio's holdings and may represent only a small percentage of the strategy s portfolio holdings. Future portfolio holdings may not be profitable. Income and growth 1 year 3 years p.a. 5 years p.a. 10 years p.a. Growth return Distribution return The Growth Return is measured by the movement in the Fund s unit price (inclusive of fees), ex-distribution, and can be positive or negative as the unit price can fluctuate with changes in the underlying market value of the Fund s assets. The Distribution Return is the amount that is paid to unitholders by way of income distribution in a 12-month period. It does not include capital distributions.

6 Applications and contacts The Yarra Emerging Leaders Fund (Direct) is no longer available for new investment. The reinvestment of distributions is still allowed where an existing reinvestment instruction is in place. Website Investor Services Team (Australia) (Overseas) IST@yarracm.com Disclaimers The Yarra Emerging Leaders Fund (Direct) is substantially invested in the Yarra Emerging Leaders Pooled Fund ( Pooled Fund ). References in this document to the underlying assets or investments of the Fund generally relate to the assets held in the Pooled Fund. The Fund s benchmark comprises 50 S&P/ASX Midcap 50 Accumulation Index and 50 S&P/ASX Small Ordinaries Accumulation Index. Yarra Funds Management Limited (ABN , AFSL ) ( YFM ) is the issuer and responsible entity of a range of registered managed investment schemes, which includes those named in this document ( Funds ). The information provided contains general financial product advice only. The advice has been prepared without taking into account your personal objectives, financial situation or particular needs. Therefore, before acting on any advice, you should consider the appropriateness of the advice in light of your own or your client s objectives, financial situation or needs. Prior to investing in any of the Funds, you should obtain and consider the product disclosure statement ( PDS ) for the relevant Fund by contacting our Investor Services team on or from our website at The information set out has been prepared in good faith and while Yarra Funds Management Limited and its related bodies corporate (together, the Yarra Capital Management Group ) reasonably believe the information and opinions to be current, accurate, or reasonably held at the time of publication, to the maximum extent permitted by law, the Yarra Capital Management Group: (a) makes no warranty as to the content s accuracy or reliability; and (b) accepts no liability for any direct or indirect loss or damage arising from any errors, omissions, or information that is not up to date. YFM manages each of the Funds and will receive fees as set out in each PDS. To the extent that any content set out in this document discusses market activity, macroeconomic views, industry or sector trends, such statements should be construed as general advice only. Any references to specific securities are not intended to be a recommendation to buy, sell, or hold such securities. Past performance is not an indication of, and does not guarantee, future performance. Information about the Funds, including the relevant PDSs, should not be construed as an offer to any jurisdiction other than in Australia. With the exception of some Funds that may be offered in New Zealand from time to time (as disclosed in the relevant PDS), we will not accept applications from any person who is not resident in Australia or New Zealand. The Funds are not intended to be sold to any US Persons as defined in Regulation S of the US federal securities laws and have not been registered under the U.S. Securities Act of 1933, as amended. References to indices, benchmarks or other measures of relative market performance over a specified period of time are provided for your information only and do not imply that the portfolio will achieve similar results. Holdings may change by the time you receive this report. Future portfolio holdings may not be profitable. The information should not be deemed representative of future characteristics for the strategy. There can be no assurance that any targets stated in this document can be achieved. Please be advised that any targets shown are subject to change at any time and are current as of the date of this document only. Targets are objectives and should not be construed as providing any assurance or guarantee as to the results that may be realized in the future from investments in any asset or asset class described herein. If any of the assumptions used do not prove to be true, results may vary substantially. These targets are being shown for informational purposes only. Yarra Capital Management, 2018.