Enhancing Equity Income Portfolios

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Edward Barber
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1 Enhancing Equity Income Portfolios 2012

2 Important Information This presentation has been prepared by BT Financial Group Limited (ABN ) BT and is for general information only. Every effort has been made to ensure that it is accurate, however it is not intended to be a complete description of the matters described. The presentation has been prepared without taking into account any personal objectives, financial situation or needs. It does not contain and is not to be taken as containing any securities advice or securities recommendation. Furthermore, it is not intended that it be relied on by recipients for the purpose of making investment decisions and is not a replacement of the requirement for individual research or professional tax advice. BT does not give any warranty as to the accuracy, reliability or completeness of information which is contained in this presentation. Except insofar as liability under any statute cannot be excluded, BT and its directors, employees and consultants do not accept any liability for any error or omission in this presentation or for any resulting loss or damage suffered by the recipient or any other person. Unless otherwise noted, BT is the source of all charts; and all performance figures are calculated using exit to exit prices and assume reinvestment of income, take into account all fees and charges but exclude the entry fee. It is important to note that past performance is not a reliable indicator of future performance. This document was accompanied by an oral presentation, and is not a complete record of the discussion held. No part of this presentation should be used elsewhere without prior consent from the author. For more information, please call BT Customer Relations on :00am to 6:30pm (Sydney time) 2

3 Today... Today s presentation is case study based: Assess an existing portfolio in the context of maximising risk adjusted income; Improve Risk/return outcome and overall income via a 4 step action plan, and Outcomes 3

4 Existing Portfolio Code Volatility (Risk) Return Allocation CBA % 20% CPU % 20% MYR % 20% LEI % 20% MQG % 20% 4

5 Problems with this portfolio fundamentals potentially impacting on income sustainability Net Interest Margin declining Code Volatility (Risk) Return Allocation CBA % 20% CPU % 20% MYR % 20% LEI % 20% MQG % 20% EPS declining down 20% y/y Operating Cash flow down 57% 5 Net Profit after tax down 8%

6 Action Plan 1. Improve sectoral allocation/ Introduce some new stocks that meet the eqr selection criteria 2. Introduce some enhanced income securities to assist with risk management and income generation 3. Eliminate problematic stocks 4. Optimise the risk/return dynamics of the portfolio - MVO 6

7 Action Plan 1. Improve sectoral allocation/ Introduce some new stocks that meet the eqr selection criteria 2. Introduce some enhanced income securities to assist with risk management and income generation 3. Eliminate problematic stocks 4. Optimise the risk/return dynamics of the portfolio - MVO 7

8 Introduction of some more appropriate stocks Application of a fundamental analysis to indentify stocks that have the potential for a sustainable income stream across varying market and economic cycles Example: eqr securities strategic research example of how fundamentals drive income strategies

9 Re-allocation of stocks Existing Code Volatility (Risk) Return Income Securities Nil Equities CBA % CPU % MYR % LEI % MQG % Remove New Code Volatility (Risk) Return Income Securities ANZPC % ORGHA % PCAPA % PRYHA % TAHHA % Equities BOQ % DUE % TAH % TLS % WBC % Add 9

10 Sector Example#1: Utilities def Assets are the key to robust income and consistent EPS 10

Example DUE: 3 key defensive assets to support income Dampier Bunbury Pipeline 80.

customers in Perth and the surrounding regions. The pipeline runs from the Burrup Peninsula, near Dampier, to Bunbury, near Perth, in the south-west of the state. United Energy Distribution 66.

UED s distribution area is largely urban and, although geographically small (about 1% of Victoria s land), serves around one quarter of Victoria s population. Multinet Group Holdings 100.

11 Example DUE: 3 key defensive assets to support income Dampier Bunbury Pipeline 80.0% interest The only natural gas pipeline connecting the natural gas reserves of the Carnarvon and Browse basins on Western Australia s North West Shelf with industrial, commercial and residential customers in Perth and the surrounding regions. The pipeline runs from the Burrup Peninsula, near Dampier, to Bunbury, near Perth, in the south-west of the state. United Energy Distribution 66.0% interest The electricity distribution network covers 1,472km² of south-east Melbourne and the Mornington Peninsula. UED s distribution area is largely urban and, although geographically small (about 1% of Victoria s land), serves around one quarter of Victoria s population. Multinet Group Holdings 100.0% interest Is a Victorian gas distribution company with a network covering 1,940km² of the eastern and south-eastern suburbs of Melbourne. Multinet is currently expanding its geographic base through participation in the state government s natural gas extension program. Multinet s distribution network transports gas from the high pressure transmission network to residential, commercial and industrial gas users. 11

12 Sector Example#2: Consumables sub sector allocation makes all the difference 12

13 Consumers aren t spending in shops...where are they spending then? 13

14 wagering numbers are up on 2010

15 Melbourne Cup numbers remain steady in most economic cycles... In possibly the closest ever finish in the Melbourne Cup's history, Dunaden wins the battle to the line, edging out Red Cadeaux to take the 2011 cup. 15

16 Utilise eqr securities Sector Benchmarks Discretionary spending has not disappeared. Discretionary funds are simply being allocated more carefully Within the consumer discretionary space, there are defensive sub sectors which we view as undervalued and resilitent For example: MYR EPS is down c20% y/y, TAH EPS is up c15%. Wagering is less income elastic relative to retail within the consumables sector. 16

17 Action Plan 1. Improve sectoral allocation/ Introduce some new stocks that meet the eqr selection criteria 2. Introduce some enhanced income securities to assist with risk management and income generation 3. Eliminate problematic stocks 4. Optimise the risk/return dynamics of the portfolio - MVO 17

18 Recent Hybrid/Sub-Debt Deals Brookfield/Multiplex Australand ALE Notes Australian Unity ANZ CPS3 Macquarie Bank Primary Healthcare Origin Energy Healthscope Tabcorp Westpac CPS Woolworths AGL IAG 18 Nb: Hybrids and Sub Debt are not the same... Nb: not all Hybrids and not all Sub Debt are the same...

19 eqr Hybrids Research - Considerations Price The market price and liquidity of security may fluctuate due to various factors, including investor perceptions, worldwide economic conditions, interest rates, credit spreads, movements in the market price of issuer s Ordinary Shares or senior or subordinated debt, and factors that may affect issuer s financial position and trading results. Changes in Interest Rate may make hybrids less attractive compared to the rates of return available on other comparable securities. The underlying market for the securities may be illiquid which may have a severely adverse effect on the market price. Dividends Dividend payments are not guaranteed and can be deferred. Furthermore, the Dividend Rate fluctuates with the Market Rate. There is no guarantee that issuer will have sufficient franking credits in the future to fully frank dividends. Conversion Conversion, Transfer or Redemption may occur in certain circumstances before the Initial Mandatory Conversion Date (for example, following a Tax Event, Regulatory Event or Acquisition Event), which may be disadvantageous in light of market conditions or individual circumstances. Mandatory Conversion is subject to the Conversion Conditions being satisfied and may not occur on the Initial Mandatory Conversion Date. Structure Securities are not guaranteed or insured by any government, government agency or compensation scheme of Australia or any other jurisdiction. There are no restrictions on issuer issuing further securities that rank equally or ahead of these securities which may impact the recoverable amount for investors in the event of insolvency. In the event of a winding-up of issuer, there is a risk for investors not receiving a full return, or potentially no return of capital, or any Interest Payments due and unpaid at that time.

20 eqr Hybrids Rating Methodology Ratings (absolute and relative) Metrics Credit rating and financial health of the issuer Initial margin, step-up margin, face value and market price Nominal yield, Yield to Maturity Liquidity Distribution franking, cumulative, deferrable, frequency, discretion Capital structure / seniority of the claim Conversion conditions, conversion date and conversion ratio Incentives for the issuer to convert (like Equity treatment by the rating agencies) Probable treatment of the security by the market (like equity, perpetuity)

21 Introduce some income securities preferred securities CBA PERLS III ANZ CPS3 Primary Bonds Series A Origin Energy Sub. Notes Ticker PCAPA ANZPC PRYHA ORGHA TAHHA Legal form Preference Share Preference Share Preference Share Note Note Tabcorp Subordinated Notes Issuer CBA ANZ Primary Health Care Ltd Origin Energy Tabcorp Holdings Ltd Issuer Ratings - S&P AA- AA- N.A BBB+ BBB Issuer Rating (eqr) Fair Value Fair Value Fair Value Undervalued Fair Value RMF Rating (eqr) Moderate High Risk Moderate Risk Moderate High Risk Moderate Risk Moderate High Risk Ranking Senior only to ordinary shares Senior only to ordinary shares Senior only to ordinary shares Senior only to ordinary shares Maturity Year 40 None Year 5 Year 60 Year 25 Call Dates 6 April Sept Sept 2015 Year 5 and interest payment thereafter Senior only to ordinary shares Year 5 and interest payment thereafter Step-up date (margin) N/A N/A N/A Year 25 (100 bp) Year 5 (25 bp) Conversion Discount 2.50% 1.00% 0.0% 0.0% 0.0% Interest payments Franked, payable quarterly Franked, payable half-yearly Unfranked, payable quarterly Franked, payable quarterly Unfranked, payable quarterly Benchmark 90 Day BBSW 180 Day BBSW 90 Day BBSW 90 Day BBSW 90 Day BBSW Margin 1.05% 3.10% 4.0% 4.0% 4.25% YTM (Gross) 9.43% 9.14% 10.47% 9.31% 7.78% Issue Ratings Undervalued Undervalued Undervalued Fair Value Undervalued 21

22 Action Plan 1. Improve sectoral allocation/ Introduce some new stocks that meet the eqr selection criteria 2. Introduce some enhanced income securities to assist with risk management and income generation 3. Eliminate problematic stocks 4. Optimise the risk/return dynamics of the portfolio - MVO 22

23 eqr Valuation screening focus on blue Chip companies with a robust track record that satisfy the following Qualitative stock evaluation guidelines: i. (Segment and position) industry/sector prospects; ii. (Key differentiating factors) barriers to entry, business model; iii. (Management and Board) experience, capability and achievements in relevant field; iv. (track record) ability to achieve targets, make successful acquisitions; v. (financial stability) gearing, interest cover, cash balances, cash flow; Free Cash Flow/ROI vi. (earnings outlook ) ability to maintain and deliver sustainable dividends,eps; vii. (likely share price catalysts) short and long-term; viii.(valuation); current price against valuation/price target ix. (key risks); and x. (Sector outlook) Stocks that satisfy this criteria generally demonstrate a cumulative return of >50% over a 10 year period to reflect managerial and operational robustness. This supports a sustainable income stream

24 eqr Risk screening reduce blow-up Risk The eqr securities Risk Management Framework (RMF) identifies and ranks stocks both on a relative and absolute basis according to key fundamental risk metrics. It is a dynamic risk management framework which adjusts to changing market fundamentals and is stress - tested on a monthly basis. Examples of Metrics below: Backtesting shows that during the period from 1/07/2007 to 30/06/2009 the probability of including stocks (that declined by more than 60%) in a 10 stock portfolio was reduced by 60% through the application of the eqr RMF Measure Weighting Consensus Score Total 54.00% Consensus Recommendation 37.00% Recommendation Trend 2.00% Sector View 15.00% Market Risk Score Total 22.00% Beta 4.00% Current Ratio 4.00% Debt to Equity 5.00% Earnings Revision 5.00% Market Cap 4.00% Valuation Score Total 18.00% EBITDA 3.00% EPS 3.00% P/B 3.00% P/E 3.00% Yield 3.00% ROE 3.00% Free Cash Flow disc Company Momentum Score Total 6.00% EPS Growth 3.00% PEG 3.00% Price Momentum Score Total TBC MACD disc RSI disc Price Volatility disc Discretionary Score Total TBC Refinance Risk disc Third Party Risk disc 24

25 Action Plan 1. Improve sectoral allocation/ Introduce some new stocks that meet the eqr selection criteria 2. Introduce some enhanced income securities to assist with risk management and income generation 3. Eliminate problematic stocks 4. Optimise the risk/return dynamics of the portfolio - MVO 25

26 Re-allocation of stocks Existing New Code Volatility (Risk) Return Existing Optimal Income Securities Nil Equities CBA % 20% 0% CPU % 20% 0% MYR % 20% 0% LEI % 20% 0% MQG % 20% 0% Code Volatility (Risk) Return Existing Optimal Income Securities ANZPC % 0% 8% ORGHA % 0% 8% PCAPA % 0% 12% PRYHA % 0% 15% TAHHA % 0% 9% Equities BOQ % 0% 7% DUE % 0% 6% TAH % 0% 15% TLS % 0% 5% WBC % 0% 15% 26

27 Step 4: brining it all together portfolio optimisation 25.00% TAH 20.00% 15.00% 10.00% PRYHA New Equity & Hybrid New Equity WBC BOQ TAHHA PCAPA TLS ORGHA ANZPC DUE 5.00% Existing Equity 0.00%

28 Conclusion: Portfolio Outcome Volatility (Risk) Return Existing Equity % New Equity % New Equity & Hybrid % 28

29 29 Thank you!

30 30 Thank you!

Adobe and BT Workplace Super Prepare for the best. October 2018

Adobe and BT Workplace Super Prepare for the best. October 2018 Disclaimer This presentation has been prepared by BT Financial Group Limited (ABN 63 002 916 458) BT and is for general information only.