11th September, 2020: Live from the desk of our CIO, Piers Bolger

11th September, 2020: Live from the desk of our CIO, Piers Bolger

11th September, 2020: Live from the desk of our CIO, Piers Bolger 150 150 Piers Bolger

Having just completed the recent reporting season for the Australian equity market, we wanted to share some of our thoughts and key takeaways that we saw over the month of August, and how we’ve been translating some of those key themes across our two equity portfolios.

At a headline level, the market was up 2.8% over the course of August – a good, solid month’s returns from equities. This continues on from what we saw through the second quarter of 2020 after the March lows.

Overall Performance

When it came to overall performance, two sectors really stood out: the IT sector, up by almost 15.5% over August, and the consumer discretionary sector, up close to 8%. Both those sectors have really benefited from both a rise in eCommerce and increased demand, the case particularly in terms of cloud and data warehousing.

Conversely, the utilities and communication service sectors were the two weakest sectors over the month, falling around about 5.5% over that period.

All other sectors delivered positive performance, so we feel that the breadth of the return profile was actually quite positive. However, this was led by just a couple of sectors – something we’ve seen over the last couple of months.

The chart below highlights here the performance has hit relative to analyst or board market expectations.

By and large, results were broadly in line with expectations. While there were some companies that did not meet these – some of which had already been flagged to the market through the months of April and May – there really weren’t too many results outside what the market was expecting.

It’s particularly pleasing that most results fell slightly above expectations. From our perspective, probably the most interesting result was what we were seeing in dividends, where we saw slightly higher expectations of returns, much of which was coming from the materials/mining and healthcare sectors. This is also true of the consumer discretionary sector, where performance was very solid.

However, when we look at results, we then start to focus on what they mean for 2021. That’s probably where we start to see a more significant level of divergence when it comes to the conversations and the presentations we had with CEOs and CFOs over the period.

And you can see, we are seeing a complete reset in the context of what FY21 might look like, in terms of both sales and dividends. This hardly surprising given what the world has been dealing with when it comes to COVID-19, and the economic impact the pandemic has been having on many corporates domestically and abroad.

From that perspective, there is quite a significant expectation of slower corporate earnings growth coming through. We can see this in terms of the earning per share revisions through FY21; quite a significant downgrade relative to what might have otherwise been expected.

When we apply this to portfolios, it means that we are focusing on quality – the businesses that have a sustained advantage and strong balance sheets relative to their peers. The ability to really generate good cash earnings is going to be particularly important as we head through the back end of this year into FY21.

Equally, we’re not expecting a significant uptick in dividends through the course of the next financial year. We would most likely expect dividends to remain low for longer as many corporates start to rebuild their balance sheets and ultimately look to grow their earnings over time. This is not inconsistent with what we’ve been seeing in terms of the overall performance of many corporates over the last six months.

When applying this to our portfolios, we’ve been considering four key themes: defensive, quality growth, category leaders and recovery leverage. And as you can see below underneath those four categories, we’ve identified the types of businesses that we feel can really take advantage of each of those key themes and play a really important part in delivering a holistic portfolio outcome.

  1. Defensives

In the defensives category are businesses that can track through difficult market conditions. Woolworths is a good example, as it has shone through the period of February and March, with the event of lockdown and people increasing their buying as a result. We have seen this demonstrated in a significant uptick in sales.

Also worth mentioning are Brambles, the mover of consumer goods through their pallets; NextDC on data and cloud warehousing, which again has become really important in the context of eCommerce; and insurance company Steadfast. All of these defensives have a very low correlation to what we’ve been seeing more broadly in terms of the impact of COVID-19, making them a crucial component.

We then consider quality growth and category leaders. These are businesses that continue to grow through what has been a very difficult period, and those that we would consider to be at the forefront of the industries that they operate in. These businesses have an advantage, not only from a product perspective, but also in their balance sheets and overall ability to be able to handle many of the recent challenges.

  1. Quality Growth

Businesses such as Goodman group (logistics, industrial warehousing) have really benefited from the rise in eCommerce. Wesfarmers has continued to be able to trade, as it has been able to manage the way that it’s been delivering its product to the market. CSL continues to be a market leader when it comes to vaccines and blood plasma – not only domestically, but globally – and has continued to be able to play that theme. And we are also seeing growth options in EFTPOS provider Tyro, as well as Xero, providing market leading cloud accounting software. All market leaders continue to provide very strong options going forward.

  1. Category Leaders

Category leaders – James Hardie, ResMed, Altium, Baby Bunting and A2 – may operate in different market segments, but they all have some key thematics. It’s these that we believe will continue to see them grow organically and continue to take advantage as we move through the post-COVID-19 phase certainly into recovery.

Renowned for its sleep apnoea devices, ResMed’s ability to be able to pivot to provide ventilators to the US has been really, really positive for the outlook for the group going forward. Baby Bunting has benefited from the shift to eCommerce, and has been quite resistant to the impact of COVID-19. It has developed its online sales process and holds a dominant position in the infant market. This has continued to be reflected in the overall performance. Similarly, A2 could also be considered on that basis.

  1. Recovery Leverage

We have also identified some businesses that we think are really linked to a broader-based recovery, particularly in the materials sector. We think this will continue to provide some strong optionality in terms of performance in the future.

This includes BHP, a broad-based, diversified company in terms of its mineral resources. We then have more specialised companies such OZ Minerals and IGO. OZ Minerals has some linkages mainly in copper, but also has some linkage to gold production which again, can act as a natural hedge in a more challenging market environment. IGO, meanwhile, deals with nickel. We believe that copper and nickel are going to be two resource commodities that are going to really benefit as we move through post-COVID-19, but equally over the next five to 10 years as well. We feel that there are some real benefits associated with that.

Toll-road operator Transurban has had a significant few months with the advent of COVID-19 and the inability of people to be able to travel outside. However, we believe that the business will start to rebound as we move through into a post-COVID-19 phase, where people can start to travel around more freely. We expect that volumes will naturally pick up, ultimately feeding through to the bottom line.

Equally, Transurban has assets both domestically and in offshore markets, predominantly in the USA. We believe it can continue to deliver on what it has done over the last couple of years, positioning for that recovery leverage.

Hopefully the above provides you with some key themes, and some of the major positions we have across our portfolios. Ultimately, these are always changing, as per the dynamic nature that we operate in in terms of financial markets.

We continue to believe that there is significant opportunity, but we need to balance that, not only with what we are seeing at a domestic, macro level, but also in offshore markets. These businesses and others can continue to grow and deliver solid investment returns for investors over time.

As always, if you have any concerns or queries about your portfolio, please feel free to reach out to any one of our advisors.

Piers Bolger is Chief Investment Officer at Viridian Advisory

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