December Newsletter Atlas High Income Property Fund

  • The Atlas High Income Property Fund declined by 2.1% during December 2019. This was a frustrating result as for most of the month, the Fund was ahead of both the index and in positive territory, but the entire market was sold down by close to -2% in a thinly traded four-hour session on the 31st December. This fall in the unit price has substantially been recovered in early 2020.
  • The wider listed property market had a tough month in December falling -4.4%, with the share prices of the property trusts with development earnings being sold down hard. The Fund’s strategy specifically avoids trusts with volatile development earnings in favour of trusts with recurring earnings streams from long-dated leases to high-quality tenants.
  • The Fund declared a quarterly distribution of $0.0412 per unit, in-line with the September quarterly distribution. The distribution will be paid to investors in early January.

Go to Monthly Newsletters for a more detailed discussion of the listed property market and the fund’s strategy going into 2020.

Banks Reporting Season Scorecard 2017

Over the last two weeks, investors had a wild ride following bank reporting season. In addition, in last night’s Budget a surprise levy of 0.06% on the liabilities of Australia’s five largest banks was announced. This move sparked a big sell-off in the shares of the four major banks on Tuesday in anticipation that this tax will reduce bank profits. Whilst this may occur, historically banks have been very successful in both passing on additional costs and using public relations muscle to alter government policy.

Prior to the 2013 election, the Gillard government attempted to introduce a 0.05% levy on bank deposits which was shelved in the face of a very impressive campaign from the banks. We expect that this tax will result in increased monthly loan repayments and cuts to term deposit rates, despite claims that shareholders will bear the brunt of this impost.

In this piece, we are going to look at the common themes emerging from the May reporting season, differentiate between them, and hand out our reporting season awards to the financial intermediaries that grease the wheels of Australian capitalism.

Key theme: profit growth

Across the sector profit growth was stronger than recent reporting seasons with ANZ leading the pack.  ANZ reported headline profit growth of 8% in a complicated set of financial statements, but this reduced to a still respectable 3.8% when backing out the impact of the sale of the bank’s Asian retail businesses, Esanda and property gains.  Across the sector solid profit growth was achieved by robust economic conditions and cutting costs.

Gold star to: 

Key theme: bad debt charges still very low

One of the key themes across the 4 major banks and indeed the biggest driver of earnings growth over the last few years has been the significant decline in bad debts. Falling bad debts boost bank profitability, as loans are priced assuming that a certain percentage of borrowers will be unable to repay, and that the bank will lose money where the outstanding loan amount is greater than the collateral eventually recovered. In 2016, we saw some evidence that bad debts were starting to rise to a normal level of around 0.3% of loans, though 2017 has actually seen another fall in bad debts that can be attributed to a buoyant housing markets and a recovery in commodity prices easing pressure on the mining sector. CBA gets the gold star courtesy of their higher weight to housing loans that historically attracts a low level of loan losses.

Gold star to: 

Key theme: dividend growth stalled

Across the sector, dividend growth has essentially stopped, with CBA providing the only increase of a mere 1c.  With relatively benign profit growth,  a bank can either increase dividends to shareholders or retain profits to build capital protecting a bank against financial shocks; but not both. In the recent set of results the banks have held dividends steady to boost their Tier 1 capital ratios. Whilst dividend growth across the banks is likely to be meagre in the near term, the major Australian banks in aggregate are sitting on a tasty grossed up yield of 8.3%.

Gold star to: 

Key theme: interest margins
Net interest margins in aggregate slightly declined in 2017. This was attributed to higher wholesale funding costs, increased competition for deposits and lower margins in lending to corporations. In May 2017 CBA and Westpac had the highest and most stable net interest margins, whereas NAB and ANZ both delivered lower margins. This reflects the two Melbourne-based banks having greater relative exposures to business banking and CBA/Westpac’s greater weighting to housing.

In late March 2017 the big four banks raised loan rates on average to investors, interest-only owner-occupiers, and businesses, with politically-sensitive principal and interest home loans remaining steady (for now). This followed rate rises that were pushed through in December 2016.

One of the key things we looked at closely during this results season was signs of expanding net interest margin [(Interest Received – Interest Paid) divided by Average Invested Assets], but this was not apparent. At the full year results in October and August (CBA) we may see signs of rising margins, as the full year impact of repricing loans upwards in December and March flows though.

Whilst Australian banks can be viewed as expensive globally, Australia is an attractive banking market which leads to strong and stable profit margins. For example, the major banks reported an average net interest margin of 2%, whereas European banks such as Credit Suisse earned only 1.2%. Small numbers that makes a large difference on a loan book in the hundreds of billions!

Gold star to:  Australian banking oligopoly

Key theme: total returns
In 2017 only NAB has outperformed the S&P ASX 200 total return (capital gain plus dividends) of 4.5%, as investors were concerned about potential new capital issues and a cooling of the housing market. NAB has been rewarded by investors as it has been both the cheapest bank (in price earnings terms) and has jettisoned its UK issues with the spin-off of the Clydesdale Bank and Yorkshire Bank.

Gold star to: 

Behind the scenes in reporting season

Over the last two weeks and for the next fortnight, visitors to the Sydney CBD may have noticed stressed analysts and fund managers in sharp suits moving about with unusual velocity and with a slightly greater degree of self-importance than normal. Simultaneously, stories from financial journalists are migrating to the front page of the paper. The cause of these phenomena is the ASX-listed company profit reporting seasons, which occurs twice a year with the regular timing of the Serengeti wildebeest migration.

Reporting season is a stressful time, as it reveals how a company is performing in financial measures such as profit, margins, debt and free cash flow, as against the expectations in analysts’ models that are used to derive a valuation. When companies reveal unpleasant surprises or point to problems in the future, the company’s stock price can decline sharply. Alternatively, it can be very pleasant when the company reports a good result which validates the investment case for owning their shares. In this week’s piece, we are going to go through how Atlas approaches each day during reporting season and what happens during a typical day in the earnings reporting season.

Before the day
In mid-January and July (in advance of the August season), Atlas reviews the companies in the portfolio and looks at our expectations for key factors against both the company’s guidance and consensus analyst forecasts. The purpose of this exercise is not so much to identify companies performing ahead of expectations, but to find those in the portfolio that have the potential to cause losses on results day. Take for example Primary Health: the weak Medicare data coming through over the past few months combined with ongoing uncertainty over Government health policy would have alerted investors to the possibility that the company was facing tougher conditions that the market expected.

On results day all is revealed
Companies normally post their results with the ASX around 9am, which gives investors some time to digest the numbers and develop a view before the stock begins trading at 10am. During this period, we will be combing through the profit and loss, balance sheet and cash flow statements, comparing our forecasts to what the company delivered. Also, it is important to compare how a company has performed against their peer group. For example, Woolworths report their results next Wednesday (22 February) and the share price reaction will be strongly influenced by how the grocery business performed relative to Coles (+1.3% sales growth and 4.6% profit margin).

Company management will then formally present their results to shareholders on a conference call or at their offices during the morning, generally between 9:30am and midday. These presentations are directed towards the institutional investment community and are effectively closed to the media and public. They can take between thirty minutes and two hours, with the management having the opportunity to explain their results and discuss factors that will influence future profits. If the company has had a poorly received result and the stock price is falling, this will give management the opportunity to calm the market and clear up some uncertainties.

The most informative part – in our opinion – is always the questions section at the end as it gives investors the chance to see how confident management are in dealing with the issues that investors may have with the financial accounts after they have departed from the prepared scripts. Earlier this week, many investors observed that Australia’s largest office landlord Dexus Property struggled when explaining the amounts and accounting treatment of the cash used to break interest rate hedges. Whilst this sounds innocuous, listed property trusts exclude the payment for breaking these hedges from their current profits, yet highlight the earnings growth from lower interest costs in future years. In our view this is accounting smoke and mirrors!

Typically, it will only be the sell side analysts asking questions of management in the results presentation, with the large institutional investors saving their questions for their own individual meetings with management. However occasionally fund managers become frustrated when company management receive “soft” questions from the sell-side analysts after releasing a result that disappointed the markets. These soft questions can be the result of some sell side analysts wanting to protect their relationship with the company. The last time that I asked a question was a few years ago at a QBE Insurance result. The stock price was down 10% on the day due to some surprise provisions. Here I was frustrated by the analysts asking benign questions about future years’ depreciation charges, and this prompted me to inquire as to “What comparative advantage does QBE have in writing Argentinian workers compensation insurance?”.

In the week after the results, the company will organise one-hour meetings with their domestic and international institutional shareholders. In these meetings, it is important to be well prepared to maximise the value of the time that you get with management, as this is often a key factor when deciding whether to commit investors’ capital to the company. Whilst these meetings can be either quite hostile or very friendly, they are a valuable forum for both parties to give feedback on not only how our clients’ capital has been managed in the past, but also how that capital should be employed in the future.
In recent meetings, one of the key topics that I have discussed with management is their attitudes to debt and gearing. Currently investment grade companies can obtain debt at historically low prices and –  more importantly  – with long duration, which would suggest that companies should raise their gearing to boost returns. The counterpoint to the thesis of increasing borrowings is the lingering memories of the GFC. Accordingly, many companies are reluctant to pay high prices for existing assets or do not have sufficient confidence in the economic outlook or political stability to spend capital.

Trading – measured decisions not made in haste
Whilst the stock-broking community would clearly prefer that fund managers trade immediately and often based on company results, the decisions to make dramatic changes to a position for fundamentally-based fund managers will only occur after sober analysis of the company’s results. The fund manager will then examine what changes are made to valuations and look at the set of competing investment opportunities and their expected returns including cash. We believe that most of the trading volume on the day of a result is either due to short term momentum-based hedge funds, or most likely the machines behind algorithmic trading. This may explain moves such as we saw earlier this week with Treasury Wine, who after reporting was down -5% on Monday, but gained +4% on Tuesday.

Reporting season is like Christmas for investors, in that we get to have a close look at the companies in which we have entrusted our capital, examine the financials, and ask questions of the management teams running these companies. Additionally it can give us a greater insight than ABS statistics into what is actually happening in the economy.

Hugh Dive CFA
Chief Investment Officer