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Monthly Newsletter December 2017

  • The Fund posted a gain of +0.6% over the last month of 2017, ahead of the underlying ASX 200 A-REIT index. December was dominated by the news of the potential takeover of Westfield by Unibail-Rodamco. Outside of Westfield, the overall performance of the index was weak.
  • The Fund remains positioned towards Trusts that offer recurring earnings streams from rental income rather than development profits, we see that this is likely to position us well going into 2018, as the property development market cools.
  • In December the Fund paid a distribution of $0.05; an increase of +2.9% over the September quarter distribution.

 

Go to  Monthly Newsletters for a more detailed discussion of the listed property market in December and the fund’s strategy going into 2018.

AFR: Why one of 2017’s ASX dogs will howl in 2018

Could sifting through this year’s ASX 100 dogs unearth next year’s gems?

That’s the question posed by Hugh Dive from Atlas Funds Management, who has explored whether it’s worth using the Dogs of the Dow theory made famous by a US investor called Michael O’Higgins in his book, Beating the Dow.

Dogs of the ASX …. Woof Woof!

The “Dogs of the Dow” is an investment strategy that is based on buying the ten worst performing stocks over the past 12 months from the Dow Jones Industrial Average (DJIA) at the beginning of the year, but restricting the stocks selected to those that are still paying a dividend. The thought process behind requiring a company to pay a dividend  is that if it is still paying a distribution, its business model is unlikely to be permanently broken. The strategy then holds these ten stocks over the calendar year and sells them stocks at the end of December. The process then restarts, buying the ten worst performers from the year that has just finished. In this area retail investors can have an advantage over institutional investors, many of whom sell the “dogs” in their portfolio towards the end of the year as part of “window dressing” their portfolio. This avoids the manager having to explain to asset consultants why these unloved stocks are still in their portfolios.

In this week’s piece written from snowy Norway,  we are going to look at the “dogs” of the ASX, focusing on large capitalisation Australian companies with falling share prices. Additionally, we are going to sift through the trash of 2017 to try to discern any fallen angels with potential to outperform in 2018.   Unloved mutts
The Dogs of the Dow was made famous by O’Higgins in his 1991 book “Beating the Dow” and seeks to invest in the same manner as deep value and contrarian investors do. Namely, invest in companies that are currently being ignored or even hated by the market; but because they are included in a large capitalisation index like the DJIA or ASX 100, these companies are unlikely to be permanently broken. They may have the financial strength or understanding capital providers (shareholders and banks) that can provide additional capital to allow the company to recover over time.

ASX Dogs over the past five years
The table below looks at both the top and bottom performers for the past five calendar years and their performance over the subsequent 12 months. As always this is measured on a total return basis, which looks at the capital gain or loss after adding in dividends received.  Whilst sifting through the trash at the end of the year yields the occasional gem – such as Qantas in 2017 (+65%), Fortescue in 2016 (+223%), Qantas again in 2014 and Challenger in 2012 (+81%) – an equal weighted portfolio of the dogs of the ASX 100 has outperformed the index in three of the past seven years.

 

Themes
Looking at the above table, finding the fallen angel among the worst performers seems to work best where the underperformance is due to stock-specific issues, rather than macro issues beyond a company’s control. For example, Cochlear underperformed in 2013 after weaker sales as the company waited for approval to sell its new Nucleus 6 product in the United States. Subsequently, Cochlear’s share price has gained 240%,  as hearing implant sales bounced back. Similarly BlueScope Steel had a tough 2015, which saw the company seeking government support to help restructure their Port Kemba steelworks. Concurrently, cheap Chinese steel took market share at the same time as key inputs of iron ore and metallurgical coal were climbing upwards. 2016 saw a significant turnaround for BlueScope’s shares which gained +111% as profits recovered due to cost controls, stronger sales and the benefits of an acquisition in the United States.

The common factor among the underperformers that have continued their slide in the following year is when the underperformance is tied to factors outside the company’s control, such as a multi-year decline in a commodity. From the list of underperformers in 2014, continuing declines in iron ore delivered further pain to Arrium, Fortescue and BHP’s shareholders. Similarly, a several year slide in oil prices pushed down the share prices of Santos and Worley in the subsequent 12 months.

Unloved hounds as of December 2017
As a fund manager the key question is whether there are potential show champions in the breed of unloved canines tabled below for the 2017 calendar year. Unlike previous years a diverse mix of sectors are represented and there are more company-specific reasons for underperformance, which should yield more opportunities to pick some treasure out of the trash.

Looking at the two telcos Vocus and Telstra, it is tough to see the near term catalysts that will transform them into stars in 2018, with the NBN market likely to remain intensely competitive with high costs to migrate customers. Fortescue is likely to continue to face Chinese preference for higher grade iron ore over its lower-grade blends to improve furnace efficiency and reduce pollution. Domino’s Pizza could be a candidate for a turn-around in 2018, now the company is more reasonably valued with multiple avenues for growth across its discount pizza operations in Europe, Australia and Japan and a falling AUD will boost earnings. Similarly Brambles could see a brighter 2018 based on growth in US pallets, management stability and a falling AUD.

 

 

 

 

 

 

 

 

Our View
Whilst the Dogs of the Dow might work in a market populated with a diversified range of companies in uncorrelated industries such as McDonalds, 3M, Merck and Microsoft, it does not appear to be a broad strategy that one can use consistently in the ASX. We see that among the companies in the ASX 100, the composition of the index is not as broad as the Dow at an industry level. The ASX has a high weighting to resource companies, whose profitability is largely tied to commodity prices (such as oil and iron ore) that are outside of management’s control and can be subject to multi-year declines.

Nevertheless it can pay to sort though the dogs of the ASX. From the table above over the past 5 years, one of the top performers in the following year can be found by sifting through the dogs of the ASX100.

 

 

Croquettes and Duck Confit for Westfield

This morning European property company Unibail-Rodamco announced that it had entered into an agreement to acquire Westfield (WFD) to create a global developer and operator of flagship shopping centres in the US, UK, the Netherland and France. This deal values WFD at A$33 billion, or at a price earning multiple of over 22 times future earnings, what appears to be a full price.

Westfield is the largest holding in the Atlas High Income Property Fund, so we were understandably quite pleased with this development. In this note we are going to look at what will likely be the largest takeover in Australian corporate history.

Today’s deal marks the end of an era for Westfield, which was originally listed on the ASX the middle of the 1960-61 recession when unemployment spiked to a post-war high of 3.1%. The above image is from 1959 and is of Westfield’s first shopping centre in Blacktown.

Westfield Development Corp’s initial public offering offered 300,000 shares at five shillings! In recent years, the various corporate changes at Westfield have appeared to be movements of the chess pieces on the Westfield board leading towards this day. Moves such as the separation of the Australian assets (Scentre: SCG) from WFD’s global assets, seemed to be designed to increase the attractiveness of Westfield to a foreign suitor such as Unibail-Rodamco, and allow the Lowy family to exit the company first listed close to sixty years ago. For a deeper dive into the corporate gymnastics that Westfield has engaged in over the years look at our piece Westfield: the Thimble and the Pea.

The Deal
Under the agreement WFD holders will receive a combination of cash (US$2.67) and 0.01844 Unibail-Rodamco shares for every WFD unit owned. This equates to A$10.01 or a 18% premium to the price at the close of trading prior to the deal being announced. It is anticipated that the combined entity will have a primary listing in Paris and Amsterdam, with a secondary listing on the ASX.

Investors in the new combined entity will own a property trust with 104 shopping centres across Europe and the US valued at A$95 billion.

A higher bid?
In our opinion this deal is likely to go ahead with a minimal chance of competing bids, as the Franco-Dutch Unibail-Rodamco revealed that they already own 4.9% of WFD and that the Lowy family which own 9.5% of WFD are supporting the deal. Digging into the detail in the documents, there is also a US$150 million break fee that must be paid to the other party if either Unibail-Rodamco or Westfield were to decide to walk away from this deal.  The details on when this deal is likely to be completed is yet to be fully announced, though the parties expect that this will be consummated around June 2018 if shareholders vote in favour.

Our Take

Looking ahead, this takeover is likely to provide a positive boost in the near term to the Australian Listed Property market, as it raises the prospect of further takeovers. In the medium term, investors that decide to cash in their Westfield holdings are likely to look to deploy some of the proceeds in other Australian Listed Property Trusts which will boost share prices in the next six months.

The Atlas High Income Trust are likely to take the money that the Europeans are offering and reinvest elsewhere, as typically these situations represent a transfer of wealth from the aquiror’s shareholders (Unibail-Rodamco) to those of the takeover target (Westfield). This occurs due to the premium required to consumate the deal ineviatably is higher than the synergies actually achieved.