The Atlas High Income Property Fund declined slightly by -0.6% which was an acceptable outcome where lockdowns in Melbourne and Sydney caused the large retail trusts to fall by between -5% and -6% over July. While lockdowns impact the economy and thus the earnings of property trusts and infrastructure assets, 2020 showed that not all assets’ owners are uniformly negatively impacted. Indeed, many companies held in the portfolio saw minimal to no impact on their profits from the lockdowns last year. Consequently, the lockdowns in July 2021 did not result in broad-based panic selling of real estate assets on the ASX that we saw in February and March last year.
o to Monthly Newsletters for a more detailed discussion of the listed property market and the fund’s strategy going into 2022.
For equity analysts and fund managers in Australia, Christmas comes twice a year, every February and August, when most Australian listed companies reveal their semi-annual profit results. Companies also guide what growth in profit, revenue, profit margins or dividends that shareholders can expect over the following financial year. Though Covid-19 has seen fewer companies commit to providing guidance given the uncertainty around lockdowns and the dramatic increase in class action lawsuits brought forth by litigation funders keen on profiting from negative deviations in company earnings. This can be a stressful time for a fund manager. When companies reveal unpleasant surprises, the company’s stock price tends to get sold down hard. Alternatively, it can be enjoyable when the company reports a good result that validates the investment case for originally owning their shares. In this piece, we will go through how Atlas approaches each day during reporting season and what goes on during a typical day during the earnings season.
Before Reporting Season
In the lead up to reporting season, Atlas reviews all the stocks in the portfolio and considers the key factors and financial metrics that investors will be looking for on results day. We compare our forecasts to the consensus analyst forecasts. What we are trying to do here is to identify which companies are performing ahead of expectations and, more importantly, which companies have the potential to disappoint.
The Spread over the Month
Companies listed on the ASX with a June year-end have until the last day of August to release their financial results; otherwise, they are suspended from trading on September 1st. However, results are not released evenly throughout the month as companies tend to avoid reporting either in the first or last week of the month, preferring the middle weeks. Consequently, there are days when several large companies report on the same day and often at the same time, which often results in the market making swift and not well-considered decisions as to whether the result was either good or bad. Frequently we see a stock trading down on what Atlas considered to be a favourable result, only to see the company’s share price recover the following day after investors have digested the financial reports. The below chart shows the distribution of results during the August reporting season, with the week starting August 16th being the heaviest. Wednesday August 18th, will be challenging for analysts with CSL, Coles, Dominos Pizza, Fletcher Building, Deterra, Santos, Supercheap Auto, Tabcorp, and Vicinity Centres reporting.
On the Day
Generally, companies post their financial results with the ASX around 9 am; this gives investors an hour to digest the facts and figures before trading on the stock exchange begins at 10 am. 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 actually delivered. Also, it is important to compare how a company has performed against their peer group. For example, in isolation, Coles report reporting a slight decline in sales and a steady profit margin could signal a great result if Woolworths and Metcash reported significant decreases in sales and shrinking profit margins.
Company management will then formally present their results to shareholders on a conference call or in-person during the morning, generally between 9 am and midday. These presentations are directed towards the institutional investment community and are effectively closed to the media and public, and can take between one and two hours. The management team gives greater detail on the factors contributing to the profit result and explains any potentially contentious issues. The most informative part is always the question-and-answer session, which allows investors to gauge how confident management is in tackling the most controversial problems coming out of their financial accounts.
Typically, it will only be the sell-side analysts asking management questions, with the large institutional investors saving their questions for behind closed doors. The problem with this is that in addition to writing research, some sell-side analysts want to protect their relationship with the company and keep on its good side for future lucrative investment banking deals. Frustratingly this can sometimes see soft questions being served up for management or avoiding the hard questions when the management has made some mistakes.
After the presentation of the results, we will generally have a quick discussion to see if there have been any fundamental changes to our thoughts and discuss the market reaction. The immediate market reaction can often be misleading, as most of the trading on results day is done by hedge funds or high-frequency traders rather than long-term fundamental investors.
Lunch with the Company??
Before Covid-19, one of the benefits of being a good client of one of the investment banks is the opportunity to have lunch with the company management team, though there have been few of these events since 2019. These events are held in the bank’s boardroom and are fully catered events, though it is rare to see anybody accepting a glass of wine with their steak or fish. Many fine bottles of wine from the cellars of the investment banks get opened, offered around the table by waiters and then returned to the sideboard with one glass poured out.
Whilst this may seem to offer institutional investors an advantage over retail investors, any new insight is rarely gained in these events. This occurs as they are essentially a group meeting of rivals trying to understand what others think about the company. Further, if you know the company well or have a particularly insightful question, an analyst will save that for a one-on-one meeting with the company. Often several large and complicated companies report on the same day, so unless an individual company has had a particularly good or bad result, it is poor time management to spend 1.5 hours over lunch picking through the financial accounts of a company that has performed as expected.
Immediately Afterwards
Over the following week, the company will then organise individual one-hour meetings with their largest institutional shareholders both in Australia and overseas. Before these meetings, it is essential to be well prepared, as this is frequently the best forum to understand whether you should buy more of a company’s stock or completely sell out. During our meetings with the management teams, we will generally seek clarity (on behalf of our investors) on specific issues that we feel weren’t covered to our satisfaction at the formal presentation. While some of these meetings can be quite hostile or very friendly, they are a valuable forum for both parties to give feedback on how our client’s capital has been managed in the past and how that capital should be employed in the future.
I have been in these meetings where management has raised a potential strategy that seemed aggressive and quite alarming. In one case, I left a meeting with management to immediately begin selling down the fund’s position. The company in question was facing both a falling oil price and published decisions of their large listed clients to delay or abandon projects, both public information. These issues were largely glossed over in the earlier analyst call in favour of softball questions to management. A similar flippant response to these concerns was given in our meeting with management, which resulted in the action taken.
After the management meetings and subsequent to reviewing the financial results of a company’s competitors, Atlas is then in a position to determine what changes (if any) are made to our valuation of the company and whether the security’s weight in the portfolio is still appropriate in light of competing investment opportunities.
The Atlas High Income Property Fund had a solid month gaining +3.8% as the Fund benefited from several holdings declaring distributions ahead of market expectations. Additionally, the market was buoyed by further positive economic data and statements from the RBA indicating that interest rates are unlikely to rise before 2024.
The Fund declared a final quarterly distribution of $0.033 per unit for the financial year. The distribution will be paid to investors in early July.
Go to Monthly Newsletters for a more detailed discussion of the listed property market and the fund’s strategy going into 2021.
Matt Williams, portfolio manager at Airlie Funds Management, agrees and says that while it might sound simple, the IPO has to be a good business with good prospects. Some ingredients to determine whether the IPO is a good business would include the level of recurring earnings, debt levels and whether the industry sector has a favourable outlook.
The last 12 months have been very kind to investors in Australian equities, with the ASX 200 index returning 24%, as the market recovered the sharp falls from March 2020. While the ASX 200’s return is market-weighted, a better measure of the broad-based gains of Australian shares can be seen in the median1 return of 25.7% of the ASX 200. Against this background of strong equity market performance, many investors will be looking at the stocks that have performed poorly over the past 12 months, looking to sell some of their winners and find the hidden gem or two that will rebound sharply in 2022.
In this week’s piece, we will look at the “dogs” of the ASX in 2021, see how 2020 Dogs performed and review how accurate Atlas’s predictions were in July 2020.
Dogs of the Dow
Michael O’Higgins popularised a systematic investment strategy of investing in underperforming companies named “Dogs of the Dow” in his 1991 book Beating the Dow. This approach seeks to invest in the same manner as do deep value and contrarian investors. O’Higgins advocated 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 still paying a dividend. Restricting the investment universe to a large capitalisation index like the DJIA or ASX 100 improves the unloved company’s chance of recovery. Larger companies are more likely to may have the financial strength or understanding capital providers (such as existing shareholders and banks) that can provide additional capital to allow the company to recover over time. The thought process behind requiring a company to pay a dividend is that its business model is unlikely to be permanently broken if it is still paying a distribution. A company’s directors are unlikely to authorise a dividend if insolvency is imminent. The strategy then holds these ten stocks over the calendar year and sells them at the end of December. The process then restarts, buying the ten worst performers from the year that has just finished.
Retail investors have an advantage
One of the reasons this strategy persists is that institutional fund managers often report their portfolios’ contents to asset consultants as part of their annual reviews. This process incentivises fund managers to sell the “dogs” in their portfolio towards the end of the year as part of “window dressing” their portfolio before being evaluated. For example, in July 2020, fund managers with Virgin UK in their portfolios would have seen some pretty stern questioning from asset consultants about why they owned the UK bank facing the worst economic conditions in the UK since the 1970s, rising bad debts and uncertainties around Brexit. However, Virgin UK’s share price recovered by +122% throughout the year to be one of the top-performing stocks on the ASX.
Here retail investors can have an advantage over institutional investors, picking up companies whose share prices have been under pressure from the tax loss selling around the end of the financial year. Furthermore, retail investors can afford to take a longer-term view on the investment merits of any particular company that may have hit a speed bump.
Dogs of the ASX in 2020
Over the past year, the Dogs from 2020 returned 32.5%, significantly outperforming the ASX 200 index’s return of 27.8% in what was an extraordinary year. From the table below, six out of the ten “dogs” of 2020 outperformed the ASX 200, with Virgin UK, Worley Parsons and NIB Holdings leading the charge. Virgin UK exceeded meagre market expectations on significantly lower bad debt charges and an improving outlook. Similarly, engineering contractor Worley Parsons had the benefit of low market expectations and a recovery in the oil price that saw the company continue to win contracts. NIB saw the benefit of customers paying for private health cover and a fall in costly elective procedures. CIMIC’s woes continued in 2021, drifting lower on delays in infrastructure contracts being awarded due to further lockdowns.
Our picks from July 2020
When making our picks twelve months ago, Atlas noted that the task was much more challenging than in previous years. The principal reason for the falls over FY 2020 was not company-specific issues that are in management’s power to fix, but rather due to an external shock from Covid-19.
Atlas correctly picked that NIB would surprise in 2021, as CV-19 restrictions reduce the number of elective private hospital procedures and healthcare premiums are paid upfront. Less successful were our picks that CIMIC would benefit from increased infrastructure spending flowing on from stimulus plans. Equally, we were cautious towards big winner Virgin UK based on the view that with international travel off the table, the trajectory of bad debts incurred by a British bank would be difficult for investors in Australia to forecast accurately.
What does the class of 2021 look like?
Looking through the list of the underperformers of 2021, the key theme again is that the falls are from factors that are outside the company’s control, such as Chinese import restrictions on Australian goods, falling electricity prices or the gold price.
China’s President Xi Jinping’s bellicose speech in Tiananmen Square over the weekend at the centenary of the Chinese Communist Party gave little indication that investors can expect China to relax import restrictions on Australian goods in the near term. Similarly, it is difficult to see a significant increase in wholesale power prices for AGL Energy and Origin Energy in the face of government policies designed to drive down prices.
Our Picks for 2022
In selecting a significant share price recovery candidate in the following year, we generally look at companies whose woes are company-specific, and AMP certainly fits the bill. However, the embattled financial services company faces the difficult task of rebuilding a damaged brand, legal actions by sections of its adviser base and declining funds under management as rival managers successfully prise investment mandates away from AMP. AMP is likely to see further pressure on profit margins in 2022, as revenue falls much faster than its ability to trim its cost base.
Consequently, Atlas are picking Beach Energy and Newcrest among the gold miners to outperform in 2022. In 2021 Beach’s share price was under pressure after the company mandates cut production guidance and downgraded its Western Flank Field reserves. The share price fall seems excessive given that this field comprises only 5% of Beach Energy’s reserves, and the company is benefiting from a sustained recovery in energy prices. Newcrest and the other gold companies have faced a weaker gold price due to outflows from Gold ETFs in the early part of 2021. Atlas see that this is likely to reverse in 2020, and Newcrest will outperform the other gold companies on this list due to its low-cost operations, growth potential and conservative balance sheet.
1.The median return of an index can give a better indication of a general return for a group of stocks as unlike a mean it is not skewed by extremely high and low returns, nor in the case of market cap weighted returns such as the ASX200 by the performance of the largest companies.
