5/31/2022 12:00:00 AM

Fund Reviews: Australasian Growth

Written by Michael Goltsman, Portfolio Manager 

Australasian Growth Fund

The Australasian Growth Fund returned -9.7% for the month, bringing it to a 12-month return of -26.9%, and 12.9% annualised since inception. 
Key detractors this month included Seven West Media and Macquarie Telecom.
Seven West Media is the fund’s only consumer discretionary exposure. The stock declined by 28.6% on no company specific news, as brokers downgraded their outlook on the media sector reflecting broader pessimism around a slowing economy. We think broker expectations have overestimated the depth of a slowdown as the TV market is yet to benefit from the auto and travel sectors which we believe will insulate some of the impact from a downturn. We continue to hold Seven West Media with the ~4x PE ratio already capturing a pessimistic outlook and ignoring the ability for the group to continue to win market share through its content and benefit from the structural growth of its digital channels. 
Macquarie Telecom was another large detractor this month declining 10.8% on no company specific news. This has been a core holding for the fund for several years and we continue to see considerable upside as the business develops its Data Centre assets. 
On the positives. Evolve Education was a good contributor, increasing 6.9% in the month. With Omicron disruptions being mostly behind us, we view the company’s earnings as being defensive and will benefit as childcare occupancy improves alongside the workforce returning to the office. Sentiment to the childcare sector has been positive on the back of supportive government policies and recent acquisitions at higher multiples. Probiotec was another defensive position that was able to withstand the decline across the market. A strong recovery in demand for its Cold & Flu customers continues to act as a positive driver of earnings near term.

The broad nature of the market sell-off this month resembled panic with many market sentiment indicators flashing red. We maintain a healthy cash position at 14% and are ready to take advantage of the opportunities that present themselves in the market. 

Written by Mike Ross, Portfolio Manager

Australasian Dividend Growth Fund

The Dividend Growth fund returned -8.4% in May, bringing it to a flat 12-month return. The fund has returned 16.7% p.a. since inception.

The Small Ordinaries Accumulation Index declined by -6.5% in May. We have started to slowly accumulate positions in select high quality opportunities that have been caught up in the market sell-off. Cash at month-end was 12% with a further 13% of the fund under takeover. 

Positive contributors were few in number in May but included GQG Partners and Alliance Aviation. GQG increased by 17% in May. The global fund manager has navigated equity markets extremely well and the business maintained positive net flows despite a challenging environment. 

Alliance Aviation gained 7.4% after agreeing terms for a sale of the business to Qantas for $4.75 per share. The share price is trading at almost a 20% discount to the offer price likely due to perceived regulatory and timeline risk associated with the deal.

Numerous holdings experienced double-digit declines in May despite releasing no new information to the market. Johns Lyng (ASX: JLG), a long-standing core holding for the fund, fell 33% during the month. We believe the stock fell for three reasons: 1) two directors sold shares during the month to fund another investment; 2) the company reiterated guidance which was slightly below expectations 3) JLG’s multiple has expanded in recent years so has come under pressure in a rising rate environment. JLG is still a pricey stock but we see upside to earnings expectations driven by organic and inorganic growth. Insiders still own a significant stake in the business and sold a small minority of their holdings in May. 

BWX was the second largest detractor to performance in May, falling 28%. BWX’s share price fell after providing an earnings downgrade early in the month. We expected a weak result but the update still missed our expectations. The company also held an investor day, disclosing the balance sheet would become significantly more geared by June and cutting its forecasts for growth in offshore markets. We are not writing the investment case for BWX off and believe successful execution offshore and the strategic value of brands could result in a share price multiples of BWX’s valuation. However a stretched balance sheet and negative earnings momentum leaves little margin for error. Over the last five years, contributed equity in the business has increased by roughly $300m (almost 4x), over which time earnings have gone backwards. Given the company’s track record of capital allocation, willingness to raise new equity and unclear earnings trajectory we exited our investment and will monitor the company’s progress.

Written by Mark Devcich, Portfolio Manager

Australasian Emerging Companies Fund

The Australasian Emerging Companies Fund returned -10.7% for the month, bringing it to a 12-month return of -9.3%, and 19.3% annualised since inception. 

The fund had a tough month being impacted by a significant drawdown across the micro-cap end of the market.

Early in the month the fund suffered from a downgrade to guidance by Atomos. We reduced our position as we believe the revised guidance is still a stretch, the balance sheet will be significantly worse than the analysts expect due to a build-up of inventory. The company’s products are great, but there have been a number of management missteps since the company listed. 

Many other positions were caught in the down draft despite no newsflow during the month, such as Frontier Digital Ventures and Kip McGrath Education.

Other changes we made to the portfolio include reducing Calix. Calix has been a fantastic performer, being up 205.6% in the last 12 months. It had a flurry of announcements over the month and it also entered the MSCI index on the last day of the month. Calix has leading technology in the emerging carbon capture arena, particular for the cement industry. However, it will be some years before meaningful cash flows are derived from their technology and, with a market capitalisation of $1.3b, there is little margin of safety in the investment. As Warren Buffett has said, to get a 10% return from an equivalent valuation would require $130m in free cash flow to be generated this year into perpetuity, and if the start of that cash flow is delayed by only a year the cash flow requirement increases to $143m in perpetuity. Such levels of cash flow would be a remarkable achievement, but would also be many years away for Calix so we have prudently decided to trim the position.

Overall, we are aiming to increase the liquidity of the portfolio and exit some historically illiquid positions where we have lost confidence in the business prospects. These proceeds will be deployed into positions in larger capitalisation companies. An example is Monash IVF which we believe has structural tailwinds from a greater prevalence of the population requiring IVF services. This has been recognised as NSW state government recently increased funding for IVF treatment and pre-genetic testing. Their closest listed peer in Australia, Virtus, has been in a takeover bidding war from private equity and NZ’s largest player Fertility Associates was also recently purchased by private equity last year. We believe it is highly foreseeable to see corporate interest in acquiring Monash IVF given its lower valuation and higher profitability margins than Virtus. Although industry-wide cycle volumes have been affected from Covid-related disruptions, these have merely been delayed not lost and new enquiry levels continue to be very strong. Other small positive contributors for the month included Smartpay Holdings, Probiotec and RPM Global. 

Thank you for entrusting your capital with us.

Written by Mark Devcich, Portfolio Manager

Australasian Growth 2 Fund

The Australasian Growth 2 Fund returned -5.9% for the month, bringing it to a 12-month return of -26.6%, and 11.6% annualised since inception.

We have added three new positions this month, which we are still building, and have reduced the weighting of some of the larger weighting software and technology positions.

This month, we will detail Credit Corp, the dominant credit collection agency in Australia with a near-monopoly position, in purchased debt ledgers. Credit Corp is managed adroitly by its long-standing CEO and CFO, thriving when many of its competitors have fallen away over recent years. We believe the stock has de-rated (down -15.5% in May) as it fell in sympathy with other diversified financials due to concerns over credit quality. High inflation and rising interest rates is putting pressure on consumer budgets, however ironically this is the most positive for Credit Corp. When times are good consumers are typically on time in repaying their credit cards and there is not much overdue debt to collect, but the opposite occurs in times of stress. The supply of outstanding debt that the banks have on their balance sheet increases substantially so they sell a lot more at lower prices to Credit Corp. Therefore, Credit Corp can be considered a counter-cyclical stock and balances out the high beta stocks in the portfolio.

For their lending book, Credit Corp is ultra-conservative in its loan provisioning, with provisioning sitting at 27% of their gross loan book (significantly higher than peers). Lastly, there is an ample opportunity to deploy capital in their US debt collection business. Charge-offs in the US troughed at ~1.5% of total credit card balances versus 4% pre-pandemic but are on the way up, and credit card balances are now back to pre-Covid levels. The higher balances flow through to more volume to Credit Corp with a typical six-month lag. We believe the US is 6-9 months ahead of Australia in witnessing this trend. Credit Corp has now solved its bottleneck to expanding faster in the US, which was limited headcount, by utilising its offshore collections team.  

Contributors for the month included Hub24 and Nearmap. Detractors for the month included Aroa Biosurgery, Corporate Travel Management and Whispir. Thank you for entrusting your capital with us.

Information is current as at 31 May 2022. Pie Funds Management Limited is the manager of the funds in the Pie Funds Management Scheme. Any advice is given by Pie Funds Management Limited and is general only. Our advice relates only to the specific financial products mentioned and does not account for personal circumstances or financial goals. Please see a financial adviser for tailored advice. You may have to pay product or other fees, like brokerage, if you act on any advice. As manager of the Pie Funds Management Scheme investment funds, we receive fees determined by your balance and we benefit financially if you invest in our products. We manage this conflict of interest via an internal compliance framework designed to help us meet our duties to you. For information about how we can help you, our duties and complaint process and how disputes can be resolved, or to see our product disclosure statement, please visit www.piefunds.co.nz. Please let us know if you would like a hard copy of this disclosure information. Past performance is not a guarantee of future returns. Returns can be negative as well as positive and returns over different periods may vary.