Market looks to company reporting season as valuations remain high

Portfolio Performance

The Australian market has risen strongly over the past twelve months as investors embraced a more positive outlook for global growth. In particular this led to rising commodity prices, with the resources index up 22.9% over the period after two years of underperformance. The banking sector also enjoyed a strong rebound over the year to produce a return of 18.4%. This was somewhat surprising given the headwinds the sector appears to be facing from regulatory and economic conditions as well as new taxes/levies. However the dividend yield on offer in this sector remains attractive for income-focused investors

AFIC’s portfolio was up 11.7% for the 12 months to 30 June 2017 compared with the S&P/ASX 200 Accumulation Index, which increased 14.1%. AFIC traditionally invests in the large resource companies such as BHP and Rio Tinto and so the portfolio was not exposed to the significant rise in the more cyclical, mid-sized resource companies which increased by approximately 76% over the period. In addition, whilst the portfolio maintains a very strong representation of the four major banks, AFIC’s exposure of 24.5% is below the 28% Index exposure to this sector.

The longer term performance of the portfolio, which is more in line with the Company’s investment timeframes, was 6.1% per annum for the 10 years to 30 June 2017, versus the Index return of 5.2% per annum (these returns include the full benefit of franking). AFIC’s performance figures are after expenses and tax paid.

Portfolio Adjustments

Major purchases included Link Administration Holdings which is new to the portfolio. AFIC also added to this holding through participation in its share placement to purchase Capita Asset Services in the UK. Carsales.com and Isentia were also added to the portfolio. Other major additions were to existing holdings in CSL, Brambles (following the recent fall in its share price) and CYBG (Clydesdale Bank).

Major sales included a slight reduction in the AGL and APA Group holdings and the complete disposal of the residual position in Santos early in the year. Cover-More Group and Asciano were sold as a result of takeovers. The position in Vocus Group, which was added to during the year, was subsequently sold following a marked downturn in its outlook.

Going Forward

Many sectors in the Australian market are trading at or close to the top of their long-term valuation ranges. Whilst this may be understandable against the backdrop of very low interest rates, the
outlook for the Australian economy remains somewhat mixed. The outcome of the upcoming reporting season will be important in providing support for the high share prices of many companies.

On a positive note, global growth may continue to deliver a better than expected outcome for commodity prices. There has also recently been a pickup in non-mining investment. However, as a counter to these trends, high levels of household debt relative to real wages growth is producing a weak outlook for consumption.

Heightened taxation risk from federal and state governments in an environment where budgets are under pressure has unfortunately also become a recent feature of the Australian economy. The latest move to tax the five larger banks is in our view symptomatic of an opportunistic approach to policy. It is not a substitute for a more well-considered comprehensive approach to taxation and budget reform.

Reforms are a difficult task for any government, but we believe they are necessary to create a more robust foundation for the Australian economy going forward.

Key Themes:

• AFIC invests in a diversified portfolio of Australian equities, seeking to provide shareholders attractive income and capital growth over the medium to long term at a low cost.
• Equity markets globally have been generally buoyant with the US market reaching an all-time high in anticipation of improved economic growth there.
• The Australian market has also risen strongly, led by a rebound in sentiment toward resources and banks.
• Share prices across a number of sectors in Australia, in our view, are fully priced.
• In this context, the upcoming reporting season will be important to support market valuations.
• AFIC has cash resources available to invest in quality companies when value presents itself.

Result Summary:

• Full Year Profit of $245.3 million, down from $265.8 million in the corresponding period last year:
  • Investment income declined $15.2 million, primarily as a result of a cut in dividends across a broad range of large companies, including resource and energy holdings.
  • Trading income was down to $3.1 million (from $12.3 million), as large gains generated in the prior corresponding period were not repeated this year.
• Final Dividend maintained at 14 cents per share fully franked. Total dividends of 24 cents per share fully franked, the same as last year
• Management expense ratio of 0.14%
• Twelve month portfolio return was 11.7%; including franking it was 13.7%.