Lillie previously completed roles with Perpetual as an External Reporting Intern and at Macquarie Capital as a Financial Control Intern during 2021. She also completed the Investment Management Mentoring Circle and Female Business Series with Macquarie and the Institutional Banking Virtual Internship with CitiBank.

In this new position, Lillie will support Tyndall AM’s ambitious and entrepreneurial 11-person senior team to help further develop and expand the Firm’s investment reach across the Australian market. She will also assist the team in implementing, analysing and executing equity trades across the Australian equity portfolios.

Brad Potter, Head of Australian Equities, Tyndall AM, commented: “We are delighted to welcome Lillie to Tyndall. She was the standout candidate through our exhaustive graduate recruitment process, and her financial skills and experience to date ensures she will be an excellent fit for our team.

“We look forward to welcoming Lillie in January for what is shaping up for an exciting year ahead for our growing business.”

Lillie joins Tyndall having recently completed her Bachelor of Accounting degree at the University of Technology, Sydney.

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Brad Potter

Tyndall Asset Management (Tyndall AM), one of Australia’s largest and most experienced investment teams, has announced its official rebranding, returning the business to its original foundations.

For more than 30 years, the Tyndall name in Australia has been synonymous with value investing. Its long-standing approach, process and performance track record have been well rated by the research community, and it boasts a highly awarded Australian share fund.

Tyndall continues to be led by Brad Potter, who brings more than 30 years’ industry experience. Potter leads an experienced and aligned team of 11 investment professionals, the majority having worked together for 15 years, focused on building high-conviction, diversified portfolios consisting of stocks with high forecast returns.

“We believe the best results in the future come from identifying value in the market today. Our single-minded focus on our clients helps us aim to deliver repeatable, sustainable and consistent investment outcomes. The team remains squarely focused on the continued delivery of strong, long-term outperformance,” said Brad Potter, Head of Australian Equities, Tyndall AM.

Tyndall believes all stocks have an intrinsic value and that inefficiencies in the market create buying opportunities. The team continues to apply its fundamental approach, known as Comparative Value Analysis, to build high-conviction portfolios comprising stocks that the team believes represent compelling value.

“The rebrand restores the business to its former heritage, and we’re really excited to be bringing back a brand that has such an excellent and long-standing reputation in the Australian market for delivering for its clients,” added Potter.

On 12 April 2021, Yarra Capital Management (Yarra) confirmed that it had completed the acquisition of Nikko Asset Management’s Australian business. Under the terms of the agreement, Yarra has ownership of Nikko AM’s Australian subsidiary and its associated entities. Under the agreement, Tyndall AM remains separate to Yarra’s style-neutral Australian equities business, with no crossover in investment management activity and no change to its value investment philosophy or process.

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Brad Potter

Reflection on 2017

In early 2017, I suggested a total return of 12-15% was a reasonable expectation given the rotation from defensive, secular growth and bond-sensitive stocks towards the cyclical and value end still had some way to go. Well, the forecast was a little high as total return for the ASX 200 accumulation index was 11.8%.

Surprisingly, interest rates stayed pretty stable across the curve in both Australia and USA, with 10-year bonds ending the year largely unchanged. The bond sensitive stocks recovered all the underperformance and more from the 2H 2016.

The years of slack monetary policy exacerbated by quantitative easing appear to have finally lit the fire under the global economy. We are in the middle of a synchronised global recovery with Purchasing Managers’ Index (PMI). The net result of the strong economic growth has been corporate profitability growing strongly, which is reflected in strong earnings growth revisions.

The bulk commodities surprised on the upside as a number of policies implemented by the Chinese government kept prices high.

The Domestic Economy

The domestic economy confounded the naysayers during 2017. Business conditions have rarely been better and unemployment levels are at very low levels.

The mining states that suffered during 2016 have recovered somewhat. Many mining companies have started to re-employ considering, in hindsight, that they probably cut too deeply initially given the combination of high export volumes post the expansion phase and reasonable prices. The non-mining states have been building momentum for some time on the back of a broad-based construction boom.

Chart 1: Divergence between consumer sentiment and business confidence narrowing on employment boom

Consumer confidence has been largely uninspiring compared to business sentiment, which isn’t helped by low wages growth and inflation in utility bills, insurance and council rates. Despite this, consumers appear to be spending. However, the latest consumer sentiment reading rose 1.8% month-on-month (~8% over the year) and is the highest since late 2013.

Rising confidence in the outlook for future economic conditions and a strengthening labour market helped drive the improvement. It is interesting that the increase in confidence was more pronounced for mortgagors compared to renters — perhaps suggesting fewer concerns on higher rates for the former.

Chart 2 Consumer Sentiment and First Rate Hike

Government spending on infrastructure both at state and federal levels continues to surprise as new projects get unveiled. The economy will be supported over the next few years with the work on current and forecast projects.

Deloitte Access Economics is forecasting the $4b trough in rail and road projects that occurred in 2015 will peak to around $16b in 2020. Macromonitor, an Industry research group, is more bullish suggesting a $35b peak in 2019/20. The stress on infrastructure has become acute and governments are finally recognising that real solutions are required.

Housing

It is difficult to envisage a national housing collapse without coincident rising interest rates and much higher unemployment, with the latter being key. We have witnessed micro housing collapses in the mining states as job losses resulted in forced sales with little buy side demand. Banks saw impairment and stress levels rise but from extraordinary low levels, and most banks are now saying the bottom has been reached and they are seeing good recovery.

Unlike other countries, the Australian regulators have been acting together and thus have put forward a number of macro prudential policy decisions to reduce the excesses. For example, limits have been put on interest only loans resulting in banks increasing mortgage rates and thus incentivising principle and interest products. Foreign property buyers are paying increased taxes and duties, and banks are becoming even more diligent with lending practices.

It is interesting to reflect that although housing stats have peaked at absolute levels well above previous peaks, when adjusted for the population growth, the peak is much more modest. It is difficult to envisage a severe house price fall without an economic shock, and a more modest house price correction is unlikely to be materially disruptive.

Chart 3 Housing Starts and relative to population

China – Beautiful China – Transforming From Fast Growth to High Quality Growth

Pollution reduction, state-owned enterprise (SOE) reforms, supply-side structural reforms, combined with controlling property prices were the main tasks outlined post the 19th National Congress of the Communist Party of China. There is no doubt that President Xi Jinping is putting his stamp on the Communist Party; essentially having as much power as any other over the past few decades. The anti-corruption effort will remain front and centre of President Xi Jinping’s goal of de- risking the financial sector, reducing excess capacity and pollution, and alleviating poverty.

Recent data clearly shows the Government is slowing the economy, with a primary objective to transition from fast growth to high quality growth. The Government will achieve this higher quality growth by evaluating local governments on the basis of efficiency (or ‘total factor productivity’ TFP) rather than the traditional GDP.

In our view, the economy will slow and transition to a more balanced and environmentally-friendly country. Fixed asset investment is destined to slow substantially over the next decade and consumption will rise. The growth in the middle class will continue to drive the incredible transformation that is occurring in China. In the short term, a property slowdown is a potential risk in 2018 as the Government tries to reign in speculation, but also effectively accommodate the low income workers.

The political aspiration of the Chinese government is to reduce annual emissions by 50–70%. This target is likely to take 10+ years and will result in profound changes to the industrial China we know and understand today. The net result of the supply- side reforms and crackdown on the environment is that high quality inputs (materials) will likely remain priced above long- term averages for some time.

In our view, industries and SOEs will consolidate and be encouraged both economically and legislatively to use inputs that are less polluting and enhance profitability. Demand for high-grade iron ore, coal and liquefied natural gas from Australia will remain high.

Iron Ore – A Tale of Two Grades

The pricing bifurcation of the iron ore market into high grade and low grade has materially changed iron ore market dynamics. Steel mills have been preferentially buying high quality iron ore versus low quality to maximise volume growth and offset the high coal prices.

Mitigating the high metallurgical coal prices were the initial reason, but this was overtaken by maximising steel volume given the high steel prices and concerns around reducing environmental emissions. Prior to 2017, 58% of iron ore typically traded at a 20% discount to the 62% benchmark price – this has now blown out to 41%.

Chart 4 Discount and premium of high and low quality iron ore over the 62% benchmark price

The consensus view was that iron ore would be in surplus in 2017 and so prices would fall. However, steel mills were motivated to purchase high grade iron ore and scrap metal to fill the blast furnaces and so a shortage of high grade ore was created. The large stockpiles in China are the currently undesired low grade ore.

It is noteworthy that Fortescue is now taking the view that the huge blow out in margin between high and low quality ore is structural—not cyclical—and is taking action to high grade their mined product. Given the obvious move to a cleaner, more environmentally friendly China, it appears this may be a structural issue. We will see when steel prices fall, but note that the recent decline in margins in China’s steel mills is restoring interest for lower grade iron ore at the ports.

The Banks

A long anticipated royal commission, Commonwealth Bank of Australia (CBA) tripping over multiple banana skins and Australia and New Zealand Banking Group (ANZ) shrinking to greatness are all areas of interest in banks starting the year.

The issues around capital have now passed with banks selling non-core assets and low returning business to move core equity Tier 1 (CET1) to levels that are within Australian Prudential Regulation Authority’s (APRA) guidance. In the case of ANZ, they arguably have +$6b in excess capital that will be returned to shareholders via on market buybacks.

The Royal Commission into misconduct in the financial system services sector appears to have a much more limited scope than many feared and includes the entire financial sector. The investigation into misconduct, and any conduct that falls below community standards, will be disruptive for the banks and certainly a distraction for management.

Compensation schemes for impacted consumers and recommended remedies for the causes of the misconduct are likely. It is, however, difficult to determine the ultimate ramifications to the banks both from a penalty and operational perspective.

ANZ and National Australia Bank (NAB) are moving down the cost out path that should result in real costs coming out of the banks rather than some esoteric lowering of the cost to income ratio due to revenue growth. This will be the first time in over a decade that real costs reductions will hit the bottom line. Westpac and Commonwealth Bank are taking the road ‘well- travelled’ and managing costs via the cost to income line. The profit prize for banks to right size their businesses to the current top line growth outlook and technology advances is large.

Asset quality remains benign and impairment charges are at 30- year lows. There has been no systemic poor lending practices that will drive a meaningful bad debt cycle over the short to medium term. Nikko AM Australia valuations assume reversion back to more normal mid-cycle loss rates despite the indications that this seems some time away.

Recent research from Merrill Lynch is music to a value manager’s ears. Their work highlighted that valuation is the one common factor in periods of sustained bank outperformance since 1999. Headline grabbing issues such as earnings per share (EPS) growth, return on equity (ROE) and other political/event risk headlines are much less reliable return signals.

The valuation metrics currently suggest that the banks are oversold and certainly look attractive compared with history. The banks, ex CBA, are all trading +1 standard deviation cheap versus the market; have a benign bad debt outlook but their capital positioning is fine and, in the case of ANZ is in excess. Dividend yields remain high at around 6% fully franked and are sustainable. Nikko AM Australia’s long term sustainable earnings valuation suggests the banks look great value versus the market – albeit with little growth.

Chart 5 12 Month Forward Rolling PE – Bank Sector vs ASX200 ex Banks

Earnings

Global earnings continue the trend that started in mid-2016 with revisions improving both in geographical and sector breath. Cyclical sectors dominate the positive trend in earning revisions as one would expect in a global reflation trade. Secular growth stocks, bond sensitive and defensive stocks are all likely to de-rate during such a reflation trade.

Profit growth within Australia has not been as strong over the past few years but it also didn’t fall as far either. Economically sensitive sectors such as cyclical, commodity and other financial companies have provided the growth, with defensives and banks the weakest. The big four banks have had the headwind of macro prudential regulation that is now abating. The top line growth for the banks should remain modest, but it is arguably all in the price. Looking forward into 2018, the market appears to have a more balanced view of where the growth emerges.

Chart 6 EPS for Major Equity Markets (Local Currency – 12 Month Forward)

Chart 7 Synchronised Global Expansion

Oil

Three core questions are paramount when determining the price of oil:

1. Will the OPEC supply discipline remain?
2. Is US shale oil/gas able to make sustainable profits/cash
   flows and thus grow production?
3. What is the demand outlook vis-à-vis the synchronised
   global growth.

Further, longer term questions are worthy of discussion – such as the electronic vehicle revolution. However, in our view the impact of this is much further out and unlikely to materially impact for a number of years despite Elon Musk’s bold predictions.

The Nikko AM Australia view for some time is that Saudi, in particular, is strongly incentivised for the supply discipline to remain and thus prices to remain high. The market is also underestimating the fragility of many Organization of the Petroleum Exporting Countries (OPEC) members and thus very little political risk premium is currently in the oil price.

The oil shale producers have consistently been unable to generate free cash flow – even at much higher oil prices, and now investors, both credit and equity, are asking for returns. Costs are rising, labour is a problem with fracking crews in short supply, key inputs such as fracking sand is scarce, and the best reservoirs may have been already drilled. There is an argument that the oil shale model is broken and can’t fill the supply gap. The distinct lack of deep water exploration and development over the past few years implies a long lead time for this potential production to come into play.

Therefore, the combination of global synchronised growth and lower production provides confidence on the outlook for oil price.

Mergers and Acquisitions

Mergers and Acquisitions are likely to remain at elevated levels in 2018 both globally and within Australia. Interest rates remain at extremely low levels despite the world in a synchronous economic growth phase.

Business confidence and conditions are high – management and boards can purchase growth at low funding costs, making the metrics of takeover deals attractive with the view that funding costs are unlikely to be any better. The earnings yield to debt yield spread remains at wide levels compared to history and thus a debt-funded acquisition can be accretive virtually from day one.

Chart 8 Australian Market Yields

The Snap Back To Value – Part Deux

Nikko AM Australia previously highlighted the huge differential in pricing between the ‘value’ stocks and the ‘quality’ low volatility stocks. The defensive bull market that saw the safe companies and secular growth stocks rally to unsustainable highs ended in August 2016. However, 2017 saw many of the defensive and bond sensitive companies retrace most of the correction as bond yields remained stubbornly low and the market seemed unconvinced on the reflation trade.

The initial rerating of the economically sensitive stocks, such as industrial cyclical, financials and material stocks, has passed and we are in the earnings expansion phase that can last 5–6 years. The aggregate market PE is a meaningless number under this scenario as it will likely fall or remain stable as earnings and price move together.

The rerating of the economically sensitive stocks and commensurate derating of defensives, secular growth and low volatility stocks will generate substantial alpha for a well- positioned active value manager such as Nikko AM Australia.

Chart 9 The Australian equity market cycle – average of previous four cycles

Conclusion

The combination of global synchronous growth, together with the ongoing accommodative monetary policy, should see strong earnings growth globally continue and Australia will be pulled up with it.

The Nikko AM Australian Share Wholesale Strategy is well positioned to take advantage of the economic upturn as we are overweight attractively valued cyclical and financial companies that are leveraged to the upswing. The stocks in the portfolio have been selected via our detailed, disciplined and extensive research that value them on long-term sustainable earnings and a balance sheet that is appropriate.

The aggregate market PE appears slightly expensive based on the average of the past 20 years of low inflation. However, it provides no insights into the market trajectory and given our belief that we are at the start of a long profit cycle, the earnings growth will drive stock prices higher. The expectation, like other profit cycles, is the market PE will remain flat at best but likely fall as earnings growth is greater than stock price appreciation.

Given the market dividend yield is around 4.5% and earnings growth of high-single digits is a reasonable assumption, a total return in the market of between 11–14% for 2018 is envisaged. Given the starting point for the market PE no PE rerating is likely. The risks to this, as always, is geopolitical volatility.

By Brad Potter, Head of Australian Equities

The post Outlook 2018: Australian market outlook appeared first on AdviserVoice.

Sam Hallinan

Nikko Asset Management Australia has secured two new Australian Equities mandates from Zurich Investment Management Limited (Zurich Investments), following a competitive review process.

Sam Hallinan, Managing Director of Nikko Asset Management Australia, said: “We are delighted to have been selected to work with Zurich Investments. This achievement is testament to our experienced Australian Equities team who has consistently delivered strong results to Australian clients for more than 20 years.”

“We are committed to growing our relationships with institutions like Zurich Investments through investment opportunities that deliver real value for clients.”

The mandates are managed by Nikko Asset Management’s Brad Potter, Head of Australian Equities and Jason Kim, Portfolio Manager, and are based on the highly successful CVA strategy run by the Australian Equities team.

Patrick Noble, Senior Investment Strategist, at Zurich Investments, said: “We were impressed by Nikko AM Australia’s approach during the review process, underpinned by the firm’s rigorous risk management framework and research-driven culture. We look forward to a successful relationship with Nikko AM Australia.”

Nikko AM Australia is the Australian subsidiary of Tokyo-based Nikko Asset Management, which held approximately USD$182.7 billion in AUM as of 31 March 2017.

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Brad Potter

TWUSUPER has awarded Nikko AM a mandate in their long running Australian Equities Comparative Value Analysis strategy.

TWUSUPER’s CIO, Andrew Killen, said that “the Board were impressed with the long-term tenure of the Nikko AM team who have been consistent in delivering excess returns over a long period of time using their Intrinsic Value methodology”.

Nikko AM’s Head of Equities, Brad Potter, said, “we’re delighted to have been selected to partner with TWUSUPER”.

“We recognise that the Australian market is competitive and that our clients have choices, so it’s particularly pleasing when your own passion of value investing is aligned to client needs, especially at a time where we have strong conviction in where our portfolio is positioned

Our strategy is underpinned by an experienced, stable team who have a history of delivering alpha to Australian clients for nearly 20 years.”

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Brad Potter

Due to continuous disclosure, reporting season is chiefly an opportunity for companies to relay their outlook to the market. Having said this, the level of detail provided by management is often greater than at other times, while the sheer volume of company newsflow also lends itself to instinct-driven price reactions. Reporting season for a long-term investor such as Nikko AM Australia can therefore be quite volatile at times, while also creating opportunities.

But while dodging bullets from stock-specific noise can be difficult, this reporting season also saw global macro bombs being lobbed into the mix, which made sifting through the immense amount of information even more difficult. The S&P/ASX 200 Index fell 8.64% in August 2015, which was the worst month since May 2008. The S&P/ASX 200 Accumulation Index was down 7.79%.

The devaluation of the yuan caught markets by surprise and resulted in even greater volatility than normal. Eventually, the market perceived this move as an attempt by the Chinese authorities to boost exports to help the weakening economy. China is driving commodity markets as never before and prices continue to respond sharply to volatility in Chinese equity and foreign exchange markets, amid concerns over underlying growth.

Underneath the macro noise, Australian stocks were reacting to results, guidance and changing commodity prices, with the ASX 200 Energy sector down 13.8%, as the oil price fell 27% to a seven-and-a-half year low, before recovering to be up for the month. According to Bloomberg, 50% of companies beat analyst expectations, 48.7% missed expectations and 1.3% were in line. By sector, Materials, Industrials and Utilities had more positive reactions to results, whereas Consumer Discretionary, IT and Telecommunications were negative.

However, it was difficult to determine how the market was responding to some results given the spike in volatility. The worst sector was Energy, followed by Financials ex-REITs (-10.6%) & Telcos (-8.3%). The sectors that outperformed should not surprise in a risk-off market, with Utilities (-0.2%), Consumer Staples (-4.1%) & REITs (-4.1%) all outperforming the broader index.

Post reporting season, consensus market earnings were revised down 150 basis points (bps) in fiscal year 2015 (FY15) and 80 bps for FY16. Resources were again the largest contributor. The outlook for FY16 saw soft guidance, resulting in 45% of firms cutting FY16 earnings per share (EPS), and downgrades outnumbered upgrades by 2.7 times, which is well above the 1.6 times five-year average.

Nikko AM Australia likes to enter reporting season holding a little more cash than usual, as we do find opportunities when the typical fear, greed and trader emotions of the market overreact. This strategy, combined with being underweight Energy and the Banks, helped all three flagship Nikko AM Australian Equities Funds outperform during August. There were also a number of stock-specific outperformers across the Funds, with Sims Metal Management (+21%) and BlueScope Steel (+18.7%) standing out.

One of the key takeaways from reporting season included dividends growing faster than earnings, which continues to be a global theme. Dividend payout ratios continue to drift higher, although this is largely because resources earnings are falling – rather than dividends increasing. Both BHP Billiton and Rio Tinto have unhelpful and poorly conceived progressive dividend policies that have no place in a cyclical company. There are concerns that the high payout ratios may be stifling capex and thus future growth. Over the long-term, this may be an issue – particularly given many companies are cutting capex to pay dividends. BHP is forecast to payout over 100% of earnings over the next five years.

The two-speed economy story also appears to be running its course. Companies with greater exposure to New South Wales and Victoria have generally performed better than those with Western Australian and Queensland operations. This is reflective of the much better retail sales, employment and house price growth in NSW and Victoria, as well as the obvious mining downturn in WA and Queensland.

Cost-out and efficiency programmes are helping to lift earnings before interest and taxes (EBIT) margins, despite top-line growth generally remaining weak. At the margin, some companies are starting to increase costs and capex in order to drive growth. However, despite these initiatives, downbeat guidance was a big driver of negative share price reactions during August. These negative outlook statements appear mainly to have been driven by sluggish global demand and higher reinvestment costs. Weak domestic conditions have been less of a driver – perhaps because there were low expectations.

From a sector perspective, banks have recently raised AUD 8 billion of capital, which helped to contribute to an 11.7% fall for the month. Overall earnings trends were broadly in line with expectations, although uncertainty remains on the horizon regarding Basel 4 changes, notwithstanding the recent capital raisings. The quarterly updates revealed subdued revenue growth due to seasonally weak markets despite loan growth remaining solid. Bad and doubtful debt charges are still at very low levels despite some emerging stress in specific areas such as retail lending to resource-exposed geographies, business portfolios exposed to mining, as well as some agricultural portfolios. Nikko AM Australia has been underweight banks for 12-18 months, due to the dilutionary impact from the capital raisings in our forecasts, resulting in lower EPS, dividend per share (DPS), return on equity (ROE) and ultimately valuations.

Despite the recent falls in commodity prices, the miners posted decent results. Cost cutting and lower capex are helping offset the lower prices but this can’t fully compensate against the price impact. The higher cost producers, often with poor quality assets, have been in constant downgrade mode throughout the year, with EPS now at half of what they were. But low interest rates are arguably keeping many alive for the moment.

Industrial earnings were solid with a combination of some domestic earnings doing well, together with the positive tailwind provided by the falling Australian dollar for offshore earners. It was interesting that in a number of cases, housing-related stocks that had strong results were met with a subdued reaction, suggesting there is concern that trading conditions cannot last for these companies.

As in all global markets, the outlook for Australian equities remains dominated by macro issues that appear to be concentrated around global growth expectations. Management guidance again seemed cautious about the outlook and this was consistent with companies increasing dividends, reducing investment and maintaining cost-out programmes. The sub-trend top line growth across most sectors, combined with cheap funding is likely to lead to increased M&A. On this point, the lower Australian dollar has also made Australia a target for offshore corporates.

The market correction has brought the aggregate market back to reasonable value and we are seeing pockets of extreme value, which represent a buying opportunity. We are cautiously moving into these names.

By Brad Potter, Head of Australian Equities at Nikko Asset Management

————-

Disclaimer: This material was prepared and issued by Nikko Asset Management Australia Limited ABN 34 002 542 038, AFSL 229664 (Nikko AM Australia) who is the responsible entity and issuer of units in the Nikko AM-Tyndall Australian Share Wholesale Fund (ASRN 090 089 562), Nikko AM-Tyndall Australian Share Concentrated Fund (ASRN 143 598 556) and Nikko AM-Tyndall Australian Share Income Fund (ASRN 133 980 819). Nikko AM Australia is part of the Nikko AM Group. The information contained in this material is of a general nature only and does not constitute personal advice. It is for the use of researchers, licensed financial advisers and their authorised representatives. It does not take into account the objectives, financial situation or needs of any individual. Investors should consult a financial adviser as well as the information contained in the Fund’s current Product Disclosure Statement (PDS) and the ‘Additional Information to the PDS’ which are available at www.nikkoam.com.au/pds before deciding to invest in the Fund. Applications will only be accepted if made on a current application form. An investment in the Fund is not a bank deposit and distributions and the return of capital are not guaranteed. Past performance is not an indicator of future performance. Any economic or market forecasts are not guaranteed. Any references to particular securities or sectors are for illustrative purposes only and are as at the date of publication of this material. This is not a recommendation in relation to any named securities or sectors and no warranty or guarantee is provided that the positions will remain within the portfolio of the Fund.

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Mr Potter joined Tyndall in 2002 and has 20 years’ industry experience (see biographies below). He has been co-managing Tyndall’s flagship Australian equity strategy with Mr Van Munster for the past seven years and in that time has delivered strong and consistent outperformance to clients. Mr Potter will maintain his portfolio management responsibilities in his role as head of the Australian equities team. Mr Van Munster has headed the Tyndall Australian equities business since 2000, and has worked with Mr Potter for 12 years.

Mike Davis, Tyndall AM’s managing director, said that this is a natural progression of the Australian equities business with succession planning being a strong focus for the team for many years. The Tyndall Australian equity dual portfolio management structure has been in place since 2007. This has been very successful for Tyndall, both in delivering strong performance outcomes for clients and retaining a stable, experienced and motivated team.

“Bob and Brad have made a major contribution to Tyndall’s success and are two of Australia’s foremost equities managers. We are naturally sad to see Bob leave the business and the industry, and understand this is his personal lifestyle choice.

“We have both an extremely capable and talented successor in Brad, and a very strong team that has worked together for an average of 12 years at Tyndall. We have a well-established investment process and philosophy that has proven itself over time and is endorsed by the entire team.”

Mr Van Munster’s co-management responsibilities for the Tyndall flagship Australian equity strategy will be taken over by portfolio manager Jason Kim, with effect from 1 May 2014. Mr Kim is one of the most experienced and talented portfolio managers in the team, responsible for managing the strong-performing Australian concentrated share strategy.

“Warwick Cumming will continue in his role as deputy head, providing high level support to Brad including team management and overall responsibility for research, allowing Brad to focus solely on generating strong performance for our clients,” Mr Davis said.

Yu-Ming Wang, Nikko AM CIO commented: “We are pleased to seamlessly transition our highly-rated and proven investment process for Australian equities from the skilled hands of Bob to Brad, Jason and Warwick. With an average of 18 years’ industry experience, the team under Bob’s leadership has been a top performer for us and we expect that to continue. We also wish Bob all the best in his retirement.”

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FY2013 results flat as expected.

Brad Potter, Portfolio Manager and Senior Analyst, Tyndall AM provides his key take-outs from the August company reporting season.

Weak consumer demand, a slowdown in China and a high Australian dollar are just a few issues challenging Australian businesses. To maintain or improve their profit margins companies have needed to cut costs, reduce capital expenditure and improving efficiencies. Is it working?

Benign reporting season – no great surprises

Overall, the company reporting season was benign with earnings coming in close to market expectations.  Around 56% of companies beat expectations. Earnings overall in FY2013 were flat, but up 7% when excluding resource companies, which have fallen substantially because of the decline in commodity prices over the year.

FY2014 earnings forecasts have been lowered as expected in the current environment. Prior to reporting season the expectation was 8% to 10% earnings per share (EPS) growth in FY2014. Those expectations have now been reduced by about 1% or 2% (this is likely to be revised as analysts fine tune their numbers).

Many of the rallies during reporting season were based on ‘no further bad news’ or that the news wasn’t as bad as priced in going into the result – rather than good results. Stocks such as Qantas, Arrium, Origin Energy and UGL were typical of these stocks which had acceptable to probably slightly down results, but were not as bad as what the market was expecting.

Top line growth continues to be weak

The key takeaways from reporting season were very similar to last reporting season. Top line revenue growth continues to be poor. This was expected. Companies suggested things were not getting any worse, which is a positive.

When there is no top line growth companies cut costs. Cost outs were again a major thematic this reporting season across the market. Companies as diverse as BHP, Rio Tinto, AMP, Boral, Coca-Cola Amatil, Fairfax, Toll, Downer and all the banks have cost out and efficiency drives in place in a bid to keep margins flat or improving.

In the case of resources companies, such as Rio and BHP, their large cost-out programs are only just beginning. They’ve slashed their exploration programs, which has saved them between $500 million to $1 billion per annum.  Miners have seen substantial cost inflation over the last decade during this mining boom and they need to pare that back substantially because commodity prices have arguably peaked. They need to cut costs as there are a number of mines in a range of commodities that are now looking unprofitable. This is likely to be an ongoing theme, which provides a poor backdrop for the mining services industry.

Dividends still the flavour of the month

Dividends surprised on the upside again, like they did last reporting season. Payout ratios continued to rise, which reflects a combination of investor appetite for yield in a low interest rate environment, strong company balance sheets, a lack of investment opportunities and/or risk appetite to invest their money. In this environment, the easiest thing for companies to do is pay back excess capital as dividends, especially when they’re being rewarded for it. Therefore dividends again outstripped EPS growth quite substantially this reporting period.

Company outlook statements were guarded

Company outlook statements were quite guarded or non-existent. That’s understandable given the problematic economic environment, exacerbated by the uncertainty of the September Federal election.

Post the Federal election consumer and business confidence, currently at very low levels, should rebound. Companies are not investing at the moment because of this low confidence.  This was clearly illustrated by the low levels of capital expenditure (outside of mining projects that are already in construction) that we saw during the reporting season.

Profit downgrades were quite modest and many CEOs suggested that business conditions haven’t deteriorated further. This reflected a combination of interest rate cuts finally starting to have an impact and the recent decline in the Australian dollar.  Although, that hasn’t had a full impact yet given that the Australian dollar only tumbled in May.

All the banks stated that provisioning levels, while very low, they couldn’t see any issues currently.  That was quite positive, given that investors worry about that on an ongoing basis.

Housing was a strong theme during reporting season. Lend Lease commented that their residential property sales in July were two times higher than March levels and they also had increasing apartment commitments.  Stockland made similar comments about residential land sales, with the run rate in the second half of the financial year the best since 2010. The positive signs have continued with long queues for residential land sales on weekends. The first release of the Barangaroo apartments in Sydney was sold out in three hours and they were all $1 million plus apartments.

James Hardie commented that they’re seeing rising building activity in Australia and New Zealand, which was interesting given we saw more comments from other building materials companies. The company was very positive on the US environment with profit margins over the 20% level, and they’re suggesting that housing is continuing to pick up in the US.

Iluka also made the point that they sold more zircon in the first half of 2013 than they did in the entire 2012, so they are starting to see green shoots in the zircon market. I expect, given the recent positive news out of Europe (one of the biggest consumers of zircon), that may continue. They also commented that the titanium dioxide market, which tends to be primarily used in painting, is turning.

Seven West Media suggested that advertising spending appears to have stabilised. This is a grey area at the moment due to the election period because there is extra advertising spending by the political parties.  A lot of companies peel back their spending during the election period and start after the election. They are now suggesting they’re seeing good interest for commitments post the election, so that’s quite positive.

Companies that provided negative comments included Toll, which suggested activity levels had yet to show any signs of improvement. Fletcher Building also pointed out ongoing weakness in Australia, but commented that New Zealand was going full steam ahead.  At Wesfarmers, Target was quite disappointing, with no signs of improvement, which the market disliked. Echo commented that the weak consumer environment was driving soft conditions on the main gaming floor. Tabcorp made similar comments about the weak consumer environment.

Boral disclosed that activity in Australia remains broadly flat in FY2014, so similar to Toll.  BlueScope had a solid result but their outlook statement suggested that the first half of this year would be flat on the last half, but over the year would be up, thus indicating the second half would be strong. The market was initially disappointed with that, and the stock was punished severely on the day and subsequent days. It has however subsequently recovered. This was a classic example of where market expectations for the stock were very high and when the company didn’t meet those expectations, the stock was sold off heavily.

Mining boom is over

The reporting season didn’t provide any further clarity on the mining boom. My views pre the reporting season haven’t changed. The mining boom is effectively over in the sense that we’re close to the peak of capex.  Commodity prices have also peaked so if that’s the definition of a mining boom then it is finished.  I don’t expect commodity prices to fall in a hole though. I expect them to remain at reasonably elevated levels for the next few years at least, given demand from China is still reasonably strong and so I expect mining companies to do quite well in certain commodities. Rio & BHP for example are making great margins in iron ore.  On the flip side of that, coal companies are really struggling because coal prices have fallen substantially. A number of coal mines have shut down because margins are just not good enough, and there are a number of them really struggling given the low margins.

Gold is another commodity whereby a number of mines have become marginal, even at current prices, just because cost inflation has been so great. Reserve decreases are the likely next shoe to fall.

Highlights for the Tyndall share portfolios?

In our flagship fund, the Tyndall Australian Share Wholesale Portfolio, Twenty-First Century Fox, our largest overweight, was a highlight. They had an in line but quite messy result given the recent split from their publishing assets. Two days later however they had a strategy day where, for the first time, they laid out quite detailed information on their strategy and all their new revenue streams. The market upgraded substantially on that view.  The market, particularly in the USA, has been reluctant to price in these new earnings streams.  The share buyback continues at a meaningful pace and there’s an expectation that once this buyback finishes they’ll start another one.  The stock was up about 5% over the month.

Downer, which is our only exposure to mining services (albeit it’s not entirely mining services as it represents only about 30% of the business), had a solid result, slightly ahead of guidance, which is very credible given the negative sentiment in the sector due to the peaking in mining capex. The company’s mining segment was down but that was offset by other divisions.  It’s been hurt over the last six months because of the ongoing downgrades from other mining services companies, despite the fact that Downer has continually maintained their guidance, which they delivered.  The dividend was ahead of expectations and their cash flow was very strong.  The cost-out program has doubled to $500 million given that they achieved $250 million two years ahead of forecast.  The stock rallied substantially to be up nearly 15% during the month.

Qantas had a strange result in the sense that it was one of those stocks that rallied on the fact the news wasn’t as bad as what the market was factoring in.  Transformational initiatives delivered $428 million to EBIT during the year. They started up the small buyback, it’s continuing and the stock rallied 11% over the month.

Sims Metal’s result was also close to what the market was expecting. All divisions had good results, other than the European division which has been problematic over the last year or so due to governance issues. Operating cash flow was strong. No guidance was given, but Sims is leveraged to the US economy and in particular the housing market and scrapping of automobiles as people trade up cars and white goods as the economy improves. So the stock actually responded very favourably; again I think it was a relief rally with the expectations that it was going to be ugly. The stock was up about 11% for the month as well.

Portfolio positioning

Banks have run hard over the past 12 months or so. We’re underweight banks because we believe they’re expensive despite the attraction for yield.  We have selective exposures in domestic cyclicals, tilted towards housing and residential as we think that’s a reasonable area given the interest rate cuts and hopefully we’re seeing some green shoots at the moment so that’s quite positive.  We also have reasonable exposure to the USA, both from a growing US economy perspective and also a falling Australian dollar.

Conclusion

It was a by and large a non-eventful reporting season, due mainly to many companies confessing or reducing earnings guidance prior. Companies are adapting to the structural changes occurring in the Australian economy as evidenced by the various cost cutting and efficiency programs in place. These initiatives are having a positive impact on company bottom lines, but we now need to see a recovery in top line growth. Lower cash rates, a weaker Australian dollar and resolution of the Federal election, together with signs of stabilisation in the Chinese economy should assist this.

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Disclaimer: This document was prepared and issued by Tyndall Investment Management Limited ABN 99 003 376 252 AFSL No: 237563 (“TIML”). The information contained in this document is of a general nature only and does not constitute personal advice. It is for the use of researchers, licensed financial advisers and their authorised representatives. It does not take into account the objectives, financial situation or needs of any individual. The Tyndall Australian Share Wholesale Portfolio ARSN 090 089 562 is issued by Tyndall Asset Management Limited ABN 34 002 542 038 AFSL No: 229664 (“TAML”).  Investors should consult a financial adviser and the information contained in the current Product Disclosure Statement available at www.tyndall.com.au before deciding to invest.  TIML and TAML are wholly-owned subsidiaries of Nikko Asset Management Co., Ltd.

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