Agenda Introduce investment guidelines Market Outlook Portfolio Construction Sector Review Questions
Investment Guidelines RISK METRICCONTROLGUIDELINES Balance Sheet Leverage Size of Balance Sheet Funding Structure Borrowed securities to fund between 40-60% of the Balance Sheet Single Name Risk Diversification Monitor size of any individual investment At least 50 Long/Short positions. No individual security to account for more than 20% of Company’s Assets Sector Bias (5 major sectors) Monitor sector variance to indexSector allocation broadly consistent with market structure Industry Bias (25 Industries) Ensure broad diversification of industries Industry allocation broadly consistent with market structure Size/Liquidity Bias Small Cap limitAt least 70% of company assets invested in the largest 200 listed companies or retained in cash
ALF L PORTFOLIO Assets $200m Single Name Risk Funding $200m SHAREHOLDER’S FUNDS $100m BORROWED SEC (Shorts) Telstra (7%)Telstra (15%) 50 Securities
Assets $200m Net Sector Weights Funding $200m SHAREHOLDER’S FUNDS $100m TARGET 3% UNDER PERFORMANCE ALF S TARGET 3% OUTPERFORMANCE ALF L Defensives Financials Cyclical Industrials Resources Small cap Defensives Financials Cyclical Industrials Resources Small cap
Assets $200m Tracking Error driven by Sector Bias Funding $200m SHAREHOLDER’S FUNDS $100m TARGET 3% UNDER PERFORMANCE ALF S TARGET 3% OUTPERFORMANCE ALF L LONG Financials SHORT Defensives Cyclicals -10% Defensives -5% Portfolio -15%
Well Balanced Portfolio SectorLong ($)Short ($)Net ($) % SHF ASX 200 DEFENSIVES & CASH 47,626,10031,680,35015,945,750 15%19% FINANCIALS 33,469,20015,473,00017,996,200 17%35% INDUSTRIAL CYCLICALS 36,822,38025,155,50011,666,880 11%12% RESOURCES AND ENERGY 38,531,8008,429,80030,102,000 28%24% Small Caps 31,328,945 -31328945 29%10% Total 187,778,425 80,738,650107,039,775 100%
Where have we come from? Through the GFC the investment strategy that paid was to avoid economic and financial leverage. For the fully invested institution, defensives sectors of the market and cash were the only place to hide. As the GFC receded and signs of recovery have emerged, investors have shifted aggressively back into the cyclical parts of the market and risk appetite has returned. Valuations overall are now more evenly balanced across the various sectors of the market, reflecting a return to normal trading conditions. Conclusion: We have returned to a stock pickers market. There are no obvious mispriced sectors, outperformance will come from investing in companies that deliver superior results rather than correctly anticipating economic trends.
Outlook: Global economy is staging a solid recovery Leading indicators in the developed world and China are showing considerable short term momentum multi-year de-leveraging in global financial system will ensure global growth is sluggish through the medium term Equities will grind higher as investors “climb a wall of worry” questioning the sustainability of the recovery
Sector Allocation is evenly balanced Sector% SHFASX 200 DEFENSIVES & CASH 15%19% FINANCIALS 17%35% INDUSTRIAL CYCLICALS 11%12% RESOURCES AND ENERGY 28%24% Small Caps 29%10% Total 100% Our challenge is to invest in the right companies in each sector Our preference is for companies with strong organic profit growth and strong management that can add value. In a credit constrained environment, asset appreciation will be harder to come by. Domestic growth is more dependable than then growth offshore Resource leadership will return as a central theme. Banks have had there run for the time being Successful investment themes to consider
Defensive sectors looking a lot more interesting Sector% SHFASX 200 DEFENSIVES & CASH 15%19% FINANCIALS 17%35% INDUSTRIAL CYCLICALS 11%12% RESOURCES AND ENERGY 28%24% Small Caps 29%10% Total 100% Value emerging in defensives shares having been left behind in rush to invest in companies leveraged to a recovery (cyclicals) Continue to short infrastructure. Telecom and healthcare are attractively priced While net position is modest, significant portion of the balance sheet is tied up in this sector
Telstra: The cost of structural separation Telstra has three NBN options- – Negotiate with the government’s new plan and vend/lease assets into NBN Co – Fight announced NBN regulation – Voluntarily de-merge its network assets Scenario analysis- suggest at least $4 per share assuming they receive full market value for CAN vested into NBN. If we assign no value for these assets, our value range falls between $3-3.50 Valuation Compelling- The securities are now trading at all time low relative to the local benchmark and global incumbents peers. While uncertainty looks set to continue, value cannot be ignored.
Bitstream NBN = two layers of competition NBNCo operating bitstream business model? Implications for Telstra? – Two layer competitive market likely to mean impact of NBN more muted. – Wholesale opportunities likely
Food and Beverage Fosters Ltd (Long) Serial underperformer bad news all in the price Wine is suffering perfect storm, excess supply - 120m cases of excess wine inventory, weak US economy; higher vintage costs The beer business is highly sort after by global players. Global consolidation in beer business will protect us from and further downside Complete change of management Goodman Fielder (Short) A difficult business operating in highy competitive markets GFF is a manufacturer of Backed goods, fats and oils and dairy products. Price taker into grocery channel. Constantly being challenged by home brands and new entrants. Input costs increasing, wheat solid milk prices on the rise
Fosters underperformed both Goodman Fielder and Coke GFF- Low return, difficult business- ShortCoke is well managed but very expensive
Gambing: Tabcorp Vs Tatts Tabcorp (Long) Good Portfolio of gambing assets, disliked and undervalued. Potential for significant turnaround at Star City following $575m renovation. Share price factoring in significant further market share gains from Corporate Bookmakers which is unlikely. Potential for corporate activity. Demerger of Casinos from Wagering business to unlock value. Attractive value. Limited downside to current share price. Key risk is the loss of Victorian Wagering Licence, although probability of this is low. Tatts (Short) Good company but expensive with few avenues for growth Loses 40% of EBITDA when gaming machine licence ends in 2012. Current share price is fair value. No catalyst for outperformance. NSW Lotteries will be a competitive tender and therefore unlikely to be cheap. It will only replace approximately ¼ of the EBITDA lost from gaming. Tatts is a defensively focussed business when market is looking for leverage to earnings recovery.
Retail Staples Wesfarmers –Turning Coles around Woolworths – Little upside Amongst the most profitable retailers in the world. Further consolidation unlikely Additional risks with growth strategy in hardware and offshore Finding top line growth harder in spite of significant investment in store refurbishment and customer retension Coles v WOW – LFL Sales GrowthColes v WOW – EBITA Margins Opportunity to improve Coles margins
Underweight financials Sector% SHFASX 200 DEFENSIVES & CASH 15%19% FINANCIALS 17%35% INDUSTRIAL CYCLICALS 11%12% RESOURCES AND ENERGY 28%24% Small Caps 29%10% Total 100% The major trading banks have been major beneficiaries of the failure of securitisation markets; the withdrawal of foreign backs from Australia; and the Federal Government funding guarantees Stronger margins and trading income reflect this Bank shares have outperformed post their results in October Valuations are starting to look a little stretched and there are regulatory risks on the horizon Credit growth will be soft in the medium term
Banks have never been so profitable Credit Impairments have peakedPre-provision profit growth at record levels
Credit growth will be soft and upside is limited Anaemic credit growth outlook Pre-provision profit multiples already back to trend- i.e no longer cheap
General Insurance QBE Insurance (Long) QBE’s share price has struggled due to adverse currency impacts from the rising $A as the majority of QBE’s businesses are located overseas QBE has reduced balance sheet gearing and now has significant capacity for undertaking further profitable acquisitions. Adverse economic conditions have pressured commercial loss ratios around the world but QBE has protected margins well through risk selection, and tightening general terms and conditions. Overall we consider QBE to be one of the most undervalued listed financial stocks in Australia. QBE is arguably one of the best global insurers, with strong management and well disciplined underwriting Suncorp (Short) Suncorp Metway faces earnings pressures not only in the bank division but also in the general insurance division. Suncorp Metway bank has been in a very distressed position and continues to suffer from a difficult funding status, poor credit quality and declining net interest margins. A negative outlook for depressed bank revenues as well as uncertainty in the run off of the commercial lending business. The insurance business has been heavily reliant on large reserve releases from prior accident years which have now been largely utilised and will no longer be available to support future insurance margins. The Suncorp Board and management are now both committed to maintaining ownership of the bank and given ACCC competition issues we see a major transformational corporate event as unlikely. Quality Global insurer attractively pricedA difficult turnaround that is fully valued
Industrial cyclicals will most likely continue to outperform in early stages of recovery Sector% SHFASX 200 DEFENSIVES & CASH 15%19% FINANCIALS 17%35% INDUSTRIAL CYCLICALS 11%12% RESOURCES AND ENERGY 28%24% Small Caps 29%10% Total 100% Industrial cyclicals along with financials have lead the market recovery. For cyclicals to continue outperforming we need to see a robust recovery and profit upgrades. While we are confident in the outlook for Australia we are less certain of the outlook offshore so are sticking with domestic cyclicals: Discretionary Retailers, Media, Agriculture and small caps.
Media: Newscorp Vs West Australian News News: A superior media content franchise built on a growing pay television business Cable exhibiting strong growth: The growth is structural rather than cyclical and driven by higher affiliate fees for Fox News and the growth of News Corps International Channels (National Geographic); Upside Earnings risk: Potential upgrades coming through from: – higher margins as FY09 cost out programs benefit FY10; – a weak USD is positive for NWS offshore earnings; – a recovery US ad market; – strong ratings performances from both Cable Networks (Fox News) and Television (Fox Network). No value in current share price for Newspapers, Books, Internet or TV; Balance sheet strength. US$7.8bn cash on hand, a 22-yr average debt maturity. Plenty of room for capital management at some point. Valuation support. EV/EBITDA at sector lows verses US and domestic peers. SOTP Valuation suggests a c.23% total return on a 12 month view WA News: A regional publishing monopoly structurally at risk from digital media WAN's ad earnings recovery could be longer dated than its media peers, given its reliance on late cycle (and high margin) classified advertising. At current levels (FY11 EV/EBITDA 10.4x; FY11 PER 16.0x), the market appears to be pricing in an over optimistic recovery profile. Longer term, newspapers remain a structurally challenged medium. WAN is yet to experience the material leakage of its classified volumes to online as seen by its east coast and offshore newspapers. While historically WAN has traded at a premium to its peers, this should be the case going forward given: (1) SEV’s 23.2% strategic stake removes the historic takeover premium; (2) the new Board has reduced the dividend payout policy; (3) structural issues will subdue the longer term growth profile; (4) WAN has limited growth options.
Overweight Resources Sector% SHFASX 200 DEFENSIVES & CASH 15%19% FINANCIALS 17%35% INDUSTRIAL CYCLICALS 11%12% RESOURCES AND ENERGY 28%24% Small Caps 29%10% Total 100% Structural growth themes around demand for resources from BRICs countries to continue Stimulus package and credit growth in China should translate into higher fixed asset investment in medium term. Resource shares are attractively priced having underperformed in recent months. When OECD demand returns from depressed levels commodity markets will tighten further
Resources Strong metals demand from China has kept markets tight, ongoing stimulus and credit growth should ensure fixed asset investment supports demand for commodities China starting to import coking coal as high cost mines are shut down
Credit growth in China should support investment spending and metals demand in medium term
Oil and Gas: Australia to lead in LNG but which projects to invest in?
Oil and Gas (LNG) Oil Search (Long) A high return LNG play with plenty of upside PNG LNG Project currently in FEED, FID targeted for 8 Dec 09 Key milestones recently achieved: 6.3mmpta of HOAs signed Benefits sharing agreements with landowners OSH current 2C resources linked to the PNG LNG project are 3,093.2bcf Additional PNG gas fields in which OSH is a JV partner contain a further 4,700bcf 2C resources We estimate a third 3.15mmtpa train operating for 20 years would require an additional 3,700bcf of gas Woodside Petroleum (Short) Growth options for WPL look far more problematic Clouds forming on WPL’s LNG pipeline of Pluto- 2, Browse and Sunrise Reserves uncertainty Woodside announced FEED for expansion trains (Pluto 2 & Pluto 3) in August 2009. WPL has outlined a major back to back drilling program of 20 wells which has to be successful if the Pluto expansion is to go ahead. They need equity gas to supply projects. The most likely supplier Apache, has recently bought into the Chevron sponsored - Wheatstone project next door to Pluto. Shareholder alignment :Sunrise and Browse continue to be hampered by political and partner alignment issues. Some projects more attractive then others