Inside the portfolio: Buying Qantas, cutting banks and backing BHP

Banks might be a familiar hunting ground for Australian income investors, but Michael Price has been reducing his exposure.

The portfolio manager of the Ausbil Active Dividend Income Fund – Active ETF (ASX: DIVI) doubled the fund’s banking underweight during the quarter, citing full valuations, modest expected earnings growth and concerns about the economic outlook.

Elsewhere, he’s found reasons to put money to work. Qantas (ASX: QAN) has joined the portfolio following its annual result, BHP (ASX: BHP) is the fund’s largest overweight, and refiners Ampol (ASX: ALD) and Viva Energy (ASX: VEA) have been its biggest positive contributors over the past quarter.

In Inside the Portfolio, we ask fund managers to explain their recent investment decisions, from new holdings and reductions to their biggest active positions and the themes shaping their thinking.

In this edition, Price takes us through those moves and explains why refining margins, the demand for copper and steel, and the outlook for interest rates are all on his radar.

What was the most notable addition to the portfolio recently and why?

Qantas was an interesting addition to the portfolio during the quarter, and we expect it to be a long-term holding.

While it pays an above-market, fully franked dividend and has attractive long-term growth prospects, we had been looking for an appropriate entry point.

The market had understandable short-term concerns regarding fuel prices, wage costs and a slowdown in consumer demand. However, the annual result showed that the company is managing costs well and that travel remains a high priority for consumers.

Increases in fuel prices have been successfully passed through to fares, and this will be a significant tailwind when fuel prices decline.

Longer term, we see significant margin upside from direct flights between Sydney and London and Sydney and New York (Project Sunrise), while Virgin appears likely to remain a rational competitor.

As a result, we established a position following a meeting with management after the annual result.

What was the most notable sell or downsize in the portfolio recently and why?

The banking sector was already the largest underweight position in the portfolio, but we doubled the size of this underweight during the quarter.

The sector was already facing headwinds from rising interest rates, falling house prices and lower credit growth.

Banks appeared fully priced for the low single-digit earnings growth expected, while better growth opportunities were available elsewhere at lower multiples.

However, during the quarter, we observed a significant shift in the Reserve Bank’s stance, with policymakers signalling that the “narrow path” of returning inflation to the target band, without a meaningful increase in unemployment, was becoming increasingly unlikely.

In Australia, bad debts for banks on housing rarely become a material issue until people lose their jobs, as mortgage repayments are generally a very high priority for employed borrowers.

However, rising unemployment and a broader economic slowdown are both negative for bank earnings and credit quality. As a result, we further increased our underweight position in the banking sector.

What’s your most notable overweight and why?

BHP. We believe the long-term tailwinds for metals and critical minerals are substantial.

Electrification, decarbonisation, the construction of data centres and electricity grids, onshoring manufacturing, increased defence spending and the rebuilding of war-torn regions all require large amounts of steel and copper.

These are structural themes that are likely to persist for many years.

BHP is a low-cost producer of both copper and iron ore, is exceptionally well managed, and remains committed to rewarding shareholders through substantial dividends.

While BHP is typically a significant position in the portfolio, it is currently our largest overweight position, aided by the fact that it has recently paid a dividend.

What’s your most notable underweight and why?

Banks, for the valuation and economic reasons outlined above. The sector remains our largest underweight following the further reduction during the quarter.

What’s been one of your most notable performers recently?

The largest positive contribution to performance over the past quarter has come from the refiners, Ampol and Viva Energy.

While these companies have benefited from higher oil prices, the market appears to have been slow to recognise that refining margins can be just as important as the oil price itself.

Oil prices have fluctuated alongside changing expectations regarding a reduction in hostilities in the Middle East. However, refining margins have remained elevated due to a reduction in global refining capacity, particularly in Russia.

These companies have also been able to pay strong dividends.

Our analysis suggests the market is still significantly underestimating the cash flow these businesses are likely to generate over the next six to twelve months.

What themes and trends are dominating discussions right now?

Markets are always interesting, but there currently appears to be even more uncertainty than usual.

Ausbil’s investment process starts with a top-down look at the world, with a focus on global growth and interest rates, and what they mean for company earnings.

Whether central banks will continue raising interest rates remains a key topic of discussion. We believe the outcome will be “data-dependent”, which means paying close attention to trends in inflation and employment.

At the same time, longer-term interest rates have returned to levels not seen for more than twenty years. Determining whether these rates have peaked will be important for the direction of markets.

Oil prices are a key contributor here, making developments in the Middle East critical to monitor. Demand for Australian commodities also remains heavily influenced by China, so we continue to watch closely for signs of further stimulus.

From a bottom-up perspective, the main issue is the potential impact of artificial intelligence on costs, margins and productivity, as well as the returns likely to be generated from the substantial capital expenditure currently being deployed.

But I could go on!

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