The best of reporting season (and some absolute shockers)
The Santa Maria was a 36-meter ship that famously transported Christopher Columbus from Spain in 1492 "across the ocean blue" and ran aground later that year (on Christmas of all days), to be abandoned off the coast of Haiti.
But not all was lost, with wood salvaged from the wreckage used to build another ship, the Navidad.
Similarly, over the past few months, the ASX has sailed through turbulent seas, with serious headwinds such as rising rates, a Russian war in Ukraine and now a rain bomb over the east coast of the country, sinking the bourse more than 6% since the beginning of the year.
And of course, who can forget reporting season. As Centennial Asset Management's Matthew Kidman put it, it was "explosive", with a number of "bombs that went off" seeing several stocks plunge deep (and in some cases, deeper) into the red.
In this episode, Matthew was joined by Firetrail Investments' Blake Henricks and abrdn's Michelle Lopez for the best results from February's earnings season (and some shockers). Plus, they also share whether they are picking over the wreckage for some oversold gems (spoiler: they are), as they strengthen their portfolios for the volatile months that lie ahead.
Note: This episode of Buy Hold Sell was shot on Tuesday 1st March 2022. You can watch the video, listen to the podcast or read an edited transcript below.
Matthew Kidman: Hello, and welcome to Livewire's thematic discussion. My name's Matthew Kidman. We've just finished February and to say one word, it was explosive. We had the Federal Reserve in the US ratcheting up interest rates, ready for them to explode. We had Russia invading Ukraine. We've even got a rain bomb ready to explode on the East Coast of Australia. And of course, we had results season. And the results, well, there was a number of bombs that went off there too. And here to discuss the February reporting season, we've got Blake Henricks from Firetrail Investments, and Michelle Lopez from abrdn.
Let's start with you Michelle, what's one word to describe the reporting season?
Michelle Lopez: Turbulent. It was one of those reporting seasons. And think about the backdrop that we went into it. We've had rising inflation, we've got interest rates and expectations of hikes coming through, and we've got geopolitical tensions escalating. I felt it was a case of "shoot first and ask questions later" this reporting season. Particularly for companies that had either very high valuations or operating leverage that was expected to come through that didn't, they're the ones that really got hit quite hard.
Matthew Kidman: Blake, it seemed like some results were just liquidity events for people. What was the one word you thought about the results season?
Blake Henricks: Well, at the outset you talked about rates, Russia, (my word is) reversion, the three Rs. So the big thing we saw was travel, the likes of Airbnb and Amex talking about travel way above pre-COVID levels. I remember two years ago, we were having debates about whether travel will ever be the same. I think that's been answered. That's coming back. On the other hand, the other things that are reverting are things like Domino's and Woolworths. Those stocks have struggled in recent times. And if you actually look at it on a two-year basis, we've been in COVID for two years, they're almost market performers now. So the reversion is underway, if not already done.
Matthew Kidman: Expectations were quite funny, weren't they? Any company with great expectations tended to be sold. Any without great expectations were bought. Expectations played a big role this time around.
Blake Henricks: Absolutely. It was probably better than I thought because we're just hearing so much about inflation, whether it's wages or in goods. But because demand is so strong, companies are being able to pass it on. There are not many I spoke to, who aren't passing it on. So in my mind, that's been better than expected. If demand does slow, we'll see how good they are at passing it on then. But so far, it was pretty good.
Matthew Kidman: Price rises were everywhere, Michelle, it seemed that way among every company you spoke to. What about the portfolio? Has the turbulent reporting season made you shift your portfolio? And the way you're thinking through this year?
Michelle Lopez: Fortunately, we didn't have any big material shifts within the portfolio. We were repositioning the portfolio to close the underweight to growth that we had all through last year. So we actually entered this year with a relatively defensive portfolio. What we have done though, and maybe picking a little bit more on the growth bucket, which is everyone's talking point at the moment. It provided us with an opportunity because there was an indiscriminate sell-off in that part of the market. So we pivoted out of a company, for example, Zip (ASX: Z1P), that had a very long runway to turn profitable. And we recycled that capital into a higher quality growth name, such as a Pro Medicus (ASX: PME), that again, got hit very hard. But, A, it's profitable, B, it's got incredibly strong margins. It's an industry leader. It's got cash on the balance sheet. And again, we felt the valuation had come off a long way. So it was just being a lot more discriminate in quality growth versus lower quality growth.
Matthew Kidman: I'm going to ask you the same question, Blake. Did you have to do much to the portfolio from what you saw, especially the reaction from investors? Michelle has just outlined it, there were big changes in the market. Growth! Who wants growth? That's taboo these days. What happened to your portfolio?
Blake Henricks: Absolutely. The portfolio handled the events pretty well. So, that was good. We added to something like a BlueScope (ASX: BSL), where the market pretty quickly sold it off as some of the margins reverted. But when we look at the business, it's got net cash. It's got a great business in COLORBOND, that's sort of the hidden asset. And the rest of the business looks pretty good to us.
Matthew Kidman: It's almost deep value.
Blake Henricks: It's almost deep value, it's great. It's got great leverage to rising interest rates too, with a net cash balance sheet. So it looks pretty good to us. But other than that, we didn't do too much. You can't just buy every stock every time it falls. That's not the way to run a portfolio. So we feel pretty relaxed and didn't make too many big moves.
Matthew Kidman: And then Michelle, the trends, you mentioned one. Was that the big trend that came out of reporting season, that growth wasn't what you should be in? There are other areas of the market that have been forgotten for a few years?
Michelle Lopez: There has been, but I think that was already in play before reporting season. The one very big theme that we saw in reporting season was costs. And if you wind back six months ago, there were pockets of growth in costs. So whether it was WA, certain industries. And this time around, it was across every industry, every sector, market cap agnostic. So really, and Blake touched on this - yes, a number of companies did pass them through. And we saw those ones that had the moat to be able to do that and the pricing ability do so. But there were a few that couldn't, and they're the ones that the margins got hit and that leverage didn't come through. And they're the ones that received less attention, or attention in the wrong way. That was one theme.
The other theme I found really questioned the impact Omicron had. So there was an expectation that there would be a very big impact from Omicron, around the operating environment. And in fact, we saw the banks come out with very solid credit growth. SMEs, which are the backbone of our economy, they're doing really well. Credit quality is strong. So, that's one area that surprised us from a trend perspective. Having said that, again, I think fundamentally businesses did well.
Matthew Kidman: And Blake, can you actually fireproof your portfolio against inflation? Keep hearing about it. People are warning of it. Now it's kind of arrived and we've got price increases. But is it possible to avoid inflation eating away your returns?
Blake Henricks: I think every stock in the ASX 200 has been written about as some kind of inflation protection. It's borderline ridiculous, in my view. The one area where we do see it, and one of the big themes that came out, is energy security. We've been on this energy transition, it's been going very quickly. But really in Jan, Feb, it's bang, energy security. So we've seen what's going on in Europe before Russia entered, with gas prices spiking. Now we've got Russia causing more concerns. And then even if you look at Origin (ASX: ORG), they're shutting down the Eraring power station and AGL's (ASX: AGL) got a bid for it with Brookfield and Michael Cannon-Brookes, which could potentially accelerate the shutdown of coal. So everywhere I look, energy's being disrupted.
Matthew Kidman: Not a crowded trade.
Blake Henricks: Not a crowded trade. And then you look at something like a Santos (ASX: STO). Check this out, in January 2020, this stock was over $9 a share. And the oil price was around $60. Today, the oil price is over $100 dollars a barrel, and Santos is around $7. So it's actually down around 20%. The oil price has almost doubled. That is an area, it's inflation-protected, huge cash flows. And if it doesn't rerate, we won't really care because we'll be getting dividends, huge buybacks. I mean, that is it.
Matthew Kidman: Black gold. Okay. Just one stock that stood out as a great result in reporting season, Michelle? That you thought, "Wow, they've done well."
Michelle Lopez: For us, Endeavour (ASX: EDV) was one of those. And Endeavour was the spinoff from Woolies (ASX: WOW). They had the retail side, which is your Dan Murphy's and BWS, and then you had the pubs and hotels. So they own a portfolio nationwide. And really that stood out, particularly the margins within the retail business, they were significantly higher than expectations. So it drove a 20% beat at the earnings line. And Endeavour's one of these stocks that almost there's a natural hedge within the business itself. So yes, they've got the retail side, but they've also got the pubs and the hotels, and it's the largest portfolio from a listed company. They get the reopening trade. They've done really well up until now, from consumption at home, and now pivoting into the hotels, which is three times the margin of the in-home. So I think that one did really well. It was up 10% of the day, but I still think it's got legs from here.
Matthew Kidman: Great way to start a listed life. What about a bad one? What made you feel a bit sick to your stomach?
Michelle Lopez: A bad one. Look a bit of humble medicine here. I think from the ones that we held, Tyro (ASX: TYR) was one that really disappointed. And that was very much at the cost line, as well. So they continue to invest and continue to add resources. So they added something like 56 people within the half. So that obviously impacted the EBITDA margin and the EBITDA line, which was significantly lower. Margins were also under pressure. But taking a step back, when you actually look at what they've been able to achieve over this period of disruption, transaction volumes are back up, churn levels are down. So I think it's probably overdone, at these levels. And there are some really clear catalysts from a reopening perspective as well for that one going forward. But it did disappoint.
Matthew Kidman: Okay. Blake, we'll go the opposite way with you. Worst first. What was the worst thing you saw?
Blake Henricks: It was a stock we own. In terms of the actual earnings, it was Lendlease (ASX: LLC). If you look at the core earnings, it was a shocking result. But I think if you just focus on that, you'd say it's really bad. But I think if you actually think big picture, this is a really big turning point for Lendlease. A couple of things out of the result - the first one was they're working to align cash flows with profits. So this is a low point. And then from here on, you're probably going to see cash flows and profits be quite in lockstep. Whereas in the past, it's been a bit noisier. So that's the first thing, this profit recognition has caused a bit of a drag. But the second thing is that they're starting to sell assets. You've got new CEO, Tony Lombardo. I think there are no sacred cows in this business. They've sold military housing for 26 times PE. I mean, this is a stock if you look at '23, '24 earnings, it's on probably around a 10 times PE.
Matthew Kidman: That stuff gets investors excited. Doesn't it?
Blake Henricks: It gets investors excited because, instead of just hanging onto it and trying to milk it, they're saying, "Hey, let's try and prove up some of this value, get the balance sheet being recycled, and grow these earnings." And I think that's why that's exciting.
Matthew Kidman: Okay. Let's go to the other side. Something good?
Blake Henricks: Seek (ASX: SEK). Everyone knows how hard it is to get people. They saw a 20% yield increase in their business. That is basically recruiters and hirers saying, "I need to get people, I'm willing to pay more." That's driving huge earnings growth.
Matthew Kidman: But investors didn't pay more. They sold it.
Blake Henricks: They did, they sold it. They bought it on the day and then they sold it because, hey, it's liquid. So, we don't get too worried about that. We think they're in a really good position. It's well run. And, this is Seek's time.
Matthew Kidman: So there's been a lot of bombs going off in reporting season, but there are some stocks that are going to get you to the other side.
Which stock do you think had a terrific result? And what was the worst?
Blake and Michelle have shared plenty of winners and losers from this reporting season, but we would love to know what you think. Let us know what stock you think had a smashing result in the comments section below. And if you feel up for it, share a stock that massively disappointed you this reporting season too.
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Buy Hold Sell is a weekly video series exclusive to Livewire. In each episode two fund managers give their views 'Buy, Hold or Sell' on five ASX listed companies. Not recommendations, please read the disclaimer and seek advice where appropriate.