Macro

Australian equities have had a remarkable performance so far this year. In this interview, Portfolio Manager at Airlie, Emma Fisher, speaks with Adrian Amores about the three key forces behind the resurgent market. 

The reelection of the Liberal-National coalition and rate cuts are two obvious ones. The other is a little-known decision by APRA, and Emma explains here why it means a 10 to 15% increase in the availability of credit for Australian mortgages. She also discusses her view of the banks in this context, and also how these three driving forces support the thesis for the latest inclusion in the fund's portfolio. 

 

Transcript

Adrian Amores:
Thanks for joining us for this Airlie Australian Share Fund update. Today I have Emma Fisher, a portfolio manager of the Airlie Australian Share Fund.

Emma, we've had some dramatic changes to the Australian landscape with a surprise reelection of the coalition government. What has this meant for the market, and how has this changed your outlook?

Emma Fisher:
Yeah, so heading into the election, the economy was facing soaring wages growth, slowing GDP, and falling house prices, and there was a view, a consensus view that a labour government, which was campaigning on a platform of higher taxes, and some policies such as the removal of negative gearing. 

There was this view that that was going to magnify some of these downside risks that the economy was facing. So the surprise reelection of the coalition government, which, in particular, I guess the main changes that we're now facing tax cuts rather than rising taxes. That has really, in our view, taken away some of these downside risks that the economy was facing, and no where has that relief, I guess, been felt more strongly, than in their housing and consumer-related sectors.

It was a pretty consensus view over the last 12 months for Australian fund managers to be underweight housing and consumer related stocks, and this sort of relief rather that we've seen has really been reflecting the fact, not necessarily that house prices will rise again or it's going to be off to the races for the economy, but certainly the fact that some of those downside risks of a housing led downturn have now been removed from the equation.

The other factors that have really come into play, sort of hot on the heels of the coalition, our victory was APRA have removed the 7.25% serviceability cap for mortgages, and so what that means is when I go to the bank to take out a mortgage, APRA was forcing the banks to assess whether I can service that mortgage based on a 7.25% interest rate, and that was sort of a static cap no matter the fact that in the backdrop, the cash rates were coming down and interest rates were coming down. So it was sort of this cap on bank's ability to lend, even in the face of ever easing monetary policy.

And so, what APRA has now said, is instead of using that 7.25% floor, you really have to use a buffer instead, so wherever the cash rate goes and interest rates go, you have to test serviceability based on 2.5% higher interest rate than that.

So what's that meant, on our numbers, is about a 10 to 15% increase in the availability of credit for Australian mortgages and the other change that we've had, sort of off the back of that has been the official cash rate being cut to record lows of 1.25% so when you put these three things together, the liberal government reelection and tax cuts potentially coming through, the removal of the serviceability cap increasing the availability of credit, and the lower interest rates. We think that the outlook is now looking more positive for housing and consumer related sectors, and you've seen that reflected in rallies in those sectors over the past few months.

Adrian Amores:
So where are you seeing value in the market?

Emma Fisher:
Yeah, so we see value still in some of these names that have been sold off because everyone was worried about the domestic outlook and weakness in the consumer. So if I could give you an example of a stock that we've recently added to the fund, the business is called Smartgroup, so Smartgroup do novated leasing and salary packaging, and a novated lease is essentially taking out a car lease but using your pretax dollars to pay that car lease. So it's sort of a tax perk, and it's usually accessed by government workers and charity workers. So they pay less on their car lease, and Smartgroup manage the lease for them. So we think it's a really good business and we've watched it for a number of years. We like the management team, and we think it's one of those rare businesses that can grow with very little incremental capital. So for a number of reasons we've like it, but it's always been a shade to expensive for us.

So the opportunity's really come in this last year. New car sales are really the canary in the coal mine for the consumer, so when house prices fall, new car sales historically fall even further, and we've seen that play out over the last 12 months. With house prices falling, we've seen new car sales fall 20%, and in this environment, Smartgroups actually managed to hold their volumes flat. So that's, we think, been a fantastic result, but the share price has fallen 40%, because everyone's worried about this end-market demand being so sluggish.

We think that's the opportunity. When we bought the business a few months ago it was trading on basically 10 times operating cash flow. The business has no debt, and we think that even though the current end-market demand looks pretty weak for them, they've managed to take share in that environment, and ultimately we think new car sales will eventually rebound and with it sort of the multiple of the stock.

We think that's a good example of a really good business, with a great balance sheet, and a good management team, that sold off because everyone's kind of concerned about the next year's outlook and trying to avoid downgrades and things like that. I mean, when we think about valuation, you're buying a business and really its value is determined by its future cash flows, and so, the fact that there maybe a couple of percent risk around earnings in any one given year, the fact that, that that leads to these huge vagaries in the valuation of a stock really presents some opportunities when the market's focused really short term and you can look out and make an assessment on the profitability of the business and what it's worth in the longterm.

Adrian Amores:

The banks continue to play a big part of the market, and with low interest rate environment, what's your view on the banks?

Emma Fisher:

When you look at the banks, there's two sort of cycles to be aware of. So there's the economic cycle, and then there's the regulatory cycle. Now with respect to the regulatory cycle, I think it's fair to say that you probably couldn't have had a more negative period for the banks than the last year that we've been through with the Royal Commission. And while that generated a lot of headlines, the outcome of the Royal Commission, we didn't really see anything that dramatically changed the way that banks make the bulk of their profits, which is through mortgages.

So, we took the view that with respect to the regulatory cycle, the pendulum had swung to an extreme, and coming out of that year that things would probably look better. And then with respect the economic cycle, as I've sort of outlined, a lot of the removal of these downside risks, has left us in this position where we think that while the economy is likely to continue to slow and remain somewhat sluggish, we don't think we're going to go into a housing led recession, which is obviously the major sort of X-factor risk for the banking sector, and as a result, we think that the banks should be able to do low, single digit tight line growth in this sort of sluggish credit environment, and then the real opportunity, I guess, for them on a stock specific level is to tackle their cost base and if they can manage to keep their cost base fairly flat, then you could see them eek out a couple of percent profit growth at the bottom line and when you couple that with very attractive high, single digit payout ratios, you can sort of stack it up and get a pretty attractive eight, nine, 10% total shareholder return outlook on a one year view.

We think in an expensive market that looks quite attractive, and we are in CBA and Westpac in the fund. The reason that we are in those two rather than ANZ and NAB is simply that we think banking is a scale game. So we want to own the scale players.

Invest where fair value exceeds market price

Airlie Funds Management employs a prudent, common-sense investment approach that identifies Australian companies based on their financial strength, attractive durable business characteristics and the quality of their management teams. To learn more, click ‘contact’ below.



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