The compelling value is in old-world businesses

In August, the words' artificial intelligence' popped up 150 times in presentations from ASX leading companies. That's three times more than the prior reporting period. Investors are often drawn to the next hot trend, but in old-world businesses with existing assets, the Firetrail team is finding the best opportunities.

Blake Henricks, portfolio manager of Firetrail Australian High Conviction Fund, has been impressed by the pricing power of companies such as James Hardie and Bluescope Steel. These businesses have gone up a gear, which has shown their brands' strength to hold on to recent price rises.

Ramoun Lazar, portfolio manager of the Firetrail Absolute Return Fund, says the Australian consumer has been resilient in the face of rising interest rates whilst mid-tier mining companies are doing it tough.

In the latest episode of the Firetrail Analyst Series, investment specialist Eliza Clarke sits down with Blake and Ramoun to dissect the crucial messages from the latest reporting season.

Ramoun shares a little-known Aussie growth story with defensive earnings, and Blake says the bad news for a struggling blue chip has presented a rare opportunity.

Watch the video or read an edited transcript below. 

TRANSCRIPT

Eliza Clarke

Hi, and welcome back to the Firetrail Analyst Series. My name is Eliza Clarke and I'm an investment specialist here at Firetrail. Now, we've just made it through a very busy Aussie reporting season, so today I am fortunate to be joined by two of our portfolio managers to help us dissect the results. With me today is Blake Henricks, portfolio manager on the Australian High Conviction Fund, and Ramoun Lazar, portfolio manager on the Absolute Return Fund. So welcome to you both.

Blake, I'll get started with you. What were some of the key themes that you saw in the large cap reporting season?

Blake Henricks

Two things stood out for me. The first one was interest costs. The market really underestimated just how much interest costs were moving higher. I think there's more of that to come. And I also understand it too, because interest rates throughout the last three months have moved a lot higher. So I think that's one area where there's just less cashflow per share, and that's been weighing on a few stocks, particularly those that are geared, I'd call out Ramsay (ASX: RHC) and Aurizon (ASX: AZJ) as ones that really struggled, and the REITs.

The second thing I saw was a lot more pricing power in really good brands. And James Hardie (ASX: JHX) would be one example. They pushed price very hard last year just to try and offset inflation. As some of those costs have come off, they've maintained those levels of pricing, and we've seen that in companies like BlueScope (ASX: BSL) as well. So There's a few companies out there with really good brands and I think they've found another leg to their pricing power.

Eliza Clarke

And Ramoun, in the Absolute Return Fund, we know you can invest the down the market cap spectrum. So what did you see in the smaller end of town?

Ramoun Lazar

I'm going to have to say the resilience of the consumer really stood out. And it feels like that seems to be a recurring theme over the last 18 months, just how resilient the Aussie consumer has been through this high interest rate cycle. CBA (ASX: CBA) put out a pretty good chart just showing how different the consumers at various spectrums look across the Aussie landscape.

On one end, you've got the millennial consumer, the 19 to 35 year olds with high mortgage balances really reigning in their spend. But on the other spectrum, you've got older cohorts, so those aged 45 and over, paid off their houses, are sitting on some reasonable savings. And for the first time in a decade are earning a return on those savings, really continuing to spend with no signs of a slowdown. So that was one that really stood out in results like Wesfarmers (ASX: WES) for example, and the travel names as well, which continue to see some strong levels of spend.

The other thing that stood out for me was just how tough it was for the resources this reporting season, downgrades outpaced upgrades by factor of three to one in that resources space. 

And a lot of that pain was felt by the small to mid-cap resources space. The stocks that we look at, cost guidance for some of those names into 2024 was up about 15% to 20%. Also, CapEx guidance was up in some cases by 40 to 50% on new projects. So looking into '24, we think balance sheets are going to play a major role in some of those small cat resource names in navigating this higher inflation environment.

Eliza Clarke

Ramoun, what is your highest conviction position now post reporting season?

Ramoun Lazar

So in the small to mid-cap space, Kelsian (ASX: KLS) is one that really stood out for us. Kelsian operates a network of buses, trains, ferries in Australia and the US. It's not a particularly sexy business, but if I stand back and have a look at it is a very high quality defensive mid-cap name. It has about 90% of its revenues contracted over several years. Its founder led. It has a great track record of retaining and winning new work. And it's got an exciting offshore growth story in the US. The result missed expectations on higher costs. But if you look at what caused that higher cost issue, it was really temporary factors, as Kelsian was ramping up a number of large contracts in its Australian business.

So if I think about what matters for the stock over the next several years. You're paying 15 times earnings or PE for about 10% average earnings growth over the next several years. And that is really going to come from this offshore growth story. They're winning customers in the US and retaining existing customers like Google and have now become the fourth-largest private bus operator in the US. So It's a great little Aussie growth story with a defensive high quality earning stream.

Eliza Clarke

Blake, what about you? What are you most excited about at the moment?

Blake Henricks

Coming out of reporting season, it was very clear to us where we should be allocating capital. And that was to CSL (ASX: CSL). Now CSL is a stock that I'm sure many viewers will know very, very well. But what I think people underappreciate is just how much of a COVID loser it was. Through the middle of COVID people worried about getting sick, and so their collection centres lost a lot of volume. In addition, there was a lot of stimulus provided, especially to low income earners. And so another reason to not go to a CSL collection centre. As a result, CSL has had a few earnings downgrades now. And in June this year downgraded again. Our view is this is a buying opportunity, because a lot of that downgrade is due to the lagged effect of some of these high incentives that were needed to be paid. So if we look at costs per litre, or cents per litre, how much are you paying for people to go into a CSL collection centre. It almost doubled. It's now come off in our view probably around 20%.

So we're still not back to where we were pre COVID, but that's now providing an earnings tailwind.

As we look into next year, we see high teens growth, maybe even 20% growth, which is a little bit above what CSL are talking. But then if we look into '25, we see around 15 to 20% again. And so for mid-teens earnings grower it's now trading, if we look into '25 on probably 23 times PE. That looks very, very attractive to us. And it's cheaper than Woolworths. Cheaper than Telstra. And for the quality of the business and the growth runway it's really a high conviction position.

Eliza Clarke

We've made it through reporting season, we've made it through winter. Summer's nearly here, but we've got four months left of the calendar year. What are you looking out for? What are some key trends, themes, Ramoun ?

Ramoun Lazar

So the one that I'm going to pick on is inflation. Again, inflation's been falling for the last six months of the year. And what's been leading that is really lower energy prices globally. But if I look at the remainder of the year, what sort of stands out, and where there could be risks to the upside for coming inflation prints, is really again a resurgence in those energy prices. So petrol prices are up about 20% year-on-year in August. And more importantly, oil prices are up about 25% off their June lows. So that is one risk I think that heading into the back end of the year could see some upside risk to those inflation prints.

Eliza Clarke

And Blake, what are you keeping a watch on?

Blake Henricks

It's a big theme and it's a bit of a catchall, but it's old world assets. So There's a lot of talk about the new world and everything that's changing. But what we are seeing is a lot of value in assets that already exist today. So there's companies like Ampol (ASX: ALD), who delivered a tremendous result. They're seeing benefits from population growth. They're seeing higher margins in their fuel sales. And they're also really seeing really good growth in their industrial business, which services the likes of the airlines in Australia. So some of these old world businesses that are trading on very depressed multiples are delivering outstanding results.

The other one I'd pick up on would probably be a company called Incitec Pivot (ASX: IPL). Now they're going to be a pure play explosives business in our view in the next year. And the explosives business, it's dirty, it's old. But to us, it looks like it's going into a very strong cycle over the next three years. And that'd be a very attractive one. So overall, we're not chasing the new shiny things. We actually think there's some great value out there in old world assets that are delivering earnings and delivering earnings growth.

Eliza Clarke

Now since COVID, we've noticed this trend of everyone tracking the buzzwords through reporting season. I don't think I could ever use unprecedented in a sentence again. But Ramoun, were there any words for you, or phrases that you think were just overused this reporting season?

Ramoun Lazar

Eliza It's pretty hard to look past AI. So artificial intelligence was called out about 150 times on conference calls by various different companies across different industries. So that was I think 3X last reporting season. 

So that was probably the most overused word I saw through reporting season.

Eliza Clarke

And Blake, I hear you've got a new favourite quote from a CEO from reporting season. Can you share that with us?

Blake Henricks

I do. Well, it's a surprising quote. It comes from the CEO of Domino's (ASX: DMP), Don Meij. So Don is let's say optimistic at the best of times. He's always up and about. And part of being in a franchise business, that's how you have to be. So we understand that. But he made a really interesting comment. It was that in COVID Domino's execution was 9 out of 10. They took advantage of the opportunity. However, in the early stage of the inflationary period, he said, he'd give Domino's less than a five. Now to us, we know that, because we've seen the earnings. But I think it's important to recognise some humility from Don who is typically up and about, to say, "Hey, you know what? We didn't execute well." We actually think from a Firetrail perspective, that's an opportunity in Domino's. But it's good to see some humility from someone who's typically right up and about.

Eliza Clarke

Great. Well thank you both very much for those insights on reporting season today. And thank you for joining us for the Firetrail Analyst Series.

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