Ellerston Australian Share Fund

Transcription

1 Ellerston Australian Share Fund PERFORMANCE REPORT April 2016 The investment objective of the Ellerston Australian Share Fund is to outperform the S&P/ASX 200 Accumulation Index (Benchmark). The Fund aims to achieve this by investing in a concentrated portfolio of no more than 25 Australian listed securities. Ellerston Australian Share Fund Performance Gross Benchmark* Excess Net 1 Month 1.45% 3.37% (1.92%) 1.37% 3 Months 9.44% 6.35% 3.09% 9.17% FYTD 2.01% (0.00%) 2.01% 1.12% 12 Months (5.03%) (4.93%) (0.10%) (6.05%) 3 Years (p.a) 5.40% 5.00% 0.40% 4.29% 5 Years (p.a) 6.99% 6.16% 0.83% 6.02% Since Inception (p.a) 10.38% 10.03% 0.35% 9.19% The return figures are calculated using the redemption price for Class A Units and on the basis that distributions are reinvested. The Gross and Excess return figures are before fees and expenses whereas the Net return figures are net of fees and expenses for the Class A Units. Returns of the Fund may include audited and un-audited results. Past performance is not a reliable indicator of future performance. * The benchmark was changed from the S&P/ASX 200 Accumulation Ex REITS Index to the S&P/ASX 200 Accumulation Index on 1 July Market Commentary The global oversupply that has plagued commodity markets from crude oil to base metals and bulks subsided during the month, propelling commodities to their largest monthly gain since December This helped equity markets to edge higher, with the MSCI World Index rising by 1.3%, driven by strong gains from Resources stocks and to a lesser extent Energy stocks (WTI Oil price +19.8% to year-to-date highs). Not surprisingly, the resource-heavy Australian market outperformed other major developed markets (with the S&P/ASX200 Accumulation Index +3.4%). Global bank stocks also performed well. Ellerston Capital Limited ABN AFSL Level 11, 179 Elizabeth Street Sydney NSW 2000 Tel: Fax: [email protected] APIR Code: ECL0005AU

2 Late in the month, the Bank of Japan s surprise decision not to extend its current monetary policy-easing stance triggered an increase in global FX volatility, driving Japanese equities significantly lower. This worked in tandem with another dovish Fed communication which capped USD upside. In the US, equity markets underperformed their global peers but still managed to eke out a modest positive return, as the S&P500 rose 0.3% to 2,065, while the tech heavy NASDAQ shed 1.9% to finish at 4,775. The world s largest economy finished the month on a positive note as a number of corporate and economic data points (non-farm payrolls which grew by 215,000 in March) surprised to the upside. The Fed again left rates unchanged, but signalled confidence in the US economic outlook, leaving the door open for a rate hike in June. During the month, 62% of S&P500 companies reported their 1Q earnings with consensus surprising positively by 3.6%. The biggest earnings surprises were in Energy (+8.7%), Banks (+6.8%) and Materials (+4.9%), however, Consumer, Health Care and Telcos were the only sectors to report positive earnings growth. European equity markets were mixed in April with the FTSE100 finishing up +1.1% and Euro Stoxx 50 up +0.8% to 3,028. The Stoxx 600, like other global indices bounced off February lows to finish 1.2% higher for the month but still continues to track lower YTD (-6.7%). The stronger than expected Eurozone real GDP for Q1 at 0.6% q/q and a drop in unemployment to 10.2% supported European markets, but these gains were capped when the IMF downgraded their global growth estimates for 2016 from 3.4% to 3.2%. At the April ECB meeting, Draghi expressed cautious optimism, with a clear easing bias. Forward guidance was left unchanged. In Asia, the Shanghai Composite (-2.2%) and Nikkei (-0.6%) both finished lower. This was despite the release of the March trade data in China which surprised on the upside and a better than expected manufacturing PMI for March at Fixed investment growth rose to 10.7% and infrastructure spending increased to 18.5%. In Japan, early positive returns were quickly reversed when the BoJ surprised markets by refraining from the much anticipated monetary stimulus increase in asset purchases, pushing the Nikkei down 3.6% immediately after the announcement. As mentioned earlier, the Australian equity market performed strongly with the S&P/ASX200 Accumulation Index rising by +3.4%. The resurgent Mining sector underpinned the strong month. With the exception of December 2012, iron ore enjoyed its largest single monthly increase in the past decade, rising by 23.4%, and the nation s biggest commodity export is now up by 46% CYTD. The recovery in iron ore prices came too late for Arrium, which was placed into voluntary administration given its huge debt burden. The largest gains were in Resources (+15.4%, its third consecutive positive monthly return), Materials (+14.2%) and Energy (+7.7%), while Consumer Discretionary (- 1.6%) and Utilities (-0.4%) were the only sectors to fall. Domestic economic data is painting an inconsistent picture, with the March quarter CPI coming in significantly below expectations. This is in stark contrast to signals from the labour market, which have been showing incremental improvement. While the RBA left the cash rate steady at 2.0% in April, it surprised the market with a 25bps rate cut in early May, reducing the cash rate to a new all-time low of 1.75%. The Australian dollar rallied in early April, hitting US$0.78 for the first time since June However, late in the month the weak CPI print saw a sharp selloff, ultimately finishing the month lower against most major currencies. The best performing large-cap stocks during the month included Fortescue Metals Group (+33.7%), WorleyParsons (+29.9%), BHP Billiton (+22.7%), Rio Tinto (+20.8%), Santos (+19.1%), ALS Limited (+17.3%) and Ansell (+15.3%). The worst performers included Nine Entertainment (-27.6%), Qantas Airways (-20.9%), Mantra Group (-18.3%), Flight Centre (-9.1%), Lend Lease Group (-8.4%) and Fairfax Media (-7.6%). For the month of April, the S&P/ASX Small Ords finished up +3.0%, in-line with the broader market s gain. The Small Industrials posted a measly gain of +0.4%, whilst the Small Resources finished the month up a phenomenal +16.3%. Equity Capital Markets activity in April picked up significantly, following a slow first quarter, particularly in the IPO space, with ~A$2.3bn of equity issuance. The notable deals were the IPOs of Reliance Worldwide Corporation and Tegel Foods, which were both well received by investors.

3 Company Specific News It was a disappointing month for Qantas Airways (QAN -20.9%) which announced a profit warning and that Group Revenue Per Available Seat declined in March, with weaker yield performance in its domestic and international businesses. This outcome coincided with weaker consumer confidence and the upcoming Federal election. However, QAN's revenue backdrop has also been deteriorating. International has been the biggest source of earnings risk for QAN (28% of Group EBIT), and this now appears to be playing out. WorleyParsons (WOR +29.9%) continued its upward trajectory throughout April, as the recovery in oil prices allowed the share price to reach a one year high of $7.07 on the 21st of April. In addition, the stock rallied hard after the company announced it had been awarded a 5-year contract to provide engineering services for the BP-operated assets in Azerbaijan, Georgia and Turkey. In an about face, the board of Broadspectrum (BRS +24.9%) announced that it would now recommend the recently revised $1.50 per share takeover offer from Ferrovial. BRS shares rose 32.1% on the day of the announcement. South 32 Limited (S %) maintained FY16 guidance for capex (US$550m), production and cost out (US$300m). Its net cash position at this point in the cycle sets a strong platform to increase returns and was a pleasant surprise for the market. Nine Entertainment (NEC -27.6%) downgraded its guidance for FY16 free-to-air advertising growth to a "low single digit decline" versus previous guidance of "flat to down marginally". NEC also downgraded its guidance for FY16 ratings share to c37% versus previous guidance of c38%, due to a subdued advertising market and softer-thanexpected ratings during the March quarter. NEC shares fell 23.7% on the day of the announcement. Wesfarmers (WES +3.2%) released a strong 3Q16 result with Coles (4.4%), Bunnings (8.3%) and Kmart (12.3%) ahead of expectations. On the flip side, Target disappointed (-0.8%) and resources production was much lower than expected. ResMed (RMD +0.4%) delivered a soft result in 3Q16, with reported NPAT of US$88.5m, 3.1% below consensus. Revenue increases of 7% (9% in constant currency) was seen globally, with growth of 12% in the US and flat ROW revenue (up 3% in constant currency). In addition the result showed a lower-than-expected gross margin. Management continued to make positive comments on their US franchise. Rio Tinto (RIO +20.8%) announced a reduction in guidance for 2017 iron ore shipment and a mixed 1Q16 result iron ore shipment guidance was reduced by 10-20mt to a range of mt. BHP (+22.7%) also lowered its FY16 WAIO shipment guidance from 270mt to 260mt, citing a two year rail maintenance program as the prime cause. MG Unit Trust (MGC -45.2%) downgraded its profit forecast to $39-$42m (from $63m), stunning investors. The dividend guidance was also lowered to cps. The company pointed to lower adult milk powder sales in China, a strengthening AUD and inventory revaluation as drivers of the downgrade. Both the CEO and CFO have left the company. Temple and Webster (TPW -41.4%) once again downgraded earnings with the company now guiding to FY16 revenue of $60-$62m (from $68.6m) and an EBITDA loss of $14-$15m. The company also announced that CEO Brian Shanahan had resigned and that COO Mark Coulter was appointed as the interim CEO. McGrath (MEA -15.4%) downgraded FY16 guidance on the back of weaker than expected market conditions and now expects EBITDA to be $4-$5m lower than prospectus forecast. MEA has experienced lower than expected volume of listings and sales in the first half of April, expecting them to be down 25-30% in Q4. Blackmores (BKL -9.1%) was hit by negative sentiment surrounding the tightening of regulations by Chinese authorities on foreign goods purchased over the internet. BKL shares fell 13.2% on the day of the announcement.

4 Performance The Fund returned +1.5% versus the benchmark return of +3.4%, in spite of no blow-ups and holding zero Qantas (QAN -20.9%) or Nine Entertainment (NEC -27.6%). The Fund could not keep pace with the +3.4% return, given that we held none of the best performing stocks which rallied significantly, namely Fortescue Metals (FMG +33.7%), WorleyParsons (WOR +29.9%), Evolution Mining (EVN +28.9%), Broadspectrum (BRS +24.9%), Mineral Resources (MIN +23.3%) and BHP Billiton (BHP +22.7%). All of these stocks delivered spectacular returns during the month. Understandably, some of the Fund s core long positions which have enjoyed big runs over the past few quarters, took a breather during April, namely Aristocrat (ALL -2.9%), Treasury Wines (TWE -3.3%), Nufarm (NUF -5.9%) and Primary Health (PRY -7.4%). This constrained the upside capture. Securities Held -0.87%, NUF GNC, 0.40% -0.76%, PRY RIO, 0.32% -0.50%, TWE BPT, 0.26% -0.47%, ALL S32, 0.19% -0.34%, ORI WPL, 0.14% -0.78%, BHP CBA, 0.46% -0.10%, FMG QAN, 0.15% -0.08%, NCM TLS, 0.14% -0.08%, STO MQG, 0.12% -0.05%, AMC LLC, 0.07% Activity Securities Not Held During the month, we initiated a new position in Suncorp (SUN) having exited over 12 months earlier at a substantial higher price (~$14.00). Trading on a FY17 PE of 12 times and a fully franked yield of 6.5%, we feel that SUN is an undervalued opportunity with limited downside. The transition to a new CEO confirms the company s strong foundations and leading financial services brands.

5 The SUN share price has been weak due to a number of factors; including an earnings downgrade in December 2015 driven by a weak General Insurance result, and poor household claims management. They were also caught up in the negative sentiment around the major banks worsening credit quality trends and fears over pockets of stress in QLD which caused a de-rating of the company by the market. The current multiple of 12x is at the bottom of the insurance cycle, after assuming a four-fold rise in the BDD charge. The PE rating is also at a low point relative to the industrial market, trading at a 35% discount relative to the ASX200 Industrials, with their direct competitor IAG trading at 15X and at a discount of 20%. SUN has a high quality group of businesses with $506m of excess capital (CET1). The bank is a de-risked financial with a better quality loan book. More than 80% of the loan book is in mortgages with average LVR in the 50-60% range, which is covered with mortgage insurance.

6 In addition, SUN has virtually zero mining services, and zero mining resource company loans. Their General Insurance segment is currently the 2nd largest insurer in Australia with circa 28% market share. With a weak H116 Insurance Margin (IM) of 9.4% (10% underlying) and a 400BP decline on p.c.p, greater than half of the decline was caused by non-recurring claims factors. We believe H116 to be the low point with improvement expected in H216 and FY17, helped by any recovery in the commercial rate cycle. A plan to restore claims performance has been activated and we expect the company to return to targeted IM of 12% in the next few years. Margin improvement should be helped by any recovery in the commercial rate cycle. The Life business is currently sub-scale, however it is past the low point in the cycle, and further to this we have seen stabilisation and recovery in performance over the last 12 months. There is embedded value of $1,936 million up 4.9% with the value of one year sales up 28% to $23 million. In summary, SUN is an undervalued opportunity with limited downside. Historically the General Insurance stocks perform strongly when the rate cycle turns and insurance margins expand. We are getting this optionality for free at current prices.

7 Strategy Outlook The 2016 Federal Government budget proved to be fairly benign, with aged care growth affirmed and new infrastructure spending announced. The budget seeks to make no great changes in taxation or spending, nor does it seek to dramatically alter the nation's fiscal strategy over the coming years. In summary, the winners are small businesses paying reduced company tax, people earning more than $80,000 that will receive a tax cut, university students, state and territory hospitals receiving additional funding and the Defence Force. The losers in the budget are multinational corporations facing a new diverted profit tax of 40%, people with super balances over $1.6m and people earning between $250,000-$300,000. It is forecast that the wealthiest 4% of the population will be hit hardest by the package. At 16.1x, the ASX MF Price to Earnings continues to trade at significant premium to long-term average as the index has moved higher and earnings have stayed muted. Source: RIMES, IBES, Morgan Stanley Research Industrials ex Banks EPS growth has now dipped into negative territory at -0.25% Source: RIMES, IBES, Morgan Stanley Research We have positioned the portfolio to capitalise on what we consider to be medium to longer term fundamental mispricing of stocks. This of course is premised on our expectation of their longer-term industry prospects and ultimately, the earnings and cash flow potential of the businesses we are investing in. We will not simply invest in stocks just because they are quality businesses, but in our eyes, do not meet our strict valuation criteria. Many of these massively high ROE businesses (regardless of the industry they are operating in) have a tendency to attract new entrants and encourage capacity expansions. We feel we have the right mix of reasonably priced growth stocks coupled with some deeply discounted cyclical/value oriented stocks. With the exception of the introduction of Suncorp to the portfolio, our strategy remains as per last month.

8 Consumer Discretionary Consumer Staples Energy Financials Health Care Industrials Information Technology Materials Other (inc Index Hedges) Real Estate Telecommunication Services Utilities Effective Cash -36.0% -7.3% 2.7% 12.2% 25.3% 19.5% 12.0% 7.2% 0.0% 2.7% 22.0% 14.8% 25.8% 37.8% 61.3% Size Comparison Chart vs ASX % 60% Portfolio ASX 200 Active 40% 20% 0% -20% -40% -60% Active Sector Exposures* Top 10 Holdings 15% 10% 5% 0% (5%) (10%) (15%) (20%) (25%) ARISTOCRAT LEISURE GRAINCORP HEALTHSCOPE ORICA PRIMARY HEALTH CARE QBE INSURANCE GROUP NATIONAL AUSTRALIA BANK SUNCORP GROUP NUFARM TREASURY WINE ESTATES

9 About the Ellerston Australian Share Fund The Fund aims to achieve its performance objectives by adopting a fundamental bottom-up investment approach to stock selection which is focussed on identifying and then constructing a portfolio of the highest conviction ideas. Investment opportunities for the Fund are identified by analysing and understanding the factors affecting (amongst other things): business model, industry structure, management team and overall valuation. Ellerston Capital typically favours businesses that can sustain high returns or improve their return on capital and looks to invest in businesses with a market value below the value we attribute to them. Benchmark weightings do not drive our stock decisions, our approach is totally benchmark independent. Due to the high conviction nature of the portfolio and the resulting deviation in portfolio composition relative to benchmark weighting, it is expected that the returns from the Fund will differ significantly from the broader market indices. Fund Facts Strategy Funds Under Management $2.32 Billion Funds Under Management - ASF Unit Trust $10 Million Application Price $ Redemption Price $ Number of Stocks 19 Inception Date 1 April 2009 DISCLAIMER This newsletter has been prepared by Ellerston Capital Limited ABN AFSL , responsible entity of the Ellerston Australian Share Fund (ARSN ) without taking account the objectives, financial situation or needs of individuals. Before making an investment decision about the Fund persons should read the Fund s product disclosure statement dated 21 October 2013 which can be obtained by contacting [email protected] and obtain advice from an appropriate financial adviser. Units in the Fund are issued by Ellerston Capital Limited. This information is current as at the date on the first page. The inception date for the Ellerston Australian Share Fund is 1-April This material has been prepared based on information believed to be accurate at the time of publication. Assumptions and estimates may have been made which may prove not to be accurate. Ellerston Capital undertakes no responsibility to correct any such inaccuracy. Subsequent changes in circumstances may occur at any time and may impact the accuracy of the information. To the full extent permitted by law, none of Ellerston Capital Limited, or any member of the Ellerston Capital Limited Group of companies makes any warranty as to the accuracy or completeness of the information in this newsletter and disclaims all liability that may arise due to any information contained in this newsletter being inaccurate, unreliable or incomplete. Past performance is not a reliable indicator of future performance