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The Quality Of Quality Continues To Show

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Always an independent thinker, Rudi has not shied away from making big out-of-consensus predictions that proved accurate later on. When Rio Tinto shares surged above $120 he wrote investors should sell. In mid-2008 he warned investors not to hold on to equities in oil producers. In August 2008 he predicted the largest sell-off in commodities stocks was about to follow. In 2009 he suggested Australian banks were an excellent buy. Between 2011 and 2015 Rudi consistently maintained investors were better off avoiding exposure to commodities and to commodities stocks. Post GFC, he dedicated his research to finding All-Weather Performers. See also "All-Weather Performers" on this website, as well as the Special Reports section.

Rudi's View | Aug 28 2019

Dear time-poor reader: August corporate reporting is once again putting quality in focus.

In this week's Weekly Insights:

-The Quality Of Quality Continues To Show
-Rudi On Tour

The Quality Of Quality Continues To Show

By Rudi Filapek-Vandyck, Editor FNArena

A lot of ink and airtime have been spent on the never ending debate on Value versus Growth investing in the Australian share market, but if the August 2019 corporate reporting season is proving anything it is that investors might be best off by focusing on corporate quality and leaving the Value/Growth debate for another day.

Sure, BWX shares were trading not that far off all-time lows when the company released FY19 financials last week which triggered a rally on the day of 28.7%. And Mayne Pharma shares that were trading near $2 not that long ago, and above $1 late last year, jumped nearly 9.5% to 52c upon releasing FY19 numbers.

But for each such positive example -often accompanied by suspicion of forced short covering- there is at least another observation that compensates with a far more negative outcome.

Boral shares dived in excess of -19% on Monday leading the stock to join the likes of Adelaide Brighton, Platinum Asset Management and Event Hospitality and Entertainment in falling to a multi-year low. Shares in ARQ Group fell to a fifteen year low this week. Shares in Michael Hill have never since its IPO traded at a cheaper price level.

In sharp contrast, dependable, high quality, structural growth achievers including CSL ((CSL)), ResMed ((RMD)), and REA Group ((REA)) all traded at all-time highs before another wave of selling hit the local share market on escalations in the USA-China trade conflict.

Equally remarkable, shares in some of the better performing retailers are also at multi-year, if not all-time highs, including Baby Bunting ((BBN)), Lovisa ((LOV)), and JB Hi-Fi ((JBH)). Footwear retailer Accent Group ((AX1)) equally appears to be performing from a sweet spot.

Inside the property sector there is similarly a noticeable divergence between, say, Scentre Group and Stockland (not so good) and the much better performing Aventus Group ((AVN)), Charter Hall ((CHC)) and Goodman Group ((GMG)); companies which are clearly enjoying much better operational dynamics, and are expected to continue enjoying just that in the year(s) ahead.


Investors are usually obsessed with valuations and how much growth can be expected and is potentially already/not yet priced in. But this August reporting season is proving yet again that (much) weaker share prices do not by default equal lower risk. Cue Costa Group. Japara Healthcare. The examples above. Numerous others.

In contrast, high-flying a2 Milk ((A2M)) and IDP Education ((IEL)) equally surprised in a negative sense, and were heavily punished for it, but a rather large number of companies in a similar position met with share market approval, irrespective of large gains, high valuations and sometimes even small misses compared with market expectations. Cue Carsales ((CAR)), Altium ((ALU)), Medibank Private ((MPL)), and numerous others.

WiseTech Global Outshines Qantas

One of the eye-catching performances was delivered by global logistics services provider WiseTech Global ((WTC)), usually the focus of criticism by value-conscious investors lamenting the stock's bubble-alike valuation for a business that since listing has continuously acquired smaller competitors across the globe at break-neck pace.

More recently, the observation was made that WiseTech Global's market capitalisation now exceeds $10bn. This makes it larger than domestic icon Qantas, which generates operational cash flow in excess of $2.8bn and recently unveiled an underlying operational profit of $1.3bn before tax.

Qantas International reported EBIT of $285m. The latter exceeds total sales generated by WiseTech Global in FY18.

While the Qantas result was positively received, it was still down -17% on the corresponding performance from the prior financial year.

In sharp contrast, every financial metric inside the FY19 update by WiseTech Global grew by a double digit percentage. Sales were up by 57%. Operating profits improved by 37%. Earnings per share increased by 27%. Dividends for shareholders went up by 18%. This is a company that reinvests between 30%-40% of its annual revenues back into the business.

Annual customer retention for the core CargoWise product runs above 99%. The business continues to add additional services, new customers, and expanded geographical reach on its global network. In response to some of the criticism, WiseTech Global added more details in the operational disclosure for investors and analysts, proving it is far more than simply a Pac Man operation that continues to gobble up smaller players.

Organic growth at WiseTech Global is running at no less than 33%. And, so explained founder and CEO Richard White, carefully chosen acquisitions, once properly integrated into the global network, actually accelerate the company's pace in organic growth. FY20 guidance is for revenue growth between 26%-32% and for EBITDA (operational profits) to improve by between 34%-42%.

Note that WiseTech Global since IPO has built up a track record of meeting, if not exceeding, ambitious looking targets and guidance. The FY19 report again forced analysts to significantly increase their forecasts, pushing up the consensus price target by 31.6% to $30. Citi analysts moved their share price target to $36.30, which is still well above where the share price is trading.

While the Qantas result contained many positives, including an additional $76m allocated to buy back its own shares, a $400m benefit from management's transformation program and Qantas winning market shares in a largely moribund domestic market, it's not quite to the same level of enthusiasm that an update as the one provided by WiseTech Global manages to attract.

Qantas shares look undervalued on 9x-8x projected EPS for the next two years and a projected dividend yield in excess of 4.5%, but the cold hard reality here is that WiseTech Gobal shares, trading on more than 100x next year's EPS forecast, might still prove the better investment.

As long as those performance promises keep ticking along. Which remains the same story as for Charter Hall, Medibank Private, the ASX ((ASX)), Iress Market Technologies ((IRE)), ARB Corp ((ARB)) and many more others that continue trading on elevated, above-market valuation multiples.

Citi analysts, in their update on Goodman Group on Monday, formulated it as follows: "Earnings growth that will let you sleep at night". That just about sums it up perfectly. As long as these companies do not destroy the market narrative through heavy disappointment, there is no reason as to why the positive tailwind from robust reporting in August cannot carry share prices longer and higher from here, macro issues not accounted for.

'Cheap' Not Automatically Value Or Defensive

The one hard lesson investors had to learn in years past is that lagging or sagging share prices do not necessarily offer better protection during times of extreme market volatility. This is in particular the case when companies released yet another disappointing market update this month. Cue G8 Education, South32, and numerous other examples – not just from this month, but equally from past reporting season experiences.

Every season offers a number of Phoenix-like resurrections and this month, thus far, companies including Lendlease ((LLC)) and McMillan Shakespeare ((MMS)) have -finally- rewarded patient and loyal shareholders. In plenty of other cases, think Fletcher Building, IOOF Holdings and Crown Resorts, it appears a lot more patience will be required.

August has also become the month wherein the divergence between old economy business models under pressure and modern day disrupters has taken an additional negative turn. Witness how WiseTech Global is responding to market doubts and questions by providing increased disclosure whereas reporting from companies including Scentre Group and Event Hospitality and Entertainment now comes with notably less disclosure and details about how operations are actually performing.

For investors this creates a different type of dilemma: do you want to be on the register of companies that are reducing their communication with investors in the hope this might sustain a higher share price?

All-Weather Model Portfolio

Having said all of the above, only Blind Freddy would disagree the overall risk profile for staying invested in equities has risen noticeably these past few weeks, predominantly because of escalating tensions between the Trump administration and China.

We have made several adjustments to the All-Weather Model Portfolio which should help cushion against potential negative consequences ahead, while also offering a higher return than simply keeping a lot of funds in cash. I'll revisit this in more detail post the August reporting season in September, as I am sure many investors are struggling with similar dilemmas.

More than 25% of the Portfolio is currently not invested in the share market. And while we remain holders of shares in quality smaller cap technology plays including Xero ((XRO)), WiseTech Global and Altium, the portfolio's overall exposure is kept to a level that not one of such stocks is likely to single-handedly destroy the performance in case of unforeseen calamities.

Paying subscribers have access to the dedicated section on the website from which the All-Weather Model Portfolio draws inspiration.

More 'Misses' Than 'Beats'

On a macro level, this reporting season has been repeating the key message that large parts of corporate Australia are, frankly, under the pump. This leads to a wide and sharp division between the Haves and the Have Nots. Australia's corporate earnings recession is poised to continue its underlying trends from the years past, with August reports signalling the gap between the quality top end of the market and the rest might be getting wider and more pronounced.

In recent days, it appears more small cap companies have managed to surprise instead of adding on to the early misses released by Brambles, Woodside Petroleum, CommBank, and others. As a result, the gap between total "beats" -at 21.3%- and total "misses" -at 26.1%- has narrowed markedly, but still retains a bias to the latter.

It'll be interesting to watch whether more upside surprises from Fortescue Metals, Audinate Group, Readytech Holdings, Santos and the likes can close the gap on ongoing disappointments stemming from BHP Group, BlueScope Steel, Boral, G8 Education, IOOF Holdings, Ardent Leisure, Iluka Resources, and others.

FNArena updates daily on August Corporate Results via a dedicated section on the website:

https://www.fnarena.com/index.php/reporting_season/

Readers of The Australian would have noticed my prior update on the August reporting season made it into the weekend newspaper (24-25 August).

See also:

August Reporting Season: Early Signals

https://www.fnarena.com/index.php/2019/08/22/august-reporting-season-early-signals/

August Reporting Season: Early Progress Report

https://www.fnarena.com/index.php/2019/08/15/august-reporting-season-early-progress-report/

August Preview: Lower Rates & Lower Growth

https://www.fnarena.com/index.php/2019/08/08/august-preview-lower-rates-lower-growth/

Rudi On Tour In 2019

-AIA and ASA, Perth, WA, October 1

In 2020:

-ASA Hunter Region, near Newcastle, May 25

(This story was written on Monday 26th August 2019. It was published on the day in the form of an email to paying subscribers, and again on Thursday as a story on the website. There will be no Part Two this week).

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena's – see disclaimer on the website.

In addition, since FNArena runs a Model Portfolio based upon my research on All-Weather Performers it is more than likely that stocks mentioned are included in this Model Portfolio. For all questions about this: info@fnarena.com or via the direct messaging system on the website).

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(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions.) 

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