03 September 2020
This report has been prepared by Northcape Capital, the underlying investment manager for the Warakirri Concentrated Australian Equities and Warakirri Ethical Australian Equities Funds.
Market Review & Outlook
The August reporting season provided some insight into the unusual conditions prevailing in the economy. Overall, the market rose by 3% over the month led by rebounds in some of the stocks that were big underperformers earlier in the year. From a sector perspective, consumer discretionary and information technology outperformed the broader market. Communication services, utilities and the bank sectors underperformed.
One of the highlights was the strong sales growth reported by retailers. In the six months to 30 June, the supermarkets saw sales growth of around 10%, but surpassing this were a group of more discretionary retailers including JB HiFi 22%, Bunnings 25% and Officeworks 28%.
It seems clear that retail spending has been supported by government stimulus as well as some diversion of spending from other categories such as travel, entertainment and dining out. On the other side of this shift, Sydney Airport passenger numbers were down by 97% in the last three months of the year and Qantas has grounded the majority of its fleet.
The banks reported that 90-95% of home loan customers are still making repayments and they expect the majority of the rest to recommence payments when their deferral period ends. While bank balance sheets now look robust to most scenarios, they are still finding it near impossible to grow revenue in this environment.
Some of the best share price performance came from stocks that had underperformed earlier in the year including Qantas, Flight Centre and IDP Education. Operating conditions remain weak for these companies but they are demonstrating reasonable resilience and expressed some confidence in the medium-term outlook.
We note that the current market is placing a very large premium on growth. This is understandable in the context of weak economic conditions and very low interest rates, so we are wary of concluding that the taste for growth has gone too far.
However, we think the market is relatively less discerning when it comes to differentiating between individual businesses within the groups of highly-rated growth stocks and low-rated value stocks. We see opportunities to position the portfolio in the stocks within these groups that have the most defensible long- term outlook.
The main contributors to performance for the month of August were overweight positions in IDP Education, Reliance Worldwide, Qantas Airways, Xero, Sydney Airport, James Hardie and HUB24.
Xero outperformed the market along with high-growth tech stocks in general, which enjoyed a further re-rating locally and in international markets. Xero is our preferred exposure in this area because we think it has a strong and durable competitive advantage in addition to attractive growth prospects. A quarterly trading update in August showed that customer numbers have continued to grow during the pandemic.
IDP Education outperformed the market off the back of a strong FY20 result, as it allayed concerns around liquidity and cash burn, demonstrated resilient profitability in the midst of widespread disruption to international education markets and illustrated robust underlying demand trends. We remain constructive on IEL’s medium-long term prospects given its strong (and improving) economic moat and the long term structural growth of the sector.
Qantas outperformed largely due to improving COVID-19 case numbers domestically and heightened optimism globally regarding vaccine development.
On the negative side, the portfolio performance was impacted by a few key positions including Transurban, Medibank Private and IAG.
Transurban’s underperformance was due to a rise in bond yields towards the end of the month. We remain attracted to the return profile of TCL, even if bond yields were to rise substantially from current levels.
Medibank Private’s share price fell after the release of their FY20 result, as the market is anticipating a rise in claims costs next year associated with a potential backlog in elective surgeries. We acknowledge this risk, but believe that structural reforms needed to improve private health care affordability, such as telehealth solutions and rehabilitation in the home, have been accelerated by the pandemic and have strengthened the medium term outlook for MPL.
IAG posted another month of underperformance as it grapples with a host of challenges including elevated perils, higher reinsurance costs, potential Covid claims, tough macroeconomic conditions, and lower interest rates. However, the majority of these headwinds are driven by industry wide issues and we see IAG’s underlying franchise, profitability and balance sheet as strong, and better placed to navigate these challenges. Valuation appeal also provides a margin of safety to these downside risks.