Hello and welcome to this episode of Shared Lunch. We were going to focus on the Australian market off the back of the recent earning season.
We're also going to chat about what to.
Look for when investing in small to medium sized companies.
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My name's Sonya Williams. I'm the co founder and co CEO at Shears's and today I'm joined by the City based Michelle Lopez, head of Australasian Equities and portfolio manager at Pie Funds. Welcome, Michelle, Hi, Sonja. Before we get started, I'd like to acknowledge the traditional custodians of the land, water and sky on which we come to you from today, the Gettigill people of the Aura nation, and pay my respects to their elders, past, present and emerging.
So thanks Heeps for joining us. Michelle.
Before we get into it chatting all things a six, can you tell us about you and what does a day to day look like for you.
Yeah.
Sure.
Firstly, thanks very much for having me on your podcast, Sonya. I'm always really happy to share a bit about the exciting world of investing and really what.
Moves and shakes it.
So, as you mentioned, I'm based here in Sydney, and as the accent is probably given away, I am at Aussie and by a way of background, I joined Pithon's early last year in twenty twenty three as a portfolio manager and as you mentioned, head of this Australation equity team, and I brought with me probably twenty years of experience investing inequities, most recently as the head of OSSI Equities at a large global fund manager, where I trained very
much much on the job as a fundamental analyst and really.
Lucky to have learned.
From some incredibly well respected and successful portfolio managers and fund managers in the region.
Markets are volatile of nature, and especially of late we've seen the A six has been down in the recent days due to some concerns around the US growth. Did this have any bearing to the end of the earning season in Australia. Yes, so.
August which we've just come out of.
You would think was a pretty you know, benign month if you looked at the performance over the month, which was virtually flat, but it certainly had a lot of volatility. And to your point, Sonya, the first week of August, you know, we had a five percent draw down which was which is quite brutal, and then it just recovered all of that as we sort of progressed through it.
To your point, yes, a.
Big driver was started coming out of the US, but as as you would.
Know, August is really all about earnings.
For US and companies reporting, so we saw a lot of big moves just on a stop by stock basis. And again if I sort of think through and I considered the earnings outcomes, again at a high level, it looked like it was quite evenly matched between companies that beat expectations and those that missed expectations. But again looking underneath the surface, there was there was a lot of
callouts from the reporting season. The first, first and biggest trend that we saw and this probably isn't going to be a surprise for most was really around the cost of living pressures and these remained persistent and widespread. So there are a number of companies referring to changed consumer behaviors in response to kind of household budget pressures.
And this was across the board, So this.
Was retailers, it was supermarkets, which you think are quite defensive, It was the utility players, it was travel. However, I would actually say that the consumer has shown great resilience if you think about sort of where we've come from from an interest rate perspective and inflation being really high, and in fact we're starting to see signs that the trough in the consumer activity is could be behind us. So that'd be the first one. The second one is margins.
So interesting that ebit DA, which is earnings before interest, tax, depreciation and amaltization, which is quite a common terminology in our market. The margins were revised lower for every single sector throughout August, and you know, one of the key drivers obviously inflation. But in our view again looking forward, which is really important is we feel that the margins
should begin to recover from here. So we are seeing cost stabilize and importantly we're seeing labor supply improving and then maybe the final ones balance sheets.
So balance sheets are strong.
So the Australian corporates have remained lowly geared and they've had shown actually very little appetite to lever up. As you would know, we're probably at an inflection point from a rates perspective in Australia. We're lagging probably New Zealand in that sense, so there is an expectation that cuts will come next you And again we'll say kind of where the balance sheets go from there, but it's meant that there's been.
A number of buybacks that companies have been able to do.
The other thing I'd probably highlight from reporting season is more on the guidance and the outlook statements. And again the one thing was where companies did provide guidance, they were very it was very conservatively set as I mentioned the living and interest rate on uncertainties, and that actually meant that downgrades outpaced upgrades. If you look into the next fiscal year so FY twenty five, and on average forty six percent of the companies had earnings downgrades and
that sort of versus twenty percent that had upgrades. So again there was a skew to having revisions revised downwards earnings revised downwards.
Yeah, and when you say the downgrades and upgrades, do you want to just explain that what you mean by that.
Yeah, of course, So upgrades.
It essentially means that the management provide guidance that is ahead of where market expectations are. So in our world, earnings really drives share prices, so having an understanding of where earnings are going.
So an upgrade is now we think earnings are going.
To be higher next year than what we originally thought, and downgrades is the inverse of that.
So we've had to revise earnings.
Down in light of what management commentary has been.
And so were there any surprises or anything that struck struck you as surprising?
There's always surprises, So there's always surprises, and by surprises, the direct correlation here is just share price moves.
So when we look at the beat versus miss ratio, a couple of things to call out. So from a sector perspective, we had healthcare the highest rates of beats, and then we had energy and utilities as the highest rate of misses. But to your question on surprises, you know, when I look at share price reactions, and in fact I pulled out I pulled out a report just just before our meeting, and they actually gave some numbers around this which I thought was quite interesting.
This is a JP Morgan report, but as you'd.
Expect, so if it met expectations, share price was benign and in line with market. If they beat consensus by more than two percent, that those that bucket of companies outperformed by three percent. So in a flat market, which was what we had in August, they are up three percent as a whole.
The interesting part is the missus.
So those companies that missed expectations by two percent or more, that group actually fell by six percent.
And that's that skew to the downside.
Is why you'll hear industry veterans saying all the time arou our reporting season that the goal is really to avoid the blowups.
Because you can see that skew.
Companies that exceeded by two percent were up three those that disappointed by two percent were down six.
Are there any particular industries that you're keeping your eye on over the next six months.
Yeah, I suppose i'd call out.
I'd probably call out three again months is a very very short time horizon for us. But let me just call something out and then I'll cave.
It all of it. But the first one would probably.
Be infrastructure and construction so we've got a really solid pipeline. It's actually one point seven trillion worth of work for the next seven years, and importantly, this continues to be replenished, so there's a real tailwind within that set. And then if I can just narrow it in more construction. In particular, there's two hundred and forty thousand new homes that are
required annually to achieve government supply targets. We're well below that level from an approvals perspective, and this has been a problem now for a couple of years, but it's really coming to a head. We've got a chronic shortage of in housing and we need to see this addressed. So I think over the next six months that's one that I've sort.
Of been looking I'll be looking at closely.
The second one is probably those consumer exposed sectors.
So as I mentioned earlier, we are starting.
To see signs of a trough and consumer activity. We've had retailers come up with trading updates throughout sort of July and into August and showing an improvement, not a huge improvement, but at least it's positive.
So again, we've got tax cuts.
That have started to filter through the economy, and we've got interest rate cuts coming next year, so I think that's going to be quite stimulatory for the consumer. And then finally, just real estate, with interest rates now sort of entering a new phase. I think that's going to
look interesting from a valuation perspective. But as I mentioned, look that that's just kind of sectors, and importantly for US, we're bottom up fundamental investors, and that means that we approach investing at the company level rather than kind of at a sector level.
And are there any big milestones or announcements that you're coming up that you think will impact the markets in any way?
Oh, there's always announcements. I mean, you just don't know what you're going to wake up to and sort.
Of overnight moves.
But I mean, I suppose the very near term ones that we're look looking for.
You know, macro data out of the US is always important.
Payrolls which we've had just very recently, we're about to enter or we're in the campaigning of the politic of the US elections, that that could have quite an impact on our market from a policy setting perspective.
The other big sort of announcements or I suppose.
External factors if you wanted to call it, that is just commodity prices. Just to be aware that our market is quite levered to commodity prices for better or worse. But yeah, they represent a large part of our exports. So any data and announcements around China policy will have will have an impact, will have an impact there as well.
Yeah, so that's a nice threat to follow there around like, what are some of the external factors that impact the Australian market.
Yeah, so I suppose, like most countries, Australia is absolutely intertwined with global markets, so we really can't say we sort of stand alone. So there's always going to be external factors. I mentioned commodities. That's a big one for us if you think about and the reason for that if you think about the top three contributors to trade, So our biggest exports there Idal, CALL and LNG, so again really important.
Just the demand for those in particular.
The other one I would probably call out, and this is again not just for Australia, but you know, geopolitics can can really impact sort of markets and then the energy situation.
So I try to desensitize.
Sort of big words and I don't think it's a crisis, so we'll call it the energy transition. But again that's that's what's proving out, is that it's slower and it's harder than what maybe we had hoped for and what government's policy had had sort of factored in.
And what we've also found out is it's most.
Likely going to need gas, so we've had no hydrogen as as an example of a renewable source that we were trying to develop, capitals being.
Sort of pulled out actually one of the major.
Ones just because there the returns are not there, so to stimulate that level. So that's a you know, the energy transition is another one that's that's playing playing out in our market.
So with the US election coming up, like how does that vector into how you know your investing decisions?
Taking a step back, what do elections mean? It could potentially make a change in And the difficult part at this juncture is the Biden Harris administration haven't got firm policies in place. I think the Trump jd Vance does have all a bit more and it's the one thing I would say is both parties are going to be very stimulatory, and this is typically quite positive for equity markets if I think about the risks either one way or the other that we're considering, So renewables as a really.
Topical policy, the Inflation Reduction Act.
Which was introduced by Biden, that stimulated a lot of investment into renewables, a lot of incentives into that.
Part of the market.
So a question mark around whether that remains under Trump. I would say it's difficult to unwind something like that. So although it's a risk, I would say it's a hugely.
Likely to happen.
But I think in totality we're not overly concerned one way or the other what way it falls and lands. We're positioned and we've positioned our portfolio such that there's no great risk either way, and in fact we see it as a positive, a stimulatory type of response from both parties.
Like now kind of honing in on one of the funds that you offer, talking about, you know, managing the risk or how you look at creating those things.
One of the interesting things.
About the PIG High Growth Fund is that you look to a lot of small to medium listed companies. What do you define as small to medium, Like we've heard a lot of the big companies or the big industries, like, yeah, how do you define that?
Yes, So there's probably two ways to look at it. Firstly, is just market cap, so the size of the business itself and small we've just given our given our size at the moment, we really do need to be mindful of liquidity risk, so we kind of say from the small end of two hundred million market cap all the way up to say fifteen billion for a mid size business. And you know, we deliberately try to keep our vestable universe as broad as we can and as deep as possible.
We don't want to limit ourselves within that. So that's the first kind of categorization. It's by market cap, it's by size. The second way to look at it, which is which is properly industry practice, is more is around the indices that they're in. So we focus on the small ordinaries for small caps, which is anything from if I think about size of companies stopping UMBER one hundred and one, so X one hundred all the way down
to the three hundred mark. And then for midcaps, we look at everything outside of the X fifty, so the top fifty names we tend to classify as large cap.
Is the way that you consider those different to how you would consider some of the larger companies, like how you evaluate them.
Good question.
I think.
Look, the approach to investing and what we call our guess our investment process is very consistent regardless of the size of the company. So the characteristics that we're looking for in the businesses, which again we could probably to a whole nother podcast on that because it's kind of obviously live and breathe and love it, so but the characteristics themselves and the kind of questions that we're trying to solve for are consistent.
The one thing I would say, though, and the reason why we have.
A preference for the smaller MidCap over the large cap, is that potential for our performance is a lot greater within the smaller MidCap space.
And there's a number of reasons for that.
The first ones that they're much there's much less research available on them, and that allows for some more mispricing opportunities, and it's also a much less efficient part of the market. So again that potential for our performance is there. The other thing I'd say around small caps is that the growth is typically stronger. So when you think about the companies that they're typically younger companies, they're at an earlier
stage of development, so that growth trajectory is stronger. And then the final piece which has probably missed a little bits, you know, merger and acquisition or i PO so initial
public offerings. Within our markets, they've been a constant tailwind for smaller mid caps, and in fact, ninety five percent of merger and acquisition targets in terms of the number of deals have been in companies that have got a market cap of less than US fifty bill and the average premium that they get when they're bid for is you know, thirty to forty percent, and that's created a
really strong tailwind within that part of the market. So that's the differences i'd call out between sort of the large versus smaller mid But what we're looking for in a company would be consistently applied in the.
Large type as well.
Some would say that the A six provides more retail or better retail opportunities than the insidets currently. What do you think about this or what do you think the main points of difference are.
Yeah, I think it just comes back to the depth of opportunities. Really, there's just much more or many more stocks in Australia. There's a greater diversity of companies and industries available for us to invest in. You know, New Zealand traditionally has been quite a high yield market, dominated by infrastructure and property names, and whilst there's actually a very strong concentration in the Australian large cap part of the market. So if you think banks, you know, the
big miners, a couple of supermarkets. If you strip that out, and again maybe one of the reasons we tend to focus on smaller MidCap it offers a real diversity of businesses and in fact there's some real global leaders amongst that pack as well. So I suppose if I had to just really zoom out, it would be that that
there's just more stocks, greater depth of opportunities. Having said that, though, I think for the first time, well the first time since I joined PI eighteen months ago, we're seriously looking at some New Zealand investments. You know that there are companies over there with very solid fundamentals, and importantly, share prices at the moment are probably factoring in continued kind of challenges and derma and gloom that the NZ market has really muddled through and.
That presents some really good buying opportunities.
Right, So we're absolutely not dismissing New Zealand, and I think probably this is the time to start really kicking the tires.
What kind of opportunities do you see?
There's a two that we're sort of really down. We're doing quite detailed work on. One of them is actually in the logistics company. And again, what we like about this investment opportunity in particular is, yes, there's a large proportion of their earnings tied and pinned to the New Zealand economy, which we think is at an inflection point. But they've also so that's the near term sort of
thesis and earnings driver. But then they've all I got optionality and upside through a US through the US side of the business. So again that's that's one. The other one is more in the property side of things. So again with interest rates being quite high in Zealand up until recently, and also you know, the valuation of a lot of these property companies have come down in a training you know, at book value or well below book value, and this particular company has got a really strong pipeline
of development sort of in the age care space. So again that's just a couple of examples that we're looking at that the valuation we think underpins quite a bit of.
Upside from here.
Well, one company, if it springs to mind, that you wish you invested in ten years ago, and why you know what, this.
One's easy for me because I also wish I invested in a PA. You know what for me, it's Promedicuse Promedicus is. It's a healthcare IT company specializing in.
Radiology imaging software. And I have been I have been a.
Shareholder from a professional capacity, and it's in the funds today.
But the stock was a dollar ten years ago.
I think it was a dollar. I'll have to check that. I think it was a dollar close to a dollar. It's one hundred and fifty today, so you know, but that that type of return, I'm not sure there are many, if any other companies. And importantly, this was not just a one hit wonder. It wasn't just that they I don't know, hit drill results in a gold mine and character this has been a really consistent compounder. And you know,
it's a super high quality business. It's like and sorry by high quality the revenues are recurring, so it's it's you know, locked in revenues five percent locked in through very long term contracts.
The profit margins are industry leading.
They've got a globally leading product, their customers and their clients are top deer academic universities in the US, so you know, think Mayo, you know, and importantly, a really solid earnings trajectory. Even as we stand here today, they've got a very clear pathway to be generating thirty percent per annum for the next three probably ten years. And the reason is their penetration is still very low. They're
you know, seven percent penetrated. And they've got new adjacencies so I mentioned radiology, they're getting into cardiology, they're you know, just being accredited the highest level of security for the US Department of Defense.
So there's all these other growth avenues. So yeah, I still am an investor, and I still think that there's.
A really long trajectory of growth. But I don't think we're going to get the fifteen thousand percent return. I think it was for a dollar to a dollar fifty for the next ten years. But I think we can get a really solid consistent return still yeah.
Yeah, And do you think, like the power of hindsight, do you think there would have been signs signs ten years ago that would have would have like what would have been the signs ten years ago that it was getting to end up on that path? Yeah.
I mean I probably started investing in this company six years ago, seven six or seven years ago, I would say, yeah, I just I think this is a really good example of a company that when you see these really solid fundamentals and you can see a global market and they're winning off the major incumbent companies like Phillips and Semens, it's it's clearly gaining traction and you've got to listen
and the repeatability of it. So if they're able to do that consistently for three four years, you know, I think sometimes valuation is evaluation has been the real blocking reason people haven't been invested in it. But I think you need to approach a company like this from a different lens, from a valuation perspective. Yeah.
Well, thanks thanks for joining us, Michelle and sharing your insights with us.
No, it's been pleasure, been absolute pleasure. So thanks for having.
Me awesome and thanks everyone for tuning in. You can Watch this Shared Lunch episode on YouTube, or follow the podcast on your favorite podcast app. Leave us a rating and a comment about what you'd like to hear about next. Thanks everyone, and goodbye.