Portfolio Change Update
Reducing Banks - Westpac (WBC) & Commonwealth Bank (CBA)
Blended & Income Portfolio
We recently reduced the Westpac (WBC) and Commonwealth Bank (CBA) holdings in the portfolios following the release of Westpac’s FY21 result and CBA’s Q3 update. We have exited the Westpac holding in the Blended portfolio and reduced the position in the Income portfolio.
Both results exhibited disappointing outcomes in the returns from the key mortgage lending markets as competition increased, notwithstanding the strength in housing markets. CBA grew its home loan book at 1.5 times the growth of the system, however this loan growth was offset by net interest margin decline, which fell by 14 basis points from 2H21 to 1Q22 just reported.
Westpac’s strategy to recover market share in mortgages resulted in significant deterioration in its financial performance relative to peers. Price competition and switching to lower margin fixed rate loans were a factor also contributing to CBA’s disappointing result, but 52% of WBC’s new home loans were fixed rate in 2H21 versus 44% for CBA (2H21) and 57% of new loans were written through brokers, compared to 47% of total mortgage balances and 44% for CBA. Prioritising volume over value resulted in net interest margin declining by 10 basis points in 2H21 and it finished the period 8 basis points lower than this average.
Earnings per share forecasts have been downgraded for both banks, however capital remains sound with CET1 for CBA at 11.2% prior to the settlement of asset sales which will contribute 44 basis points, and WBC’s CET1 at 11.8%.
Bought Oz Minerals Limited (OZL) | Blended Portfolio
We have initiated a position in Oz Minerals in the portfolio. OZL is the largest copper-focused miner listed on ASX with a market capitalisation of $8.6b. While the medium term outlook for copper demand is positive amid its key role in the electrification of transport and energy transition to renewable generation and battery storage, we’ve been cautious in the near term due to slowing economic growth in China amid a sharp slowdown in its property sector. The copper market has, however remained relatively stable in the second half of the year - especially compared to iron ore - declining just 2.4% over the past 6 months. Economic recovery in developed markets and persistent declines in copper inventories have supported the price in the near term, even resulting in significant backwardation as scarcity prompts inventory build among consumers. OZ Minerals has two long-life, low-cost copper/gold underground mines at Prominent Hill and Carrapateena in South Australia, with a greenfield copper/nickel project under development at West Musgrave WA and copper/gold production and processing at the Carajás East Hub, Brazil. West Musgrave is being designed as a zero emissions mining operation and the final investment decision is expected in the second half of 2022. OZL currently guides to production of 120,000-145,000 tonnes of copper (and 220,000-243,000 ounces of gold) at all in sustainable cost of US$1.25-1.40/lb, while the balance sheet at the September quarter had net cash of $188m and the dividend yield is approximately 1.3% fully franked.
Increased BHP Group (BHP) | Blended & Income Portfolio
We last added to BHP in March 2020, having subsequently reduced the position in December 2020 and again in May 2021. It has been a core stock in the portfolio since inception but its significant share price volatility due to macroeconomic and commodity market conditions warrants some flexibility in its portfolio weight. The BHP Ltd share price has declined 25% since the Singapore spot iron ore benchmark price peaked at ~USD224 in May. Although iron ore made up 57% of FY21 revenues for BHP, market expectations already factored a steep decline in iron ore prices during FY22. Since the FY21 result BHP has announced the unification of its dual listed structure into the Australian listing, the sale of BHP Petroleum to Woodside for scrip consideration payable directly to shareholders and approval of the USD5.7b Jansen Potash stage one project in Canada, with first ore due in 2027. BHP also plans to exit its remaining thermal coal assets. We view these developments favourably as the focused group will have forecast 2022 respective revenue/EBITDA exposure of iron ore 46%/54%, Copper 35%/35%, Nickel 4%/2%, Coking Coal 16%/9%. Market forecasts for 2022 free cashflow yield are 8.0-8.5%, with spot prices implying a free cashflow yield of ~13%. With gearing below target and a simpler capital structure to be in place next year there is also potential for BHP to exceed its 50% dividend payout ratio and consider a share buyback.
Increased Telstra (TLS) | Blended & Income Portfolio
Telstra’s T25 strategy aspirations have recently been reiterated in its Investor Day #2, which target mid-single digit annual EBITDA growth rate from FY21-25 and underlying eps growth of high teens. This is to be underpinned by mid-single digit mobile services revenue growth. Telstra has also outlined its strategy in Health and Energy Retailing to assist this growth at the margin. This earnings trajectory would see Telstra’s annual dividend of 16cps (ordinary plus special) be maintained through the period and enable it to transition to a 16cps ordinary dividend, for sustainable yield of 4.1%. With a net debt to EBITDA ratio of ~1.0 and more than 5 times interest cover, Telstra’s balance sheet is very robust.
Increased Brambles Ltd (BXB) | Blended Portfolio
Brambles first-quarter trading update exceeded our expectations with 9% sales growth (constant currency), reflecting rollover pricing benefits across all key markets. Sales growth is expected to moderate for the remainder of FY22, with Brambles maintaining its guidance of sales growth of 5-7% and underlying profit growth of 1-2% for FY22. Brambles expects an acceleration of earnings growth to recommence in FY23 as the benefits of an investment program in supply chain automation and digitalisation are realised. The recent share price weakness provides an attractive valuation entry point with high single digit earnings growth forecast over FY23-FY26.
Increased News Corp (NWS) | Blended Portfolio
News Corp (NWS) first-quarter trading result was well ahead of market forecasts, delivering earnings momentum across Digital Real Estate, Dow Jones, Subscription Video and Book Publishing. Operating trends continue to improve, as NWS’s portfolio of businesses become increasingly digital, driving both revenue and earnings growth. Moreover, licensing deals with Google/Facebook on news content of ~100m per annum has further entrenched the value of its news content. Our investment thesis for NWS is underpinned by its sum-of-the-parts discount valuation, execution of an on-market buyback, potential realisation of Foxtel investment, and continued positive earnings momentum.