• Marcus Bogdan

Portfolio Changes - September 2018


Recent changes to the Blended Australian Equities Portfolio


Sold Bega Cheese Limited (BGA) - We have sold our position in Bega (BGA) following its FY18 result. Whilst FY18 headline growth was strong and in line with guidance, underlying organic growth noticeably weakened over the last 6 months. Organic earnings trends in Bega Cheese have continued to deteriorate and extended drought conditions remain a meaningful headwind in FY19. The acquisition of Mondelez assets in July 2017 and the acquisition of the Koroit facility in August 2018, had added considerable debt to BGA’s balance sheet. Valuation metrics on both an earnings and asset multiples remain elevated at a time when earnings quality is deteriorating, and the balance sheet is leveraged.


Sold Origin Energy (ORG) - We exited Origin Energy, having already reduced the position during July. The FY18 result was in line with guidance but the outlook for FY19 disappointed because Origin will absorb the impact of rising NSW wholesale prices rather than pass these on to consumers at a cost of $80m. This is a decision based on the increasingly hostile political and regulatory environment, which has deteriorated with both sides of parliament competing to reduce costs to consumers and in the process damage retailer returns. The Labor policy would expand the scope of the LNG export gas mechanism to focus on prices rather than market balance.


Kevin Gallagher, CEO Santos stated “if governments continue to escalate their interventions to change the rules after investments have been made in export projects, they increase the prospect of investors assessing Australia as being too risky a destination for their funds.” We agree.


Purchased Cooper Energy (COE) & Senex Energy (SXY) - We added these two mid-tier domestic gas producer/developers to offset the exit of Origin Energy and gain exposure to their projects which will increase supply of uncontracted gas to the east coast gas markets. The ACCC’s forecast gas price is $8.75-$11.00 and even under the Labor Party’s policy of the ACCC setting a “benchmark” price for gas, the ACCC has stated this is expected to be based on LNG net-back prices.


In the case of Cooper Energy, its revenues are expected to grow from FY18 $67.5m to more than $300m in FY20, with production from the Sole field in the Gippsland Basin Victoria to commence in FY19, followed by its Manta development. Senex is developing the Atlas project in Queensland which was granted by the state government to develop gas supply for domestic users. The field is in a well-defined area surrounded by LNG export projects, so its production outlook is relatively low risk for an unconventional gas field. Senex’s revenues are expected to grow from FY18 $73.1m to more than $200m in FY20. Our decision to own both companies is to diversify the risk of project timing and completion and to aggregate a position in the major sources of new domestic gas supply for the east coast in the near term and out to the mid-2020s. Importantly, these companies are not integrated electricity retailers nor LNG exporters, so they are not the focus of political regulatory scrutiny while they are adding to the domestic gas supply.


Increased Caltex Australia (CTX) - The Caltex 1H18 profit of $296m was a record result but at the lower end of guidance due to a weaker than expected refiner margin in June. However, the decline in the share price was driven by disappointment in the lack of restructuring to enable the return of the company’s significant franking credit balance to shareholders. The strategic review resulted in plans to “explore” forming a partnership with a property company and the ultimate sale of 15-25% of the site portfolio which is valued at $2b.


Whilst acknowledging this as a positive first step, its quantum was underwhelming. It may, however require greater investor activism to realise this value. Unambiguously, we see potential strategic value in the company’s assets and took advantage of the share price reaction.


Increased News Corporation (NWS) - Recent share price weakness has provided the opportunity to increase our weighting in News Corp (NWS). NWS’s FY18 result highlighted the continued strength in its Digital Real Estate business, driven primarily by growth in REA. Top line trends in its US Realtor business were also encouraging. While, operating trends for Foxtel remain challenging, the recent Foxtel-Fox Sports merger should provide more compelling sports programming and cost synergies. NWS’s valuation metrics are attractive on a sum-of-the parts basis and the retention of net cash on its balance sheet underpin its investment proposition.


Recent changes to the Australian Equities Income Portfolio


Increased Woolworths Group (WOW) - Woolworths recent share price weakness can be attributed to a mildly softer than expected FY18 result (Big W) and slower 1H19 sales growth in its Australian Food division (c.70% of Group EBIT). Interestingly, the transition of phasing out single use plastic bags has been problematic for the major supermarkets, as consumers purchased fewer items per basket. Nevertheless, based on similar programs executed by supermarkets internationally, we expect this to be a temporary adjustment. Holistically, our investment thesis in Woolworths is supported by the likelihood of further capital management. WOW recently announced a 10 -cent special dividend and a successful divestment of both its pubs investment in ALH Group and its petrol sites business should underpin further capital management initiatives.


Increased Caltex Australia (CTX) - The Caltex 1H18 profit of $296m was a record result but at the lower end of guidance due to a weaker than expected refiner margin in June. However, the decline in the share price was driven by disappointment in the lack of restructuring to enable the return of the company’s significant franking credit balance to shareholders. The strategic review resulted in plans to “explore” forming a partnership with a property company and the ultimate sale of 15-25% of the site portfolio which is valued at $2b.


Whilst acknowledging this as a positive first step, its quantum was underwhelming. It may, however require greater investor activism to realise this value. Unambiguously, we see potential strategic value in the company’s assets and took advantage of the share price reaction.

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Blackmore Capital Pty Ltd (ABN 72 622 402 895) (Blackmore Capital) is a Corporate Authorised Representative (CAR) of Artesian Venture Partners Pty Ltd (AFSL 284492)