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Portfolio

Portfolio Update – Purchase of Sydney Airport Limited (SYD)

By | Portfolio

Within investor portfolios, we have bought Sydney Airport Limited (SYD). Sydney Airport Limited has the concession to operate Australia’s largest airport, Sydney’s Kingsford Smith Airport until 2097. In 2019, the airport was used by 44 million passengers and connected Sydney to more than 90 destinations around the world. Revenue is generated by aeronautical charges largely based on a per passenger basis, rent from the hotel, logistics, office & retail tenants as well as parking and ground transport fees.

We are positive on the medium-term outlook for Sydney Airport Limited for the following reasons:

  • The airport has a monopoly position for both domestic and international airline passengers in Sydney and is a key freight hub given its proximity to the city and major road networks;
  • A weaker A$ makes Australia an attractive destination for international travellers which are more profitable for the airport. The pace of travel recovery across both international and domestic segments could be quicker than we anticipate;
  • It owns some of the most productive retail space in the country underpinned by fixed escalating rental revenue streams and it’s logistics and office portfolios are almost fully let and deliver solid annual increases;
  • Expiry of the Qantas Jetbase lease on 30 June 2020 (a 30 hectare site adjacent to the domestic airport with direct access to airside areas), gives SYD full operational control of the entire airport site for the first time and offers some attractive medium-term development opportunities.

Obviously the Covid-19 pandemic and associated travel restrictions present a significant short-term headwind. We are not expecting any real improvement in activity until the 2nd half of this year, and even then anticipate that it will be gradual. Furthermore, we expect the recovery in international travel to take longer than the domestic recovery as governments have to reopen borders which will likely be a staggered process and airlines assess existing routes – a recovery to pre-crisis levels is not expected until 2022. With the reduction in passengers, we also expect that the airport will have to provide some level of rent relief to its tenants such as retailers, car hire companies and hotels. This has been factored into our forecasts, but for long term investors, the current crises provide an opportunity to acquire a critical monopoly infrastructure asset at an attractive valuation.

Portfolio Update – Purchase of Beach Energy (BPT:ASX)

By | Portfolio

Across investor portfolios, we have bought Beach Energy (ASX: BPT), an oil and natural gas exploration and production company with interests in five producing basins across Australia and New Zealand. Via its interest in the Western Flank of the Cooper Basin, it is Australia’s largest onshore oil producer and supplies approximately 15% of Australian east coast domestic natural gas demand.

We are positive on the medium-term outlook for Beach for the following reasons:

· Firstly it has a strong balance sheet (net cash position), combined with growing operating cash flows, allows for self-funding of the significant investment in organic production growth at very high rates of return.

· High certainty of revenues and cash flow – Beach has limited exposure to lower domestic spot gas prices with almost all volumes contracted and by 2022, more than 70% of east coast sales are expected to be via higher-priced market offers versus current.

· Beach Energy is a well-managed low-cost producer with a diversified portfolio of quality assets and;

· Management continues to guide the market towards substantial production upside over the next 5 years and has demonstrated significant exploration and development success in allocating capital in the past.

Furthermore, at Elston Asset Management (EAM), we are focused on both value and growth when selecting businesses for investment. We believe Beach Energy meets both of these criteria with the material production and free cash flow growth over our 3 – 5-year investment horizon whilst trading at approximately 5 times this year’s EBIT we believe the business is inexpensive. In the short term, the coronavirus outbreak has clouded the outlook for global energy demand and production; this has provided a long-term opportunity to invest at a significant discount to our intrinsic value giving investors a margin for safety given obvious short-term uncertainties. EAM focus only on the top 100 companies enabling us to act decisively when market dislocation occurs, these dislocations present opportunities to invest in businesses that we understand well.

We have funded the purchase of Beach Energy from the sale of Tabcorp which we believe may take longer to turn around it’s waging business than initially anticipated.

Portfolio Update – Purchase of Treasury Wine Estates (ASX: TWE)

By | Portfolio

Across investors portfolios, we have bought Treasury Wine Estates (ASX: TWE). TWE is a vertically integrated global wine company focused on growing & sourcing grapes, winemaking and marketing & sales of its expanding portfolio of brands. The business has established a global footprint operating over 13,000 hectares of vines across 127 vineyards, 17 wineries and sales networks across more than 100 countries throughout Australia & New Zealand, the Americas, Asia and Europe.

We are positive on the medium-term outlook for Treasury Wine Estates for the following reasons:

  • A growing portfolio of valuable brands, led by Penfolds, from multiple countries-of-origin enables the targeted regional premiumisation strategy based on local tastes which increase average selling prices and margins
  • Asia is a material opportunity with wine consumption significantly below developed market averages but growing solidly particularly at premium price points. China, in particular, offers substantial opportunity via a growing middle-class and underpenetrated Tier 2+ cities in terms of wine consumption
  • The shift to Luxury and Masstige segments away from the Commercial segment over recent years leaves the company less susceptible to inventory write-downs since the cheaper wines do not store as well as premium wines
  • Changes to the US distribution model that provides the opportunity to capture a portion of the distributor margin combined with the consolidation of the Commercial segment provides scope to increase profitability over time

With the aim of maintaining a style neutral exposure within the portfolio, we are constantly balancing value against growth. We think TWE offers both. Softer conditions in the USA market followed by short term concerns around the CoronaVirus and Asian based sales has seen TWE’s share price fall substantially from close to $18 down to current levels around $9. We have forecast a CoronaVirus lead pullback in revenues within our modelling however we view this as a short-term cyclical event and not structural in nature. We also note TWE’s strong balance sheet which should allow the business to withstand any earnings decline. We see the market reaction as a short term disconnect between price and value providing an opportunity to longer-term investors such as ourselves. With regards to growth, TWE maintains a robust outlook. The business has a track record of generating earnings growth and with the exception of lower earnings forecast for the current year, the business is expected to continue to achieve robust levels of earnings growth going forward.

We have funded the acquisition of TWE through selling our position in Fortescue Metals. Our main investment thesis for holding Fortescue was the narrowing of the pricing discount applied to Fortescue’s lower quality ore. This thesis has played out which combined with iron ore prices currently well above our expectations going forward means we see limited long term upside for the miner.

UK banks move into Virgin territory

By | Blog, Portfolio

The stock in focus this month is CYBG (CYB). CYBG is a full service UK bank previously owned by NAB. After years of underperformance CYB was demerged in 2016.

It operates under the brands Clydesdale Bank, Yorkshire Bank and more recently B Brands. Despite serving nearly three million customers and having a branch network of over 200 branches and business banking centres, CYB struggled to grow its footprint nationally and has been largely confined to Scotland and the north and midlands of England.

This led to a major strategy shake-up. In June 2018 CYB purchased Virgin Money, an iconic brand with strong credit card and mass mortgage product capability in different geographical markets. The combination with CYB’s retail and SME customer base made strong strategic sense.

The complementary nature of the business means that substantial cost savings are targeted with expectations of annual net cost savings of 200 million pounds by 2022, enabling the Bank to significantly reduce their cost to income ratio.

The other exciting opportunity for management is to lever the other aspects of the Virgin group to enhance the experience for Bank customers and to begin to build an ecosystem which incorporates the other Virgin brands that UK consumers are using including Virgin Atlantic, Virgin Mobile and Virgin Media.

However, in the short term there are macro factors impacting the UK economy, specifically regarding Brexit and the political and economic uncertainty this is creating.

After talking to CYB and other UK focused firms, most businesses in the UK are in a holding pattern until this situation is resolved. With the new PM in place, this resolution, while still unknown, is closer to happening.

While any solution will probably lead to short term volatility, the long runway for the process means that authorities and policy makers are prepared to provide the support the system needs to overcome these short term issues. We therefore see this as an opportunity to purchase businesses at a good level for the longer term.

Quick Snapshot

  • CYB will change its name and branding to Virgin Money from late 2019.
  • The newly combined entity will have 9 billion pounds of deposits and 7 billion pounds of lending.
  • The flagship product, the Virgin Money personal account, will launch in the third quarter of this financial year.

Purchase of Westpac Banking Corporation

By | Portfolio

Across the Australian Equity component of investor accounts we have bought Westpac Banking Corporation (WBC). Westpac Banking Corporation is Australia’s oldest banking and financial services group, with branches and operations throughout Australia, New Zealand and the near Pacific region as well as offices in key cities around the world. This purchase has been funded from the sale of Commonwealth Bank of Australia (CBA).

We are positive on the medium-term outlook for WBC for the following reasons:

  • It has a relatively low risk business mix with overweight exposure to retail banking, as represented by peer group leading impairments performance;
  • Operating expenses are being well managed and the ongoing efficiency program is delivering consistent annual savings;
  • The balance sheet is strong with ongoing organic capital generation positioning it well for expected increases in core tier 1 capital requirements. Along with its peers it is amongst the best capitalised banks in the world;
  • With bond yields low Westpac (and the banking industry generally), will continue to find support from retail investors given their attractive fully franked dividend yield.

As with all investments it is not without risks which include increased pressure on Bank margins from lower interest rates and cost pressures, exposure to the domestic housing market and ongoing regulatory scrutiny following the recent Hayne Royal Commission.

The purchase was funded from the sale of CBA. While their businesses are largely the same, there is a large valuation differential between WBC and CBA, beyond the historic premium that CBA has been afforded (with WBC at 1.5 times price to book value and CBA 2.1 times). This in conjunction with the fact that CBA has just gone ex-dividend for its FY19 final dividend, we believe WBC offers greater income and has greater valuation support over the medium term.

Download Westpac Factsheet

If you have any queries, please contact SB Wealth

Purchase of Clydesdale Bank

By | Portfolio

Across clients accounts, we have bought Clydesdale Bank, the UK based full-service bank focused on consumers and small and medium-sized enterprises (SMEs).

We are positive on the medium-term outlook for CYB for the following reasons:

  • It is well positioned to grow its loan and deposit book due to structural tailwinds for UK challenger banks, reductions in its capital requirements, and its ability to source deposits at costs lower than other challenger banks;
  • The business has significant balance sheet capacity to fund growth and should be able to increase its dividend payout ratio;
  • Merger with Virgin Money in the UK we see as complementary to the existing business and product lines while also providing opportunity for further cost out and simplification benefits;
  • CYB will be completely rebranded to Virgin Money which strategically enables management to improve the mix of assets by growing market share in the higher-margin business and personal lending portfolios while maintaining market share in the more competitive UK mortgage market;
  • Strength in combination of CYB, a traditional bank with a large customer base, network and strong capital position with a mostly digital neo-bank in Virgin Money; and
  • Short term uncertainty regarding the economic implications of Brexit has created a significant discount to what we believe to be the intrinsic valuation of the business.

We have funded the purchase through the sale of Ansell. ANN is a well-run business but at current valuations we see it as close to fully valued compared with the relative value in CYB. The positive catalysts in CYB flowing from the Virgin Money (VMA) acquisition and rebrand strategy mean that we see CYB as a more attractive proposition.

As with all equity investment, CYB is not without risk. While the strategic rationale behind the VMA merger is sound, as with all mergers, there remains the risk that the value of merger synergies (e.g. economies of scale, best practice, the sharing of capabilities and opportunities) may be overestimated.

Download Clydesdale Bank Factsheet

If you have any queries, please contact SB Wealth

Purchase of Origin Energy

By | Portfolio

Across client accounts we have bought Origin Energy (ORG), a vertically integrated energy company with operations including oil & gas exploration and production, power generation and retailing. This purchase has been funded from the sale of AGL.

We are positive on the medium-term outlook for ORG for the following reasons:

  • ORG owns 37.5% of APLNG, a global low-cost, long life LNG producer backed by long term contracts. Due to its position on the cost curve, it should be cash profitable throughout the economic cycle.
  • ORG also has a portfolio of strategically attractive electricity generation assets, which includes a mix of gas, modern coal and renewables. Not only does this provide generation flexibility depending on demand, but it also enables the company to divert gas between the spot gas and electricity markets to maximise value.
  • ORG has restored the strength of its balance sheet with gearing heading to the bottom of management’s target range. This combined with increased cash distributions from APLNG provides scope for a more progressive dividend policy from next financial year and may lead to other capital management initiatives in the medium term;
  • The LNG market is currently undersupplied from 2023-2025. During this period, prices are likely to increase significantly.

As with all investments it is not without risks which include being exposed to declining energy demand due to increased energy efficiency initiatives and changes in industry regulation. With its interest in APLNG there is the risk to dividends and debt reduction if oil prices fall significantly for an extended period.

As AGL has a similar business with the generation and sale of energy, it is exposed to similar risks that ORG. However, it lacks the level of vertical integration which ORG enjoys, and given the increasing cash distributions from APLNG we see more potential upside for both income and capital appreciation from ORG.

If you have any queries, please contact SB Wealth

Download Origin Energy Snapshot

Purchase of Clydesdale Bank

By | Portfolio

Across investor accounts, we have bought Clydesdale Bank (CYB), the UK based full-service bank focused on consumers and small and medium-sized enterprises (SMEs). The purchase was funded via the sale of Bank of Queensland (BOQ.ASX).

We are positive on the medium-term outlook for CYB for the following reasons:

  • CYB is well positioned to grow its loan and deposit book due to structural tailwinds for UK challenger banks, reductions in its capital requirements, its ability to source deposits at costs that are in line with larger incumbents; and leveraging opportunities arising from the recent Virgin Money merger
  • The UK government is looking to increase competition in the system. They are introducing a variety of incentives to help customers switch to smaller challenger banks;
  • CYB recently gained IRB (internal ratings-based approach) accreditation significantly reducing the capital intensity of the business as it reducing the risk weighting of loans. This means going forward it requires less capital to fund growth;
  • Deposit funding costs of the existing bank are broadly in line with large incumbents and well below other challenger banks meaning CYBG should have a pricing advantage vs competitors and should also be able to improve the profitability
  • CYB has significant balance sheet capacity to fund growth and should be able to increase its dividend payout ratio

We have funded the purchase through the sale of BOQ. BOQ’s recent result highlighted the pressures that increased funding costs and competitive lending environments are having on regional banks and we expect earnings to remain under pressure in the near term. The positive catalysts in CYB flowing from the Virgin Money (VMA) acquisition mean that we see CYB as a more attractive proposition.

As with all equity investment, CYB is not without risk. While the strategic rationale behind the VMA merger is sound, as with all mergers, there remains the risk that the value of merger synergies (e.g. economies of scale, best practice, the sharing of capabilities and opportunities) may be overestimated.

For more information refer to the CYB Company Snapshot attached.

If you have any queries, please contact SB Wealth

Download Company Snapshot – Clydesdale Bank