Interview: Midway through earnings season, here’s what you need to know

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Jennifer Duke: Welcome to the Fear and Greed daily interview. I’m Jennifer

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Jennifer Duke: Duke. We’re now halfway through earning season and are getting

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Jennifer Duke: a clearer picture of the trends and some of the

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Jennifer Duke: factors affecting companies reporting their results. Last week saw some

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Jennifer Duke: big companies reporting, with some mixed outcomes, and this week’s

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Jennifer Duke: also gearing up to be a bit of a busy

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Jennifer Duke: one. It’s a lot for investors to process. That’s why

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Jennifer Duke: we thought we’d invite Roger Montgomery, the founder and chief

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Jennifer Duke: investment officer of Montgomery Investment Management, to take us through

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Jennifer Duke: some of the stocks and trends that he’s watching. Now,

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Jennifer Duke: this information is general in nature and you should seek

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Jennifer Duke: professional advice before making any investment decisions. Roger, welcome back

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Jennifer Duke: to Fear and Greed.

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Roger Montgomery: Great to be with you, Jen. Thank you for having me.

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Jennifer Duke: Let’s have a look at some of the companies that

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Jennifer Duke: you’ve been keeping an eye on. What did you make

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Jennifer Duke: of Carsales last week?

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Roger Montgomery: What was interesting is that despite absolutely soaring fuel costs,

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Roger Montgomery: which were expected to really hit sales of SUVs, which

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Roger Montgomery: are obviously the biggest selling vehicles in Australia, that didn’t

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Roger Montgomery: seem to happen, which was interesting. I mean, the company

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Roger Montgomery: did report a 301% increase in full year profit, but you

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Roger Montgomery: have to remember that was boosted by a revaluation of

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Roger Montgomery: about almost $500 million, about $486 million of its minority

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Roger Montgomery: stake in a US-based website called Trader Interactive, and also

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Roger Montgomery: a Brazilian business that it owns called Webmotors. So on

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Roger Montgomery: a proforma basis, which is where you’re assuming consolidation of the

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Roger Montgomery: acquisitions in both periods, revenue was up about 18%. It’s

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Roger Montgomery: still a good result and was somewhat surprising.

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Jennifer Duke: So, also Nick Scali reported last week. Any thoughts on their results?

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Roger Montgomery: Yeah, so Nick Scali was interesting because, number one, it

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Roger Montgomery: came out with earlier in the year around May, the

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Roger Montgomery: company had been saying that things are looking pretty bleak.

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Roger Montgomery: And the share price consequently was hammered. But they have

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Roger Montgomery: completely outperformed expectations. They reported sales revenue of about $508 million.

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Roger Montgomery: That was up 57%.

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Jennifer Duke: That’s crazy.

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Roger Montgomery: Yeah. And a gross margin of 63.5%. Now, part of

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Roger Montgomery: the reason for that is that they’ve seen… What they’ve

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Roger Montgomery: not done is discounted their products, but they’ve seen lower

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Roger Montgomery: freight costs and that means their margin has gone up.

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Roger Montgomery: And that’s continuing into the new year. What’s happening is

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Roger Montgomery: shipping expenses have declined since March, but they’re selling their

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Roger Montgomery: product at the same price. Rather than pass on the

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Roger Montgomery: lower shipping costs by lowering prices, they’re maintaining their higher prices,

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Roger Montgomery: and that means they’ve got this terrific margin improvement. And

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Roger Montgomery: so they’ve got better buying conditions because their buying power

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Roger Montgomery: is improving. And if analysts start to see this as structural,

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Roger Montgomery: then analysts are going to upgrade their earnings estimates for

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Roger Montgomery: next year, 2025 and 2026 as well.

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Jennifer Duke: Those two didn’t do what I expected them to do

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Jennifer Duke: at all given the cost of living pressures. But what

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Jennifer Duke: about JB Hi-Fi?

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Roger Montgomery: JB Hi-Fi is a slightly different picture. I mean, they

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Roger Montgomery: still are a brilliant business. They are really sort of

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Roger Montgomery: the litmus test for the consumer picture, notwithstanding that that

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Roger Montgomery: new CBA Household Spending Insights Report that’s now being conducted

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Roger Montgomery: on the 7 million credit card and debit card holders

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Roger Montgomery: that the bank has will be a pretty useful monthly report,

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Roger Montgomery: I think, because that’ll be up-to-date. Not withstanding that, JB

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Roger Montgomery: Hi-Fi is the litmus test for consumers in Australia and

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Roger Montgomery: they had sort of mixed results. Their sales increased by

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Roger Montgomery: just under 6%, which was great. Same store sales was

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Roger Montgomery: up about 5%. But The Good Guys, their results were

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Roger Montgomery: only up 0.8%, and their same store sales growth was

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Roger Montgomery: also up 0.8%. What’s interesting is that The Good Guys,

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Roger Montgomery: which obviously are selling major appliances, they’re selling products that

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Roger Montgomery: are largely at the tail end of renovation demand. I

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Roger Montgomery: don’t know if you know this Jen, but people buy

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Roger Montgomery: houses or they buy an apartment and typically in aggregate

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Roger Montgomery: or on average, there’s a 10- month lag between buying

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Roger Montgomery: a place and then renovating a place. And that’s because

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Roger Montgomery: it takes time to apply to council and so on.

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Roger Montgomery: And then after the renovation’s done, then you see demand

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Roger Montgomery: for appliances: fridges, freezers, those sorts of things, people installing

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Roger Montgomery: those into their kitchens and so forth. And that is

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Roger Montgomery: starting to slow down a little bit. So, JB Hi-Fi

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Roger Montgomery: noted that there’s increased variability now across months and across sectors,

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Roger Montgomery: and that’s going to make it challenging for them to

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Roger Montgomery: optimise their inventory. We saw their inventory come off about 8%,

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Roger Montgomery: which says that they’re pretty dynamic managers of their inventory.

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Roger Montgomery: But how they manage that going forward is going to

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Roger Montgomery: be quite a challenge because like-for-like sales have definitely slowed down.

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Jennifer Duke: Stay with me, Roger. We’ll be back in a minute.

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Jennifer Duke: My guest this morning is Roger Montgomery, Founder and Chief

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Jennifer Duke: Investment Officer of Montgomery Investment Management. That housing factor is

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Jennifer Duke: fascinating to me, actually. And I did think we also

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Jennifer Duke: saw Domain’s results and REA was a couple of weeks

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Jennifer Duke: ago now. What do you make of those two in

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Jennifer Duke: light of that picture with listings and what they were posting?

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Roger Montgomery: REA is a phenomenal business. We’ve owned it in the

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Roger Montgomery: past. We’ve talked about it for the last 13 years

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Roger Montgomery: on our blog. And it’s one of those businesses that

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Roger Montgomery: you can count on two hands the businesses of the

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Roger Montgomery: highest quality in Australia that have sustained that high quality

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Roger Montgomery: for a very long time, and REA is one of them. What

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Roger Montgomery: many people don’t understand is that REA’s performance is not

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Roger Montgomery: tied to house prices, but it’s tied to listings. And

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Roger Montgomery: what’s interesting is that over the last decade, national listings

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Roger Montgomery: have actually been declining in Australia, and yet REA’s profit

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Roger Montgomery: and revenue have been rising most years, with the exception

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Roger Montgomery: of the COVID of course. But the reason for the rise

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Roger Montgomery: in revenue has been, within them, they harbor the most

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Roger Montgomery: valuable competitive advantage of all, and that is the ability

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Roger Montgomery: to raise prices without a detrimental impact on volume.
The

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Roger Montgomery: worst thing you can do is if you start a

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Roger Montgomery: business and you start generating really high rates of return

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Roger Montgomery: on equity of 30 or 40%, your worry will always be

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Roger Montgomery: that a competitor comes in and charges a lower price

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Roger Montgomery: for the same thing, and they’ll undermine your profitability. Well,

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Roger Montgomery: the worst thing a competitor could do is offer the

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Roger Montgomery: same product for free. And here’s the thing, there are

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Roger Montgomery: 83 websites in Australia offering people the ability to list

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Roger Montgomery: their house for sale. And of those 83, about 78

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Roger Montgomery: of them or 79 of them charge nothing for it.

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Roger Montgomery: And yet REA’s website, realestate. com. au, has the most

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Roger Montgomery: number of houses and the most number of viewers, despite

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Roger Montgomery: the fact it’s the most expensive. So you really want

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Roger Montgomery: to own a business that can raise prices without detrimentally

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Roger Montgomery: impacting unit sales volume.
And they’ve been doing that regularly,

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Roger Montgomery: and they’re going to do it again in a couple

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Roger Montgomery: of months and raise their prices quite a bit, by

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Roger Montgomery: double digits. And they won’t see any reduction in the

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Roger Montgomery: number of people wanting to sell their house. In fact,

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Roger Montgomery: when it gets tougher to sell, it’s more important to

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Roger Montgomery: have your property listed on REA so that you can

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Roger Montgomery: sell your property. And then of course they’re going to

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Roger Montgomery: get a massive boost because listings have recently increased. Now,

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Roger Montgomery: whether that’s sustained or not, we don’t know, but listings

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Roger Montgomery: are picking up because there is some pressure on people

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Roger Montgomery: to sell property as a result of the 12 interest

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Roger Montgomery: rate increases that the RBA has put through.

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Jennifer Duke: Now, we will get to the… well, what’s happening this

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Jennifer Duke: week in a moment, but I can’t help but ask

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Jennifer Duke: you about a blog that you had up about the

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Jennifer Duke: mortgage cliff and how it’s more of a stepping stone.

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Jennifer Duke: Can you explain why you don’t think we’ve got a

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Jennifer Duke: mortgage cliff, and what’s a stepping stone, Roger?

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Roger Montgomery: Yeah. Many people would know that I write a fortnightly

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Roger Montgomery: column in The Australian. And back in November last year,

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Roger Montgomery: and earlier this year in March, I think it was,

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Roger Montgomery: I wrote a couple of articles for The Oz just explaining

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Roger Montgomery: that all of this fearmongering about the mortgage cliff was misplaced.

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Roger Montgomery: And the reason everyone was concerned was because there was a very

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Roger Montgomery: large number of people who’d borrowed money during the period

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Roger Montgomery: of the term funding facility that was offered by the

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Roger Montgomery: Reserve Bank of Australia to the banks. And that meant

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Roger Montgomery: that the banks could borrow for three years at 0.1%.

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Roger Montgomery: And consequently, when they can borrow money really cheaply, they

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Roger Montgomery: then go and lend that money really cheaply. And so they

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Roger Montgomery: were offering three and four- year mortgages for as little

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Roger Montgomery: as 1. 98%. And so a lot of people borrowed money

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Roger Montgomery: fixed rather than variable. So in Australia, we usually see

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Roger Montgomery: people on a month- to- month basis. It’s usually 15 to 18%

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Roger Montgomery: of new mortgages written that are fixed. And the rest

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Roger Montgomery: of them, the vast majority, 82% or thereabouts, are written variable.

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Roger Montgomery: But during 2021, there were a couple of months there

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Roger Montgomery: where about 45% of new loans written were fixed. And

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Roger Montgomery: that’s because the fixed rate was lower than the variable

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Roger Montgomery: rate at the time. And that’s highly unusual, we don’t

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Roger Montgomery: see that in Australia. And that’s why we saw that jump.

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Roger Montgomery: But remember this, I remember years and years ago, Jen,

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Roger Montgomery: and I’ll just digress for a second. I was at

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Roger Montgomery: university and I remember reading a newspaper headline and it said…

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Roger Montgomery: What did it say exactly? It was something like, ” 40%

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Roger Montgomery: of homes burgled have inadequate security.” And that was the headline.

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Roger Montgomery: And I thought to myself… And I was studying statistics

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Roger Montgomery: at university at the time, I thought, ” That means 60%

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Roger Montgomery: of homes burgled have adequate security.” In fact, you’re better

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Roger Montgomery: off having no security because there’s only a 40% chance

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Roger Montgomery: of you being robbed.

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Jennifer Duke: Don’t let logic get in the way of a good headline.

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Roger Montgomery: That’s right. And so it was the same thing that

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Roger Montgomery: I noticed with all of these headlines about the mortgage

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Roger Montgomery: cliff. They’re saying, ” 45% of people on a monthly basis

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Roger Montgomery: are taking out fixed rate mortgages. They’re going to roll

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Roger Montgomery: off onto variable, and when they roll off onto variable,

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Roger Montgomery: they’re going to go from 1. 98% to 6% and they’re

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Roger Montgomery: going to have to sell their houses. They’re not going

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Roger Montgomery: to be able to afford it.” And I thought to

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Roger Montgomery: myself, ‘But hang on a sec. Even at those peak

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Roger Montgomery: months when 45% of loans were written as fixed, 55%

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Roger Montgomery: were written as variable. And even before that we had

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Roger Montgomery: 85%, the standard is about 85% variable.” So the vast

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Roger Montgomery: majority of loans, a significant number of loans are variable.

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Roger Montgomery: And they’ve already experienced the increase in interest rates, and

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Roger Montgomery: we’re not falling off a cliff.
So this smaller proportion

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Roger Montgomery: of people who are going to go from fixed to

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Roger Montgomery: variable, yes, there’ll be a few people that are shocked

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Roger Montgomery: by it. But we already know the vast majority have

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Roger Montgomery: been able to stomach, endure and survive the increase in

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Roger Montgomery: interest rates without pushing the economy into a deep recession.

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Roger Montgomery: So these few people who are going to switch from

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Roger Montgomery: fixed to variable, they’re not going to be the straw

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Roger Montgomery: that breaks the camel’s back, so to speak. So I

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Roger Montgomery: was just saying that everyone’s unnecessarily concerned about this. It

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Roger Montgomery: won’t be a cliff, it’ll be a gutter that we’ll

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Roger Montgomery: step over. It will be a speed bump, not a

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Roger Montgomery: cliff that we’ll all fall off.

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Jennifer Duke: I don’t think I can argue with that logic. And

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Jennifer Duke: just finally, what should investors be keeping an eye on

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Jennifer Duke: for the week ahead?

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Roger Montgomery: Well, we’re still in the thick of reporting season, so

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Roger Montgomery: it’s going to be a busy week. And again, I

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Roger Montgomery: think everyone will be thinking very, very carefully about the

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Roger Montgomery: businesses that sell to retail. So Universal Store, for example,

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Roger Montgomery: will be reporting next week. And these are some of

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Roger Montgomery: the smaller cap companies because I think that’s where the

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Roger Montgomery: interesting stories really are. Obviously, the headlines are dominated by

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Roger Montgomery: the majors. But really what we want to know is

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Roger Montgomery: what’s going on in consumer land because it’s the biggest

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Roger Montgomery: part of our economy. So Kogan will be out, Domino’s

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Roger Montgomery: Pizza will be out. Breville will report.
Breville’s an interesting

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Roger Montgomery: business, just as an aside, because a lot of people

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Roger Montgomery: think of it as a retail business. They don’t have

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Roger Montgomery: any stores. They sell through other stores. They are a

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Roger Montgomery: brand ambassador, if you like, and an inventor. So we

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Roger Montgomery: really like that business. That’ll be an interesting one as

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Roger Montgomery: well. Ardent Leisure will come out, so we’ll see how

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Roger Montgomery: spending on recreation is going. So there are some interesting

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Roger Montgomery: retail businesses that will be putting out their results, and all

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Roger Montgomery: eyes will be on them.

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Jennifer Duke: Roger, thank you very much for talking to Fear and Greed.

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Roger Montgomery: Great to be on the program again. Look forward to

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Roger Montgomery: talking with you again soon.

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Jennifer Duke: And that was Roger Montgomery, the Founder and Chief Investment

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Jennifer Duke: Officer of Montgomery Investment Management. This is the Fear and

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Jennifer Duke: Greed daily interview. Remember, this information is general in nature,

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Jennifer Duke: and you should seek professional advice before making any investment

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Jennifer Duke: decisions. Join us every morning for the full episode of

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Jennifer Duke: Fear and Greed, Australia’s most popular business podcast. I’m Jennifer

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Jennifer Duke: Duke, economics correspondent for Capital Brief. I’m filling in for

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Jennifer Duke: Sean Aylmer. Have a great day.