Interview: The companies this investor is watching this reporting season

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Sean Aylmer: Welcome to the Fear and Greed Business Interview. I’m Sean Aylmer.

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Sean Aylmer: We’re heading into earning season on the ASX, the time

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Sean Aylmer: when companies report profits and perhaps more importantly, let the

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Sean Aylmer: market know what they think is going to happen. Today

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Sean Aylmer: I wanted to get an idea of what to expect,

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Sean Aylmer: the trends and companies we should be keeping an eye on.

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Sean Aylmer: The Australian Foundation Investment Company, AFIC, is Australia’s oldest and

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Sean Aylmer: largest listed investment company, specialising in Australian equities. It reported

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Sean Aylmer: last week. It reported a drop in profit, but that

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Sean Aylmer: was mostly thanks to a mega dividend from BHP 12 months ago. Remember,

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Sean Aylmer: this is general information only. You should seek professional advice

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Sean Aylmer: before making any investment decisions. Mark Freeman is the Managing

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Sean Aylmer: Director of the Australian Foundation Investment Company. Mark, welcome to

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Sean Aylmer: Fear and Greed.

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Mark Freeman: Yeah, thanks for having me.

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Sean Aylmer: Just before we jump into it, can you give us

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Sean Aylmer: a 101 on list investment companies and exactly what you

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Sean Aylmer: guys do and how you invest?

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Mark Freeman: Sure. I guess the difference between a listed investment company

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Mark Freeman: and a managed fund is given the name, we are

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Mark Freeman: like managed funds, but we’re in a company structure rather

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Mark Freeman: than a trust structure and being in a company structure,

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Mark Freeman: we then are listed on the stock market and we

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Mark Freeman: put out monthly updates that says what is essentially fair

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Mark Freeman: value for the portfolio. We call that an NTA (Net Tangible Assets per share). And

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Mark Freeman: I guess, we see it’s an advantage of having a

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Mark Freeman: portfolio within a company structure, is that we’ve got a

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Mark Freeman: limited number of shares on issue. So we don’t have

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Mark Freeman: funds flowing in and out of our company on a

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Mark Freeman: regular basis, which requires us to keep buying or selling.

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Mark Freeman: We’ve got a fixed capital base, and so we can

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Mark Freeman: essentially control how we manage the portfolio and are not

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Mark Freeman: forced to transact based on whether money is coming in

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Mark Freeman: or out of the company. We do pay tax, so

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Mark Freeman: we are a tax aware investor. I guess that puts us

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Mark Freeman: into a similar position that most retail investors are. As

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Mark Freeman: many people may or may not understand, managed funds tend

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Mark Freeman: to see themselves or measure their performance pre-tax and give

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Mark Freeman: you performance numbers on that base. Ours are actually post-tax,

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Mark Freeman: so we are aware that tax can be a considerable

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Mark Freeman: drag on the performance, but that’s included in the way

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Mark Freeman: we run the funds. Being a company structure, we have

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Mark Freeman: a board of directors, group of people who are all

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Mark Freeman: experienced business people, often sitting on a number of boards.

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Mark Freeman: They provide oversight in terms of the company, so investors

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Mark Freeman: can take comfort that there is a group of people

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Mark Freeman: that oversee what we do. We have an investment committee

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Mark Freeman: that oversee how we manage the portfolios. There’s transparency from

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Mark Freeman: coming with a listed company. You can see our financial accounts.

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Mark Freeman: We make ourselves available at AGMs and shareholder briefings. You

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Mark Freeman: can see what we do. You can interrogate us. We make

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Mark Freeman: ourselves accountable and we tend to be long-term investors. And

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Mark Freeman: so we’re trying to find quality companies that we can truly

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Mark Freeman: hold the long-term and we understand the importance of paying

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Mark Freeman: out franked dividends to our investors. So that’s a bit

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Mark Freeman: of an overview.

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Sean Aylmer: So some of your big holdings are companies that we’d

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Sean Aylmer: all know, BHP, Commonwealth Bank, CSL, Macquarie, Transurban. Your results

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Sean Aylmer: very much reflect how those companies perform. So the net

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Sean Aylmer: profit last week of $310 million, which was down a bit, 14%,

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Sean Aylmer: that was I think in part because of the special

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Sean Aylmer: div that BHP paid out, but am I right basically

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Sean Aylmer: saying if the companies that you are holding do well,

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Sean Aylmer: you tend to do well, as does your share price?

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Mark Freeman: Yeah, that’s right. We’re essentially a conduit between the investments

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Mark Freeman: that we hold and our end investors. And I think

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Mark Freeman: the other thing I didn’t put out earlier is the

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Mark Freeman: cost to run efficacy is around 0.14% with no performance fees.

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Mark Freeman: So it’s a very low cost to run it. Shareholders own

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Mark Freeman: the company. We’re accountable to the shareholders. So therefore, given

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Mark Freeman: that very low cost to run the business, as you said,

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Mark Freeman: it means the performance we get out of our investments

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Mark Freeman: flow through to our end shareholders.

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Sean Aylmer: So with all that in mind, we’ve got earning season

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Sean Aylmer: kicking off properly this week. We had a few last

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Sean Aylmer: week, but basically things heat up during the middle of

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Sean Aylmer: this week and beyond. What are the key themes that

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Sean Aylmer: you’ll think you’ll see during reporting season?

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Mark Freeman: Yeah, well look, going into any reporting season, everyone’s trying

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Mark Freeman: to predict how the market will go. I guess one of the

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Mark Freeman: factors I think about though is, where’s the market at

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Mark Freeman: going into that reporting season? So if the market is

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Mark Freeman: very high or has had a very high run, it’s

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Mark Freeman: quite likely that whatever companies produce will probably disappoint the

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Mark Freeman: market. If the market’s at a very low level, once

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Mark Freeman: again, company results will more likely provide a movement upwards.

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Mark Freeman: So there’s the results the companies produce, it’s where the

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Mark Freeman: market is, but in particular, it’s the outlook comments that

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Mark Freeman: companies make. And particularly going to this year, I think most

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Mark Freeman: market participants have been surprised at how well equity markets

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Mark Freeman: have held up here and globally. It’s fair to say

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Mark Freeman: that going back three or four, five months, everyone was

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Mark Freeman: expecting the economy to really tail off with rising interest

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Mark Freeman: rates.
Everyone was expecting a fair bit of pressure to

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Mark Freeman: come on the economy and certainly there are areas that

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Mark Freeman: are under that pressure, but broadly, company profits have held

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Mark Freeman: up pretty well. The US economy seems to have held

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Mark Freeman: up pretty well. And so we go into this period

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Mark Freeman: and probably results will be broadly be reasonable. So I

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Mark Freeman: think then what people will be saying, well, how are you

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Mark Freeman: seeing the next six months? Are you starting to see

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Mark Freeman: finally some signs of a slowdown occurring with customers? And

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Mark Freeman: when you talk about the resource part of the market,

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Mark Freeman: that’s very leveraged to what China may or may not

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Mark Freeman: be doing.

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Sean Aylmer: Stay with me, Mark, we’ll be back in a minute.

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Sean Aylmer: I’m speaking to Mark Freeman, Managing Director of the Australian

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Sean Aylmer: Foundation Investment Company. So let’s take resources and the big

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Sean Aylmer: miners in particular, what do you expect to hear from

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Sean Aylmer: them over the next couple of weeks, given what’s playing

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Sean Aylmer: out in China and the uncertainty around stimulus? Having said that,

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Sean Aylmer: last week they did come out and say they’re trying

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Sean Aylmer: to help the property market, which will help commodities, but

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Sean Aylmer: consumers are still seemingly not a lot around for them

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Sean Aylmer: at the moment. How do you think it, what will

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Sean Aylmer: the BHPs and that be talking about?

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Mark Freeman: Look, I think it’ll be, certainly they’ll have healthy balance

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Mark Freeman: sheets. I think they’ll probably talk about the cashflow and

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Mark Freeman: dividends they’re producing and the big resource companies, the BHP

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Mark Freeman: and Rio, they have become important sources of franked dividends

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Mark Freeman: to Australian investors. And I think the model those companies

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Mark Freeman: have at the moment is to keep themselves financially strong

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Mark Freeman: and get dividends to shareholders, which we appreciate and applaud.

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Mark Freeman: And I think everyone will want to know what they’re seeing out of China and

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Mark Freeman: as you said, the stimulus that comes out of China.

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Mark Freeman: I think there had been an expectation that perhaps they

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Mark Freeman: would start to pull that back a bit. They want

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Mark Freeman: to see their economy more driven by a consumer led

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Mark Freeman: approach rather than constantly having to do capital investments. But

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Mark Freeman: once again, it sounds like that sort of stimulus may

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Mark Freeman: continue, which gets resource stocks running in the short term.

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Mark Freeman: So I think that’ll be a discussion about where they

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Mark Freeman: see China and its policies.

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Sean Aylmer: Among the big four banks only Commonwealth Bank reports in

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Sean Aylmer: the next few weeks. Macquarie Group also reports, but with

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Sean Aylmer: Commonwealth Bank particularly, is it that ongoing story of profit

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Sean Aylmer: margins as in net interest margins?

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Mark Freeman: Yeah, well that’s the focus and probably increasingly though, everyone’s

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Mark Freeman: watching what’s happening with the bad debts. Are they rising?

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Mark Freeman: They’ve been incredibly low for a number of years now

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Mark Freeman: and most people would say probably unsustainable, so everyone’s expecting

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Mark Freeman: them to creep up a bit. But I think compared

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Mark Freeman: to perhaps where we were in the past is, the

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Mark Freeman: capital that banks have to hold now is far greater

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Mark Freeman: than it ever used to be. So they are in

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Mark Freeman: a financially stronger position. All the four banks have to

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Mark Freeman: focus their businesses. They’ve sold off what you’d call sort

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Mark Freeman: of non-core assets and got back to core banking activities.

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Mark Freeman: They have more sustainable payout ratios, so the dividends can

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Mark Freeman: be a bit more reliable. So in this environment, the

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Mark Freeman: dividends and the franked dividends they pay out, we are

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Mark Freeman: pretty comfortable with. And I think the part the market

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Mark Freeman: often misses with the banks is perhaps an under-appreciation of

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Mark Freeman: the value of the franking credits. And we certainly value that. We’ve

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Mark Freeman: been nibbling a little bit at NAB as it dipped,

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Mark Freeman: because we look for what we call temporary bad news

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Mark Freeman: in the stock. It tends to provide the best buying opportunities.

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Mark Freeman: So we have a list of companies that pass our

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Mark Freeman: quality criteria. Then it’s often bad news that invites us

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Mark Freeman: to add more. With the banks, you had a double

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Mark Freeman: whammy between rates going up, but also there was obviously

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Mark Freeman: a lot of issues with the US banks recently. A

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Mark Freeman: few of the regional banks went under. That caused a

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Mark Freeman: lot of nervousness in our banks. They got sold off

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Mark Freeman: quite a lot and we were starting to see some value.

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Mark Freeman: So NAB, for example, got to a yield of about

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Mark Freeman: around 6%. When you add ranking to that, you’re getting

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Mark Freeman: something close to 9% yield and that’s when we start

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Mark Freeman: seeing some value in the banks.

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Sean Aylmer: What about, another one I want to mention when you

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Sean Aylmer: talk about seeing value is CSL. You hold CSL. It

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Sean Aylmer: has been a darling of the market until about the

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Sean Aylmer: middle of last month, and it’s come off about 15%

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Sean Aylmer: there on some misses. What do you expect from CSL this

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Sean Aylmer: reporting season?

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Mark Freeman: I guess it goes with these same patterns where the market,

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Mark Freeman: I think, was a little bit of ahead of itself

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Mark Freeman: in terms of the profit forecast. There’s still an ongoing recovery

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Mark Freeman: from the COVID period coming through and downgrading a profit forecast.

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Mark Freeman: The market doesn’t like it, and it was on probably,

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Mark Freeman: I would say a fairly full valuation, PE multiples in

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Mark Freeman: the low thirties, but it’s had quite a significant pullback now.

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Mark Freeman: So it’s back to more what I would call longer

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Mark Freeman: term multiples. So I’d say it’s a very fair price

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Mark Freeman: for this stock now, and there’s still lots of projects

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Mark Freeman: they’ve got in play. There’s still some quite significant products

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Mark Freeman: that are going through trials. One in particular, the market

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Mark Freeman: is quite excited by, which is a product they’ve been

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Mark Freeman: working on for a number of years that, again, it’s

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Mark Freeman: an outcome of their plasma product that they extract. They

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Mark Freeman: utilise components within plasma to produce the products that they do,

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Mark Freeman: but then a lot of it’s wasted and they do

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Mark Freeman: a lot of research on the wasted product, and they’re

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Mark Freeman: working on a product that if you suffer a stroke,

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Mark Freeman: you take this product and it’ll help clear the arteries.

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Mark Freeman: But look, when you’re in trials, these are very high risk.

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Mark Freeman: But I’m really trying to do that to illustrate that

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Mark Freeman: there are a number of projects the company’s working on

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Mark Freeman: that’ll take shape over a long period of time. But

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Mark Freeman: there’s temporary weakness in the share price because I really

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Mark Freeman: think because market’s expectations on profit growth were too high,

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Mark Freeman: they’ve really come back to much more reasonable levels and

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Mark Freeman: the stock’s come back to a much fairer price.

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Sean Aylmer: Mark, thank you for talking to Fear and Greed.

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Mark Freeman: Pleasure. Anytime.

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Sean Aylmer: That was Mark Freeman, Managing Director of the Australian Foundation

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Sean Aylmer: Investment Company. This is the Fear and Greed Business Interview. Remember,

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Sean Aylmer: this is general information only and you should seek professional

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Sean Aylmer: advice before making investment decisions. Join us every morning for the

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Sean Aylmer: full episode of Fear and Greed, Australia’s best business podcast.

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Sean Aylmer: I’m Sean Aylmer. Enjoy your day.