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Featuring Daniel Moore and Mike O'Neill

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Daniel Moore and Mike O’Neill from IML discuss the key themes which emerged from Reporting Season, the performance of IML’s large cap portfolios and how they view the future outlook for markets.

Edited transcript

Daniel: So Mike, with a few hours to go in reporting season, it’s fair to say it’s been a little bit mixed. Markets are down roughly 1% for the month. We’re seeing some good results: roughly about a third of results beat expectations; about a third were in line and a third were below expectations. So a little bit mixed. And as always, there’s some key themes that come out of reporting season. So, probably the first key thing was the consumer, more resilient than expected. And we saw a number of retailer results, particularly in the consumer discretionary space, which were a little bit better than expected. Whether it was JB [Hi-Fi]’s or Nick Scali, companies we don’t actually own in the portfolio. Sales were roughly for the sector flattish in the second half of the financial year and outlook statements were slightly negative. I think JB’s sales were down about 3% in July. But that’s still 38% above COVID. So better than expected, despite the small decline. So that was definitely a key theme, one key theme across reporting season.

Michael: It feels like some of these macroeconomic effects are being felt unevenly. And if we look at the bank results, there was fear around a bad debt cycle, but looking at CBA’s result in particular, it feels like we were all jumping at shadows because there wasn’t any real evidence of stress. You know, we saw arrears remain near historic lows. In fact, the 90-day arrears are still under half a percent. And we only saw a minor tick up in the 30-day arrears to just over 0.9%. So one of the big reasons is over the last four years, the balances in offset accounts and redraws has outpaced mortgage growth considerably. We’ve only seen a minor turnaround in offset balances, down from $70 to $69 billion for CBA in the last six months. And the stat that most interests me is the fact that hardship claims where a customer seeks out assistance from the bank because they’re facing the risk of not meeting their repayments, they are still 27% percent below pre-COVID levels, which is surprising.

So another key theme we saw during reporting season was around interest rates and bond yields and the differential impact of these changes on different sectors. So one key beneficiary of rising rates and bond yields is the insurance sector.

Daniel: Absolutely.

Michael: So if you look at what the insurance companies have been earning on their investment portfolios, as rates have been falling for the last decade, In 2022, the earnings they earned on their investments to back future claims was 1.5%. In the last year, it’s risen to 5%. So this benefits companies we own such as Medibank, Suncorp and IAG. And for companies with big retail brands with scale, they can manage inflation on the other side quite well. Medibank’s a stand out in this regard. For the first time in their listed history, we’ve seen premium rate increases considerably below headline inflation and below wage inflation. Another beneficiary of rising rates is the owners of regulated assets. So Aurizon owns 5,000 or so kilometers of rail across Queensland, Northern Territory and South Australia. So when inflation ticks up, the regulated asset value goes up with that calculation, and it provides a tailwind for earnings and dividends.

And probably one of the final beneficiaries under that interest rate dynamic is companies with strong balance sheets and strong cash flows. So Sonic [Healthcare], for instance, you know, they’ve retained windfall gains from COVID testing, and they’re able to find bargain acquisitions in this market, to build on their positions in markets such as Germany and Switzerland and enhance their competitive advantage in those markets. And of course there’s the losers out of rising rates.

Daniel: Yep.

Michael: The companies that benefitted from the last ten years as their valuations appreciated. That unwinds as rates go up. Particularly the REITs, such as Dexus, some of the infrastructure companies as well. Companies like The Lottery Corporation and of course, those companies with heavy levels of debt are finding repayments going up, and that will continue to drag on earnings in future years, companies like Ramsay and Transurban.

Daniel: Having a lot of debt, is definitely a bit of a weight on the shoulders at the moment for sure. And I guess if we sort of tie it all together, back to the portfolio, how did we go for for the month? We did pretty solidly. We’re sort of roughly in line, some funds a bit better, than the market. And I guess if we looked at maybe a couple of key results, I think Brambles was probably the standout for the portfolio.

Michael: Yeah, and it was nice to sort of end on a high note with a big position in our funds and see the stock go up. What was it? 7% on the day.

Daniel: Yeah, it was good.

Michael: It’s understandable given that they grew their earnings, per share 20%. This is in an environment of retail destocking, the volumes were down 2-3%. They got 16% in terms of price. I mean, that just points to the strength of the pricing power of their business. And they are now guiding to another year of double digit growth.

Daniel: Fantastic. It’s been a really good holding for the funds. And then, on the negative side, interestingly, Telstra, a big holding for the funds was down around 6% post its result but it was actually from our point of view a fantastic result. The NBN headwinds are well and truly behind them. They grew earnings, around 14%, which was a great outcome. They delivered really good pricing power. You know, prices are up strongly in mobile. Their NPS scores are up with their customers, which is impressive despite pushing up prices. And they guided for more strong growth in the coming years. So, a good result, but there was, perhaps a bit of disappointment that they decided not sell their infrastructure assets. So, sudden disappointment from the market about that, but in regards to the outlook for the business, the strength of the business, the result wasn’t too shabby at all. So, all in all, a bit mixed, but the IML portfolios have performed solidly.

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