At Devon we focus a significant amount of time and energy on the Australian stock market and we have a heavy investment weighting to it across many of our funds. In recent months our Australian exposure has performed well and has helped drive the good returns we have achieved, however over the past five years the Australian market has notably underperformed the New Zealand market. As we look to the future we are of the view that valuations in Australia are looking increasingly attractive and we are currently identifying a range of very interesting investment opportunities over there. The most direct exposure we offer to the Australian market is the Devon Australian Fund - many of the Devon funds invest into Australia but the Australian Fund is solely focused there with a diversified portfolio of around 35 listed Australian companies.
The Australian market offers significant attractions for NZ equity investors – it is much larger than the New Zealand market (A$1.8 trillion versus NZ$100bn) and offers exposure to a number of sectors that are not available in New Zealand. It is also much more representative of the underlying economy with a large exposure to banks and materials in particular.
The performance of the Australian market has been particularly strong over the last quarter - the S&P/ASX 200 rose 8.5%, outperforming most other global equity markets (New Zealand finished up 7.5% over the same period) and during the year to June 2018 it rallied 13.0%, its second year of double digit returns. Having underperformed global markets during 2017, this year has been much better for Australia and its relative returns have significantly improved.
A number of factors have contributed to this, including;
- Business confidence, which has tracked at elevated levels over the past 12 months. Recently it has been at levels almost double its long-run average, which is in stark contrast to the New Zealand experience. Australian GDP growth in the first quarter expanded by 1% relative to the last quarter and by 3.1% over the same period last year. Both these data points were stronger than expected. Australian GDP growth is now tracking above that in NZ.
- The weaker Australian Dollar (relative to the US Dollar) and low interest rates have been supportive for equities. Despite strong GDP data the Reserve Bank of Australia appears unlikely to raise interest rates for the foreseeable future, due to concerns around the potential escalation in the US-China trade dispute and the possible risks to housing markets from the Royal Commission review into bank lending practices and elevated household debt.
- Global economic strength has driven improved demand for commodities, underpinning prices and volume demand. This has seen a strong recovery in not just the large miners like BHP and Rio Tinto but also in their smaller counterparts and across the mining services sector.
- A strong global environment has also helped other companies that earn offshore revenue. A large portion (circa 40%) of ASX 200 profits are influenced by global trends including commodity prices, currencies and off-shore earnings. Strong sectoral performance in Energy, Healthcare, Materials and Diversified Financials are being supported by these positive trends.
- Dividend Yields – Australia is benefiting from offshore investment flows as global investors look to achieve exposure to listed equities that pay high and sustainable dividend yields. On a one-year forward basis the Australian market currently has a dividend yield of almost 4.5%.
At Devon we believe in the value of intensive research and follow a fundamental process that involves visiting many companies across a range of sectors and countries. Our proximity to Australia means a Devon team member is across the Tasman almost every week and we have attended over 200 meetings with Australian corporates during the last twelve months. These visits are made to both review existing holdings and research new ideas. A key advantage of being based in New Zealand is that all due diligence and investment work is done internally away from the day to day “noise” of the Australian market. Our analytical focus on cash-flow and the heavy weighting we place on valuation in our investment decision making has generally not been rewarded over the past two years due to the markets being so heavily influenced by “momentum” strategies which are typically valuation agnostic, but over the long-term this approach has resulted in a good outperformance over a 3 and 5 year period.
We are very excited by the number of high conviction ideas that we are identifying in Australia, such as the following:
- Brambles (BXB) is a global provider of supply chain logistical solutions based on the provision of reusable pallets, crates and containers for shared use by multiple participants throughout the supply chain. BXB is the largest player in the global pallet pooling market with key client relationships including Unilever, Pepsi and Kellogg’s. Over the past year the US segment the business (around 35% of EBIT) has been challenged by cost inflation but the company is looking to mitigate these pressures through transportation surcharges, cost efficiencies and price rises. BXB has underperformed the market over the last year and is now trading at 6 year relative lows and in line with the broader Australian market. We see the current weakness as a good buying opportunity.
- Aristocrat Leisure (ALL) is primarily a manufacturer and seller of slot machines to casinos. It has around a 70% share of the Australian market, a meaningful exposure to Asia (mainly Macau where it has a 27% market share) and Latin America, and a large scale business in the US (31% share of video pokies). All markets, with the arguable exception of Macau, are mature and demand is primarily for replacement stock – machines are typically replaced every 10 to 12 years. The dramatic change in the business over recent years has been through the growth in the “participation” market in the US - where casinos lease games off manufacturers for a share of daily revenue. The other key development for ALL has been the growth of their digital business both organically (Product Madness) and by acquisition (Big Fish and Plarium). Their recent result confirmed positive trends across all divisions.
- PWR Holdings (PWR) is an Australian based business that focuses on the design and production of customised cooling systems for the motorsports and automotive industry. They work closely with racing teams involved in Formula One, NASCAR and the World Rally Championship and have a dominant market position in each. The group has been investing in staff (doubled in three years) and new facilities for R&D and manufacturing growth ahead of expected new demand. Revenue and earnings growth are forecast to accelerate in FY18-21. The outlook is very positive with opportunities to grow its Emerging Technologies division (electric cooling) across clients including Google and Tesla, increasing penetration in motorsports and in the automotive aftermarket.
- National Tyre & Wheel (NTD) is a wholesaler of (unsurprisingly) tyres and wheels to customers in Australia, New Zealand and South Africa under a range of brands including Cooper and Mickey Thompson, with a particular focus on the 4WD and SUV markets. The Group has recently started distributing a passenger car range which provides an interesting growth opportunity. The broader tyre market has been resilient and has grown in-line with an expanding vehicle fleet but the company’s exposure to 4WD and SUV vehicles (which has grown much more rapidly) has boosted earnings. This business has a successful history of growth, organically and through acquisition, which we expect to continue over the medium-term.
At Devon we have a long history of investing in Australia and believe we understand the market and its constituents well. Our deep institutional knowledge of the Australian investment world, allied with our rigorous investment approach, puts us in a strong position to add value from across the Tasman. We are excited by some of the opportunities we are finding in that market, particularly in comparison to the high multiples currently being applied to New Zealand businesses, and are confident that they will serve as productive investments in not just the Devon Australian Fund but across our broader portfolios.