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Podcast – Australian Stocks Education - Watershed

efan Angelini

Good day folks hello thanks for joining us today we've got a few people on the live event

today my name Stefan Angelini I'm the host today I'm the host of the Investor Types Podcast but as well as this special series the Asx Stock Tips Education series. We're fortunate enough to be joined by Watershed today who manage over 700 million dollars worth of assets.


Allright alright everybody welcome back hello on the screen I've got Daniel McDonald who founded and created the ASX Stock Tips Facebook Group is also Director of McDonald Legal, Adrian Rowley from Watershed Funds Management, who's gonna be our feature present and presenter today thanks a lot for coming on and I'm of course your host Stefan Angelini I run Angel Advisory a financial advisory practice based in Melbourne.


We're quite special today coming out of reporting season which is of course something that grabs everyone's attention we're lucky enough to be joined by Adrian to give us a bit of a wrap on reporting season. If you don't know Adrian he manages quite a large company with a lot of funds under management they've got a few different sectors to their business they run what's called SMA or managed accounts. Some of the some areas they invest into are international sectors they have vetting for large capitals all the sector. They also go into Adrian that's your microphone that's going a little bit crazy so I just muted you quickly there.


They also do they also have a quite a good focus on emerging markets and emerging leaders as well as small caps which is obviously of big interest to the group. But what I'm do is I might kick it off with introducing Daniel and Daniel's involvement in the group.


Daniel would you mind introducing yourself and maybe firing off a few questions to Adrian just to get us going.


Daniel McDonald

yeah sure thanks Stefan and hello members welcome to to our video today. It's really great

to to have you Adrian. Thanks a lot for being here a little bit about ASX.


Adrian Rowley

no worries


Daniel McDonald

yeah we started the group about about four years ago which wanted to get a community together. We noticed there was a bit of a a hole in in Facebook in terms of having an online community where people could share trading ideas and insights into companies and sectors and and emerging emerging industries.


So we started the group with just a handful of members and since then it's now grown to be Australia's largest ASX stock trading community on Facebook and we're just about to tip 50,000 members. And I guess you know the benefits the members get from the group is the ability to share ideas and the and the and communicate thoughts on particular companies and the and use some of the contributions from the other members to formulate insightful investment decisions. And in between a lot of the rocket emojis sometimes we actually get some of those insightful inside says giant through.


Quick question for you then so since March there's been significant growth in the IT sector. Assumption being a lot of this growth probably driven by a large proportion of the world's global workforce working from home and having to utilize IT infrastructure in order to function and do what they need to do.


Does Watershed have a view that this growth in the IT sector is gonna continue in the medium to long term?


Adrian Rowley

yeah look we do. I think you know what what this whole Covid crisis has done has really

accelerated a lot of the thematics that are driving the IT space. So if you think about

the big tech sectors the Amazons, the Microsoft a lot of their structural growth is coming from the shift to the club. And this environment has accelerated that plus obviously working from home everybody buying online so it's really accelerated a lot of these things that have been positive for the tech space you know for a number of years. But what we've what we've also seen I think is more of a there's been a big macro driver as well in that and and I'll touch on that a little bit in our presentation.


But in in an environment of ultra low interest rates with central banks pumping money into the system. It's very similar to the environment we have coming out of the GFC and and really any business that can grow its earnings in a low growth environment which is what we're expecting for the next few years as the world slowly gets out of this. People are willing to pay a premium for that growth when it's hard to find so you've seen really really strong multiple expansion right across the the tech space. To a point that it probably was a bit stretched and a bit overvalued and we've seen the Nasdaq come back pretty sharply. And I can comment on that a bit as well so you know all of this cheap money out there is flooding its way into markets QA design to reflate asset prices but in the short term it can really distort asset prices. And the first two sectors that we saw that happened so really with a gold complex and and some of the tech stocks not just U.S but here the Chinese tech stocks Israeli tech stocks. There's been a big wave of money chasing that space


Stefan Angelini

Quite a quite interesting space now Adrian I know you guys also run an emerging markets fund. We're gonna learn more our following reporting season on some of the big big cap stocks and how they reported


Adrian Rowley

Yeah


Stefan Angelini

In their in the emerging leaders fund they obviously look into smaller companies which is what a lot of the chat is within the group. What has driven a lot of the outperformance in your fund over the last few months?



Adrian Rowley

Sure there's a couple of things the first one is that we are very dynamic in how we manage the asset allocation. So we spend a lot of time thinking about market valuation the ultimate macro environment and earnings outlook and we we manage the the market weights fairly actively so you know coming into the correction in Feb and March. Our mid cap portfolio was 34% cash maximum cash for that mandate is 40%. So we we we were really concerned about the environment at the start of the year we had a lot of cash now when markets melted down in Feb and March I mean the large cap stocks and I run a large capital portfolio and spend most of months on there you know large cap stocks were off 20 30 some 40%. But in that mid cap space it was a bloodbath you know there were stocks that were off 60 70 percent I mean Afterpay which we own got under 10 dollars you know it was it was just incredible.


So we you know we got fully invested in March. So we we came out of that March quarter with only four to four percent cash so we got about 30% of the portfolio into mid cap stocks in in that correction. And really there were some high quality companies that whose share prices halved or more than halved despite being businesses that we thought should hold up fairly well in this environment.


So a good example is is Collins foods you know they run KFC's franchises and stores across the country you know that that should be a fairly defensive resilient business. But the share price more than half during that correction and sure enough we came out of this environment and they had strong sales growth strong revenue growth and and continue to deliver earnings growth. So you know it halved but it snapped back to where it was you know within a couple of months of the low. So you know for us equities are inherently volatile mid cap stocks are even more volatile. So we tend to hold a higher level of cash in that mandate because you do get opportunities to deploy cash and for us to deliver you know what we've been in markets for sort of 20 years now and there's nothing nothing worse than having a major market dislocation and not being able to do anything about it.


So you know while while it's incredibly important to get the stock calls right it's also incredibly important I think to to manage the overall weights of the portfolio there's times when everything's expensive and you should be disciplined and taking money off the table. And be patient to you know sit back and and make sure you've got a decent amount of capital to buy these dislocations when they happen. And really over the last 12 years we've had one every couple of years you know every two two and a half years you've kind of had a fairly major market dislocation for one reason or another.


Stefan Angelini

and even if you've got to look at indexes and the ASX 200 index returned. I think it was 19% for the 2019 year. So typically after periods of high rises will come a little bit of a fall so you want to make sure your asset allocation is positioned the right way. Look what's happened in the past maybe free up some cash so you can take advantage of opportunities, I mean that's what and that that's the game basically.


Adrian Rowley

spot on yeah it looks fine even in even in good years you tend to get a correction of 10% or so for you know for one reason or another.


Stefan Angelini

cash is king, cash is king, that's what they all say. Without a further a do, Adrian what we might head into is into the presentation you've got some really good really good data there especially coming out of reporting season. And what we might do is we might take some questions from the audience as you're presenting and fire up some questions at the end of it. So what I'll do now is I'll bring up the presentation and I'll hand it over to you mate


Adrian Rowley

great thank you so you can see my screen here if I flick through the slides


Stefan Angelini

yep can see the whole power point yep there we go


Adrian Rowley

brilliant. That's me when I had a little bit more hair. Here we go so look I'll start with I can't help but do a little bit of a macro backdrop I won't go to throw too much detail. But sitting here in Melbourne you know from our study that we're down and it's pretty easy to get you know a a bearish kind of view of the world and markets and the global economy when when we're in total lockdown. But but the rest of the world is continuing continuing to open up. Now now we're watching this very closely at the moment because you have started to see some restrictions because of the second wave in in Spain, the UK is talking about it a little bit. So you know that that that has us a little bit concerned but broadly speaking from the lockdown in March and April the rest of the world has continued to open up. So this is just Google's mobility data if you look at retail


For example and and this talks to those structural things that we were talking about a

little bit earlier. You know retail sales and should go the baseline here is is January and February so before the virus hit. So retail sales are now only sort of 10% below where they work but if you go to something like you know workplaces as well. Workplaces now that are only sort of 20% below where they were so despite the fact that we're locked down here.


Most of the rest of the world certainly Europe and large parts of the US and and large parts of Asia are are largely back to work. So you know with if that continues then effectively what we're looking at is is. You know a short very sharp recession this year. But coming into next year that we should have relatively synchronized global growth from most parts of the world and generally speaking that's a pretty good backdrop for four equities. Okay, but having said that we came into reporting period with about 15% cash with a view that we would get an opportunity to to add to a few holdings during the reporting period. Because it was likely to be a pretty tough one you know the whole the whole country was locked down pretty much for the last three months of the financial year. And in August as results were coming out Melbourne was back in in lockdown again. so our expectation was that you know not only would would results be fairly challenged but but outlooks would be fairly uncertain.


So our view was that you know we've got to get an opportunity to to deploy some cash during reporting season. Having said that during August the market was incredibly resilient we started the start of the month at about 6,000 we finished the month at about 6,000 there wasn't a lot of volatility. Having said that we've seen a 5 or 6 percent fall in the first few weeks of September and that's giving us an opportunity now to deploy some cash. But talking about valuation so as I mentioned we spend a lot of time thinking about the macro view and market valuation as well as the earnings outlook and determining you know what exposure we want to markets.


This this chart here in the shows the ASX 200 in the blue line. So you can see we nudged sort of 7,000 before the correction shut all the way back down to 4,000 but then rebounded really

quickly back to 6,000 we hit at the start of June. The red line here shows the underlying earnings of the ASX 200. So this is Bloomberg consensus forecast so effectively you saw analysts re-base earnings down about 30% as as the world sort of went into lockdown.


What is interesting is here in August. So so what this shows is that earnings expectations actually declined over the course of the month as results were being delivered so you know a lot of businesses didn't didn't meet the the earnings forecast that had already been pulled back 30%. But the market held up fairly well and you know there was almost a little bit of exuberance and we certainly saw that play out in some parts of the market like the S&P 500 and the Nasdaq and some of those tech stocks


Having said that we've seen a little bit of a pullback and that makes sense. So just to give you a feel you know on a current sort of earnings multiple here at around 6,000 we're trading on about 21 times earnings we've now pulled back to sort of 58 50-ish today. Now the one year forward multiple of our market is about 18 and a half now. So that's getting back to a more reasonable level given where interest rates are currently. But it's still fairly elevated so there's not a lot of room here for anything to go wrong with this second wave or lockdown. So markets are very much pricing in the world get continuing to get back to normal over the next 6 to 12 months.


Okay so here's just that one year forward multiple so it's about 18 and a half times next year's expected earnings and the market has an earnings growth of about 6% pencilled in for the ASX 200 at the moment. So you know where we're trading over the next 6 months that whether that 6% is held will be critical so as we know Victoria is still in lockdown where you know a bit over a quarter of the country's GDP. We'll have half year results coming out in February so the longer this lockdown lasts in Victoria the more risk there is to those half year results in in February. And you'll see that a lot a lot of the buying that we've done we're very much focused on on some of those global earners that aren't necessarily leveraged to the domestic economy here we're pretty cautious on domestic cyclical stocks that are leveraged to late economic activity here.


What is interesting though here is that you know the long run average multiple of our marketers as most of you would know is kind of 14 15 times. So 18 and a half is a relatively elevated multiple but you're more comfortable paying an elevated multiple for the market when earnings have rebates 30% lower


So if we take at 2 or 3 year view you would expect the earnings of the market to get back to where they were so you kind of got 20 to 30 percent earnings growth over the next 2 to 3 years which will see that multiple move back to a more normal level. So you're more comfortable paying an elevator pair if you think we are through the cyclical low in in that earnings number.



The other key driver which I touched on a bit earlier is this ultra low interest rate environment that we're in. So you know our cash rate here is 25 basis points the 10-year bond yield here is is is 90 basis points 0.9%. So you know the lower cash rates are the lower that risk-free bond yield is the more that people will pay for the market at the higher the multiple will be. Again I can talk to that in detail down the track it's not an issue for the next year or two but the market the next you know major kind of market correction in our view will probably be when when central banks start to try to normalize interest rates now that's probably not for at least a couple of years but that's that's really a key thing to to watch.


Okay now this is a a kind of a a bit of a scary and a bit of a disappointing graph here. You know we often get questions about why the Australian market has lagged the US so much you know we we only recently kind of got back to our GFC or pre-gfc highs in January and and we're now well below again. And the reason there is that you know we just haven't delivered the same underlying earnings growth that the US has.


So this is the same chart that I showed earlier but just for a longer time frame so it goes back to 2005. So it shows the ASX 200 in blue here now we sort of hit six and a half thousand or bit over just before the GFC. We just hit that level again before the Covid 19 correction. And what the red line shows you is the underlying earnings of our market. So we know that earnings got whacked 25 to 30 percent during the GFC they progressively recovered 2015-16 was when we had that China trade balance issue this iron ore oil prices plunged we had about a 25% market correction then. but recovered really nicely 2016 17 18.


The 30% sort of decline in earnings expectations for the current year has seen earnings now back to the low that we saw at the GFC. The the 2009 GFC recession low so the key question now is how long will it take for this figure to get back to where it was is and and and that's the talk about you know what kind of a shape recovery is it is it a V-shape, a L-shape, a W-shape recovery. Now our expectation and the market's expectation is that earnings probably aren't get back to where they were until about 2022 2023. But the market as you can see has snapped back pretty quickly. So you know almost 6,000 again now our view coming out of this correction in March and as I mentioned we aggressively bought the dip we were pretty comfortable to do that when we saw just the extent of the actions of the fed in the US. Just how much money they are pumping into the system the the their commentary that they came out and were basically buying anything distressed. So they really underwrote credit markets which meant that this would not be a full-blown credit crunch like the GFC. It would be a recession. So they stabilized the financial system we were comfortable to buy markets but they've snapped back incredibly quickly. So our view coming out of this was the fair value for our market was sort of 55 to 5700. And that's effectively applying a normal market multiple of 15 to 16 times on trailing earnings. So if you take if you take the 2019

reported earnings and we assume that we're gonna get back to that level in a couple of years and we apply a normal kind of market multiple at around 16 times. Then that gets you that sort of 55 to 5700 range.


So that that's our kind of assessment of fair value for our market. Now we thought that it could overshoot to sort of 6,000, as we got closer to Christmas and as the economy and the world was starting to open up. But it shot through that in the first week of June. So within our large cap mandate we went from fully invested back to 15% cash with our emerging leaders portfolio. We went from fully invested back to about 17% cash. So that's that's just just talking to the point I made earlier about dynamically managing the overall market exposure and and and cash weights. Okay so


Stefan Angelini

We've got a quick little question


Adrian Rowley

Sure


Stefan Angelini

From from the group someone said. Well if there is a Covid vaccine announced,

what sort of a market do you think we will have following that?


Adrian Rowley

yeah look I our view very much is this is this is very much a buy the dips market so what is interesting I think is that you know the the fed that they're making last week basically came out and said they're not expecting to increase interest rates until 2023. So if we have two years of central banks being super supportive and ultra low interest rates. As soon as people get confident that this economic recovery is sustainable that money will continue to flow into

equities and credit because you know you're not gonna get any money out of cash any return out of cash, any return out of you know bank deposits, any return out of government bonds so you're going to see money flood into anything that can deliver some earnings growth or anything that can deliver some yield so I and I'll back up a little bit. If you go back to late 2019 early 20, so this was when the fed had their mid-cycle adjustments so they cut rates by point seven five percent to one and a half percent so 150 basic points of one and a half percent.


Markets absolutely ripped and traded up just kind of multiples of about 20 times so the view then was you know the the lower rates are getting the higher that the market multiple should be and and you you saw money flood into markets well. Now that fed cash rate is not 1.5 it's 0.25 and the 10-year bond yield is not 1.6 it's 0.6. So ultimately you know our view coming out of this was that once there's a bit of certainty that the economy is getting back to normal globally and that's obviously very reliant on what happens with this vaccine. But if you're sitting here and there is a vaccine announced and the world's starting to open up and rates are still at zero.


Well I I think you'll see more multiple expansion from the market and it could push higher now. That was our view coming so. Yeah that was our view coming out of the correction in in Feb and March. We thought that markets could could really rip towards the end of the year but you know interestingly all of the things that we expected to happen all happened within three months not over a six or twelve month period. So markets kind of priced all of this good news in very very quickly which then meant that we had to start paying a little bit more cautious. So you know our view is that you know taking a 12-18 month view. We think equities will still continue to perform and continue to outperform most asset classes. But given that valuations have somewhat stretched already that you know there is risk in the short term that we have a bit of a pullback. And and that's actually kind of happened over the last two three weeks but it's still very much a buy the dips market.


Yeah. It's a long-winded answer for you but hopefully that that that makes some sense. So yeah. So so we're coming to reporting season with some elevated cash levels not super elevated. But as I mentioned 15% in our large cap portfolio the market came off 5, 6 percent and we've now started to just trip that into the market. Where we say that the short term outlook is a little bit challenges because you know we we are in lockdown here and while the economy has globally started to rebound quite nicely. That that mobility data has flattened off a little bit so with the second wave happening if you look at things like. You know global flight numbers those those sorts of measures it looks as though things are starting to flatten off a little bit


So what that means is there's a bit of risk that the earnings rebound is not going to be quite as v-shaped as markets are currently pricing. And you know those previous charts that I had showed that you know with the market trading on sort of 20 times even though we're expecting initial to recover over the next couple of years in the short term it's hard to see a lot of upside there. So we're happy to you know to wait for the dips and but but very much want to want to get fully invested during those those corrections.


Okay so the 2020 reporting season. I'll run through just some of the key observations I guess and and themes that we saw. So broadly speaking earnings from the ASX 200 fell about 20% for the 2020 year based on off the 2019 financial year. But coming into the correction the market was pricing in you know 8 to 10% earnings growth. So it went from a market pricing in you know almost 10% earnings growth to earnings declining at 20%. So it was about a 30% rebasing of earnings expectations. But the biggest decline no surprise was from the banks the banks reported shocking results now. It was only circa that reported the 4 year result the other provided trading updates and they report next month.


So that'll be that'll be interesting but yeah big big downgrades from the banks as you'd expect in in a short sharp recession. Followed by insurance all full results from AIG, QBE and AIL. Telco sector so again Telstra continue under underperformed utilities AGL had a shocker and the rates. Now what's interesting about that is traditionally you know telecommunications utilities real estate investment trust they would traditionally pay some of the more defensive sectors that you would expect to hold up in a more constrained or challenged economic environment.


But they were some of the hardest hit so some of those defensive sectors have been the worst performers. And conversely what what's interesting is that that you know some of the more economically sensitive sectors actually hold up really well

So resources x energy held up well so we only had about a 2% decline in earnings for the resource complex and I'll touch on that a little bit later. Healthcare held up really well as you

would expect but surprisingly. You know retail did really really well you know normally if

you if you're in the middle of a recession discretionary retail spending drops off a cliff

and you'd expect those retailers to struggle. But the massive cash handouts that we've had

as well as you know six months of mortgage relief has meant that people's savings rates have actually increased over this period and there's been you know elevated retail spending.


So you know discretionary retail spending has almost been higher now than it was at at the start of the year. There's a bit of risk to that obviously like


Stefan Angelini

These are companies like JB Hi-Fi, Harvey Norman


Adrian Rowley

Spot on yeah JB Hi-Fi, Harvey Norman, Baby Bunting which we hold in in the mid cap portfolio has done done really well. So yeah all of those discretionary stocks things Kogan as well the online guys you know everybody's been been spending all of their their job seeker payments online by the looks of it. But obviously there's there's a bit of risk to that so you know we're concerned and we've got a pretty cautious outlook on the banks but we're concerned that as we get through to next year. You know the large end of corporate Australia is gonna be okay but there's really gonna be an SMA a small you know a medium business insolvency crisis sort of next year. And so as as you get the job seeker rolling off and you know as you get the banks you know that they've given a lot of lenders a mortgage holiday. But eventually they're gonna be bankers again and you're going to have to start repaying your home loan.


So we're a bit concerned about what happens next year. And we don't want to chase those

discretionary retailers at the moment because you know the the tail winds that I've had

could become headwinds over the next 6 to 12 months. And finally food staples so you know

your Woolies and Coles have done exceptionally well you know all the stockpiling and

everybody's sitting at home cooking meals has been brilliant for for Coles and Woolies. So the expensive defensives this was the other theme that we really saw and this this really talks to the tech question that you asked


So you know those those structural growth stocks, who have been able to grow their earnings for whatever structural tail wind and that and that is largely the tech complex. But some of those health care stocks some of the media stocks here and I'll

run through a few of them. They did exceptionally well throughout this reporting period and they were expensive coming into the results. But ultimately in that macro environment that I mentioned of ultra low growth you know no inflation, you know low rates then you know these structural growth stocks should perform well. Now we were hoping that we'd get a bit of a pullback in some of those stocks and and we'd be able to buy even more add to them.

But they came into reporting season expensive and they tried to even more expensive levels.


So there's been a lot of money chasing not so many sort of growth stocks in the Aussie market. Again though the the little pullback that we've had in the last week or so is starting to open up some opportunities but what what you've seen is this massive dispersion in the valuation of different parts of the market and I'll touch on that in a bit of detail 'cause that that I think is opening up some opportunities as well. So really the reporting period was all about you know those opposing forces of the the stocks that benefited from you know the government stimulus and and there were clear Covid winners and and losers.


Okay so our broad positioning you know coming out of this environment as I mentioned we want exposure to those structural growth stocks but at the right price which is which is critical. we also want exposure to defensive yield as I mentioned you know I think as we continue to get through this there's going to be more money coming out of you know no zero yielding cash and deposit and kind of bond portfolios chasing yield anywhere else. But we don't think you necessarily want to get that from the banks or from the property trusts. There's been a lot written so I won't spend too much time on that


But about you know the issues with the retail property space. Now that structural shift

to online was already happening and already hurting the sector and this has accelerated at.

But also no concerns around just how much office space we'll need going forward whether some of the themes that we've seen throughout this period as I mentioned you know are accelerating structural change that could be you know a long-term tailwind for for that property trust sector and we're seeing continued kind of equity raisings as they all try to repair their balance sheets.


So we're kind of looking for defensive yield in things like consumer staples and infrastructure looks really really interesting to us and I'll touch on that. The other one which I never thought I would say but you can actually look at the resource sector for yield at the moment and I've got a chart on Rio but I'll show just how much cash they are spitting out and the kind of dividends we can expect from Rio over the next two to three years. And then finally while those expensive growth stocks have gotten more expensive some of the value and cyclical names that are very leveraged to the economic recovery and the vaccine trade we think you want part of your portfolio there as well as because they should you know outperform as as the world get gets back to normal. Okay


Stefan Angelini

Adrian just have you popped on just as you're touching resources there what a question


Adrian Rowley

Sure


Stefan Angelini

If we do get a vaccine and the market takes a bit of a recovery gold prices which obviously have been going through the roof as of late especially with


Adrian Rowley

Yeah


Stefan Angelini

Markets the question is that gold will probably take a hit wouldn't you think so?


Adrian Rowley

Yeah I agree with that it's it's an interesting one that gold did exceptionally well for a period there and again it was linked I think to ultra low rates. So you know historically you know holding gold as a store of value actually costs money to do that. So if you got your money in the bank account in a normal environment you're getting two or three percent. You know that that that that has an impact on the value of cash and cash assets whereas it costs you to hold gold.


Now in the middle of this crisis when central banks cut raised to 25 basis once you had you know most of the European complex with negative rates and the U.S got very close to

negative rates as well. So all of a sudden gold as a store of value became far more

attractive. So you saw a phenomenal running gold it also tends to do very well in uncertain times. If you're the sort of person that likes charting and technicals if you look at the gold price the moving averages are literally kind of running in a triangle at the moment. So it looks like it could break either way and you would want to either buy or sell the break. To me I think the break is probably going to be down gonna be down as yeah as you say if the world starts getting back to normal and currently the market is not pricing in any rate hikes for a couple of years


But if we're sitting here in the middle of next year and you do have synchronized global growth the world has to start thinking about sort of higher rates. So I think for the time being gold's kind of had its moment in the sun and but if you're a technical kind of trader I'd be looking just to watch which way it breaks. If for example we saw you know broad lockdowns happening again in parts of the world because of this second wave then all of a sudden you know I think I will have another pretty strong leg up


Stefan Angelini

Yeah beautiful one thanks


Adrian Rowley

No worries sorry what was that one?


Daniel McDonald

Which we're seeing now obviously with with what's happening in the U.K. so what more

lockdown seemed to be


Adrian Rowley

Yeah


Daniel McDonald

It seemed to be coming


Adrian Rowley

Yeah spot on spot on and I won't get into a political debate about whether I think that's

right or wrong. Well I'll just say I think it's wrong. You know I think the cure is becoming far worse than the disease certainly if they do start to lock down again. But we're starting to see signs of it so that's really one to to to watch closely and and that would fundamentally where where we have a broader view that we want to buy the dips if you did start seeing you know broad lockdowns again then you'd want to significantly increase increase your cash levels. Because you know the little five percent correction that that we've seen could become a 10 or a 15 pretty quickly.


Yeah so if I look at the the market and this is just the the underlying composition of the

market just into the broad based sectors and and the earnings that they've delivered so you can see the the overall market earnings came up came off about 20%. Resource sector earnings held up really well now. If we look at the broad market the really analysts out there aren't expecting earnings to recover to where they were till the 2022-23 financial year.


So we've got fairly flat earnings here from Macquarie. If I look at Bloomberg consensus you've got about 6% earnings growth coming through. So they're a bit more cautious than the market but resources held up really well so after delivering you know 20% earnings growth last financial year. The resource sector's earnings held up really well now I'll I'll touch on this a bit more detail later. But the market's currently got earnings coming off for the resource sector but that's just a real really a function of them normalizing commodity prices back to the sort of long run average. So we actually think there's there's some upside risk there and we think that number could move from negative to positive and that the the the resource sector is actually in an upgrade cycle. The banks while weight 30% declining earnings there expecting a bounce back over the next couple of years. But that is obviously reliant on you know vaccines and how long we are locked down. So that's a very very difficult number to try predict at the moment trying to predict what happens with bad and doubtful debts at the banks is gonna be really really difficult I'll touch on that a bit later as well.


So then breaking up the other sectors as you would expect you know your staples held up pretty well. Healthcare held up really well but insurance diversified financials communication

services utilities and rates were all were all pretty tough. And for some of those sectors we're not expecting a rebound next year as well or rebound next year either which means that you know we're happy to to completely avoid them


Okay so sector performance we've touched on this one already. But what I want it showed you is the companies or sectors of the market that that were able to to you know deliver earnings that were roughly in line with last year had phenomenal performance. So what it meant is any decline slightly but share prices went up a long way which meant that they went from being relatively expensive to even more expensive


So things like IT if we look at healthcare. You know earnings down sort of two percent but stocks up 16% over the last 12 months. IT obviously that's that's the buy now pay later sector that's that's done exceptionally well that's zero on a few of those other other large capital IT stocks.


Materials did well so that's the resources that I'm talking about and consumer staples. So you had a pocket of the market but it was really only those sort of five sectors that delivered positive share price returns over the last year and as you would expect energy financials rates those Covid losers were were all all belted over the course of the year. Having said that some

of these like energy lead what we think look fairly interesting.


Okay this is the PE dispersion that I mentioned so coming through August. The share price reactions were really interesting. So what what this shows is in blue the earnings revision so what that means if it's something positive. So if we look at retailing here what that means is that the retailers delivered earnings that were slightly above the analysts expectations so they slightly bate the analysts expectations. But you saw share prices pop 10% on the back

of it. So with the tech with health care for example so some of these sectors slightly missed

the market's expectations. But the share price is still rallied so that to us was a bit perplexing.


But really I think it's all been driven by style rotational thumb flows so and and again I'm not sure if there's too much jargon here just let me know but you know you've got different style managers out there there are growth managers that have done exceptionally well over the last few years and there are value managers that have had an incredibly tough period. And going back or a couple of months there was a few articles in the press so it's fairly well known but a few you know high quality long-term value managers lost big mandates. They

lost you know one and a half billion dollar mandates and all of that money is going across to these growth managers.


So they're getting huge fund flows and all that money is then going into a handful of those growth stocks in our market. So despite these companies slightly missing and already being expensive you've just got this wall of money that's been chasing these stocks so

the great companies we like them but the point that I mentioned earlier is we like them at the right price. But even you know it was really interesting how we the market started at 6,000 finished at 6,000 even sectors that disappointed.


So you know Telcos utilities they said banks that that delivered results that were you know analysts were expecting the results of the banks to be sort of 30% lower but I've missed

even that. Same with Telco's and utilities but the share prices actually pushed up during reporting periods. So was really unusual environment but we're starting to see that shakeout

a little bit now.


Daniel McDonald

so you'd think Adrian the common sense would suggest that with a huge dependency on the on the global population requiring that the services of telco you would actually think that that particular sector would perform very well?


Adrian Rowley

yeah look it should be. But the the two a few interesting things so Telstra's obviously the biggest driver in that space it's kind of the the you know dominant stock in in that complex. So you know the broad sector numbers are really reflective more of Telstra than the others. But really the one the the biggest driver for Telstra negative driver for Telstra is is the nbn rollout. So you know Telstra's old business where they had you know ISDN broadband going into households their margin on that broadband business was almost 50%. Their margin on reselling the nbn is was about one and a half percent I think in that in in the year four-year result.


So this massive shift to the nbn with all the telcos trying to resell the nbn and it's a land grab but they're trying to do it and making no money out of it. So that's the biggest drag on on Telstra now the mobile business eventually will turn around and they should do okay. But the other thing which was interesting is they that there was something like a two or three hundred million dollar hit. Because there was no international roaming so if you think about all these the. Yeah. All the Aussies that have mobile phones that go overseas for work for holiday for whatever nobody's been allowed to leave the country for 12 months so so


Daniel McDonald

Likewise with the tourist


Adrian Rowley

Yeah


Daniel McDonald

Likewise with the tourist


Adrian Rowley

Yeah no tourists coming in. Yes spot on. So you know so they had you know one part of their business was was really adversely affected so yeah in interesting space but you're right it should be a space that would do well but it's really the nbn that's causing a big structural headwind to all of those telcos. Eventually that will get sorted out and eventually there'll be winners and losers and I'd back Telstra probably to be a winner. But I still think that's a couple of years away.


Stefan Angelini

Now Adrian I'm just thinking about timing


Adrian Rowley

Sure


Stefan Angelini

For the audience I was hoping if we could maybe get your your view on PE


Adrian Rowley

No worries


Stefan Angelini

Price earnings multiple let me quickly go into some of those the stock focuses that

you've been looking at


Adrian Rowley

No worries


Stefan Angelini

And then we'll take some questions


Adrian Rowley

Not a problem I might just flick through some of the stock fundamentals this. This is an interesting one the comment that I made about you know looking at some of the resource stocks for yield. So this chart here just shows the iron ore price so the iron ore price is about $125 a ton at the moment this shows the long-term price going back to 2012.


So at the moment it's about $124 and you'd expect that to be weak during a recession but obviously you know China had a short sharp slowdown and then it was you know back

back on the tools so at the moment and these are just Citigroup numbers they've got a forecast on iron ore prices for a hundred dollars this year spots 124 that's probably about right there's only a few months to go and then they've got it normalizing to $90 next year then $80 then $60 in from 21 22 23 for as long as I've known analysts have always normalized the price three years out.


So you know if the iron ore price is $20 they'll have it going up to 63 years out if it's 100 they'll have it going down 9 to 60 sort of three years out. Now given that iron ore price assumption which all I think is is pretty conservative. So you've got I know going from 125 all the way back down to $60 over the next two and a half years. Now if that is what actually happens, Rio will spit out enough cash and finally we're seeing the resource stocks the BHP's and Rios, who have a horrific history of M & A and buying businesses at the top of the cycle and blowing up capital really since the GFC they've done the right thing they've just managed the assets


They've tried to reduce their cost of production they've spit out a heap of cash and they're returning it to shareholders. So if the on iron ore price goes from 90 to 80 to 60

on Citi's numbers. They'll pay an average dividend yield fully frank of 9%

over the next three years. Now these used to be highly highly cyclical businesses

and historically you would never have thought of you know holding a a resource stock for

yield but the BHPs the Rios the Fortescue if you want something a little bit pointier. These guys are spitting out phenomenal amounts of cash and I think they will just continue to return it to shareholders over the next few years. The banks I might flick over this unless they're specific questions but really this chart just talks to how banks have proved to be the ultimate cyclical stock again where we've had an economic downturn their earnings have been smashed and that's on the back of you now three years of huge remediation costs coming out of the royal commission.


So you know NABs dividend is not forecast to get back to $1.23 until 2023. Now that's still 24% lower than where it was pre-GFC and pre discorrection. So you've had a period of declining earnings and declining dividends from the banks that doesn't look like turning around over the next 12 or 18 months in our opinion. Some of the places that we would look for yields so as I mentioned you know the resource sector. But some of these value stocks so that money that I talked about that's been taken away from value managers and chasing growth managers a lot of these guys hold similar stocks. And that's actually opening up some pockets of real value we think. So you know horizon is just the old qr national someone owns you know rolling stock and and tracks in Queensland and up and down the East Coast.


Most of their customers are all on take or pay contracts. So this is a business that actually grew earnings for the year and put the dividend up for the year and is forecast to increase their dividend again next year.


It's forecast to pay about 26 cents per share fully frank. So that gives you about a 6% dividend yield fully frank from mostly pay or take or pay contracts. So we see very little risk that that's not gonna be met but you can see what the the the share price reaction as there's been that rotation out of value into growth. So the the red line the blue line here just shows the horizon share price the red line there shows the dividends that that horizon is paying. There's a clear disconnect there that we think is interesting and attractive and we'd much rather own that for defensive yield than the banks. Some of the Covid losers


Stefan Angelini

Just quickly Adrian just to step in just remind everyone that sort of general information we're

talking about


Adrian Rowley

Absolutely


Stefan Angelini

While we ask not specific stocks of course do your own research and seek advice from professional but that's all I'll say I'll let you hand it over 'cause I know Sydney airport has

been getting a great amount of attention from a lot of people


Adrian Rowley

Yeah look I I think it's probably one of the best buyers in the market and from our broad portfolio positioning at the start of this year. We had no infrastructure in the portfolio because the whole sector was too expensive to us. But in this environment we saw all of those stocks come off you know 20 30 40 percent pretty quickly and this very much is a short-term issue that'll wash through so Trans. We put Transurban into the portfolio in March and we've just added Sydney airport to the portfolio over the last week.


So this is you know clearly a business that has you know it's a critical piece of Australian infrastructure. It's still gonna be a critical piece of Australian infrastructure in 100 years there's obviously zero traffic going through the airport at the moment. They they raised two billion dollars and again this is where we say you need to be a bit patient they raised two billion dollars to shore up the balance sheet. So the equity raises out of the way they can now get through this period and hopefully we're sitting here in you know 12 18 months time and things are back to normal. Interestingly during the reporting period when I did the equity raise it was being done at a 15% discount we thought and went into trading for three days we thought you beauty we'll get a an opportunity to have a have a hundred asset when here it started trading and it was up five percent that day and then three percent the next day so that's that's this spike here. But anyway we're we're patient and as this dragged on and Victoria went into the second lockdown share price you know got kicked back to $5.50 I'd be very surprised if if it's not back to sort of $8 in in a couple of years and they'll return to pay dividends up towards the end of next year.


So some of these Covid losers we think look really interesting the other so I mentioned we added Transurban we like those infrastructure stocks for yield maybe not for the next

6 to 12 months but going further out. Atlas Arteria we also added to the portfolio so it's effectively a Transurban but it owns toll road predominantly in Europe so it runs one key toll road that runs through France. Now most of Europe is back to normal and their volumes are almost back to normal but the share price is still sort of 30% below where it was so we like we like that. Cochlear this is a good example of a really high quality structural growth stock. It's like a CSL it's clearly the dominant player in their sector globally they spend you know more on R&D than all of their competitors combined and and you know which will see them always ahead of the technology curve


Now when the lockdown happens elective surgery was effectively shut down globally if I look at Europe now. Elective surgery is back to about 80% of the level that was before the lockdown it's still locked down here. But most of the reps of the world is getting back to elective surgery.


Again Cochlear raised a couple of billion dollars and they've continued to invest in R & D

all throughout this period. So that's a great example of now now this is one of those stocks that it reported a result that was you know pretty weak it was down some 20% on the year before and had a pretty pretty weak outlook because the lockdown was still ongoing.


But it popped almost 10% on the day of the result so it was a good an example of one of those structural growth stocks that was expensive that got even more expensive. Having said that we were patient and it got back to $1.90 bottom end of the trading range and and we put that into the portfolio just last week. So here's here's our overall portfolio happy to share it with you we're effectively breaking the portfolio into three parts so defensive yield which are the consumer staples the infrastructure stocks that I mentioned we put in there global packaging with AMCOR horizon that I mentioned and we that was that was 18% we actually we bought a half holding in Atlas Sydney and actually topped those up yesterday


So the infrastructure part of our portfolio has gone from zero at the start of the year it will be over 10% and those defensive yield stocks will be getting up to about 23% of the portfolio so about a quarter of the portfolio leverage a defensive yield we then got those structural growth stocks the Aristocrats, Cochlear, CSL, Resmed, Sonic and we put Goodman group in there as well you know a bit like this you know the online trade Goodman group in industrial real estate is very much leveraged


So you know the online retail thematic globally and then the other part of portfolio that we've built and these are the Covid losers is that if the economy does improve over the next 12 to 18 months then these are the secret stocks that are leveraged to an improvement in that global economy so they're things like the energy stocks we've got origin oil search Woodside we think the oil price should be you know fair bit higher 12 months from now when there's planes back in the sky again something like star entertainment group you know monopoly assets Queensland casinos in in Sydney Queensland that were shut down for a period now their volumes will get back to normal and we do still have some of the banks in there despite our negative view.


Now we're very underweight the bank so we're nearly 10% underweight financials and the only reason we've got those three there is that they are actually three of the big four are trading below book value at the moment so as we open up I would expect the banks to pop back to kind of book value or maybe a bit of a premium but we'll be looking to to to lighten our exposure further into that that's pretty much all that I have but happy to take as many questions as you have


Stefan Angelini

Beautiful mate that was a fantastic presentation I might kick it off the first question

Daniel that's he said right just on you spoke about Sydney airports obviously travel stocks travel stocks one of the questions asked one of the questions asked throughout the presentation where do you see travel stocks going if there is a vaccine work would you open up how do you look at it


Adrain Rowley

Yeah we we've avoided the pointer end of the sector if that makes sense so you know things like a Webjet you know Webjet almost went valley up during this environment they had to had to raise a fair bit of money so you know Webjet flight center some of those kind of travel stocks you know they've started to rebound the flight center only got to $10 it's about $13 now but to me there is still a fair bit of risk around those over the next 3 to 6 months so we'd rather play it through you know a Sydney airport through some of those you know the trans urbans through some of those bigger infrastructure plays at this point in time until we're comfortable that because the the problem that we have here in Australia is that while most of the rest of the world is opening up we're an island state so trying to get a handle on when a vaccine will be effective enough to allow our borders to open which is what you need for those travel stocks to perform is very very hard to tell now that could be three months that could be nine months it could be you know 15 months if it's closer to 12 months than three months then these stocks have a pretty tough time ahead of them


So we we would rather play it more conservatively at this point in time until you are really confident that the borders are gonna open up


Stefan Angelini

Make sense Daniel take any questions mate


Daniel McDonald

No selling my flight center we


Adrian Rowley

Not personal advice


Daniel McDonald

Just just just what is the view of Watersheds on some of the airlines I mean is there do they think that they've got a bottom down or do you think there's a potential for them to have further to go with the rest of the world opening up


Adrian Rowley

Yeah it's yeah it's it's very very hard to tell with a Qantas you know Qantas should come out of this reasonably well because their main competitor is gonna be very constrained so Virgin tried to take on Qantas as a full service airline and under the new private equity kind of ownership I think it will be cut back to a kind of a more core service and a more budget airline gain which should give Qantas a much more dominant position as we come through this having said that though every month that goes by that our state borders are locked and our international borders are locked I think Qantas is I'm trying to remember the figures but it's losing a lot of money every month so again until you're comfortable that those borders are gonna open up I think there's there's still probably a bit of risk there


Daniel McDonald

And it probably is vaccine dependent because you know we've got we've got countries in Europe that are running a completely different Covid strategy than Australia obviously trade's got a suppression contained strategy that's obviously going to have some impact on Qantas in the long term and with a complete misalignment I guess you know the only thing that could probably steer Qantas into the green would probably be the the global implementation of a Covid-19 vaccine


Adrian Rowley

Spot on I mean I saw a headline this morning that apparently three cases in WA have popped up now and they they've had no cases for ages and it was three return travelers so you know that's just another example of I think the government response will be to continue to have a lockdown until they're 100% certain that that we have a vaccine that works and trying to get a vaccine that's you know manufactured in volume that's then you know distributed among the population to the point that we get that heard immunity you know in the US they're talking about some volume by Christmas but if we look at a CSL for example who's involved in a couple of those trials they're still talking you know June next year


So you know to me that's still a long time in financial markets so you know February we're gonna get the half year results for these companies and I don't think it's likely that we're gonna have borders opened up by Feb so I think there's still a bit more pain before before you know you get you get the upside down


Stefan Angelini

Unfortunately yeah hey Adrian I know you got taking enough fairly good look at resources and you're fairly bullish on the sector particularly some of the larger names but there's been a question reach out about energy obviously energy stocks have not done well in the past


Adrian Rowley

No


Stefan Angelini

Show some light on what's happened to the energy sector


Adrian Rowley

yeah look sure can so you know what's amazing a little while ago during the lockdown that the the futures contract oil price actually closed negative for a period there so with all of the

planes on the ground and everybody in lockdown globally all stockpiles were building to the point that the world was actually running out of storage capacity so the futures contract actually went negative for a period there so it was literally no zero dollar oil price now that's an incredibly unusual period now I I think you know the oil prices back to sort of $40 and it's bouncing around a lot on virus news our view is that you know as as as the world gets back to normal over the next 12 months we're probably gonna see a an oil price a little bit higher now taking a longer term view what we've seen and and and again it's another theme that's been accelerated through this period


So over the last few years with the world's kind of you know transition to renewables there has been less and less and less money spent on exploration and bringing new production online so a lot of the world's oil fields are actually in decline at the moment and again this is accelerated so there's no new oil coming to market over the next you know two to three

years so if you take a longer term view we're actually we've got you know demand that really

probably hasn't tapered very much but production starting to decline so taking a longer term view we're actually pretty constructive on the oil price but it's it's gonna take a little

while for the world to get back to normal and for for some of those excess inventories

to be knocked out of the system but certainly buying some of those oil and gas stocks with a 12 to 18 month view what we think it's one of the last remaining real pockets of value in in

our market


Stefan Angelini

Beautiful Daniel any more questions mate


Daniel McDonald

Look I'll be doing the group a great disservice if we didn't talk a little bit about BNPL all the buy now pay later


Adrian Rowley

Yeah


Daniel McDonald

It's it's really probably been the the buzz stock in our group probably for the last since March

what's Watershed's view on buying now pay later stocks do they see continued growth in the

short medium long term or do they see it sort of topping out at some point in the near

future


Adrian Rowley

Look we we hold Afterpay our mid cap portfolio and we have held that since well since

it was below $2 so it's been in a ripper for us it's look it it's a it's a sector that is continuing to grow and we think it will continue to grow globally one of the huge endorsements of Afterpay is that a lot of the big global competitors are now actually joining forces with Afterpay so it's had you know the banks and the credit card companies and you know the the traditional payment sector trying to compete with it and they're


Now actually joining forces with it which to me you know is a huge of confidence in in their strategy um now they their role out in the US was more successful than we expected

and now they're rolling out in Europe and again it's beating all expectations so they are becoming a true global kind of payments payments player so we really like the space

but again with all of these tech stocks you do still need to be a bit mindful of valuation you know we we we chopped our holding in half when it went through 50 and sure enough a couple months later it was $90 so you know there's a lot priced into the value of this sector at the moment so you know short-term we're a bit cautious valuation-wise but you know we we think Afterpay executed really well and you need to have belief that they can continue to execute globally to kind of justify the value of the business now but certainly don't think all the boxes so far


Daniel McDonald

There's been a lot of media about new entrants in the market and some of the more traditional players coming to the market so we were PayPal offering a buy now pay later offering the banks looking at rolling out interest-free credit cards do you think any of these other sort of services being flooded into the market will have an impact on some of the


Adrian Rowley

They've all tried over the last while and they've not been able to gain traction and one of the real advantages for someone like after paying the bank pay now the buy now pay later sector is that they have such a strong relationship with the retailers so they're shooting huge numbers of referrals back to the retailers so they're almost creating a bit of a retailing ecosystem as well as a payment system so it's very hard for you know the banks and some of those traditional incumbent utilities to to you know aggressively attack the space


I think to me it's a little bit like you know the early days of seeking rea.com and you know we had monster so in the early days of employment online you had three or four groups that were competing aggressively and it was a real land grab but you ended up with one dominant player and then it's incredibly difficult for others to compete once they've got that market foothold you saw it with the employment space you've seen it with you know the real estate.com the the online advertising space and I think now the deals that Afterpay has done with with the big global majors is testament to the fact that I think they're starting to win that that global land grab so I think you know it's gonna be pretty hard for the banks and for those traditional payment systems to to compete but I always do bring it bring it back to price so there's a lot built into the price of all of those at the moment


Stefan Angelini

You see Afterpay jump and up from ten dollars to nearly a hundred dollars things are going a bit crazy hope the rockets keep flying for everyone in the group there was a question about an ETF potentially coming up in the buy now pay later space so I've ever asked that question we've got a few episodes coming up a few education events with ETF providers so Vaneck and Betashares I know look some of these providers have started ETFs in the online gaming space


I wouldn't be we can ask the question about the buy now pay later space so don't worry about that look I'm probably gonna end it end it there Adrian an amazing presentation thank you so much for your time I do really appreciate you coming on Daniel thank you for sponsoring thank you for starting the group did you want to have a quick 30 seconds about McDonald Legal just so everyone knows what you do


Daniel McDonald

Oh sure yes so we totally got a full service law firm, commercial property state planning,

self-managed super funds anything in that space so we're operating out of Victoria but we

operate in all jurisdictions


Stefan Angelini

Beautiful mate thanks a lot and Angel Advisory if you're looking to build an investment portfolio that's what we do for a living we also focus on tax planning and superannuation Adrian we use you in our portfolios thank you so much for your time I appreciate you coming on again mate very insightful thank you very much


Adrian Rowley

No worries at all pleasure


Stefan Angelini

To everyone out there thanks a lot I hope you enjoyed it see you later


Adrian Rowley

Thank you


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