Tuesday, 10 March 2020 15:55

Montgomery's Best of the Best - February 2020

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The investment team from Montgomery's are pleased to bring you their latest edition of "Best of the Best".


In this edition they discuss:


  • Have low interest rates made assets too expensive?
  • Why Infigen should profit from our decabonising economy
  • What should we expect from the big 4 banks in 2020?


Download your copy by clicking on the report below.


Article written by Shane Oliver - Chief Economist AMP Capital

Coronavirus continues to rattle investment markets as the number of new cases outside China continues to rise posing increasing uncertainty over the impact on economic activity. And its impact has intensified following the collapse of OPEC discipline causing a further plunge in oil prices raising concerns about debt servicing for oil producers. From their highs global shares and Australian shares have had a fall of around 20%.

Source: PRC National Health Commission, Bloomberg, AMP Capital
Given the extreme uncertainty this note looks at various scenarios in relation to global and Australian economic growth and what signposts to look at in relation to how it may unfold.

Much ado about nothing or a major global catastrophe

It seems there are two extreme views on coronavirus. Some see it as just a bad flu and can’t see what the fuss is all about. Others think that it will trigger a major humanitarian and economic catastrophe killing millions and triggering a major global recession as excessive leverage is finally exposed. The optimist in me wants to lean to the former:

  • So far over 114,000 people are reported to have contracted the virus of which nearly 4000 have died. Of course, this number is still growing but in China where the number of new cases has collapsed (see the first chart) the number is 80,754 cases and 3136 deaths. In the 2017-18 US flu season alone 44.8m Americans got sick and 61,099 died.
  • The actual death rate from Covid-19 may be 1% or lower, rather than the currently reported rate of 3.5% because many of those who get the virus don’t get sick enough to seek medical help and so won’t be included in the case count. The Diamond Princess episode may provide a rough guide – all 3711 passengers and crew have been tested with 705 contracting the virus of which seven have died and most of those are believed to have been over 70. This would suggest a death rate of around 1% which is only just above that for regular flu for those over 65.
  • It appears to be less contagious than regular flu.
  • China’s experience shows it can be contained. Maybe this is due to extreme containment measures in Hubei that are not possible in other countries. But the case count in the rest of China has also been contained with less extreme measures and Singapore and Hong Kong have had some success in slowing new cases without extreme quarantining.
Source: PRC National Health Commission, Bloomberg, AMP Capital
  • Alternatively, at some point authorities outside China may just conclude that containment is impossible and, as the death rate is not apocalyptic, shift from containment to just treating those who get very sick. This could enable life to return to normal, albeit with a change in behaviour - less handshaking, frequent handwashing and wearing a mask. 

But I also must concede I just don’t know. There is much that is unknown about the virus itself and how long it will continue to spread. And even if there is a switch to just treating the very sick it’s unclear there will be enough hospital beds. And there is also the human or behavioural overlay which is intensifying the economic impact. Just look at the toilet paper frenzy to see that this can have a real economic effect even before the virus has really taken hold in Australia. While there may be a boom in demand for hand sanitisers, toilet paper and long-life food, this will be a temporary boost as the spread of the virus globally and the disruption that containment measures are causing is continuing to increase the risk of a longer and deeper hit to economic activity. And there is a risk of secondary effects as the short-term disruption risks leading to business failures and households defaulting on their debts if they can’t keep up their payments and so causing a deeper impact on economic activity. The secondary effects of the coronavirus outbreak and its flow on is highlighted by the 45% collapse in oil prices since mid-January. Ultimately lower petrol prices will be a good thing as this will boost consumer spending when the virus goes away but for now all the focus is on the downside of lower oil prices – debt problems and less business investment by producers.

Base case versus global recession and beyond

Given all these uncertainties it’s still too early to say that shares, commodity prices and bond yields have bottomed. The following charts present three scenarios for the global economy: 

  • How we saw global growth panning out prior to the virus. Basically, we were expecting a mild pick-up in growth.
  • A sharp downturn centred around the March quarter as the Chinese economy contracts sharply but rebounds in the June quarter offsetting recessions in developed countries including in the US. This is our base case.
  • A worse case downturn that sees global growth contract in the March quarter (led by a sharp contraction in China) and the June quarter as (as developed countries get badly hit) resulting in a global recession to be then followed by a rebound as life returns to normal led by China.

Note: the scenarios show quarterly annualised growth. The key is to focus on the pattern of growth rather than the precise level.

Source: Bloomberg, AMP Capital
The next chart shows three scenarios for Australian growth:
  • How we saw global growth panning out prior to the virus.
  • Mild downturns in the March and June quarters driven initially by the lockdown in the China and then the coronavirus flow on to the rest of the world and Australia, followed by a second-half rebound. This is our base case.
  • A worse case downturn that sees deeper downturns in the March and June quarters then followed by a rebound as life returns to normal.
Source: Bloomberg, AMP Capital
Last week we moved to forecasting a recession for the Australian economy in our weekly report. We were already expecting a negative March quarter on the back of the bushfires and the hit to tourism, education exports and commodity exports from the slump in China. But the spread of coronavirus globally and in Australia has made it likely that we will also see a contraction in the June quarter too. As with the global outlook this should really be “a disruption” that will pass once the virus runs its course - hopefully at least as the Northern Hemisphere heads toward summer. The worse case scenarios would likely see a deeper decline in shares and bond yields.

What to watch?

Shares will bottom when there is confidence that the worst is over in terms of the economic impact from the virus and its largely factored in. So, the debate is largely now about how big the hit to growth will be and this relates to how long the virus will weigh on global growth and any secondary effects it may cause. In this regard the key things to watch are as follows:

  • A peak in the number of new cases – as per the first chart.
  • News of successful vaccines or anti-virals.
  • Whether governments switch from containment.
  • Timely economic indicators, eg, jobless claims and weekly consumer confidence data in the US and Australia.
  • Measures of corporate stress, eg, spreads between corporate bond yields and government bond yields. 
  • Measures of household stress, eg, unemployment and non-performing loans.
  • Measures of market stress, eg, bank funding costs as measured by the gap between 3-month rates and central bank rates. These have risen but are well below GFC levels.
Source: Bloomberg, AMP Capital

  • The monetary and fiscal policy response – this will be critical in terms of minimising the impact on vulnerable businesses and households from the coronavirus disruption, ensuring financial markets remain liquid and driving a quick recovery once the threat from the virus is over. So far so good with policy makers moving in the right direction (rapidly so in Australia it seems) – but there is a fair way to go. 

What does it all mean for investors?

The rapidity of the fall in share market has been scary. In our view the key things for investors to bear in mind are as follows: 

  • periodic sharp falls in share markets are healthy and normal. With the long-term trend ultimately remaining up & providing higher returns than other more stable assets. 
  • selling shares or switching to a more conservative investment strategy after a major fall just locks in a loss. 
  • when shares fall, they are cheaper and offer higher long-term return prospects. So, the key is to look for opportunities the pullback provides. It’s impossible to time the bottom but one way to do it is to average in over time.
  • while shares have fallen, dividends from the market haven’t. Companies like to smooth their dividends over time – they never go up as much as earnings in the good times and so rarely fall as much in the bad times. 
  • shares and other related assets bottom at the point of maximum bearishness, ie, just when you feel most negative towards them. 
  • the best way to stick to an appropriate long-term investment strategy, let alone see the opportunities that are thrown up in rough times, is to turn down the noise.  

Douglas Isles (Investment Specialist - Platinum Asset Management) met with Kerr Neilson (Founder Platinum Asset Management) recently to talk about investing.



Monday, 16 December 2019 08:53

Best of the Best - December 2019

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The Investment team have provided their final "Best of the Best" report for 2019.

In this issue they discuss the insanity of negative interest rates and what investors should do about it.

Other topics in the report include:


1. Why valuation still matters

2. Implications for asset prices from low rates

3. The anatomy of the Small Company market


Download your copy by clicking on the report below.

Thursday, 07 November 2019 08:39

Comedy piece - Google and Pizza ordering

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Is this Gordon's Pizza?


No sir, it's Google Pizza.


I must have dialled a wrong number. 


No sir, Google bought Gordon’s Pizza.


OK.  I would like to order a pizza.


Do you want your usual, sir?


My usual? You know me?


According to our caller ID data sheet, the last 12 times

you called you ordered an extra-large pizza with three

cheeses, sausage, pepperoni, mushrooms and meatballs.


OK! That’s what I want ...


May I suggest that this time you order a pizza

with ricotta, arugula, sun-dried tomatoes and

olives on a whole wheat gluten-free thin crust.


What? I detest vegetable!


Your cholesterol is not good, sir.


How the hell do you know!


Well, we cross-referenced your home phone number

with your medical records.  We have the result of

your blood tests for the last 7 years.


Okay, but I do not want your rotten vegetable pizza! 

I already take medication for my cholesterol.

GOOGLE:    Excuse me sir, but you have not taken

your medication regularly.  According to our database,

you purchased   only a   box of 30 cholesterol tablets

once, at Walgreens, 4 months ago.


I bought more from another drugstore.


That doesn’t show on your credit card statement.


I paid in cash.


But you did not withdraw enough cash

according to your bank statement.


I have other sources of cash.

GOOGLE:   That doesn’t show on your last tax return

unless you bought them using an undeclared income

source, which is against the law.




I'm sorry, sir, we use such information only

with the sole intention of helping you.


Enough already!  I'm sick to death of Google, Facebook,

Twitter, WhatsApp and all the others.  I'm going to an

island without internet, cable TV, where there is no

cell phone service and no one to watch me or spy on me.


I understand sir, but you need to renew your passport first.

It expired 6 weeks ago... 

Tuesday, 05 November 2019 06:35

Waste Management - turning trash into profit

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Investors seeking an industry sector  - that is almost certain to grow would be wise to take a look at the Waste Management sector.

Andrew Mitchell (Ophir Asset Management) is attracted to the sector because “Waste is a huge industry which will increase with population growth.”  He also likes the high barriers to entry in particular segments of the waste sector such as municipal collections and commercial waste.

The chart below shows the growth in core waste in Australia over a decade with a compound annual growth rate of 1.2%pa.


There are three main segments of the waste industry:

  1. Municipal (council kerbside household waste)
  2. Commercial / Industrial waste
  3. Building and demolition (construction and infrastructure)

Municipal and Commercial waste is generally considered ‘recession proof’ among professional investors while building and demolition waste is more cyclical.

Waste Management companies of the future are increasingly focussed on recycling, particularly following the introduction of the Chinese ‘National Sword’ policy last year.  China used to be the biggest importer of recyclable materials globally.  It took 30m tonnes of the world’s waste each year, including Australia’s.  Put simply, China used to buy the world’s recyclable waste, and it largely banned it overnight.  Australia will need to build its own recycling facilities to dispose of the waste appropriately.

Mitchell believes that “it’s becoming a social imperative that more is done with waste.  The call for more to be done on sustainability and recycling is growing louder within the community.  We believe Australians are becoming more accepting now of paying for the cost of sustainability.”

Emma Goodsell (Airlie Funds Management) says “the waste management industry is increasingly focused on building out critical recycling infrastructure.  The issue for the whole waste supply chain is that the cheapest way of doing things is usually the worst for the environment (ie landfill).  So it requires government intervention, in the form of levies on the cost of disposing a tonne of waste into a landfill, to adjust the playing field and allow for investment in recycling assets.”

The graph below shows the growth in recycling over a decade, with compound annual growth of 2.4%pa.

Landfill levies collected by the NSW government alone are approaching $1bn per year and are increasing.  Australia recycles or converts waste to energy for around 50% of waste according to Mitchell, so is considered middle of the pack by global standards compared with the US or developed European peers where this figure is around 80% plus.  Mitchell sees Government landfill levies as a potential revenue pool for Waste Management companies who are able to divert waste from landfill.

Goodsell points to Cleanaway’s joint venture with Macquarie’s Green Investment Group for a Western Sydney plant that will convert waste to energy as an example of business diverting waste from landfill.  This plant is likely to have the capacity to cut landfill volumes by 500 kilotonnes per year.

The biggest risks of investing in this sector would seem to be regulatory.  There is a lack of cohesion between State Governments which results in the waste industry being effectively different in every state.  Landfill levies can vary significantly from state to state and until recently Queensland didn’t charge a landfill levy which saw large movements of NSW waste shipped across the border.  Lack of uniformity in bin sizes across states increases costs as trucks need to be designed differently for each state.

Mitchell believes that Governments are slowly realising that more needs to be done in the waste sector, particularly with more national cohesion noting that there is now a Federal minister for waste reduction.

The ASX is home to one of the worlds’ largest listed waste management companies,  Cleanaway (formerly Transpacific Industries), and Bingo Industries is a relatively new addition to the ASX.  Mitchell is attracted to Cleanaway as “we like the more stable and defensive earnings streams of Cleanaway (mainly municipal and commercial) whereas Bingo operates in the more volatile/cyclical building and demolition space.  There are also a lot lower barriers to entry in that part of the market (Bingo Industries)”.

Most investors would associate waste management with garbage collection, where as the future lies with the recycling of waste.


This article was written by Mark Draper (GEM Capital) and appeared in the Australian Financial Review during October 2019

Tuesday, 05 November 2019 06:32

Best of the Best - October 2019

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The team at Montgomery Investments produce a magazine "The Best of the Best".

In the latest edition they discuss:

1. Five Global Investment Themes

2. Reliance Worldwide

3. Flight Centre

and much more.


Click on the report to download your copy

Best of Best image Oct 19

Friday, 04 October 2019 07:24

Retail Property - apocalypse or rebirth?

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Every month Mark Draper (GEM Capital) writes a column for the Australian Financial Review.  Here is the column that featured in the month of September 2019.


Often investors accept a simple thematic to determine their investment view on an entire sector.  Amazon’s entry into Australia was to be the death of our retailers, but JB Hi-Fi and Super Retail Group’s recent good results have defied this theme.

A common investment theme is that the internet will turn shopping malls into museums and investors in retail property will be left with a worthless asset.  Those who believe such a simple thematic without further investigation could well be passing up high investment income from some attractively priced retail property assets.

The bears of retail property will refer to the US experience of shopping malls being closed and 5 – 6,000 shops going out of business last year as reasons to avoid the sector entirely.

While it is true that US shopping malls are closing, Hugh Giddy (Investors Mutual) and Hugh Dive (Atlas Funds Management) believe that it is dangerous to extrapolate these closures across the entire global retail property sector as the US retail property market is over supplied.  This was due to overbuilding of malls between 1970 and 2015 where the number of malls in the US grew twice as fast as the population.  The chart below shows the level of commercial retail space in the US per person, compared with other countries.

Dive says “the thesis that all shopping malls are ruined and are going down, doesn’t account for the changing composition of tenancies”.  The better shopping centres are changing their tenancy mix to include more services and experiences.  This is likely to appeal to a wider audience including the Millennials who are less focussed on “things” and more interested in experiences.

Dive adds that “the good shopping centres are placing more emphasis on dining, entertainment, fitness, massage, healthcare and education services – things that can’t be easily delivered online”

Giddy says that “traditionally shopping centres were anchored with department stores and fashion apparel shops but those tenants are reducing space which is being taken up by medical centres and other service providers.”  Cinema admissions are still strong, and consumers are attracted to the shopping centres to watch movies.  Giddy asks “why are people still going out to the movies?, because they don’t want to only watch a movie on DVD or Netflix, it’s a social experience”.

Giddy points out that the shopping centre sector is turning into ‘the haves and the have-nots’.  The ‘haves’ are the centres that are well located in densely populated catchment areas, near transport hubs offering a diverse range of shopping and entertainment experiences.  He quotes Chadstone, Bondi Junction, Westfield London and Pitt Street Mall as examples of ‘the haves’ which are very high quality centres that have no problem filling their locations with shoppers and tenants.  This provides investors with high occupancy rates and rental income certainty.

The ‘have-nots’ which should be treated with caution, are typically located in regional locations with low catchment population, offering a narrow range of shops and services.

The strong shopping centres are also building residential apartments over them to capture value from the air rights over their centres.  Dive said that “Vicinity plans to build 900 apartments over the Chatswood shopping centre to capture value from the air rights.  In 2017 Vicinity also sold the air rights to a developer for $60m over their Melbourne shopping centre, and this development should be completed by 2020.”  Not only are the shopping centres capturing value from selling air rights, but they are also capturing additional shoppers who will reside within the shopping centre complex.

Investing into retail property can be through owning individual listed property trusts such as Scentre, Vicinity and Unibail Westfield or via managed funds and ETF’s.  Unlisted property trusts are unlikely to offer access to the type of retail properties described as ‘the haves’.

The risks to retail property investors include prolonged economic downturns that result in reduced consumer spending although Giddy says “during the GFC the Westfield Group held up quite well”.  Continued online competition will put pressure on the amount of bricks and mortar retail space required but Giddy argues that consumer brands are still going to want to have physical presence in the premium shopping centres as a branding opportunity.

Friday, 04 October 2019 07:18

Cloud computing the global growth opportunity

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Mark Draper (GEM Capital) writes a column for the Australian Financial Review every month.  Here is his column that featured during the month of September 2019.


What do Amazon, Google and Microsoft have in common?  They are all huge players in the world of global cloud computing.  Most would associate Amazon with online shopping and yet Amazon’s cloud business generates more than 50% of group income at a margin of 28%, and the most recent quarterly revenue grew by 37% from the previous year .  Very few large businesses have the capacity to grow at this rate.

Cloud computing is defined as using a network of remote servers to store, manage and process data, typically delivered via the internet rather than using a local server or personal computer.

The simplest example of cloud computing is business email.  Many businesses used to run their own email servers where they would buy the server hardware, buy the email exchange software and then pay an IT specialist to install and manage the email service.  That can all now be replaced by using Microsoft’s Office 365 which is a cloud based solution.  In essence cloud computing results in businesses and consumers renting services rather than owning the hardware and software.

The benefits of using cloud computing are that consumer and business users do not need to incur a large upfront cost to buy hardware and software and instead access these services more quickly, reliably and securely than traditionally.  It is often less expensive for users to access services from the cloud.  It is these reasons that provide optimism for the continued growth in the cloud.

From an investors perspective, it is important to identify 3 key segments of cloud computing.  Infrastructure as a Service (IaaS) delivers computer infrastructure on an outsourced basis.  Typically IaaS provides the hardware, storage, servers and compute services.  Secondly, Platform as a Service (PaaS) includes application development, security, databases, analytics and tools that the applications depend on to work.  Differentiating between IaaS and PaaS is difficult as they are often provided by the same company.  The 3 dominant players in these segments are Amazon, Microsoft and Google.

Scale is important for IaaS/PaaS players to support the operation of large, globally distributed data centres and the development of complex software underlying the rapidly expanding functionality of IaaS/Paas.  Kris Webster, (Portfolio Manager Magellan Financial Group) believes that the market outside of China will be dominated by Amazon, Microsoft and Google for that reason.  He says that the current annual revenue from cloud computing infrastructure is below US $100bn but forecasts the addressable market by 2030 to be US $800bn per year.

Finally, Software as a Service (SaaS) is also known as cloud application services in which end user software is rented on a subscription basis and is centrally hosted.  Common examples of SaaS are Adobe Creative Cloud and Dropbox.  Before the cloud, Adobe Professional suite of software would attract an upfront cost of well in excess of $1,000.  The high upfront cost often led consumers to pirate the software.  According to Webster, “Adobe has done a terrific job at bringing in the pirates to its network and thereby generating additional revenue, by charging a more affordable $50 monthly subscription”.

Other common examples of SaaS are music subscription services and video on demand services such as Spotify and Netflix.

Andrew Clifford (CEO Platinum Asset Management) highlights that many SaaS companies trade in the range of 15 – 25 times sales (not earnings).  He believes that the likelihood of any company growing fast enough for long enough to justify such valuations is very low.

Platinum are instead investing in companies that produce memory chips for computers and data centres that stand to benefit from the growth in cloud computing.  Some of these businesses can be purchased on single digit earnings multiples.  Platinum are also significant investors in Alphabet which owns Google.

Risks to the investment case for cloud computing exist if the switch to cloud computing is slower than forecast due to security or other concerns.  Counter to this point NAB’s IT executive Steve Day said recently “the cloud providers have realised they are so large, they can invest in the sort of security a bank like NAB could only dream of”.

With forecast growth of cloud computing of over 20%pa over the next decade, investors can not afford to ignore this sector.

Tuesday, 03 September 2019 15:10

Demergers - the hidden treasure

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Mark Draper (GEM Capital) writes a monthly column for the Australian Financial Review.

This column was published in the month of August 2019 in the AFR.


There have been many Australian demergers in the last 15 years and well known US investor Joel Greenblatt says “there is only one reason to pay attention when they do; you can make a pile of money investing in spin offs”.

A spin off, created from a demerger, is the establishment of a separate independent company through the sale or distribution of new shares of an existing business or division of a company. Generally the reason behind demergers is the belief that the demerged company will be worth more as an independent entity rather than being part of a larger business.  

Unrelated businesses may be separated via a demerger so that the separate businesses can be better appreciated by the market. Sometimes the motivation for a demerger comes from the desire to separate out a ‘bad’ business so that an unfettered ‘good’ business can shine through to investors.  There are many other reasons why a company would pursue a demerger, but broadly the idea is to create the environment where 1+ 1 = more than 2.

Paint company Dulux is the poster child for the demerger Fan Club according to Matt Williams (Portfolio Manager Airlie Funds Management).  He quips he is the founder, president and treasurer of that club.   “The simple fact is that demergers have a higher probability than not, of adding considerable value. In 2010 Orica shareholders received one Dulux share for each share they owned in Orica. Dulux shares closed at $2.54 on its first day as a stand-alone company. Nearly 10 years later shareholders will receive $9.75 as giant Nippon Paints adds Dulux to its stable. The total shareholder return for Dulux over this period was more than 20% p.a.” said Williams.

Goldman Sachs analyst Matthew Ross in a research paper on the value of demergers showed that Australian ASX100 demerged entities on average have outperformed the market by 18.5% in the first year post demerger.

That same study found that one of the significant drivers of value for the shareholders in the companies involved in demergers, was that they typically increased the prospect of a takeover of either business.  Shareholders in demerged companies Dulux, Recall, Sydney Roads, and Rinker can attest to this assertion.  Demergers where the parent company still owns a stake such as Coles lessens this likelihood.

Williams said that “like all good things its pretty simple, demergers work because:

-      They allow good businesses previously trapped inside a conglomerate to be valued more precisely by investors.

-      Management can be properly incentivised and rewarded thereby driving positive outcomes and

-      Companies are able to be taken over, or if not at least a ‘control premium’ can start to be factored into the share price”

Investing in spin offs is not smooth sailing immediately following demergers however as quite often the spin off company is initially sold by investors.  This is because spin offs can often represent a small holding in the context of an investors’ portfolio and therefore sold as nuisance value.  Alternatively institutional investors sell as they are either not allowed to own stocks below a certain market size or they simply do not understand the new spun out business.  After the initial period when this wave of selling is done, an investment in a spin off can be lucrative.

Joel Greenblatt says that “both spin offs and merger securities are generally unwanted by those investors who receive them. Both spin offs and merger securities are usually sold without regard to the investment merit”.  This often results in the immediate performance of a spin off post demerger being poor.  He adds “as a result, both spin offs and merger securities can make you a lot of money.”

So enthusiastic about demergers is Greenblatt that he dedicates an entire chapter to the subject in his book “You can be a stock market genius”, which is well worth a read.

The next demerger that is proposed for Australian investors to consider is Woolworths spinning off their drinks division, good luck in the treasure hunt.