Wednesday, 01 April 2020 13:23

Alibaba - why the smart money likes it

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Chinese CurrencyWith the Chinese middle class population forecast to double to over 600 million over the next 5 years, which in turn increases consumer spending, it is not difficult to see why the ‘smart’ money is investing in Alibaba, one of China’s largest companies that is likened to Amazon, eBay, Paypal and Google all rolled into one.

Alibaba was founded during the 1990’s by Jack Ma who realised at that time China lacked technology in the business world.  Alibaba, now one of China’s largest companies, listed in 2014, and today is highly profitable with a market capitalisation of over US$580bn.  This is about 6 times larger than Australia’s largest company CSL.

Alasdair McHugh (Product Specialist Baillie Gifford) is attracted to Alibaba due to their very strong position in ecommerce transactions in China where their market share is over 60% by gross merchandise value and likely to rise further.  He also likes the fact that the original co-founder and visionary Jack Ma is still involved in the business.  

According to the China Ministry of Commerce, total retail sales across China increased 8% in calendar 2019, for a total of RMB 41 trillion (AUD $9 trillion).  Consumption contributed over half of China’s economic growth.  Online retail sales for the year was RMB 8.5 trillion (AUD $1.87 trillion) up 19.5% from the year before.  It is clear that consumption is now a major driver of economic growth in China, and online retail is an important driver of consumption growth. Alibaba’s dominant position means it is well placed to capture this growth.

The scale of the opportunity is extraordinary and underestimated by certain investors, particularly some from the west who still consider China as a risky emerging market.  But McHugh suggests that those who still treat China as an emerging market are overlooking the fact that the addressable market for Chinese consumer spending is 1.3 billion people.  

Illustrating this point was the recent ‘Singles Day’ held in November 2019 where another record was broken with total sales of RMB 268.4bn (approx. AUD $59.2bn).  Almost 1.3 billion packages were delivered by Alibaba from ‘Singles Day’ orders and of those 960 million were delivered within one week.  This is equivalent to 2.3 times the combined online sales of Black Friday and Cyber Monday in the US.  It reflects the strength of Alibaba’s digital economy and of Chinese consumers consumption power.

Joe Lai (Portfolio Manager Platinum Asset Management) says that “mobile monthly average users on Alibaba’s retail marketplaces in China reached 824 million in December 2019, an increase of 39 million from the previous quarter”.  

Beyond the ecommerce business, Alibaba operates the largest cloud computing business in China, Alibaba Cloud.  Many believe that this business can ultimately become the largest division within the company despite it presently representing less than 10% of overall revenue.  Revenue from Alibaba Cloud grew by 62% over the year to December 2019.

A fascinating aspect of Alibaba’s recent quarterly earnings update related to the company’s involvement in procuring and delivering 40 million units of medical supplies worth around AUD$100 million to Wuhan which has been impacted by Covid-19.  This shows a company that is so much more than an online retailer. 

Lai points out that “The Alibaba ecosystem keeps delivering new sources of value to shareholders.  Amid the Covid-19 lock down in China, Alibaba’s new enterprise communication app, DingTalk, has achieved new prominence.  Alibaba introduced a new digital health check in feature on DingTalk, which as at February 2020, had recorded more than 150 million daily health check ins.”

While currently investors are obsessing over Covid-19, Alibaba management said “17 years ago, the ecommerce business experienced tremendous growth after SARS.  We believe the adversity will be followed by changes in behaviour among consumers and enterprises and bring ensuing opportunities.  We have observed more and more consumers getting comfortable with taking care of their daily living needs and working requirements through digital means.” 

With the huge growth in China’s middle class and online commerce in coming years, combined with Alibaba’s dominance across retail, financial and computing businesses it’s clear to see why the company is in Platinum and Baillie Gifford portfolios.  Investors can of course buy Alibaba directly either on the Hong Kong or US exchange and can also gain access to it through managed global funds.

 

This article appeared in the Australian Financial Review during March 2020 - written by Mark Draper GEM Capital

Wednesday, 01 April 2020 13:04

Solvency and Debt in time of crisis

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This article was written by Hugh Dive - Atlas Funds Management and he has generously authorised its reproduction ..... Thanks Hugh!

 

Alongside the worldwide devastation as healthcare systems struggle to cope and deaths are well into the tens of thousands, the COVID-19 crisis is having a chilling impact on Australian corporates. Many companies are removing profit guidance given less than a month ago, cancelling dividends, raising debt, and in the last five days attempting to raise capital. Eleven years ago during the GFC many companies raised equity, often at deep discounts to their share price, as nervous bankers put pressure on management to shore up weakened balance sheets. In some situations, companies were forced to raise equity as their bankers were unable to refinance loans that had become due in a frozen credit market. 
 
In this week’s piece we are going to look at the various debt measures that we examine to assess a company’s solvency. These measures provide insight into whether management will be forced to raise equity during times of stress.

Gearing


Gearing is the most commonly discussed measure of a company’s debt. It indicates the degree to which a company’s business is supported by equity contributed by shareholders, as opposed to debt from banks and bondholders. Gearing is measured by dividing net debt by total equity (assets plus liabilities).  During times of buoyant business conditions, companies with a high level of gearing generally deliver higher returns to investors. However, when the tide turns, highly geared companies have a riskier financial structure and have an increased chance of going into administration or having to raise equity to retire debt.

Most companies on the ASX have a gearing ratio between 25% and 35%. However, the level of gearing needs to be assessed in the context of the industry in which the company operates.  Utilities such as Spark Infrastructure with regulated revenues can “safely” have a higher level of gearing than a highly cyclical stock such as Myer or Qantas. The latter two have more variable earnings and thus a variable ability to meet interest payments.

The key weakness in using gearing alone to measure a company’s solvency is that it assumes that the company’s assets can be realised for close to what they are valued on the balance sheet. The shortcomings of this approach are especially apparent for companies with a large proportion of intangible assets on their balance sheet, such as goodwill stemming from acquiring other businesses at prices above their net asset backing. In 2019 AMP’s gearing increased rapidly after the financial services company wrote down the asset value of its troubled wealth management and life divisions by $2.5 billion. Shortly after writing down the value of its assets, the highly geared AMP both cancelled its dividend and conducted a $650 million equity raising at a 16% discount to the share price at the time.

Companies such as Medibank PrivateJanus Henderson and A2Milk are in the fortunate position in 2020 of having no net debt on their balance sheet. As a result, each has a negative gearing ratio and is facing no anxious discussions with their bankers. By contrast AMP, Pact and OohMedia (which raised $167 million last week) all have high levels of gearing.
 

Short-Term Solvency


Short-term solvency ratios, such as the current ratio, are used to judge the ability of a company to meet their short-term obligations. The current ratio divides a company’s current assets by their current liabilities (i.e. liabilities due within the next 12 months). Firms can get into financial difficulties despite long term profitability or an impressive asset base if they can’t cover their near-term obligations. A current ratio of less than one would indicate that a company is likely to have trouble remaining solvent over the next year, as it has less than a dollar of assets quickly convertible into cash for every dollar they owe. A weakness in using this measure to assess the solvency of a company is that the current ratio does not account for the composition of current assets which include items such as inventory. For example, winemaker Treasury Wine reports a robust current ratio. However, a large proportion of current assets are inventories of wine which may be challenging to convert into cash at the stated value during times of distress (panic buying of wine notwithstanding).

A further limitation of the current ratio in assessing a company’s financial position is that some companies such the ASX, Coles and Transurban which have minimal inventories or receivables on their balance sheet. This occurs as they collection payment immediately from their customers, but pay their creditors 30 or 60 days after being invoiced. These companies will tend to report current ratios of close to 1. Alone, this figure would indicate that these companies may be in distress. Indeed Coles has a current ratio below 1, which far from being alarming is due to the nature of the grocery business. Suppliers such as Kellogg’s and Coke are paid on terms between 60 and 120 days after they deliver their goods which creates a large current payables balance, while the receivables balance is small when customers pay for their cornflakes or Diet Coke via direct debit. This favourable mismatch between getting paid and paying their suppliers allows Coles and Woolworths to report an alarming current ratio that is effectively a loan from their suppliers to fund the grocers’ working capital.
 

Interest Cover


A debt measure that we look at more closely than gearing is interest cover, as this measures cash flow strength rather than asset backing. Interest cover is calculated by dividing a company’s EBIT (earnings before interest and taxes) by their interest cost. The higher the multiple, the better. If a company has a low-interest cover ratio, this may indicate that the business might struggle to pay the interest bill on its debt.

Before the GFC, I had invested in a company that had significant asset backing held in the form of land and timber. Using gearing as a debt measure alone, Gunns appeared to be in a robust financial position. However, interest cover told a different story. The combination of a rising AUD (which cut demand for its woodchips) and weak economic conditions resulted in Gunns having trouble servicing their debts despite their asset backing, and the company ended up in administration.

As interest rates have trended downwards over the past decade, it has become easier for companies to pay their declining interest bills, so in general, the interest cover ratio for corporate Australia has increased. Across the ASX companies such as JB Hi-Fi, Goodman Group, Wesfarmers and RIO Tinto all have an interest cover of greater than ten times. At the other end of the spectrum Nufarm, Viva Energy, Boral and Vocus all finished 2020 with interest cover ratios less than three times, which is likely to result in some worried discussions with their bankers. Nufarm has since sold its South American crop protection business with the proceeds going to pay down debt.  
 

Tenor of Debt


A very harsh lesson learned on debt during the GFC was not on the absolute size of the debts owed by a company, but the time to maturity – known as the tenor of the debt. The management of many ASX-listed companies sought to reduce their interest costs by borrowing on the short-term market and refinancing these debts as they came due. While this created a mismatch between owning long-dated assets that were refinanced yearly, it was done under the assumption that credit markets would always be open to finance debt cheaply. This strategy worked well until global credit markets seized up in 2008 and a range of companies such as RAMS and Centro struggled to refinance debts as they came due.

When looking at a company’s solvency during times of market stress, one of the critical items to look at is the spread of a when a company’s debt is due. If the company’s debt is not due for many years, management teams may not be forced by their bankers into conducting dilutive capital raisings during a period of difficult economic times. In the ASX over the next year Seven West Media, Downer and Southern Cross Media all have significant levels of debt to refinance, which may prove challenging in the current environment.

After the GFC many of the larger ASX-listed companies have sought to limit refinancing risks by issuing long-dated bonds in the USA and Europe. Toll road companyTransurban does carry a large amount of debt, but as you can see from the table below, the maturities of these debts are spread over the twenty years with an average debt to maturity of 8.4 years.

Similarly, at the smaller end of the market, the supermarket landlord SCA Property has minimal debt due over the next three years after issuing long-dated bonds in the USA. While COVID-19 is disrupting SCA Property’s business in March 2020, this spread of debt maturities positions this property trust better to ride out the current storm.


 

Covenants


Covenants refer to restrictions placed by lenders on a borrower’s activities and are contained in the terms and conditions in loan documents. These are either affirmative covenants that ask the borrower to do certain things such as pay interest and principal, or negative covenants requiring the borrower not to take on more debt above a certain level – for example; gearing must stay below 60% or an interest cover above three times. For investors, covenants can be difficult to monitor since, while companies reveal the maturity, currency and interest rate of their debts in the back of the annual report, disclosure on debt covenants is generally relatively weak.

Debt covenants were something that received little attention before the GFC when a covenant linked to Babcock & Brown’s market capitalisation triggered the collapse of the company. In June 2008, Babcock & Brown’s share price fell such that the company’s market capitalisation fell below $2.5 billion, and this triggered a covenant on the company’s debt that allowed its lenders to call in the loan.  After this experience, very few borrowers will include a market capitalisation covenant in their debt, as this leaves the company vulnerable to an attack by short-sellers. More recently in 2019 when Blue Sky Alternatives breached covenants, bondholders called in the receivers to protect their loan.

In 2020 amid the COVID-19 crisis, debt covenants are once again in the minds of investors, particularly in the hard-hit media and listed property sector. In the media sector, a fall in TV advertising revenue of 10% is likely to trigger Seven West Media’s debt covenant of 4 times EV/EBITDA (enterprise value divided by earnings before interest, depreciation and tax).

In listed property, the embattled shopping centre trusts have more breathing room, as they entered 2020 with a lower level of debt. The key covenants for Scentre are gearing (less than 65%) and interest cover (higher than 1.5 times). For the gearing covenant to be breached, the independent valuation of Scentre’s assets would have to fall by 60% from December 2019; for the interest cover to be breached, earnings would have to fall by 60% assuming no change to Scentre’s cost of debt.
 

Hedging


In the context of debt, hedging refers to the addition of derivatives to limit the impact of movements in either interest rates or the currency in which the debt is denominated. Many Australian companies borrow in Euros, US dollars and yen – both to take advantage of the lower interest rates in these markets, but more importantly to borrow money for a longer-term.  In 2020 the Australian dollar has fallen 12% against both the Euro and the US Dollar.

Companies that have significant un-hedged debt – such as building materials company Boral – will see their interest costs increase, especially if the company does not have enough foreign earnings to service their debt. This situation occurred in 2010 for Boral and required a dilutive $490 million to keep the company within their debt covenants. In December 2019 Boral’s debt was A$2.8 billion, but currency movements over the past 90 days have added $340 million to the struggling building materials company’s debt pile.

Our take

The upcoming year  will be tough for Australia’s companies as the sudden step change in demand is very different to the falls in 1987,1991,2000 or 2008/09. While demand for goods and services fell during these previous times of stress, some companies are now facing a government mandated shut-down in their businesses.

On a more positive note businesses are also likely to find more sympathetic bankers in 2020 than they faced in previous recessions, as well as massive government support. During the GFC,  the banks themselves were not well placed to help businesses, as issues with the global banking sector were at the heart of the crisis. The banks were de-levering their own balance sheets, while struggling to explain collapsed credit markets and the problems created by complex financial instruments to hostile politicians. Given that the shutdowns from COVID-19 are a temporary state of affairs and in light of the massive fiscal stimulus, we would expect the banks to give many struggling firms a degree of leeway over the next year.

 

 

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.

 

Media

Monday, 16 December 2019 08:53

Best of the Best - December 2019

Written by

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

Written by

CALLER:

Is this Gordon's Pizza?

GOOGLE:

No sir, it's Google Pizza.

CALLER: 

I must have dialled a wrong number. 

GOOGLE: 

No sir, Google bought Gordon’s Pizza.

CALLER: 

OK.  I would like to order a pizza.

GOOGLE: 

Do you want your usual, sir?

CALLER:

My usual? You know me?

GOOGLE:

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.

CALLER: 

OK! That’s what I want ...

GOOGLE:

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.

CALLER: 

What? I detest vegetable!

GOOGLE: 

Your cholesterol is not good, sir.

CALLER: 

How the hell do you know!

GOOGLE:

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.

CALLER:

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.

CALLER: 

I bought more from another drugstore.

GOOGLE: 

That doesn’t show on your credit card statement.

CALLER: 

I paid in cash.

GOOGLE: 

But you did not withdraw enough cash

according to your bank statement.

CALLER: 

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.

CALLER: 

WHAT THE HELL!

GOOGLE: 

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

with the sole intention of helping you.

CALLER:

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.

GOOGLE: 

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

Written by

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?

Written by

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.