A most unusual reporting season

Relative to what we were preparing for in March and April this year, reporting season was surprising in how normal most results were. Maybe investors have been conditioned too well by management to look through anything deemed one-off – but with the exception of a few names (Webjet, Fletcher Building, Sims Ltd) – operating results themselves were reasonable given COVID circumstances.

Specialty retailers were a focus as our view is that we are going through a structural change, moving to omni-channel retailing, accelerated by COVID. As we discussed earlier in the year, this is driven by cost (revenue per employee and rents) as well as revenue opportunities (customer preference) and improved competitive position. Many results demonstrated consumer traction and financial benefit from online sales – although some are executing better than others. There remains plenty of uncertainty around temporary influences from JobKeeper, JobSeeker, government stimulus, economic growth, and employment and no one has a crystal ball on the path forward over the next 12 months. We do, however, think the omni-channel retail winners are likely to be higher quality businesses earning more in 3 – 5 years’ time.

We have been waiting for two or three reporting seasons to see evidence of a clear pick up in mining services activity and although outlook statements were caveated with COVID disruption risk, we see clear signs that the cycle is picking up. A combination of deferred maintenance Capex, brownfield expansion, firmer commodity prices and clients across the market cap spectrum being financially robust (whether from operating cash flow at the quality end, or from capital raisings at the more speculative end) are all filling up order books and supporting margins.

National Australian Bank (NAB) acquired MLC for A$4.6bn cash in April 2000 with funds under management and advice (FUMA) of A$52bn. Fast forward 20 years and the wealth management part of this business was sold to IOOF in September 2020 for less than A$1.5bn with FUMA of A$308bn. The real cost to NAB shareholders is much higher than it first looks (and the first look is pretty bad). Had NAB invested the cash used for MLC into an Australian equity index fund over that time, whose total return was 9% a year, they would have A$26.5bn today. Earnings over the period, proceeds from the 80% sale of MLC Life and businesses retained (such as JB Were) need to be weighed against the Hayne Royal Commission remediation and compensation payments. As a ratio of FUMA, IOOF has paid a fraction the price paid by NAB in 2000 and they have greater potential synergies from three business combinations (IOOF, ANZ, MLC). It is very very early days on what this means for IOOF, however, we think the historical context is a useful place to start.

Across high growth small cap names, we were surprised by how few companies delivered meaningful operating upside surprises. In one case, calling out sales and marketing (a pretty normal cost to grow a business) as a cost that should be ignored suggests they are already stretched beyond their ability to deliver what was priced by the market. Inside owners in many of these names appear not at all surprised and have continued to ‘free up room on the register for other shareholders’, a wonderful euphemism that used to be called feeding the quacking ducks.

August showed that speculation remains well bid. The number of ASX listed loss- makers >A$100m market cap jumped 25% (from 138 to 172) since June 30. It hurts our relative performance not to participate, but FOMO doesn’t form part of our investment process, so we get over it and move on.