The Long and The Short: What reporting season can tell us about life in Australia

Kardinia Capital

2 September 2021

Just as the Australian Census promises to provide a comprehensive snapshot of the country and how we are changing, so too the recently-complete Australian profit reporting season can tell us what life has been like for Australians over the past 12 months.

Growth of online sales
With so many Australians stuck behind their computer screen during the day, it is no surprise that they have been spending online with a vengeance, fast-tracking the structural move from bricks and mortar to online shopping. The CEO of Australian online book seller Booktopia stated "the pandemic was a massive bump for people buying online ... online retail in FY21 was 13% of all retail. In three years by FY24 online retail will be 24% of all retail, almost double"[1].

Source: Booktopia FY21 Results Presentation

Australian online home furnishing retailer Temple and Webster (TPW) is another such example, where FY21 revenue is up 85% on prior calendar period. We also got a glimpse of current trading, with July month to date revenue growth accelerated to +39%. We expect TPW to report a tremendous uplift in gross profit, enabling significant reinvestment in FY22.

Savings rate still elevated
The savings rate among Australians has fallen, but remains at elevated levels (at ~12% of disposable income). Reporting season saw a record in dividends declared, with over $40bn of dividends to be paid: almost double that paid in the same period last year. Most of these dividends will be paid in September and October. Consumers' banks balances will swell as a result of these record dividends as well as buybacks and the proceeds from a record year of M&A deals. Retail will remain a beneficiary, as will the share market (given a significant amount of this cash will undoubtedly be recycled back into Australian equities). FY21 has seen some of the biggest deals in Australian history with Square's takeover bid for Afterpay, BHP Petroleum's proposed merger with Woodside Petroleum, MIRA/Aware Super's acquisition of Vocus, Seven Group's partial takeover of Boral and the bid for Sydney Airport by a consortium of super funds.

Internet data usage swelling
Many Australians no longer find themselves catching the train to work in the city. Instead, government-imposed COVID restrictions mean they are housebound, working from home and juggling the demands of home learning for schoolchildren. For this, they need a fast and reliable internet connection - and as a result, demand for high speed broadband has gone through the roof. Uniti Group's share price increased by 133% for the year, with "work-lifestyle changes making fibre networks an essential commodity"[2]. Aussie Broadband (ABB) has seen revenue growth of more than 80% from its residential and business customers.

Solid demand for cars
While at home, people are getting onto jobs that usually take a back seat, such as renovating the house or upgrading the family car. Based on VFacts, the Australian new vehicle market grew +38% over Jan-May 2021. Strong demand, reduced discounting and a normalisation of parts and servicing demand has contributed to explosive car dealers' results.

We have seen very strong profit results and growing forward order books from dealers like Eagers Automotive (APE) and Autosports (ASG) - both companies' share prices have appreciated over the previous 12 months, at 145% and 118% respectively. APE's "order bank growth is expected to continue as new vehicle demand remains strong and vehicle supply remains constrained"[3].

Source: Morgans, ABS

Renovation explosion
Further to the above, Australians are building and renovating their homes with vigour, driven in large part by support from the Federal Government's Homebuilder program. James Hardie's Asian Pacific region's sales growth increased 55% in the three months to the end of June. As an aside, the US restore and restoration market also grew at around 15% in the previous quarter.

Source: J.P. Morgan, ABS

Weak travel results
This spending around the home has come at the obvious expense of travel, with significant losses reported by the listed travel companies (Qantas $1.8b loss, Flight Centre $507m loss, Corporate Travel $33m loss). It's refreshing to hear from a CEO who states it as it is, and Rex was perhaps the most direct of the airlines with its outlook statement, saying "the second half will still be struck by further waves of infection given the experience of other highly vaccinated countries. As such the outlook for the FY is pessimistic."[5]

"It's not for lack of trying. Australians are ready to travel. Qantas Chief Customer Officer, Stephanie Tully, commented: "So we [have] obviously been researching our customers throughout the pandemic on their desire to travel and doing that monthly and in the last couple of months, particularly for international, we've seen the highest demand levels we've ever seen. When you compare that to pre-pandemic levels of people that are likely to travel in the next 12 months, we're seeing triple the amount of people looking to travel internationally in the next 12 months."

Aircraft are being pulled out of storage, including the A380s, and reconfigurations are currently underway with the intention to return to the skies when the magical 70% and then 80% vaccination rates are achieved. Bolstering management's confidence was the strength of the domestic business in the June quarter of FY21 - by the end of June, management basically saw the domestic business booking curves back to pre-COVID levels.

Concerning inventory levels
Arguably the number one theme of reporting season has been online retailers ending up with too much inventory.

Everyone seems to want to 'invest' in inventory as a strategic play. A stretched global manufacturing and supply chain is creating challenges - including longer lead times, higher freight costs and shipping delays - leading to companies growing inventory levels. Supercheap Retail (SUL) management said: "If it's [inventory is] not in the shed or on the shelf today, for Christmas this year I think the chance of it being [in stock] come that peak time is incredibly remote."[7]

However, we do not want inventory growth outstripping sales growth, and this is something we'll watching closely in future periods. Retailers (BRG, SUL, KGN) continue to show higher levels of inventory and it's concerning us. Only JBH and BBN have managed to keep inventory days down so far. Whether customers will be the major beneficiaries of heightened promotion activity (for inventory vulnerable to obsolescence such as technology) remains unknown; only time will tell.

What does all this mean for the future?
With COVID vaccinations accelerating across the country, we believe Australians can look forward to a happier 2022; with blunt lockdowns less likely, and more targeted measures introduced when COVID hospitalisations or deaths spike. At the time of writing, ~60% of Australians over the age of 16 have received one dose of vaccine while ~35% have received two doses. Globally, more than 5 billion doses have been given.

Source: Australian Government 

Department of Health

We predict the 70% threshold for vaccinations will be reached by the end of October, which will be around the same time as AGM season. Our view is CEOs will start to get more optimistic around this event. This is likely going to continue the rotation towards coronavirus-impacted sectors. 

The Kardinia portfolio is positioned for re-opening, with stocks that benefit from this comprising ~30% of the long book and lockdown stocks only ~10%. We believe some themes, such as the shift to online, are enduring, and we continue to hold exposure to the technology sector. Of course, new COVID variants and government nervousness around a likely rising death rate (as witnessed overseas) present risks to our view, but the Kardinia fund's ability to shift its net exposure to markets in a range of -25% to +75% allows us to quickly respond to any change in outlook.

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To invest or not to invest in China?

Robert Swift, Delft Partners

September 2021

Investing in China remains a moral question, but to not invest now because of more government intervention and capricious legislation is illogical, since that would be to ignore the fact that these trends are clearly evident in other countries. More government, capricious and unexpected legislation to the apparent detriment of companies and shareholders, is now omnipresent as a global systemic risk to equity returns. Consequently, prepare for lower rates of profit growth and 'fatter' tails in your investment outcomes, even if you decide to never invest in China again.

There are similarities between Xi Jinping's increasing intervention in the Chinese corporate sector and those by Western governments

1. Policy with social objectives (with a lack of awareness that the years of free money created the wealth inequality in the first place)

2. More taxation and worryingly more centrally directed capital allocation and subsidies (Tesla anyone?)

3. Penalising 'rentier capital' aka private savings 

4. Population coercion to behave by scare tactics/messaging, and surveillance; China uses facial recognition software and 'social scores' (but you may care to read this: Amnesty - New York Police Facial Recognition Revealed)

At least China has finally done something about moral hazard which would still seem to be prevalent in 'the West'. China Evergrande is 95% certain to default on over $80bn of bonds and we'll have to see how that pain gets allocated between locals and foreigners before making more judgements, but bankruptcy is part of capitalism, or it used to be. In this respect China is ahead of the US perhaps and certainly the Europeans in letting a failed enterprise actually fail.

For those of you who think that China's decision making comes without due warning and therefore makes it too risky in which to invest, the second part of the US 'Infrastructure' bill, equal to a 3.5tln $ spend, will take 17 days (!) to debate. Obamacare took 9 months even with a significant Democrat majority, (which is not the case now) and FDR's programmes were spread over his first 2 terms - 8 years. The UK government recently announced hikes on national insurance and dividend tax increases in essentially a unilateral decision by the prime minister. The unelected European Central Bank has essentially decided both monetary and fiscal policy for Europe and the result has been less than stellar growth. The Euro remains a political construct not a valid economic one but it's an ideology akin to 'Mao thought' and so on we go regardless.

In short, governments everywhere are consulting less and intervening more quickly.

Government exist to provide essential services but to also redress other imbalances dangerous to national cohesion - or they should. Currently imbalances are very evident in wealth inequality and the share of profits in the economy relative to wages. Using the US data (the best around) we can see from the chart below that corporate profits have been on a rising trend relative to wages. Since the consumers of the companies' products need money with which to buy them, this % allocation tends to oscillate around an average. If wages rise too quickly then companies become less profitable, can't invest and won't hire which the reduces wage growth. Vice versa. Sometimes a nudge is needed - the General Strikes in the 1920s, the Reagan, Thatcher, Laffer curve revolution of the late 1970s and the Schroeder reforms in Germany in the 1990s serve as examples.

Source: BEA, BLS

This swing back to wages is needed and will come with the attendant ever bigger government. Don't blame government - blame companies that have indulged in such anti-social behaviour as zero contract hours, and paying no taxes while enjoying the legal protection, trained workforce, and infrastructure that other people's taxes have provided. Could this have been prevented in the last few years had companies perhaps not bought back stock to the tune of c$900bn p.a., significantly benefitting corporate executive share option schemes, and instead raised wages, increased re-investment and improved job security? This imbalance got a big tailwind from ZIRP aka "monetary policy for rich people", and so we would actually view this shift as much need rebalance because without the rebalance...economic distress causes revolutions and if you want examples checkout Wikipedia -The_Great_Wave

Two final thoughts.

Trickle-down economics is dead and as investors you should prepare for more government, National Industrial Polices, thus more inflation and taxation and lower returns from equities. Our advice is to focus on smaller companies since they are seldom directly in the firing line of legislation, find companies that do 'useful things' such as building a country's capital stock, look very closely at Japan which we think is both cheap and showing change for the good, and increase the volatility of returns if you do such things as portfolio optimisations.
The moral issue of investing in China requires consistency. If you don't like the idea of benefitting from profits made in China's repressive regime, shouldn't that dislike include profits made in China regardless of the geographical listing and domicile of the company?  

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One way or another China is always in the news. The current nervousness by some fund managers surrounding China is a reflection of the risks involved, while others see resulting lower prices as an opportunity.

In this video Chris Gosselin explores both sides of the argument with Rob Swift from Delft Partners, Jack Dwyer from Conduit Capital, and Alex Pollak from Loftus Peak.