2 September 2021

Twice a year we summarise the half-year and full-year results of the companies in the Arminius Capital ALCE portfolio https://arminiuscapital.com.au/funds/. Most of our companies reported strong earnings recoveries in the June 2021 half-year, and it has also been a record season for dividend payouts and share buybacks. Despite the recent surge in COVID-19 lockdowns, company boards – who by definition are in possession of inside information – are broadly positive about the outlook for FY2022.

In management commentary on the results and outlook, two themes stood out. The first was that most companies are still in a transitional phase, within sight of operating normally, but not there yet. Or, as Arminius has been saying since last November, there is a light at the end of the tunnel, but we are still in the tunnel. This is a W-shaped recovery: vaccinations take us two steps forward, then lockdowns take us one step backward.

The second theme is that supply of goods is more and more of a problem. Obviously, freight costs have tripled (or worse). Shipping times are also lengthening, because the world has discovered that it does not have enough containers or enough container ships, especially when many of them are stuck in queues off ports like Los Angeles/Long Beach in California. In addition, most items with a computer chip inside are in short supply, and the chip shortage will not go away before 2023.

For Australian companies ordering goods or parts from overseas (especially from China), the big problem now is that everything has to be ordered well in advance of actual need, and probably in bigger quantities (in the hope that at least some of the order will arrive soon). The net effect is a 30% to 50% increase in inventories, creditors, and other working capital. This trend will worsen over the next few months, and will last into 2022 at least.


Australian and US steelmaker Bluescope reported a surge in profitability in line with its earlier guidance. Net profit leaped from $96m to $1193m, and the dividend was tripled from 8c to 25c, plus a 19c special dividend. More important was management’s outlook: in the current half-year, earnings before interest and tax (EBIT) are expected to be between $1.8bn and $2.0bn – compared to $1.7bn for the whole of FY2021. Dividends are intended to continue at the rate of 50c per year, and a share buyback is planned in the near future. Strong cash flow generation has allowed Bluescope to avoid debt, despite being in middle of a major expansion of its North Star steel mill in the US. At year-end the company held $798m net cash, placing it in a very strong position to fund a possible further expansion of North Star and a probable $800m to re-line the No. 6 blast furnace at Port Kembla (which has been mothballed since 2011). Bluescope’s profitability relies mainly on US steel demand, which we expect will be supported by the housing boom and infrastructure spending.


Property group Charter Hall beat consensus forecasts with FY2021 operating earnings per share (OEPS) of 61c and a dividend of 37.9c (40% franked). Funds under management (FUM) increased 13% year-on-year to $52.3bn, about equally from valuation increases and acquisitions. Office makes up 44% of FUM, which may expose Charter Hall to medium-term problems if demand remains in the doldrums. Look-through gearing rose from 29.4% in June 2020 to 32.4% in June 2021. Management guidance for FY2022 OEPS was 75c, implying dividends of 40c. Better contributions from performance fees and development profits may well lift these figures.


Computershare’s result met market expectations. Revenue slipped 0.8% and EPS dropped 7.3%, but the final dividend was maintained, and FY2021 should be the bottom of the cycle. The US and UK Mortgage Services businesses suffered some disruption from the pandemic, but should return to normality in 2022. Share registries and associated services continue to expand globally, and the group’s cost reduction program is proving successful. Management forecast that FY2022 would see a 4% increase in earnings per share from Computershare’s existing businesses.


The housing boom delivered NZ and Australian building materials group Fletcher Building (FBU) a net profit turnaround from its FY2020 loss of $196m to a FY2021 profit of $305m. The 18c final dividend takes the full-year payout to 30c unfranked (zero in FY2020). Better product prices helped lift revenue 11% to $8.12bn, and margins rose from 7.2% to 8.2%. Strong cash flow allowed FBU to cut its net debt from $497m to $173m. The company also announced an on-market share buyback of up to $300m. Management did not provide any earnings guidance, but noted that the residential outlook was very strong in Australia and New Zealand, even though both markets were suffering input cost inflation and supply chain disruption.


Diversified property trust GPT announced an operating result slightly ahead of market expectations. Rent collection in the retail portfolio reached 104% of net billings in the June half, and occupancy was up from 98.0% at December 2020 to 98.9% at June 2021, but re-leasing spreads remain negative. The office portfolio still needs large incentives to fill vacancies, and oversupply in key markets will last into 2023. GPT came late to the logistics sector, but its industrial portfolio is doing well, with a 10.6% rise in valuation. Group funds from operations of $302m was 24% above the June 2020 half (which suffered the onset of the pandemic), but below the $310m of the December 2020 half. In view of the headwinds in retail and office property, GPT will not back to normal before 2023.


Pathology and radiology provider Healius reported strong rises in revenues, profits and cash flow. Underlying earnings per share rose from 8.5c to 23.7c, and the full-year dividend was lifted from 2.6c to 13.25c. Net debt was reduced from $666m at June 2020 to $205m at June 2021. The explosion in COVID-19 testing lifted pathology revenues by 25%, but imaging revenues rose only 8%. Similar trends are already apparent in FY2022. Management indicated that the share buyback would resume, and that Healius would make bolt-on acquisitions when the price was right.


The June 2021 half-year was the first period for mineral sands miner Iluka without the mining royalties business, which was spun off in October 2020 as Deterra. (Iluka retains a 20% stake in Deterra.) Comparable earnings per share rose from 18.8c in the June 2020 half to 30.3c in the June 2021 half, with a fully franked dividend of 12c (zero last year). Higher rutile and zircon prices lifted margins, but the main profitability driver was the 75% increase in total production. Asset sales and strong cash flow from operations have bumped up Iluka’s net cash position to $220m. The group is considering several expansion projects, including a rare earths refinery based on the monazite stockpile at Eneabba.


Diversified property trust Mirvac reported FY2021 operating earnings per share of 14.0c and a distribution of 9.9c. Lower development earnings caused a 9% fall in net profit to $550m. Rental income from the office and retail portfolios is recovering very slowly. The resurgent housing market is lifting development profits, but Mirvac’s focus on apartments means that it has not enjoyed as much uplift as house developers. Management indicated that FY2022 operating earnings per share would grow 7% to 15.0c, with a 10.2c distribution.


Sleep apnoea and COPD group Resmed announced a fourth-quarter result which was at the low end of market expectations due to a fall in gross margins. The fourth-quarter dividend was increased 8% to USD0.42. The pandemic made patient diagnosis more difficult, but the progressive re-opening of the US and European economies has lifted current diagnosis rates almost back to pre-coronavirus levels. Resmed’s sales in coming months will be boosted by a product recall which its competitor Phillips announced on 14 June 2021, subject to supply blockages which have caused shortages in some micro-electronic components. One positive outcome from COVID-19 has been that patients are now far more comfortable with remote screening, diagnosis, and monitoring.


Miner South32 gave its shareholders a pleasant surprise with a strong FY2021 result, an increase and extension of its share buyback, and a higher than expected dividend. Earnings per share rose from US3.9c in FY2020 to US10.4c in FY2021. The final dividend was US5.5c fully franked (including US2.0c special), making US6.9c for the year. Nine of the ten operating divisions performed well, the exception being Illawarra Metallurgical Coal, which attracted a post-tax impairment charge of US510m. Assuming aluminium, manganese, and base metals prices which are lower than current spot levels, South32’s production and cost guidance for FY2022 suggests that EPS will reach US25c per share.


Insurance broker Steadfast continued its record of steady growth, despite the pandemic. Underlying net profit after tax rose 18.1% to $160m inFY2021. Insurance broking continued to benefit from premium increases by insurers, with no loss of volume, while insurance underwriting continued to benefit from market share gains as well as premium increases. The full-year dividend was lifted from 9.6c to 11.4c fully franked. The $411m acquisition of Coverforce is expected to be EPS-accretive immediately. Management guidance is for FY2022 underlying diluted EPS growth of 10% to 15%.


Global scrap metal processor Sims had foreshadowed a dramatic improvement in its profitability earlier this year, but the actual result surpassed expectations, and a share buyback was announced. Underlying earnings per share leaped from negative 29c to positive 140c, and the annual dividend was increased from 6c to 42c (50% franked). Although sales volumes only rose 5% year-on-year, the increase in prices since April 2020 has lifted margins and raised EBITDA from $145m in FY2020 to $580m in FY2021. Cash flow from operations was only $129m because year-end inventory rose sharply, reflecting higher scrap prices, but the inventory position is expected to be reduced in coming months. Sims has zero net debt, and the capital expenditure postponed last year will now be implemented in FY2022. Management noted that FY2022 had started well but did not offer guidance for this year’s profits.


Diversified property trust Stockland met market expectations with FY2021 funds from operations (FFO) of 33.1c, which was down only 4.7% year-on-year. Distributions were lifted 2.1% to 24.6c. The group’s residential development business prospered in the housing boom, especially as Stockland focuses on houses rather than apartments. The industrial and retirement portfolios held up well, showing the advantages of diversification. As with other property trusts, office and retail income suffered in the pandemic, but Stockland’s overweight in convenience retail meant that it suffered less than others. Management indicated FY2022 FFO in the range 34.6c to 35.6c. The new CEO announced a strategic review, with an emphasis on portfolio re-weighting and capital partnering.


Telstra announced its first increase in net profit in five years, to $1.9bn, based on strong performance from the mobile division. The dividend was maintained at 8c per half-year (fully franked), which is slightly more than net profit but amply covered by free cash flow. Pandemic costs and NBN effects reduced FY2021 revenue and underlying EBITDA by 9.6% to $bn, but management indicated that FY2022 EBITDA was expected to be $7.0bn to $7.3bn, implying year-on-year growth of 4% to 9%, and said that its FY2023 target was $7.5bn to $8.5bn (which would support a dividend of 16c per year).


Wesfarmers exceeded investor expectations with its profits and dividends, and threw in a 200c capital return. Net profit after tax (excluding significant items) jumped 16% on a 10% revenue increase, propelled by Bunnings, Kmart and Officeworks. Earnings per share rose 16% to 214c, and the dividend was lifted from 151c to 178c fully franked. Bunnings saw revenues and margins rise, so that it contributed 62% of Wesfarmers’ profits. Kmart benefited from closing Target stores or converting them to the Kmart format. Officeworks enjoyed an 8% rise in sales, and 35% of its sales are now online. The group had $109m net cash at June 2021, so even after the capital return it has plenty of firepower for acquisitions.


Global mining contractor Worley reported a June 2021 half-year where profits, margins and cash flow were worse than the June 2020 half but better than the December 2020 half. The pandemic caused delays and deferrals in customers’ projects, not to mention restrictions on site access. Conditions stabilized in the June 2021 half, and activity appears to be picking up, as the sales pipeline grew 16% between January 2021 and July 2021. Gearing was reduced to 21.7%, well below Worley’s target range of 25% to 36%.

In a gesture of confidence, directors maintained full-year dividends at 50c, even though this payout was well above normalized earnings per share of 31c. Management guidance mentioned only an “improved FY22”, with the provisos that COVID-19 would continue to impact the global economy and that different sectors and regions would recover at different rates. US and European engineering groups have been equally cautious about guidance. There is no doubt that infrastructure spending, de-carbonization programs, and mine expansions will lift demand for Worley’s services – but we might have to wait a year or two for this demand lift to materialize.




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