by Daniel Moore and Phillip Gray
In a reporting season where most companies reporting were materially impacted by the disruption caused by COVID-19 and a change in consumer patterns – some positively and some negatively – it was reassuring to see the vast majority of the core holdings in IML’s large-cap Funds report positive results for the first half of the 2021 financial year. This once again reinforced our belief in the benefits of owning good quality, well-established businesses that generate real cashflows, real earnings, and real income from dividends, and which trade on reasonable valuations.
Amcor
Amcor is one of the largest packaging suppliers with diversified operations around the world and with the majority of its sales to defensive fast-moving consumer goods companies. This enables Amcor to produce relatively steady and predictable earnings even in times of economic uncertainty.
Amcor had a strong first half 2021 result as it reported a 12% increase in net profit after tax (NPAT), driven by better than expected volume growth (particularly in rigid plastic packaging), synergies flowing through from the Bemis acquisition, and lower interest costs. Amcor continues to execute well and is on track to achieve its sustainability goal of a fully recyclable or reusable portfolio by 2025. While growth into 2022 is expected to moderate, Amcor has a strong balance sheet, is paying a good dividend, is using its strong cashflows to undertake a US$350 million share buyback, and is trading on a reasonable 15 times earnings.
Aurizon
Aurizon owns and operates essential rail infrastructure assets in Queensland and an above-rail business hauling coal and other freight. Aurizon had a reasonably positive first half 2021 result which was a very good outcome in a difficult environment given the coal import bans imposed by China. Aurizon generated a net profit after tax of A$267 million and declared a 14.4 cents dividend per share, 70% franked. The Australian coal industry is recovering strongly as it has been able to diversify destinations for Australian coal away from China, thereby overcoming the effects of the Chinese embargo.
Aurizon remains a very well-managed company whose Board and management are using the strength in cashflows from its existing coal business to invest and grow the company’s non-coal haulage operations. These investments will make a substantial contribution to Aurizon’s future earnings, offsetting any deterioration from its coal haulage operations, which seem likely to diminish progressively in the next 20 or 30 years. Aurizon continues to produce substantial free cashflows, and continues to reward patient shareholders with healthy dividends while also using its surplus cashflow to fund new investments and a share buyback.
Coles Group
Coles Group, Australia’s second-largest supermarket player, had a strong first half 2021 result, generating a net profit after tax of A$560 million, with the result buoyed by strong sales as people ate more from home during COVID-19. The company gave a realistic assessment of the abnormal boost to earnings from COVID-19-generated demand. Coles has a very strong balance sheet and continues to offer a defensive business model, with earnings growth and margin improvements to come from management’s focus on extracting efficiencies as well as rationalising and improving the distribution centre footprint between now and 2023.
Sonic Healthcare
Sonic Healthcare is a global pathology company which holds market leadership positions in Australia, Germany, the United Kingdom, and Switzerland, and is the number three player in the United States. Sonic had a very strong result for the first half of the 2021 financial year, generating a net profit after tax of A$678 million. The company was a major beneficiary of COVID-19 testing, and while these revenues will taper off going forward, there will be continuing demand for COVID-19-related testing and diagnostics for international travel. Importantly, Sonic’s underlying non-COVID-19 revenue also showed very good momentum.
The strength of Sonic’s cashflows combined with the company’s extremely low level of debt means that Sonic’s balance sheet is in its healthiest state in 20 years. This has positioned Sonic to emerge in a much better position than many of its smaller or more leveraged competitors. Given that Sonic’s balance sheet is now under-geared, we expect further earnings-accretive acquisitions in the year ahead, with Sonic’s highly-capable and experienced management team continuing to build the company’s global platform as the company has done very successfully for the last two decades.
Tabcorp
Tabcorp owns valuable gaming licenses across the lotteries and wagering sectors in Australia. Tabcorp had a reasonable overall result for the first half of the 2021 financial year, producing an A$207 million net profit after tax with very strong free cashflow. Tabcorp’s lotteries division continues to perform well, with increased earnings and margins from new and enhanced games and increased digital penetration. The wagering division, as expected, was affected by COVID-19 venue shutdowns, but this was partly offset by stronger digital growth and better cost control.
We welcomed the recent announcement of a new incoming Chairman and CEO. Tabcorp also appears to be making good progress on the potential sale or demerger of its wagering business, which we believe is likely to unlock significant value for shareholders. In our view, a standalone lotteries division would be a very attractive business and would trade at a significant premium to the sharemarket, given the very strong cashflows and steady growth expected from this division.
Telstra
Telstra’s first half 2021 result met our expectations, with the company reporting a net profit after tax of A$1.1 billion. Pleasingly, in contrast to its largest competitor which went backwards, Telstra reported mobile subscriber growth of 80,000 customers, with average revenue per user increasing – boding well for Telstra’s future earnings. Telstra is extending its network advantage because the rollout of its 5G network is substantially ahead of its competitors, putting the company in an even stronger position to win and retain high value customers. Telstra has also increased its cost savings target and is progressing well its plans to sell some of its infrastructure assets. Telstra remains a well-run company which generates extremely strong cashflows and which has a very strong balance sheet. Given all this, we firmly believe that Telstra’s current 16 cents per annum per share dividend is sustainable well into the future with growth beyond 2022.
Conclusion
The positive results from core shareholdings in IML’s large-cap Funds for the first half of the 2021 financial year reiterate the rationale for continuing to invest in good quality, well-established businesses which produce real cashflows, earnings, and dividends. We continue to stay disciplined, looking to select the right companies at attractive prices to enable us to deliver very positive long-term outcomes for our investors.
