2015 has been a very tough year for investors in the Australian sharemarket with the market impacted by the huge downturn in commodity prices as well as the raising of billions of dollars of equity by all of Australia’s major banks to comply with tighter capital requirements introduced recently.
The ongoing downturn in commodity markets is due to the advent of huge oversupply in most commodities – with the slowdown in the Chinese economy also contributing to the downturn. Despite most commodity prices trading at near ten year lows there appears to be little sign of any sustained supply cutbacks. The downturn in commodity markets has also led to severe recessions in countries that rely on commodity exports such as Brazil and Russia.
As 2015 comes to an end, the global economic outlook remains uncertain. The US Federal Reserve increased the US cash rate for the first time since 2006, the ECB continues to talk about further QE to try to revive European economies. In the meantime emerging economies and their currencies – particularly those relying on commodity exports – will continue to face severe pressure in 2016.
2016: more of the same?
Looking ahead to 2016, it seems investors can expect more of the same. The growth prospects in many parts of the world remain uneven and the timing and extent of further US rate rises will continue to cause jitters amongst investors. On the other hand, the expectations of further stimulatory policies in Europe and China are likely to support financial markets.
Locally, so far the Australian economy has been buffered from the slowdown in our resources sector by the fall in the AUD. This has seen several sectors, such as tourism, agriculture and many of our services exporters gain a relative advantage against their overseas competitors. In addition, the feedback from several companies that we talk to is that the strong incentive to outsource to Asia has abated, and this has alleviated some of the pressure on Australian industry from import competition.
While lower interest rates have helped the local housing market earlier in the year, this benefit seems to have passed its peak with the housing market slowing in the face of tighter lending standards being applied by the banks.
Stocks to hold in a low-growth environment
Against a backdrop of a subdued economic outlook both in Australia and overseas, IML believes it is likely to remain a stock picker’s market.
Our focus continues to be on investing in companies that can continue to deliver consistent earnings and dividends and that can grow in the years ahead in what we believe will be a low growth environment for some time. We thus remain very cautious of many cyclical sectors- including the Resource sector.
IML has always adhered to the mantra of investing in quality companies which have a competitive advantage, that generate recurring and predictable earnings, that are run by a capable management team and that can grow their earnings over time. Price is always important and the key to our approach is to hold companies which are trading at reasonable valuations.
Spotlight on quality mid & small cap names
Pact Group, Steadfast & SCA Property Group
Based on this investment mantra, one company we believe can do well in the years ahead is Pact Group (SGH).
Pact Group is the largest manufacturer of rigid plastics in Australia and New Zealand, with a small presence in the Asian region. The company has over 6000 customers, including household names such as Unilever and Fonterra, spread across over 100 different product segments; reinforcing the defensiveness of their earnings. The demand for these customer-products is generally stable and predictable, making the sales of Pact’s packaging products to these customers also relatively stable and predictable.
The real opportunity for Pact is to continue its successful track record of using the company’s significant cashflows to make sensible bolt-on acquisitions at attractive prices. The company has grown this way for many years with 43 completed since 2002, with a strong track record of successfully integrating these acquisitions and extracting synergies.
Steadfast (SDF) is another such company continuing to do well, despite a low growth environment. Steadfast is an industry leader in the Small to Medium Enterprise insurance broking and underwriting sector with 750 offices across Australia and New Zealand. Its broker business has strong bargaining power with insurers, providing them with a distribution channel which cannot be easily replicated. The broking relationship is sticky with client renewal rates over 90%, underpinning a resilient earnings stream. Going forward, investors can expect organic earnings growth in the company’s insurance operation to be augmented by further acquisitions of brokers to their network, as well as acquisitions of further underwriting agencies.
Finally, SCA Property Group (SCA) also fits the criteria that IML looks for. SCA owns a diversified portfolio of neighbourhood shopping centres located throughout Australia and New Zealand. The portfolio consists of 85 centres valued at over $2Billion.
The SCA portfolio is predominantly focused on neighbourhood and sub-regional shopping centres. Over time, these asset classes have proven to be resilient due to their exposure principally to non-discretionary retail tenants. Woolworths represents 46% of SCA’s gross rental income. SCA Property Group’s portfolio has a weighted average lease expiry of 12.6 years which provides security of income. Over time, growth will come from increasing rents from existing tenants, expansion of existing centres through brownfield development, as well as from selective acquisitions. At current levels SCA is yielding close to 6%, which we believe is attractive in the current low interest rate environment.
We hold all these companies as well as many others like them across IML’s portfolios. We believe companies of this ilk exhibit the key criteria that IML looks for in a stock – competitive advantage, recurring earnings and good management – and we also believe that these stocks have the ability to grow in the predicted low growth, patchy economic environment.
In our view, investors will need to be continue to be extremely selective moving into 2016, ensuring they focus on quality companies, as history shows it is these that are always best supported in periods of market volatility and economic uncertainty.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
