Airlie's view for 2022: Key insights and portfolio highlights

Investors can expect a bumpy ride in the sharemarket this year but it should do well overall, says Airlie Australian Share Fund portfolio co-manager Matt Williams.

Equities surprised in 2021 with their steadily positive progress through the chop, but the headwinds now making themselves known can be expected to get blustery.

In his fourth-quarter update with Magellan Asset Management key account manager Jennifer Herbert, Williams captures the mood of 2021 and ponders the year ahead.

“Last year the S&P 500 had the fewest draw downs of more than 5% in its history, almost,” Williams says. “I guess our prediction is that this year we get a hell of a lot more volatility in the market.”

Read on for 10 takeaways from their discussion — such as why Airlie is cautious about the major banks — and six highlights from the fund’s portfolio.

1. The value of predictions

“I guess people who I've spoken to over the years would know that I generally dismiss macro forecasts and predictions as not very helpful to investing and running a portfolio,” Williams says.

But there is value in predictions made with the right mindset. His holiday reading turned up this helpful quote from NYU Stern professor Scott Galloway: "The value of a prediction is the act of making it, not the prediction itself, and contemplating what may happen encourages us to take responsibility for decisions we make in the present."

Looking back over those predictions provides a way of measuring progress, Williams says.

We won’t cover it in detail here, but it’s interesting to hear how last year’s predictions, made with portfolio co-manager Emma Fisher, panned out.

“With macro there's too many variables and impacts for a clear path to investment success,” Williams says. “And timing can be everything. You can be right on your big view around currencies, around economic growth, around share market direction. But if your timing's wrong, then you're just wrong.”

The role of macro predictions at Airlie is to inform sensitivity analysis to ensure the portfolio is not accidentally betting on particular trends.

Micro predictions, however, have great value. Williams defines these as company-specific predictions.

“These are much easier to ascertain, research and talk about,” he says. “And really this is what we do when we analyse companies.

“We are looking at industry and company-specific micro influences, and we combine those with valuation and return analysis to help us predict whether a company's prospects are better or worse than what the consensus view is.”

2. The role of market perception

“Another investor that I read about over the break makes a good point about perceptions and market perceptions,” Williams says. “And I've never heard of this guy.

“Robert Wilson is little known but was an amazingly successful investor. Started out with US$15,000 in the mid 1950s and turned that into US$800 million by the mid 1980s."

“He said the only way one makes money in the market is when the perception of a stock changes.”

Williams aligns the idea with Airlie’s endless search for undervalued, quality companies.

“We try and take advantage of these opportunities and buy these companies, or ultimately sell them, where we think perceptions will change.”

3. Interest rates are turning around

“The dominant narrative right now is inflation occurring and tapering from the central banks around the world, which leads to high rates,” Williams says.

While this might be the consensus driving market behaviour at present, he acknowledges not knowing how high rates will go and what will happen with inflation.

4. Expect more volatility

“I guess our prediction is that this year we get a hell of a lot more volatility in the market,” Williams says.

“We think markets don't like inflation, but not all inflation is bad. It just depends how much. You look at the differing levels of inflation over the year. The sweet spot is where we've been the last decade — 0-3% inflation."

“If it goes higher for prolonged periods, then history suggests things are much more difficult on the market. And so we predict a lot of volatility in the market this year as investors worry about this.”

5. Inflation is not always good for banks

“Generally, historically, theoretically, higher inflation is better for banks because they can increase the price of what they're selling: loans,” Williams says. “In Australia's case, let's say the mortgages. Your mortgage rate will go up.

"Banks can increase the spread at what they borrow at and then what they lend out at. Hence their margins improve and so profits should improve. But that's just taking inflation in isolation and things don't happen in isolation.”

Airlie is cautious about the major banks, however, for several reasons:

• Higher interest rates will curtail demand for mortgages and the housing market can be expected to deflate

• Competition in the mortgage market has increased to unprecedented levels

• Bank valuations on a pre-provisioning level are levels not seen in more than 20 years.

6. The M&A boom will continue

“Right up to Christmas, we saw some big deals,” Williams says. CSL raised more than $6 billion in equity and several Airlie portfolio companies, such as CSL, Aristocrat, Ebos, Horizon, Nick Scali and Helios, made acquisitions in 2021.

“I think that reflects the strong balance sheets that our companies have in the portfolio,” he says.

“Generally we are pretty nervous and sceptical about acquisitions, particularly at this point in the cycle if we do get an upward trend in interest rates.

“We were least excited about Aurizon's purchase of One Rail. We think they overpaid. We're most excited about the Nick Scali purchase of Plush sofas. Plenty of synergies to come there.”

7. Profit season will be tough

Williams warns that the supply chain issues and staff shortages now being experienced will show up in profit season.

“And if Omicron gets into China, that will have implications for the supply chain as well. That could prolong the issue.

“So we think the second-half '22 profit season is going to be pretty tough.”

8. Volatility doesn’t mean disaster

“I don't want to sound too negative because we think 2022 can be another reasonable year for the market overall,” Williams says.

“Omicron may hasten the end of the pandemic, interest rates may go up but they may still remain relatively low, balance sheets are still really strong. Fiscal spending will step up as monetary policy gets pulled back.”

And where else can investors get adequate returns?

“Maybe we don't do 17% again but if I was forced to pick a number, why not an average year for the market of a 7% or 8% total return?” Williams says.

9. Value stocks will keep running

“The ever-widening valuation disparity between the high and low PE companies has continued in 2021,” Williams says.

“I think there's room for that to narrow if this higher interest rate scenario continues. Cyclical companies should rally and we've seen evidence of that already.”

10. Highlights from the portfolio

The M&A boom is making itself known at Airlie.

Williams says Tabcorp’s demerged lotteries division is a takeover target, as is its remaining wagering business.

“We've already had a private equity approach for Smart group, which is in the portfolio,” he says. “That deal fell over but these things have a habit of coming back.”

Mineral Resources rose nearly 30% in December after Emma Fisher pointed out the value in the company’s implied lithium business.

Williams says the company’s longer-term prospects are positive but it has had a strong stint.

“We think this green metal frenzy (for lithium, cobalt and nickel companies) may continue to run, but we find it very hard to find attractively priced opportunities,” he says. “I think some consolidation of these stocks might be in order.

In the technology sector, Williams says Dicker Data, a distributor of hardware, software and cloud technology, is providing the shovels for the gold rush of global digitisation.

“The digitisation of the end-to-end processes for companies is just continuing apace and the runway is long,” he says.

“The market is underestimating the strength and duration of this process. We think the market over time will upgrade its perception of Dicker Data.”

Over at Seven Group, the price/earnings ratio of 12 is about a 60% discount to the industrial market average, Williams says.

“The businesses within Seven Group are way better than a 60% discount. In fact they're market businesses, their major business being WesTrac, which has the Caterpillar franchise for Western Australia and New South Wales. This is a fantastic business that has had steady growth for a number of years and produces high returns.”

Williams uses the example of PWR Holdings to extol the adaptability of quality management.

“Whatever macro influences could happen, I always find that over time, really skilful quality management teams can grow through any kind of scenario,” he says.

PWR produces high-tech cooling systems for the automotive industry and is pivoting into emerging technologies, producing items for aerospace and defence.

“We think that has a big runway. We're quite excited about the medium and long term growth for that company.

“So good companies that can grow. It really doesn't matter, generally, what the macro influence is going to be. Good management teams can navigate these trickier times and still perform.”

To view the full interview, click here.

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