Consumers will continue to defy doomsayers

The Covid-19 crisis has brought with it many predictions about the demise of the Australian consumer. But time and time again since the pandemic began, the reality has been the exact opposite. Governments have shown zeal and vigour in ensuring the retail sector holds up by front-loading stimulus, including in the recent Federal Budget. To that extent, we continue to hold significant exposure to this part of the market rather than predicting doom and gloom for the consumer discretionary sector.

In this wire, I share the stocks we are investing in and have on our watchlist as part of an update on where Aussie shares are headed. I also discuss the importance of focusing on quality rather than getting entangled in the value versus growth debate.

Obviously reporting season's behind us, the Federal Budget is out, the U.S. elections are coming up, COVID-19 is re-spiking in parts of the world, Australia seems to be doing okay and the borders are slowly opening. What does this all mean for equity markets?

It's a good question. This year continues to throw up surprises and shocks, so what does all this mean for equity markets? I think the short answer is that markets continue to look through the crisis. It's quite unbelievable to think that the S&P 500 is up 7% this calendar year, when we think what's happened this year and still what's to come with the U.S. election, etc.

It's all due to stimulus, monetary and fiscal. This week's federal budget in Australia continued that theme: tax cuts, investment and employment incentives, and a boost to infrastructure spend. And to put this stimulus in context, the budget deficit this year will be 11% of GDP versus only 4% in the GFC, so an almost three-fold increase. This is obviously going to help with the forecast earnings recovery for companies, and combined with low interest rates it all remains pretty supportive of equity markets for the rest of this year and into next year. But it's a brave person who forecasts with any certainty in this environment, Frank. So, that's our sort of feeling at the moment.

The government did announce a big-spending Budget. Which are the companies that you think will benefit from the stimulus? And, maybe a comment on how you think this might impact the Aussie consumer?

A lot of companies obviously can benefit from the budget incentives and allowances. Goldman Sachs estimate that the CapEx allowances are a potential 5-10% boost to free cash flow over the next couple of years. That's fairly significant. 

But the key design of the budget is to lower the unemployment rate. So lower unemployment combined with brought forward tax cuts, mean consumers will continue to defy the doomsayers, including myself.

I've spoken previously about angling the portfolio, the Airlie Australian Share Fund, just angling it a bit away from too much consumer exposure. But I think this is going to boost the retail sector. Stocks in the retail sector have already benefited, but we expect these measures to prolong this earnings boost. 

So we own Wesfarmers, Coles, Premier Investments and Nick Scali who will continue to grow profits under this scenario, and so we're happy to hang onto those. In the near term, this also might boost the bank stocks as we, once again, avoid a serious, bad debt cycle. A sharp relief rally in banks would not surprise, however the medium-term outlook for banks continue still pretty tough.

There are lots of supposed experts talking about the death of office buildings and shopping centres. What's your current view on that topic?

Things will be different for sure, but let's talk office first. Our best estimate, or guess really, from talking to office landlords in the last few months is that companies will need approximately 15% less space than currently. Now that's a lot, and that's going to have an impact obviously on so many things and ultimately valuations in office.

But look, we think this will take time to work through. You could ask the question, has the market looked to price this into office exposed REITs immediately? We've got to remember that the current super low interest rates are supportive of relative valuations for office. There's also still capital looking to invest here. And we own Charter Hall Group, whose funds management business benefits from this trend in global capital still looking to invest in office.

I think retail REITs look tougher. They're going to need to reinvent themselves. We're looking at retail REITs, but currently sticking with neighbourhood supermarket owner, SCA Group, and petrol station landlord, Waypoint. These are more defensive type rates and yielding 6% and 5.5% respectively, which we think is pretty good in this market where term deposits are less than 1%.

You've called out Qantas as probably one of your best vaccine stocks. Is that still your current view?

Yes, I have called Qantas the best vaccine in the market. And I think the stock has trended up as the news on vaccine progresses, and slowly but surely borders move to re-open in Australia. 

I don't think it will be a smooth ride, it will be a bumpy ride, but we expect Qantas to survive and then thrive. They haven't wasted this crisis. Management has acted really decisively to cut into their cost-base and come out fighting fit against the re-capitalised Virgin and ambitious Rex. 

Flight Centre and Webjet, on the other hand, we think are more problematic as they need international travel to open up to really get their mojo back.

Can you explain how the investment process has held the fund in good stead over the last six months?

It's been pleasing to outperform the index when the market fell heavily in the March quarter, and then also to outperform when the market rallied strongly in the June quarter. To us, it shows our conservative process focused on quality works. Our stock selection filters really came to the fore in a sense of the conservative balance sheets when things went very poorly in the March quarter, but then our focus on quality really helped us in the June quarter. 

Some of the stocks that have done well for us include Mineral Resources, which is up over 50% year to date due to the iron ore price, mostly. Reece and James Hardie, both up around 25% this year due to the amazing resilience of the U.S. housing market. And, Nick Scali and Premier Investments, two solid retailers, both up over 20% due to the talked about strong boost to retail. The things we've missed, unfortunately have been gold and the technology sector, generally.

And that whole buy-now-pay-later space, Matt?

Yeah, we've missed that. I talked about our process. It's a conservative process and we really like to have seen a reasonable track record for companies before we invest in them. And to be fair, the BNPL players are quite recent, really. And we haven't seen how they perform in a tougher consumer environment. And so, that just doesn't pass our filters, unfortunately.

You've heard the argument about growth versus value many times. Right now there's a lot of people suggesting that value should outperform growth. Any comment there?

It's an interesting debate and it's been going on forever. It's definitely true that certain areas of the global market have done better than others. I mentioned earlier that the S&P 500 is up 7% year to date. But, within that, a very narrow selection of stocks, mostly technology, have shot the lights out whilst the great majority of stocks have actually struggled to generate a positive return at all.

It would not surprise us if we get a period of mean reversion at some point. And I'd welcome that as we own quite a few so-called value stocks here in Australia, like Aurizon, it's a logistics and infrastructure business, Ampol in petrol retailing and Medibank Private in health insurance. But, ultimately I think this value versus growth argument, it's just a wrong way of thinking about things.

We'd like to just focus on quality first and then valuation, and that's the cornerstone of our process. Quality first, then we'll think about valuation. And so the only reason we may not own certain growth stocks that we think are quality is because of valuation. 

We always think about the prospects of the company first and foremost, and not market factors which are generally too hard to predict. 

I remember five years ago the same pundits saying the same thing, that it's time for value to outperform, and they were wrong then it still hasn't come to fruition. There's no doubt that growth versus value companies, if you wanted to put those in their buckets, that it's at a very wide level, the valuation disparity and the performance disparity. 

But, I think it's a wrong way to think about things. And particularly here in Australia, where we just don't have the depth of either growth or value companies. I think you've just got to have a much more pragmatic view and think about the company first, before any other factors.

Lots of opportunities out there. Anything new that you can talk to us about?

Yeah, some quality companies have fallen from lofty share prices, whether those share prices were deserved or not is another argument.

But, companies like Treasury Wine Estates, the owner of the Penfolds wine brand, A2 Milk, with infant formula, both of those are exposed to the Chinese trade risk that we see happening at the moment. So we're thinking, is this an opportunity to take a medium-term view and buy those companies? Crown Resorts has been in the news a lot with the New South Wales inquiry. Is this a catalyst for a corporate transaction, or at least just better corporate governance and representation of independent minority shareholders? We think that's potentially interesting. 

I'm not suggesting our viewers today run out and buy these, but I highlight them as certainly companies of interest.

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