TOL - 16th Apr, 2024
Is this the end of the ASX's Mundane 7?
Yarra's Dion Hershan is not afraid to think differently - his bold move away from some of the ASX's most-loved companies is proof of that.
The storm is clearing
In an interview in December last year with my colleague James Marlay (available here), Dion Hershan, Head of Equities at Yarra Capital Management, said "If you're not confused by markets, you're probably not paying attention".
Fast forward to today and the picture is much clearer, according to Hershan.
"I'd characterise the environment now as less confusing in the last three or four months, [because] a few things have transpired."
For one, it has become clear that inflation is trending down, notes Hershan, whilst the Australian consumer has proven resilient, and earnings season proved that corporate Australia remains in solid health, with the former supporting the latter.
Inside the Yarra war room
Given Hershan's comments about inflation, it should come as little surprise that its path and the subsequent impact on rates remains the hot topic being debated in the Yarra war room right now.
Hershan has a strong view on the outlook for rates, saying, "My personal opinion is we probably won't see cuts in Australia this calendar year, and with the view that although the economy is resilient, asset prices are high, and I don't think you'd want to overstimulate an economy like this."
The other area of focus concerns the resources sector, with Hershan noting that it constitutes around 20% of the market and 30% of market volatility. Hershan goes on to add that there are significant crosscurrents within the sector and that "we're now at a period of time where I think we'll see greater diversions within commodities" – more on that in a moment.
The Mundane Seven
Perhaps the most interesting part of the conversation was Hershan's take on what he terms the "Mundane Seven" – a cohort comprising of the big four banks and the big three iron ore miners – stocks that many Australians hold as cornerstones in their portfolios.
Whilst many might consider such a term blasphemy, Hershan is not afraid to think and act differently – and he and the Yarra team have the data and analysis to back it up.
For instance, the Magnificent Seven in the US comprise 30% of the S&P 500, have had phenomenal earnings growth and have driven the index higher. Meanwhile, the Mundane Seven comprise 35% of the S&P 200 – in itself a fairly shocking number – and, as Hershan puts it;
"In the next three years, if you believe consensus numbers, [they] have 0% earnings growth," he says.
"So whilst the Magnificent Seven might be pushing up S&P 500 returns, our view is the biggest seven companies in Australia could well be an anchor for our market in the medium term."
To be clear, Hershan is underweight the Mundane Seven but has clearly taken the view that there are better returns to be had elsewhere. He also believes China has seen 'peak steel' whilst the Big Four have seen peak earnings, adding that "Credit growth is reasonably slow."
"Productivity is reasonably poor. Costs are growing a lot faster than revenue, and we're also at a period of time where bad debts are coming off the lowest level in history," he adds.
The hunting grounds
As noted above, the banks and miners comprise significant weight in the Australian market, so if Hershan is 'underweight' on the big names, the question is, where is he 'overweight'?
His primary focus right now is Ex-20 stocks, noting that once you get into mid-caps, there are plenty of proven business models, with real growth potential. Unlike the top 20, which tend to be mature and GDP-like in terms of their return profile, mid-caps offer more compelling characteristics. As Hershan puts it,
"What you find with a lot of mid-caps is they're not hostage to Australia's growth prospects," he says.
"Very often, they are either a small market share, they're growing quickly, or they're an Australian business that has a lens on global markets and expanding offshore."
Sectors and stocks
Hershan nominates tech and resources (ex-iron ore) as the major areas of interest.
When it comes to tech, Hershan notes we're in an environment where productivity is challenged and labour costs are high, "So we really want to find businesses that have strong pricing power, really good operating leverage and limited capital intensity".
He adds that many of the technology companies Yarra invests in, such as Car Group (ASX: CAR), Seek (ASX: SEK) and Pexa (ASX: PXA), have all those attributes.
As for resource stocks, Hershan notes that once you look outside iron ore, "there are a lot of other resources where the supply side looks completely challenged". He is referring to the likes of mineral sands or copper where "even if demand was to stagnate, the supply outlook is so poor it speaks to really high commodity prices in the future".
Other themes discussed
In the View from the Top interview above, Hershan also shares what he looks for in a management team, as well as why he is underweight two of the most loved companies on the ASX.
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My passion is equity research, portfolio construction, and investment education. There are some powerful processes that can help all investors identify great opportunities and outperform the market, and I want to bring them to life and share them...
Expertise
My passion is equity research, portfolio construction, and investment education. There are some powerful processes that can help all investors identify great opportunities and outperform the market, and I want to bring them to life and share them...
Expertise
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