The ASX remains a "universe of attractive investment opportunities"

Centennial Asset Management's Michael Carmody has been bullish (and on the record about it) for quite some time. 

With the dust having settled on reporting season, I caught up with Carmody again for a Rapid Fire interview, to see what he made of the season and, more importantly, understand if he remains bullish. 

Carmody also shares a handful of stocks that he and the Centennial team are finding attractive right now. 

How would you characterise reporting season? 

The recent reporting season was better than expected. Economic headwinds from higher interest rates, cost of living pressures and softer demand were expected to subdue reported earnings growth in FY24. While there were marginally more result misses than beats, the magnitude of the shortfalls was not as large as feared. 

More importantly, company trading updates and outlook statements that typically set the tone for the reporting period were cautious but not as bad as expected.

Despite a sharp initial market sell-off in early August around recession concerns, the All Ordinaries Accumulation Index finished the month in positive territory due in part to a reporting season that wasn’t as bad as expected.

What were the major themes of the season?

Inflation was the hottest topic during the reporting season. 

That said, peak inflation now appears to have passed and while cost pressures remain, supply-driven inflation has declined. 

It is still clear that price rises are outpacing price reductions, but the size of the increases has moderated compared to a year ago.

Within the services sector of the economy, staff costs remain a key area of focus for management teams. This is particularly true for the Financial, Consumer Discretionary and industrial sectors. Again, high wages appear to have peaked and are now stabilising at current levels.

The reporting season delivered evidence of demand destruction in some sectors of the economy but despite the 13 consecutive RBA interest rate increases delivered since May 2022, the consumer remains broadly resilient. Consumers are purchasing fewer discretionary items and trading down within supermarkets but underlying demand hasn’t deteriorated significantly. With unemployment still structurally low, there has been little evidence of severe financial distress within the economy. Households continue to prioritise their debt obligations delivering the dominant banking sector less margin pressure than many investors expected at his point in the cycle.

As a result, companies delivering structural growth (Technology) remained expensive as investors rewarded pricing power within the sector. Despite stretched valuations, the banking sector benefitted from relatively stable non-performing loans, consistent margins and an ongoing capital management plan. Resources remained under pressure as the price of iron ore declined and the Chinese economy continued to grow below trend.

What was one highlight of reporting season? 

Supply Network (ASX: SNL) 

SNL delivered a great FY24 result. 

The company has a well-established track record for delivering consistent growth and high-quality results. 

SNL reported an NPAT result that was up +21% compared to the previous corresponding period. Importantly, growth was strongest in Australia, SNL’s largest market. Despite inflation pressures, SNL delivered stable operating margins in FY24. The result was particularly impressive given the +30% revenue growth the company delivered in the previous year.

The demand outlook from commercial vehicle customers remains strong and industry tailwinds are positive. Specifically, structural issues such as vehicle complexity, increasing task volume growth and ageing vehicle fleet life were all positive structural growth drivers for the company.

SNL’s growing distribution footprint in addition to its expanding capacity is expected to contribute to further earnings growth in the next year. Specifically, a distribution centre expansion in Melbourne and several other initiatives will expand the group’s capacity to at least $400 million per annum, above the $300 million delivered in FY24.

Going forward, we expect the experienced SNL management team to maintain its commitment to disciplined capital allocation and expense management. The company is forecast to grow earnings ahead of its long-term average (+14%) again in FY25.

What was one lowlight?

A2 Milk (ASX: A2M)

The A2M result did surprise us on the downside. While the FY24 result was ahead of consensus forecasts, earnings outlook commentary was below expectations. Before the FY24 result, investors were expecting ongoing revenue growth and operating margin expansion. However, at the result, the management team announced that supply constraints were expected to impact product availability and, as a result, the profitability would be negatively impacted in the first half of FY25. Specifically, additional airfreight costs were expected to drag on short-term earnings.

Post the FY25 guidance update, the growth outlook for A2M is lower than expected and the share price has fallen accordingly. Management maintains that the "supply constraint" issue relates to operational production and is expected to be resolved in the second half of FY25.

Notwithstanding the one-off nature of the disruption, the downgraded outlook continues to adversely impact the company's share price. We were surprised by the FY25 earnings downgrade. Exposure to the stock negatively impacted the Fund’s performance during the reporting season.

How is Centennial positioning currently?

September is historically the worst month of the year for capital markets. As a result, we have slightly more cash than normal. 

That said, we continue to own a portfolio of predominantly ex-100 companies that we believe are well-positioned to outperform.

Centennial’s Level 18 Fund mandate hasn’t changed over the 12 years since its inception. We focus on bottom-up investment fundamentals and prioritise earnings growth, balance sheet strength, free cash flow and management quality.

We currently hold several companies exposed to the evolving AI/data centre rollout theme. SKS Technologies Group (ASX: SKS), Technology One (ASX: TNE), Superloop (ASX: SLC) and Southern Cross Electrical (ASX:SXE) are owned in the Fund.

We expect valuations to recover in the ex-100 non-bank financial services sector during the next 12-24 months as interest rates start to fall. We are increasingly comfortable with recapitalised balance sheets and expect sustainable growth to return to the sector over the next year. We have a position in both Judo Capital (ASX: JDO) and ZIP Co (ASX: ZIP). 

In addition, we like the outlook for companies with capital markets exposure. We have investments in Regal Partners (ASX: RPL), Pinnacle Investment Management Group (ASX: PNI) and Bell Financial Group (ASX: BFG).

Can you share your thesis on a couple of stocks you are bullish on?

Generation Development Group (ASX: GDG)

GDG has been a core holding in the portfolio for several years. It is currently the Fund’s largest exposure. The company manages and sells tax-effective investment bond products and services in Australia.

We recently added to the Fund’s position via the recent capital raising to fund the acquisition of the remaining stake in Lonsec that the company didn’t already own.

The company has a well-established track record for delivering consistent organic and acquisitive earnings growth. Over the last six years, the company has transformed into an innovative high-growth financial services group.

GDG delivered an excellent FY24 result with better-than-expected revenue growth and margin leverage. The group’s underlying NPAT was up +55% compared to the previous corresponding period. We continue to expect the company to deliver strong growth over the long term.

SRG Global (ASX: SRG) 

SRG is another core portfolio holding. SRG also delivered a strong FY24 result. EBITDA increased by +24% versus the previous year. Importantly, the result was driven by strong organic growth within the core Asset Maintenance division.

In addition to the result, SRG announced the acquisition of Diona, which provides asset maintenance services to the water security and energy transition sectors. We believe the acquisition provides an attractive exposure to two new growing sectors for the company.

We believe SRG’s strong balance sheet and track record position the company well to deliver ongoing growth from its recurring revenue business contracts.

You’ve been on the record bullish for some time now – has anything changed post reporting season?

Post the reporting season, we have added new exposures that look well-positioned to deliver a recovery in earnings growth over the next 12-18 months. We continue to identify a good number of investment opportunities at attractive valuations. The Fund’s fundamental stock selection and risk management parameters are unchanged.

In contrast to the economic cycle, we have always maintained that the monetary cycle is a more important lead indicator for equities valuations.

Importantly, post the 2024 Jackson Hole Symposium in the US, it now looks like interest rates are set to be cut in the near future. The next FED meeting on September 18 is expected to deliver the first interest rate cut of this cycle.

While the economic cycle in Australia currently appears to be approximately 9 to 12 months behind the US, equity market trends and US monetary policy remain strong leading indicators for Australian investors. A move down in US interest rates is a positive for Australian equity valuations. Despite recent Australian CPI results delivering only a small decrease in annual inflation, we continue to believe that rates have peaked in Australia and wouldn’t be surprised to see the RBA cut rates before the end of CY24.

As a result, our outlook for domestic equities remains bullish. 

Notwithstanding a strong market performance in the last two years, we can still see a universe of attractive investment opportunities.  

Want to know more?

Michael Carmody and Matthew Kidman are Portfolio Managers for the Level 18 Fund. If you would like more information, it is available via the Centennial Asset Management website.