OC Premium Small Companies Mandate commentary or the month ended August 31, 2016.
OC Premium Small Companies Mandate – Performance Review
The month of August was dominated by stock-specific news which came as the vast majority of ASX-listed stocks released their annual results and accompanying outlook statements. Volatility for the month was quite low, likely driven by an absence of material macro news other than the RBA’s decision to cut the cash rate by 25 basis points to a new low of 1.5% early in the month.
Once again the OC Premium Small Companies Mandate enjoyed a relatively strong reporting season during which most of our holdings released results in line with or ahead of market expectations. The Mandate finished August up 1.1%, comfortably ahead of the S&P/ASX Small Ordinaries Accumulation Index and the S&P/ASX Small Industrials Accumulation Index which were down 1.6% and down 0.5%, respectively. The Mandate has returned 21.5% p.a. for the past five years, significantly ahead of both indices, which are up 2.6% p.a. and 11.7% p.a., respectively, over the same time period.
Some of the Mandate’s bigger holdings reported excellent results and were rewarded accordingly with Webjet Limited, Altium Limited, Ardent Leisure Group and Mineral Resources among the best performers for the month.
Webjet Limited (WEB, +28.4%) – announced a result that exceeded market expectations driven by an outstanding performance from the B2C (business to consumer) division where TTV margin accelerated by 0.6% in the second half as a result of strong operational leverage brought about by continued market share gains. But the result itself was somewhat overshadowed by a £21m deal signed in its hotel business which provides hotel inventory to travel agents. The deal with large UK-based travel company, Thomas Cook, involves WEB taking over Thomas Cook’s 3000 hotel supply contracts and in turn WEB entering a minimum five-year deal to supply these hotels, and its other hotels, to Thomas Cook. This provides WEB’s B2B (business to business) division a material step change in scale, as well as directly related financial benefits (not material until FY19), providing us greater transparency on continued high EPS growth into the future for the company.
Altium Limited (ALU, +26.1%) – the stellar share price performance of international circuit board design software company, ALU, accelerated after posting a strong result and updating the market on potential further expansion of its Dassault Systems JV to include its premium high-end CATIA product. It appears the market is, however, beginning to price in a takeover premium for ALU, given its clear appeal to Dassault. While we consider an eventual offer as a real possibility, we see it as at least 12 months away with a lower risk outcome for Dassault likely to be for it to wait until the JV products are fully developed and demand is established. The ALU share price continued to climb in early September and exceeded our valuation. As a result, we have taken advantage of the higher price to exit our ALU position and will retain a watching brief should the share price retreat.
Ardent Leisure Group (AAD, +19.3%) – the sale of the Goodlife health clubs and Hypoxi weight loss businesses caught the market by surprise early in the month, with the AAD share price opening 9% higher on the announcement. The gyms had been seen as an ongoing headache with business transformation underway to cope with the increasing prevalence of cheaper 24-hour small format gyms and the sale was seen as representing a fair price. The annual result was announced a few days later with solid performances across all divisions; particularly in bowling which is benefiting from a number of initiatives introduced from the US Main Event business. In meetings with management earlier in the year, we had a number of robust discussions about exiting some of the lower returning businesses such as marinas and health clubs and redeploying that capital into the high growth, but capital hungry, Main Event roll-out in the US. Credit is due to the management team who not only listened to the market but executed an unexpectedly strong outcome with the sale of the health clubs. With the sale of the marinas business still tracking to management’s schedule, the company is now in a strong position to accelerate the roll-out of Main Event, which is a quality business that has achieved very high returns on invested capital.
Mineral Resources (MIN, +15.5%) – again surprised the market on the upside reporting FY16 EBITDA of $286.1m, at the top end of the recent guidance range. It was a high quality result characterised by strong cash conversion and the company now has net cash of $188m and several meaningful growth options. Management provided earnings guidance of $360-$400m EBITDA, implying EBITDA growth of circa 33% at the mid-point, well above consensus which forecast a 13% decline into FY17 prior to the result. Although earnings are still sensitive to the iron ore price, the company’s cash cost has continued to decline (A$54.60/wmt in H2 FY16) and the business is strongly diversified and continues to be underpinned by the mining services division which operates largely with blue chip clients on low-cost projects and should therefore be relatively resilient through the mining cycle. The high quality Mt Marion lithium project comes into production in the coming months with first ore expected to be shipped in October 2016. We continue to rate MIN’s management as among the best in the business and expect them to continue to build shareholder value through their innovative low-cost solutions.
APN Outdoor (APO, -34.9%) – the major disappointment during the month was without doubt the unexpected negative earnings revision from APO, which was released with its half-year result. Most readers would know APO had been a stellar performer for the Mandate since listing in November 2014, with the market having become accustomed to profit upgrades driven by market share gains and the attractive financial metrics around the conversion of static billboards to digital (three to five times revenue uplift and material margin uplift). We were blindsided by the moderation in full-year guidance from management who cited the impact of the drawn out election result and the Olympics as impacting forward sales. Earlier in the year we had discussed both of these upcoming events with management which we had raised as potential headwinds. Management, at the time, believed the ongoing roll-out of digital billboards would insulate the company from any impact of these events. Obviously this belief has proven to be unfounded. Compounding matters, APO has more static exposure than competitors, such as QMS, and recent price deflation in static billboards looks like it will be a drag on earnings in the near term. The company also looks like it has lost market share to QMS and Adshel in the Australian and NZ markets and has changed its management team to address issues across the Tasman. While the share price fall, prima facie, seems disproportionate to the quantum of the earnings downgrade, we have nonetheless taken the conservative approach to exit the stock until we get further clarity around the trajectory of sales into the critical September to November period.
Aconex (ACX, -20.1%) – while the ACX annual result delivered in