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Quality companies doing more with less

March 2024 |  7 min read | Download PDF

Anthony Golowenko, Senior Portfolio Manager

 

A lot has been written about blows to living standards on the heels of the sharp rise in interest rates and inflation over the past few years.  The Reserve Bank of Australia has termed what many Australians are enduring as a “painful squeeze.”1

Adapting has meant cutting back on things once taken for granted, to stretch pay-packets.

Few, if any, can escape the clutches of inflation and interest rates, including corporate Australia.

Businesses are grappling with higher labour, energy, and transport costs. Like households, they too are being impacted by rising rents and interest payments.

So, how are the country’s listed companies faring?

Recent profit results reveal an intriguing, even encouraging picture, at least from what we would term “quality” companies.

By “quality”, we mean companies with records of strong return-on-equity and profitability, unthreatening debt levels, good interest cover, and management teams that have demonstrated the ability to manage costs effectively and implement productivity boosting plans across operations.

Brambles Limited (Brambles), Seven Group Holdings Limited (Seven), and Metcash Limited (Metcash) are examples of what we regard as quality companies that have, up to now, succeeded in doing more with less by bending cost curves and improving margins.

Despite plentiful speculation over when Australian and global interest rates may be cut, we don’t expect to see cuts any time soon, and certainly not rapid-fire cuts when they do eventuate. That being the case, companies will need to keep doing more with less for some time yet.

The days of bullish top-line, or revenue growth, are likely to be some time away.

Brambles: profit growth ahead of sales revenue growth

Logistics is unglamorous but fail at it and there’s a fair chance a business will struggle. In that light, Brambles’ reusable pallets and containers form part of the backbone of global supply chains helping to efficiently move everything from fresh produce to consumer goods.

From an investment lens, a highlight of Brambles’ half-year financial results was a 19% rise in underlying profit, which was impressively ahead of a 10% rise in sales revenue and just a 1% increase in volumes.2

This achievement was made possible by “operating leverage supported by flow-through of pricing and commercial terms to recover cost-to-serve and transformation-linked productivity gains.”3 In other words, getting more out of current business relationships by bearing down on costs as well as lifting operational productivity.

The company expects the “continuation of current operating conditions and trends”4 so it will have to keep wringing more efficiencies to meet investor expectations.

Seven Group’s multi-business model delivering

There was a time when Seven was just associated with the media industry – television and newspapers.

However, it has progressively changed and grown to become a diversified, multi-industry company through ownership of industrial services companies like WesTrac and Coates, and energy through a sizeable shareholding in Beach Energy as well as other energy assets in Australia and the United States.

Seven is also a major player in Australia’s building materials industry through its majority ownership of Boral. In February, Seven offered to buy the rest of Boral,5 a powerful endorsement, we believe, of the ongoing turnaround under the CEO appointed in December 2022.

At a group level, Seven reported a 28% rise in earnings before interest and tax (EBIT) on the back of a more than 20% lift in margins, and a 25% rise in operating cashflow that translated to a heady 31% gain in net profit after tax, for the half-year 2024.6

The numbers tell a tale of a well-run operation, in our view. As good as the numbers are, it’s what happened at companies in the Seven stable that especially interest us.

WesTrac, at its core, is an authorised dealer of Caterpillar construction, mining, and engineering equipment. It also services the equipment, which provides recurring income. The beauty of WesTrac is that its earnings are linked to mining production volumes, not commodity prices.

Commodity prices are volatile and the share prices of many mining companies reflect this as it means that margins can fluctuate significantly.

WesTrac, as an equipment provider and servicer, makes money irrespective of commodity price direction as evidenced by reporting a 31% rise in its half-year 2024 results.7 While iron ore prices have softened over the past year, iron ore export sales volumes have continued to be both stable and high (Chart 1), which is positive for WesTrac.

Chart 1: Iron ore sales volumes have been stable, benefiting WesTrac

Western Australia's iron ore sales

Chart 1: Iron ore sales volumes have been stable, benefiting WesTrac

Summary of Western Australia’s iron ore sales which have continued to be stable and high from 200 million tonnes in 2002-03 to over 800 million tones in 2022-23.

 

Source: WA Department of Mines, Industry Regulation and Safety, Resources Data Files (Bi-Annual); and WA Government.
Mid-year Financial Projections Statement 2023-24 (December 2023)

Key phrases related to WestTrax, from Seven’s half-yearly results announcement, included “cost and efficiency initiatives delivering margin improvement; margin growth, cost discipline……”8

Coates’ industrial services business also reported similarly impressive metrics with a 28% EBIT margin and asset utilisation 60% above performance benchmark, again owing to “improving operating leverage and yield driven by pricing and cost discipline.”9

Investment industry people are familiar with the line, “past performance is not a reliable indicator of future performance” and so while companies like Coates may gain kudos for good, reported results, investors lookout for what the future may hold.

On that score the company had encouraging news for its shareholders with a $1.7 trillion infrastructure and construction pipeline and a “dominant and growing market share of Tier-1 infrastructure and construction customers.”10

Boral, the largest holding within Seven, is still in the early days of its turnaround but the signs, so far, are encouraging, in our view.

Led by Vik Bansal, a CEO with a formidable record of improving the financial and operating performance of companies he’s helmed, Boral is focused on “embedding the operating model to drive commercial, operational and financial rigour.”11

The company’s industrial services arm reported a whopping 111% EBIT and 196% operating cashflows uplifts while managing to pull down overheads 6% attributable to strong cost management.12 All this was achieved even as sales volumes only went “marginally up.”13

Talk about doing more, in fact much more, with the hand you’re dealt.

Metcash: challenging giants

Metcash represents a kind of second or third force in Australia’s structurally concentrated retail food, liquor, and hardware industries.

The company is a supplier to independent supermarkets trading under the IGA and Foodland brands. In liquor, its network is home to brands including IGA Liquor, Bottle-O and Cellarbrations, and its hardware brands Mitre 10 and Home Timber and Hardware take up the fight to Bunnings.

Metcash recently announced the acquisition of three businesses — Superior Food Group, Bianco Construction Supplies, and framing and truss operator Alpine Truss.14

In our view, this transaction makes strategic sense (Chart 2) as long-term trends point to the foodservice market growing faster than the grocery and supermarket sector, coupled with the hardware-orientated latter two businesses rolling into Metcash’s Independent Hardware Group (IHG), which has effectively built out Total Tools and amplified the core Home Hardware and Mitre 10 brands.

Chart 2: Metcash’s Super Foods acquisition makes strategic sense

Chart 2: Metcash’s Super Foods acquisition makes strategic sense Metcash's Super Foods acquisition makes strategic sense as long-term trends point to the foodservice market growing faster than the grocery and supermarket sector.

Source: Metcash Investor Presentation. Acquisition of Superior Food, strategic hardware acquisitions and equity raising, 5 February 2024, https://www.listcorp.com/asx/mts/metcash-limited/news/strategic-acquisitions-and-equity-raising-presentation-2989865.html

When revenue growth across many industries is modest, buying growth through acquisitions is strategically sound, if you don’t overpay. Financial discipline is extremely important when high interest rates are squeezing corporate as well as household borrowers.

With that context, Metcash’s claims that the acquisitions are expected to be margin accretive and to boost earnings per share15 will likely have reassured shareholders.  

Superior Food is Australia’s third-largest food distribution business16 and supplies aged care homes, cafeterias and canteens within universities and schools, hotels, hospitals, and mining sites, as well as fast food outlets like Domino’s, Hungry Jack’s, and Subway.

Our take on Metcash’s Super Food acquisition is that it will help the company reach new markets and also benefit from growing demand for ready-made and takeaway meals available from supermarkets.

Investors will have their fingers crossed for Brambles, Seven and Metcash over the rest of the financial year and beyond. Their recent performance has merited market participants’ support and continuing in the same vein by getting more from existing operations as well as value-accretive acquisitions will be important to future success.

 

References

1 Statement by Michele Bullock, Governor: Monetary Policy Decision. Media release number 2023-30, 7 November 2023, https://www.rba.gov.au/media-releases/2023/mr-23-30.html
2 Brambles, half-year 2024 results presentation, 23 February 2024, https://www.listcorp.com/asx/bxb/brambles-limited/news/brambles-2024-half-year-result-presentation-2997607.html
3 Ibid
4 Ibid
5 Australia's Seven Group offers $1.2 bln for full control of Boral. Scott Murdoch and Sameer Manekar,
February 19, 2024, https://www.reuters.com/markets/deals/australias-seven-group-offers-12-bln-full-control-boral-2024-02-18/
6 Seven Group Holdings HY24 Results Presentation, 14 February 2024, chrome-extension://efaidnbmnnnibpcajpcglclefindmkaj/https://clients3.weblink.com.au/pdf/SVW/02772162.pdf
7 Ibid
8 Ibid
9 Ibid
10 Ibid
11 Ibid
12 Ibid
13 Ibid
14 Metcash Investor Presentation. Acquisition of Superior Food, strategic hardware acquisitions and equity raising, 5 February 2024, https://www.listcorp.com/asx/mts/metcash-limited/news/strategic-acquisitions-and-equity-raising-presentation-2989865.html
15 Ibid
16 Ibid


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This information has been prepared by MLC Asset Management Pty Limited (MLCAM) (ABN 44 106 427 472, AFSL 308953) (ABN 30 002 641 661, AFSL 230705). MLCAM is part of the Insignia Financial Group of companies comprising Insignia Financial Ltd ABN 49 100 103 722 and its related bodies corporate. No member of the Insignia Financial Group guarantees or otherwise accepts any liability in respect of the Fund or the services provided by MLCAM. The information contained in this communication is general in nature and does not take into account your objectives, financial situation or needs. Because of that, before acting on this information we recommend you obtain financial advice tailored to your own personal circumstances. 

The information in this communication is prepared for information purposes only and does not purport to contain all matters relevant to any particular investment. Any opinions expressed in this communication constitute our judgement at the time of issue. We believe that the information contained in this communication is correct and that any estimates, opinions, conclusions or recommendations are reasonably held or made at the time of compilation. However, no warranty is made as to their accuracy or reliability.