2018 Federal Budget – A Small Cap Portfolio Perspective

The Small Cap  team examine their portfolio in light of the 2018 Federal Budget. 

The Australian Equity Small Cap team undertakes a ‘bottom up’ stock picking strategy – that is we look to identify particular companies with fundamentals that offer compelling opportunities, rather than a top down strategy which focuses initially on the macro or industry conditions.
​
However, with federal government spending representing around 25% of Australian economic activity, the annual federal budget can have a direct or indirect impact on a number of our portfolio positions. Below we provide a high level summary of the 2018 federal budget highlights, and comment on budget initiatives relevant to three key sectors (healthcare, infrastructure and tourism).

BUDGET HIGHLIGHTS

The budget announced on 8 May 2018 was positive in its outlook, with the expected budget outcomes across the forward GDP growth estimates being the strongest since the Global Financial Crisis.

The Government noted that momentum is building in the Australian economy, as it moves into its 27th consecutive year of growth. The economy’s transition towards broader‒based growth and less dependence upon mining investment  has driven a pick–up in non‒mining business investment with business conditions at their strongest level since the Global Financial Crisis. 

Australia’s economy is expected to grow by 2¾ per cent in 2017‒18 and a further 3 per cent in 2018‒19 and 2019‒20. Strong labour market performance is expected to continue and the unemployment rate is expected to decline further. As the labour market tightens, wages are also expected to increase.

HEALTHCARE 

After social security / welfare, healthcare represents the second largest area of government spending at approximately 20%.  The 2018 Budget fully funds a new five year public hospital agreement with the states and territories that will deliver more than $30 billion in additional funding between 2020/21 and 2024/25.  This represents a 30 per cent increase over the previous five years. Commonwealth funding to Australia’s public hospitals is now on track to more than double from $13.3 billion in 2012/13 to $28.7 billion in 2024/25. The Small Cap portfolio remains invested in Paragon Care (ASX:PGC), one of the two largest consumables suppliers into Australia’s hospital and aged care sector. PGC sells its wide range of capital equipment and consumables into most of Australia’s public hospitals and aged care facilities and, following a series of acquisitions in a very fragmented market, should deliver 20% EPS growth in FY19.

More and more Australians are choosing to access aged care in their homes rather than in aged care facilities. To support Australians who wish to stay at home, the 2018 budget provided for an extra $1.6 billion to support 14,000 additional high level home care packages by 2021 22. The small Cap IMA has been a long time investor in Zenitas Healthcare Limited (ASX:ZNT) – a provider of community healthcare solutions. Zenitas is the only ASX listed company which provides exposure to this growing home-care spend. In early May, Zenitas acquired Australian Home Care Services from Multiple Sclerosis Ltd to complement its existing Nextt home care business.  The acquisition adds another 1,302 carers to the Zenitas team and another 4,109 clients requiring services within the home care industry. After generating EBITDA of $7m in FY17, ZNT is forecast to deliver FY18 EBITDA of ~$14m and then FY19 EBITDA of ~$20m.  

The implementation of the NDIS remains on track to be fully rolled out from 2020. There are currently more than 140,000 participants benefiting from the NDIS. In late 2017 we participated in the IPO of People Infrastructure (ASX:PPE). As the largest provider of workforce management services to the Australian disability sector, People Infrastructure is well positioned to benefit from major growth in demand for disability services through the implementation of the NDIS. Expenditure on disability services is forecast to more than double to $22bn over the four years to 2020 and the roll-out of the scheme is expected to drive major demand for employees in the disability sector. Following a very pleasing first half result, PPE is on track to report a very strong full year result, with significant momentum heading into FY19.

INFRASTRUCTURE / ROADING

This Budget includes funding of $24.5 billion for new major projects and initiatives that form part of the Government's $75 billion investment in transport infrastructure over the next decade. These strategic road, rail and public transport projects are intended to boost productivity, reduce congestion and improve safety. In particular, $3.5 billion is to be invested in roads of ‘Strategic Importance’, including $1.5 billion for Northern Australia, $400 million for Tasmanian roads and $100 million for the NSW and ACT Barton Highway Corridor. Our portfolio is well leveraged to this spend through:

• Traffic Technologies Limited (ASX:TTI). TTI is a leading supplier of LED road lights to the Australian market and the largest supplier of lights for major roads (Category V) in Australia.  TTI continues to be the dominant supplier of traffic signals to the Australian market and a major supplier of traffic light controllers. TTI is trading on a single digit NPAT multiple. 
• Engineering services company SRG Limited (ASX:SRG) offers a diversified range of infrastructure, civil, building and mining services and has a market leading position in bridge works and bridge construction systems and has been designing, constructing, repairing and strengthening bridges since the 1960’s. SRG is likely to be involved in many of the bridge construction projects. (Please note SRG has announced a merger with GCS.AX as at 12 June 2018)
• Engineering solutions provider Legend Corporation (ASX:LGD) supplies a range of components, consumables and tools to major infrastructure projects and is well placed to benefit from this infrastructure spend. During the month LGD provided NPAT guidance for FY18 of $5.7m (+19%) and is trading on a single digit NPAT multiple.

TOURISM

As mentioned, growth in the Australian economy in recent years has been driven by non-mining sectors. A key contributor to this growth has been the tourism sector, which is now the second largest export earner after iron ore. The Government, through the 2018 Budget, continues to increase its funding into Tourism Australia. 

The budget also includes $45 million in grants through the Building Better Regions Fund to help move tourists beyond the major cities. These funds will support projects in regional areas and encourage more visits and expenditure in regional locations. The Government continues to focus on Australia's most valuable inbound tourism market, China, with further funding for the Approved Destination Status Scheme which allows Chinese tourists to travel to Australia in guided groups. 

Given the importance and size of this sector, there are surprisingly few tourism related names on the ASX. Nevertheless, our Small Cap portfolio has strong exposure to this increasing tourism spend, through our holdings in Elanor Investors (ASX:ENN) and Sealink Travel Group Limited (ASX:SLK).  Elanor Investors owns and/or manages a number of hotels and tourism assets including the Featherdale Wildlife Park and the Cradle Mountain Lodge, while Sealink is one of Australia’s largest tourism and travel operators operating Captain Cook cruises business on Sydney Harbour and Perth's Swan River, ferry services in Queensland and the Kangaroo Island ferry off South Australia. We also remain invested in Apollo Tourism and Leisure (ASX:ATL) which owns the largest fleet of recreational vehicles (camper vans) in Australia. 
​
With economic growth heading towards 3%, unemployment falling and business confidence rising, the key economic metrics in Australia are trending in the right direction. Our portfolio is well positioned to capture this momentum through investments in well managed high quality companies, purchased on low multiples, and benefiting from favourable tailwinds.