Sid Ruttala continues his exploration of the top end of the market, this time moving just past the surface of the ASX and going outside the Top Ten. This week we look at Macquarie Group (MQG), Telstra Corporation (TLS) and Rio Tinto (RIO).
This week we continuing publishing my notes on individual companies. At the beginning of this particular series, we were going to limit ourselves to the Top Ten but due to significant interest from readers, we’ve decided to continue down the list by market capitalization. Next on the list for this week are: Macquarie Group (MQG), Telstra Corporation (TLS) and Rio Tinto (RIO).
Talking Top Ten | Part 1: The Banks
Talking Top Ten | Part 2: CSL, BHP & Wesfarmers
Talking Top Ten | Part 3: Fortescue, Woolies & Transurban
Macquarie Group (MQG.ASX)
MQG is one security that held up relatively well through the Covid selloff, the twelve-month number coming in at -8.3%, a stellar achievement given the performance of financials on the ASX broadly. Numbers-wise, overall operating income was down -3% for FY2020, to $12.3bn AUD, with profit coming in at $2.7bn AUD, an 8% decline on the previous year. The more important metric in my opinion was the EPS. At $7.91 AUD per share, it represents a 10% decline from the previous year.
Breaking it down by division, MAM (Asset Management) and CGM (Commodities & Global Markets) were the performers in terms of income. The Asset Management division printed higher than expected (my expectations at least) management and performance fees, while commodities and global markets have held up relatively well with particularly higher business in the commodities lending business (thank you, iron ore). As expected MacCap has seen lower DCM (Debt Capital Markets) revenue partially offset by M&A activities and, for the foreseeable future, this will be the silver-lining if management continues to get themselves onto deals which we can certainly expect (given their track record).
Looking to the future, recent HY21 guidance suggests that NPAT will be down 35% YoY. Management has taken a conservative and prudent approach by increasing provisioning for Covid-19. Also problematic is the higher Australian Dollar, given that 69% of MQG’s income is now global. Numbers-wise, a 5% swing in the spot rate will result in a 3.5% swing in the NPAT (either way). For the number-crunchers among you, happy to share the TWI (Trade Weighted Index) calculations.
Red Flags & Risks: The biggest risk comes from Covid. One saviour for Macquarie Capital has been M&A activity and unless we see a marked improvement in the overall economy we will continue to see stress (including increased provisioning) across BFS (Banking and Financial Services). There is downward pressure on EPS and management will need to be diligent in increasing AUM for MAM in order to circumvent these headwinds. On the upside, however, the continued decline in AUM for AMP has meant that it has been receiving flows (including to its Macquarie Wrap platform). The key will be reaching enough scale in terms of inflows to offset the margins on the annuities like business (i.e. infrastructure and green assets).
My Expectations: A fair substitute for the Big Four. Messy short-term outlook with headwinds across the investment divisions and likely increases to provisioning going forward. We will see increased M&A activity but it will probably not be big enough to offset the declines across DCM. The Asset Management division is likely to be the knight in shining armour given the illiquidity and stickiness of the underlying assets, including renewables and infrastructure. That said, the business has a proven track-record of close to 51 years of profitability, one can probably trust that track record. A long-term hold.
Dividend Yield: The current dividend yield stands at an exceptional 3.6%, assuming a price of $118.69 AUD.
Though on a nominal basis we don’t expect this to stay put through the next FY due to increased provisioning and short-term declines in NPAT. Over the long run, we expect the company to maintain a consistent payout ratio (above 50%).
Telstra Corporation (TLS.ASX)
Telstra is one Australian company that never ceases to disappoint. Every time it starts to look cheap, it surprises investors by getting even cheaper (eventually it becomes a habit). With that in mind, I can’t say I was overly surprised by a rather disappointing FY20 result. NPAT was down 12.6% to $1.8bn AUD with the biggest declines by segment across Fixed (-11%) and, more concerningly, Mobile (-4.4%). Greater than expected decline, in my opinion, in ARPU (Average Revenue per User) even factoring in less roaming charges (i.e. no international travel). What was more disheartening was the DATA and IP segment declining close to 13% due to increased competition. This is while we live in a Covid world where consumers don’t do much other than use the internet; everything was online for at least a few months there.
On the positive side, the one bright spot is the value (longer-term) of its infrastructure with close $1bn p.a. in recurring payments from NBN. InfraCo has a lot of untapped potential and should create a buffer for the company.
Much will be contingent on management. One trend we have seen is that TLS has taken the lead in raising prices higher, especially 5G, and others will likely follow suit. Until now the play has been to increase usership at all costs, but a rationalisation might be in order. Especially targeting premium customers and increasing margins per customer. Its main competitors, Optus and TPG, are also likely to follow suit with TPG also indicating that its discounts are not going to become a permanent fixture. The accelerated digitisation as a result of Covid could become a tailwind for the largest telco in the country (though they do have a track record of not taking advantage of such things…).
Red Flags & Risks: Simply put, competition is the biggest risk for the company. Until now, telecommunications has been a race to the bottom (granted, beneficial for the consumer). What we are likely to see is a consolidation and rationalisation, with market shares becoming stable. TLS will have to focus less on the acquisition of customers and more on the monetisation of its existing infrastructure and user base.
What has been frustrating to watch has been the lack of willingness to look at alternative revenues and diversifying the business. It took the company until last year to even think about rationalising its product line. Looking at their global counterparts in the States, AT&T acquired Time Warner, Verizon made multiple acquisitions across cloud security and more recently drone tech company Skyward, and Singtel (Optus) is buying up broadcast rights to sports left, right and center. It will be key for TLS to move into the 21st century and shake off its public sector roots. Vision 2022, which includes a move to digital and IoT, at this stage remains all flash and no fire. They’ve talked the talk, time to walk the walk.
My Expectations: While at current valuations it does look cheap, especially when one considers the true value of its infrastructure assets, there is too much up in the air and it relies on flawless execution by management. Even with regards to InfraCo, there has been no clear outline of how it will be monetised.
The company needs to modernise, ARPU will get higher but this is probably contingent on international travel being opened up again. One thing I did like was the Capex brought forward despite Covid,
Personally, I am a fan of Andy Penn but he is fighting an uphill battle. If you hadn’t picked up on it by now, to put it bluntly, still not a buy for me.
Dividend Yield: The current dividend yield stands at an exceptional 5.7% assuming a price of $2.82 AUD.
On a nominal basis we expect this to stay put, though the yield might keep going higher if past performance is anything to go by.
Rio Tinto (RIO.ASX)
Before getting onto the recent events that culminated in the ousting of CEO Jean-Sebastian Jacque and several other top executives, let's go through the numbers. The company has certainly put out some stellar results buoyed by iron ore prices, NPAT was at $4.8bn USD while EPS was at $2.94 USD per share which represents a slight decline of -3%, a positive given the environment. What is immediately evident was that the impact on the firm from Covid was minimal, only showing up in terms of slightly lower cash conversion.
Division and commodities wise, iron ore was, as expected, the outperformer. What was rather surprising to me was the aluminium and bauxite numbers, driven primarily by prudent cost management and margins despite the prices tumbling. Corporate cost cuts were also evident across Escondida. Projects-wise and in terms of growth catalysts, fieldwork across the assets in Guinea is to commence this year, despite my expectations of it being pushed into next year (another positive). The Oyu Tolgoi copper/gold project has been facing some hurdles in terms of a slower than expected ramp-up (this one is a negative).
It was exciting to see the maiden resource for the Winu project coming in at 500m tonnes at a grade of 0.45% CuEq (copper equivalent), Australia’s newest tier-1 project. Though still in its infancy this could be the next catalyst for Rio, especially given the likely upward trajectory in Copper spot prices.
Red Flags & Risks: The biggest risks currently are related to the uncertainty around management going forward. Whatever the market may say about the previous CEO, he has been interesting for shareholders from a pure numbers perspective, putting steady dividends into our pockets. That being said, the rather blasé attitude to corporate and social responsibility has done some irreparable damage to the company’s brand. Blowing up a 46,000-year-old site of immense cultural importance and then trying to assume plausible deniability in a parliamentary inquiry will do that. You would hope they have learned their lesson.
Scalps have been taken. These include the CEO, the Head of Iron Ore division and the group executive for corporate relations, all by mutual consent of course. Though the consent did cost a tidy $80m AUD. The new CEO, whoever that might be, faces a decent challenge. This includes but is not limited to dealing with the Mongolian government in putting the Oyu Tolgoi copper mine in order and ramping up production, hitting the ground running with the Guinea assets (i.e. Simandou Iron Ore project) and placating a wide group of rather aggrieved stakeholders due to the aforementioned PR disaster.
Risks also include project execution and keeping Capex in line, to meet the expectations of now rather spoilt shareholders (this will include the Oyu Tolgoi, Amrun and Koodaideri projects).
Currency wise, Rio’s revenues are inversely correlated to the AUD and a higher AUD will create a rather messy P&L.
My Expectations: I tend to be contrarian when it comes to the price of iron ore, though many have said it is toppy, and my expectation is that, while volatile, there are catalysts that will apply upward pressure in the medium to long-term, including higher infrastructure spending around the planet. Copper will remain an interesting buffer for the company and Winu creates the potential for stellar upside.
That said, there is a lot of uncertainty concerning the leadership of the company and what this means for the existing strategy, including the cost-cutting measures. Simply put, environmental and ethical concerns aside, a great business. I would hold if I already owned but wouldn’t be adding to the position with great conviction.
Dividend Yield: The current dividend yield stands at an exceptional 5.9% (approx.) assuming a price of $103.740 AUD.
On a nominal basis we expect this to stay put with potential upside on the underlying security if management gets its act together and doesn’t decide to ignite a museum or look for ore under the Pyramids.
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