Read the previous week’s Investment matters.
Photo © Fatih Kaya from Via Canva.com
This week we provide an update on two portfolio holdings. Each listed, one, was a dominant performer on the ASX REIT index in the past 12 months and sits in the Property sub-portfolio, the other forms part of Australian Equities sub-portfolios.
The Market
HMC Capital (HMC.ASX)
HMC has grown significantly in recent years. It now has a market capitalisation of over A$4bn. While it does not technically form part of the ASX REIT index (XJO), it is clearly a property-focused organisation in its origins and activities. At this market capitalisation, it would be top 10 ranked by market value in the Australian REIT index.
HMC Capital is among the most exciting positions clients hold in the Property Securities sub-portfolio. The stock has been an exceptionally strong performer since listing in 2020. (see chart below).
In the past fortnight the company outlined plans to enable further growth in Digital Infrastructure. The news was appreciated by the market, and investors await with some excitement the launch of the new data centre-focused company that HMC Capital will seed with funds raised.
HMC has successfully utilised the ASX for the purpose that equity markets were originally designed – to raise capital to grow. Instead of depleting its capacity through underfunded dividends or through raising debt as many REITs are forced to do, HMC maintains a modest 1.2% dividend yield (partially franked), and regularly raises new equity to fund value-enhancing acquisitions.
HMC is led by the same management team that acquired and successfully repurposed the former Masters portfolio from Woolworths in 2017. The management team and board are strongly aligned with shareholders via their significant stake in the business. Over the last seven years, the executive team has grown to become the owner/manager of a range of listed and unlisted funds. HMC maintains both a shareholding of units in each new fund and benefits from the fees generated from growth in value/asset in the funds. This has led to strong growth in earnings.
We appreciate this business model that emphasises alignment of objectives, albeit the leakage of some value to management and founders is inevitable.
HMC Capital share price since listing in 2020
Although Investment Matters has often reported on HMC Capital (including when formerly known as Home Consortium), this week we have provided a little more detail regarding the breadth of their interests and operations. We have also outlined the investment case and how it suits clients’ Property Securites sub-portfolios.
A timeline portraying diversification and growth
A brief outline of the transactions undertaken highlights the diversity of interests in HMC’s funds and explains the growth in share price.
- HMC began life as the owner of the property assets acquired from the former Masters Home Improvement business founded by Woolworths and closed in 2016.
- As an unlisted company, it has utilised a relationship with Chemist Warehouse to repurpose and refit these assets ultimately listing the company as Home Consortium in 2019.
- In November 2020, it split off a portfolio of ‘Daily Needs’ assets (convenience-based retail shopping assets) into a separate listed vehicle (HDN.ASX) that subsequently acquired Aventus Group in October 2021, creating what is now a $2.6bn property company.
- Exploiting trends in healthcare-related property, HMC created a newly listed Healthco Healthcare and Wellness REIT (HCW.ASX) now worth $650m. It subsequently grew this capability to source and fund almost $3bn of hospitals and life sciences properties.
- In December 2022 it established an unlisted $1bn “Last Mile Logistics” fund (LML.ASX).
- In 2023, it begins its investment in Private Equity and Capital Solutions businesses in order to invest the firm’s $1.2bn balance sheet. This led to taking substantial stakes and subsequently aggravating for change in companies including Sigma Healthcare (SIG.ASX) and Lend Lease (LLC.ASX), a client shareholding.
- In January 2024, it leads the merger of Chemist Warehouse and Sigma Healthcare (SIG.ASX) to enable one of Australia’s great retail brands access to the ASX.
- In July 2024, establishes a $1.6bn Private Credit platform with the acquisition of Payton Capital.
With such a track record, and especially considering the breadth of exposure, we have been comfortable growing our position as HMC Capital grew.
Given the increasingly active approach of HMC management towards utilising capital and seizing upon long-term investment opportunities, it therefore came as no surprise in recent weeks when HMC announced key initiatives to establish a global DigiCo Infrastructure REIT (intended to be listed on the ASX) and a new institutional unlisted fund with the acquisition of Global Switch Australia for $1.937bn, alongside a $300m fully underwritten institutional placement.
Global Switch has two adjoining co-location data centres with 26MW located in the Sydney CBD. The site has 120MVA of electrical capacity and a development pipeline to expand IT capacity to 88MW, looming as strategically important player to participate in the increasing demand for computing power as Artificial Intelligence applications begin to ramp up by Australian corporates.
The scale of HMC Capital’s plans in listed digital infrastructure, and its acquisition of Global Switch are likely to create substantial value. This value will be augmented by a pipeline of additional growth assets held in an additional HMC unlisted digital infrastructure fund which will hold operating and greenfield assets and have a committed development pipeline.
HMC is also likely to develop additional assets in the energy transition space over the next 12 months.
As sceptical analysts, we are usually reticent to simply repeat obviously promotional depictions of a company’s business model and strengths. However, in this case, the HMC Annual Report has provided an informative and accurate assessment of its strengths in a graphic it refers to as its “Economic Flywheel”. Flywheel, of course, describes how small wins can build up over time to create momentum and sustained growth.
We would not suggest the HMC business model is suitable for all conditions, nor would we assume “sustainable growth” over any span longer than 7-10 years. Regardless, HMC has so far made a series of decisions that rely on economic tailwinds that we find favourable.
Each has created capacity and profits that will continue to be reinvested.
HMC Capital Economic Flywheel
Source: HMC FY24 Annual Report
Investment case
Clients’ Property Securities sub-portfolios have, over the past 5 years, been invested towards two critical goals:
- Create a set of investments that represents a true diversification away from the remainder of the equity, income and alternatives sub-portfolios; and
- Invest in companies that benefit from the long-term trends in activity and profit growth from property without necessarily requiring asset price growth.
In an environment (a) in which interest rates were rising and (b) where the long-term impacts of covid have changed usage patterns for office and retail property, we foresaw risks to asset values, especially those in highly-geared vehicles.
For this reason, we have invested a higher proportion of the sub-portfolio in property-related companies that are exploiting income and growth that do not rely upon rising capital values. We have looked for corners of property, especially industrial property, that benefit from inflationary forces and population growth.
There are a wide range of listed companies that pursue such a business plan. Few however have the trajectory of growth, and the breadth of expertise that HMC Capital has been able to develop since listing. asing cycle gets underway. This augurs well for a significant proportion of our property portfolio. As such, we anticipate an increase in the newsflow from our holdings over the next 12 months.
Imdex (IMD.ASX)
Who are Imdex?
Imdex Ltd is held within clients’ Australian Equity sub-portfolios. The company engages in the provision of mining equipment, sensor technology, and services. It operates primarily through the AMC, REFLEX and Devico brands. The AMC brand deals with drilling fluids, equipment, technologies, and software. The REFLEX brand includes downhole instrumentation, data management and analytical software for geological modelling.
As a diversified business, the company supports mining company clients with operations in 100 countries via 26 offices. From this footprint, it generates around $450m of revenue a year and has a current market capitalisation (value) of A$1.3bn,.
Devico acquisition makes Imdex a more formidable competitor
Devico is a leading provider of Directional Drilling equipment.
The acquisition of the Norwegian competitor in February 2023 provides Imdex with global market leadership and provides them with a more diversified business.
The timing of that deal has also allowed the company to enjoy revenue growth in FY24 against a challenging mining exploration backdrop.
Source : Company Reports
A challenging revenue backdrop in the near-term
The January 2024 release of the Corporate Exploration Strategies (CES) series, which is produced by S&P Global (more commonly known for its Credit Ratings Agency business) which shows that macroeconomic headwinds and geopolitical tensions have taken a toll on exploration activity. While metal prices remain elevated compared to pre-pandemic levels, most have fallen considerably from their 2022 highs.
Monetary tightening by central banks has restrained the flow of new capital, directly impacting junior explorers, which rely heavily on capital raisings to finance their exploration programs. S&P’s survey of 3,100 public and private mining companies in 2023 revealed that the global aggregate nonferrous (metals excluding iron or steel) budgets fell 3% year over year to $12.8bn and was expected to fall by a further 5% in calendar year 24.
Source: S&P Global Market Intelligence
Revenues grinding higher – against that challenging mining exploration backdrop
Against a softer mining exploration backdrop, the addition of the Devico acquisition and its’ stronger ties to the European markets has allowed Imdex to grow its revenues in FY24.
Core mining markets of Canada, Australia and Mexico, by contrast, were generally difficult markets with junior miner activity levels being a little more subdued.
Revenues higher due to Devico acquisition
Source : Company reports
Green shoots in junior miner capital raisings
There are however signs of improvement in terms of capital raisings by junior miners as an enabler of exploration activity – with the value of equity raised – up 21% (Australia) and 65% (Canada) in the past 6 months (vs pcp) by junior mining companies.
Index’ proposition is that, over time, not only will, the underlying cycle be improved and that a more diversified geographic spread of business be advantageous, but also that a more complete product and service offering will allow for deeper penetration/share of company exploration budgets.
Almost half of IMD’s top 250 clients now have more than 3+ products.
Conclusion
While the ‘measured’ outlook statement offered by the company on its result day last August was a catalyst for share price disappointment (down 4% on the day), we remain optimistic that the company is being well run and that the company can continue to win share at the expense of its competitors.
At present, the stock is trading at the low end of its historic range of 13-30x on a Price to Free Cashflow (P/FCF) basis.
The stock will remain in client portfolios as a high-quality cyclical offering significant share price upside to a recovery in global mining exploration activity as part of a basket of mining services companies.
The information in this article is of a general nature and does not take into consideration your personal objectives, financial situation or needs. Before acting on any of this information, you should consider whether it is appropriate for your personal circumstances and seek personal financial advice.