Read the previous week’s Investment matters.
Background
ASX reporting season
Most companies who have an accounting year-end date in June, select August as the month to report their full year results. We’ll provide updates in Investment Matters over the course of the next few weeks. Here’s a snapshot of results reported in the week just past for stocks held within client portfolios.
The Market
Seek (SEK)
We have invested in Seek with a medium-term view, noting that technology firms with strong franchisees, like seek.com.au, rarely trade at relatively cheap levels. The share price discount that Seek attracts is due to current the weakness in the economic cycle, the company’s expensive investment programme in platform unification, and a cost base that had grown to levels which reduced margins.
We believe that in the medium term the investment will be productive, the cycle will turn and that the company can continue improve its cost discipline. This programme of improvement is expected to be completed by FY28, providing the perfect opportunity for medium term value creation.
In the meantime, we are looking for signposts of progress whilst anticipating that the cycle will crimp current earnings.
Reporting on the FY24 outcomes, SEEK was met by share price disappointment (-7%) as revenue declined in both the Australia/New Zealnd and Asian businesses due to a cyclical downturn in job ads. This led to a decline in core profit within its ‘Continuing Business’ operations.
Additionally, pre-flagged write-downs in its Chinese subsidiary, Zhaopin, and a decline in value of its venture capital-style Investment Portfolio drove reported net profit to a loss for the period. Neither affected our view of the value of the company.
The decline in the reported value of the Investment Portfolio merely reflected the view the markets, and First Samuel already held that the carrying value of the investments was overstated.
The cyclical decline in job ads is shown clearly in the chart below. Of importance for long-term value is the relatively muted reduction in unique hirers versus job ads placed.
Cyclical weakness versus stronger foundations
Despite cyclical weakness, the signposts for medium term value creation were positive. The table below outlines the companies view of its progress.
While the current job ads cycle is weak and the backdrop for the next year looks challenging too, we think there are a few notable positives to be excited upon for the medium-term investment horizon. The core business is in very good shape;
- Market share is being maintained, particularly in higher margin segments like SME
- While job ads are falling, the company is still able to pass through price increases and is making continuous improvement in yields with new products and offerings
- One of the biggest challenges for businesses tends to be their core technology stack and the level of automation and flexibility within the business. Seek has now come to the end of a core technology infrastructure replacement cycle and its businesses will be running on common platforms which should improve efficiency in cost and new product launch rollout times
With a stronger jobs market in the future, the benefits of yield growth and cost control are likely to create quick growth. These elements are not currently factored in the Seek share price.
What they said – “Strong yields but waiting for volume stabilisation”
“SEK reported solid 2H24 revenues, driven by ANZ yield strength which surprised materially, offsetting volume pressure, but EBITDA and NPAT missed primarily driven by higher D&A. Looking into FY25e, ANZ volumes remain the key unknown, but we continue to remain positive on yields, which should drive significant operating leverage for the business when volume declines stabilise….. we reiterate our Buy rating on SEK, with the stock trading on 11x 2yr fwd EBITDA (more than 1SD below last 5yr avgs) and 35x 2yr fwd “Adjusted” P/E (1SD below last 5yr averages), for 11%/ 17% EBITDA/Adjusted NPAT CAGR over the next 3yrs.” UBS
Seven Group Holdings (SVW)
As investment professionals, we generally like to have a passionate view about our trade, but a dispassionate view about the individual names we own. That way, we can be objective about when to adjust, and particularly trim, portfolio holdings.
However, we must confess to having a little bit of admiration for the strategic focus, financial discipline and execution capability at Seven Group Holdings. It consistently remains one of our largest portfolio holdings.
As usual, the 3-pronged Industrial Services businesses of Seven Group were the engine of another strong year of earnings in FY24. As a reminder, these businesses are
Industrial Services Businesses – a 3-Pronged attack
The largest division, WesTrac, continued to demonstrate its earnings power with double digit sales growth in both Machines (think Yellow Equipment) and Servicing and Parts. Given the industry is mid-cycle in fleet replacement (ageing equipment will require more servicing and parts) and it is one of the strongest resources capital sales pipelines in over a decade (the absorption of cashflow this period reflected new equipment being ordered and prepared for sale), the outlook for this business remains favourable.
The completion of the takeover-in-full of the Boral business in the period should assist to drive further operational improvement and cost control at a time when volumes in concrete and bricks remains stable, rather than growing.
Revenue growth was 3% in FY24, yet Earnings Before Interest and Tax (EBIT) was up 61%. This business remains a big area of focus for the Group in FY25 and management remains optimistic that this will be the fastest growing profit pool in the Group of the ‘Big 3’.
Earnings growth rates slowed in Coates in FY24, but remained at high single digit levels. State-level construction work may have recently hit a cyclical peak, but the outlook for activity remains buoyant.
While occasionally we seek to trim holdings to reflect a share price that appears stretched, Seven Group Holdings has high quality assets and a very high-quality management team. Accordingly, it will remain as one of our core portfolio holdings.
What they said – “Industrial Services momentum to support EBIT growth in FY25.”
“We are Buy rated on SGH, with the stock offering a 3yr EBIT CAGR of 7%, and strong operating cash flows supporting further deleveraging. The stock trades at a 1yr forward P/E of 17x, representing a ~20% discount to the ASX200 Industrials (ex-Fins). Continued improvement in Boral’s operating performance is a key catalyst for SGH in the short term, which we expect investors to remain focused on post-acquisition.” UBS
Beach Energy (BPT)
Beach has been a recent portfolio ‘add’ as an Energy (LNG) player with prospective operations in Waitsia (WA), Cooper Basin (NSW) and the Otway Basin (Vic/SA) and a resultant strong cashflow outlook. Supporting our decision to buy is the stewardship of Beach’s 30% shareholder, Seven Group Holdings, which is consistently one of our largest portfolio positions.
Despite beating consensus estimates on an ‘underlying’ basis, the company chose to write down the value of its New Zealand and Bass Strait assets. More notably however, was the ~20% reduction in overall probable reserve estimates, pertaining particularly to their Enterprise field in the Otways.
This magnitude of reduction in reserves was worth around 10 cents per share reduction in value in share price terms. It also reduces investor appetite for further exploration around that asset and adds to queries about the outlook for capital returns to shareholders versus additional exploration spend required to replenish reserve levels.
Beach Energy reserves – trimmed Otway
We suspect that the new Group CEO, Brett Woods, has used this as an opportunity to ‘clear the decks’ in his first financial result since becoming CEO. The buck now stops with him! We’ve used the fall in share prices of ~13% on result day to add to client positions and the share price has steadily recovered ground since.
What they said – “FY24 result: the double kitchen sink”
“Following the update, we downgrade reserves (the major driver of our PT decline), increase capex in FY25 and reduce D&A and opex (the driver of EPS upgrades), leading to EPS revisions of +50/21/16% in FY25/26/27E and a Price Target decline of 8% to A$1.70/shr (from A$1.85/shr). While BPT continues to disappoint operationally, the stock is priced for failure, but the cash flow outlook is compelling (FY26-30E FCF yield ~30%).” Barrenjoey
Nufarm (NUF) – Trading update in a cyclical trough
Amongst the scheduled financial reporting requirements, companies are also required to meet continuous reporting obligations and report to the ASX if financial performance is materially different to market expectations.
Nufarm released a Trading Update as it approached the conclusion of its financial year, ending August. In it, the company has indicated that challenging trading conditions remain for its businesses, in particular its largest business manufacturing Crop Protection products (think Roundup).
Excess global inventories of pesticides and agricultural chemicals have seen product dumping by suppliers worldwide and falling prices/margins for Nufarm in recent halves. In addition, slowing business activity levels appear to have impacted Nufarm’s third-party manufacturing performance. Much of this trend has been a feature of recent results and was in stock pricing.
In aggregate, new profit guidance for FY24 EBITDA now sits between a range of $300-330m; down more than 15% from guidance issued in May (with the delivery of the half-year result). As has been the case in recent reporting seasons, bad news is punished. The stock fell almost 10% on the day of announcement.
Medium term approach
We own Nufarm for two structural reasons, other than the cheap price at which the stock trades. We believe the market too heavily discounts the cost of inventory and working capital management, and we believe the company’s Seed Technology business is significantly undervalued and should ultimately be divested or demerged.
The update pleasing demonstrated good control of working capital, and despite the lower earnings base, we believe the company is well capitalised
Disappointingly the faster growth, higher value Omega-3 oil business has also suffered from a cut in pricing, despite reporting still robust demand. Revenues from this source are still expected to double in FY25. The performance of this business, which sits within the highly valuable Seeds division, will be important for long-run valuation creation for investors in the stock.
The company will provide a further update to the market before the end of the year, and we continue to review our underlying thesis.
What they said – “Downgrade to Neutral. Losing comfort/visibility on the earnings recovery”
“Nufarm also provided an update on Omega-3 FY24 revenue. The company now expects to deliver A$50mn of revenue vs. the previous A$50-70mn target range. Whilst disappointing, the reduction is quite marginal overall and does not change our optimism around the structural growth opportunity within the Seeds division.” UBS
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.