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This fund manager thinks the RBA got it right in moderating rate rises

The WaveStone principal says retail will drop away but quality operators will find a way through.
Vesna Poljak
Oct 17, 2022

Fund manager Catherine Allfrey says the Reserve Bank of Australia was “absolutely” right to moderate the pace of interest rate increases this month, in a nod to Australia’s unique sensitivity to the cost of borrowing.


The real toll of this monetary tightening cycle on households is not yet apparent, and the 19 per cent seasonally adjusted growth in retail sales year-on-year is almost a “false signal” if tougher times are indeed ahead.


The WaveStone Capital principal and portfolio manager says the first quarter for most businesses is going to look reasonable.


But a huge cohort of borrowers will experience their fixed rate mortgages rolling off after Christmas; the RBA has estimated two-thirds are scheduled for refinancing before the end of 2023.


“So that’s just going to kill consumption, right? It hasn’t hit yet. But I must say, those quality operators they always find a way to steer through. They’ve had some good times for a couple of years now.”


The annual general meeting season under way will be particularly illuminating on the subject of margins.


“That’s interesting too in terms of what they’re seeing at the coalface dealing with inflation. They’re finding it hard both from a labour perspective, but also from putting prices up. The initial rounds of prices going up were easy. I think going forward, it’s going to get a lot harder.”


Australia’s inflation is lower than the rest of the world. The consumer price index jumped 6.1 per cent in the June quarter, and rose to 7 per cent in July on the new monthly CPI. UK inflation was 9.9 per cent in August and US inflation 8.2 per cent in September.


“A lot of multinationals who want to sell things into Australia are like, ‘Well, hang on, we’re putting prices up 8, 10 per cent in Europe, the US, and if you don’t want to accept that price increase, then we’ll just move it to another market’.

“And then the Australian retailers are saying, ‘Oh, hang on. No, no, we want the products because we know there’s a demand for them. So OK, we’ll have to accept that increase’.”


WaveStone’s Dynamic Australian equity fund is ahead 1.1 per cent over the year to September 30 in gross performance terms, or negative 0.7 per cent net of fees, bettering the S&P/ASX 300 accumulation index’s loss of 8 per cent over the same period. Since inception in 2009, the long-short strategy has earned average annual returns of 12.6 per cent, before fees.


Allfrey is a presenter at this year’s Sohn Hearts & Minds investment leaders conference on November 18, which takes place in Hobart, and aims to raise money for medical research. She was moved to participate for the first time by a close friend who is suffering from terminal brain cancer.


The sharemarket volatility has made it difficult to settle on a Sohn stock selection, but she promises it will be “true to style”.


WaveStone’s long-short strategy has thumped the market with tactical shorts against buy now, pay later technology and consumer discretionary stocks such as Zip, Block and City Chic Collective.


“The retailers are sitting on quite a bit of inventory. It’s always the way, people think it’s going to extend forever and the free government payments and the low rates were never going to continue forever. And so, that’s where we’ve made our money.”


On the long side, WaveStone has succeeded with Treasury Wine Estates, Santos and IGO.


“It’s really old-fashioned bottom-up stock picking,” she says. For example, there were three ASX takeovers that collapsed in the past month, of which WaveStone actively owned none, because it could never make the valuations stand up. In the dissolution of the deals, its outperformance was enhanced by not owning the jilted targets.


Formerly it had a large position in Sydney Airport, which it held through the coronavirus, participated in its recapitalisation, and was validated by the eventual privatisation.


Streaming future

One of the strategy’s worst performers is Nine, publisher of The Australian Financial Review, and a position Allfrey is confident can turn around. “We look for quality, growth at a reasonable price, and to be honest, management have delivered in terms of being in a constant upgrade cycle and then they’ve also come through finally with the buyback.”


The fund manager says media is one of the first parts of the economy to soften. However, this was not yet apparent, and Nine was in an advantageous position as an owner of first-party data through its digital assets. Streaming asset Stan’s progression into sport has held up its subscriber numbers, even though “it’s not making any money”.


“That’s one of the things that clearly the stock’s sold-off on, the valuation of Stan given what’s happened to the Netflix share price.” She speculated that striking a deal with an international content provider could be “quite transformational”.


In a cyclical bear market, Allfrey says history is the best guide.


“When will the market turn? The market always looks six to 12 months out. And we’re already pricing in obviously the contraction of consumption. The market will bottom when we know that rates are going to moderate.”


Wall Street is down about 25 per cent but cyclical bear markets are usually 30 per cent drawdowns, she adds. “The problem is the rate increases have been so fast, what problems does that cause?” This has led to an obsession with corporate debt markets and a hunt for potential structural casualties.


“Let’s hope it’s just a rate-driven correction.”


The historic unification of BHP Group in January wins Allfrey’s approval. “The stock’s continued to perform despite not owning any energy assets," she says. BHP’s petroleum business was merged with Woodside to create the enlarged Woodside Energy. “That’s fascinating in itself.”


The main reason she attributes to Woodside Energy’s outperformance of the ASX energy sector is the fact its gas is not fully contracted. Over one year, Woodside’s 32 per cent return has trailed only coal producers Whitehaven and New Hope.


“It’s got the exposure to the spot gas price in Asia. That’s been clearly the right way; I don’t think it was by design, to be honest,” inferring that BHP entered the merger with less contracted gas. “Who do you want to be exposed to? You want to be exposed to those gas players that aren’t contracted at $4, they’ve got exposure to that $34 LNG price in Asia.”


Allfrey is an advocate for more lithium processing to be done in Australia.


“We’re not processing the raw material,” she observes regretfully, although IGO and Wesfarmers “have both stepped up”. It should be something the federal government is encouraging, she argued. “Let’s see more of the raw material processed in Australia. If you think lithium’s going to be around for generations, let’s invest as a country and let’s focus on this industry.


“Because it’s embryonic.”

The central question about spodumene, from which lithium is derived, is what happens to the price as more supply arrives.


“No one has worked out exactly what it should be except that the cash costs are so low. You look at Greenbushes, which is IGO’s mine, the cash cost is [around] $300 a tonne versus the price today [around $US7000]. Usually it moves down to the marginal cost.”


Electric vehicle sales from China are behind much of the demand. The fund manager personally drives a hybrid. “It does 35 kilometres which is perfect. Do the school drop-off, come back, put the battery back on.”


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This article was originally posted by AFR here.

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