Adding cyclical positions to portfolio


Transcription of Finance News Network Interview with Northward Capital CEO and Sector Portfolio Manager, Darren Thompson

Clive Tompkins: Hello Clive Tompkins reporting for the Finance News Network. Joining me for an update from boutique Australian Equities Fund Manager Northward Capital is CEO and Sector Portfolio Manager, Darren Thompson. Darren welcome to FNN. When we spoke to Northward Capital in September last year, the markets were in a state of turmoil yet today we’ve had one of the best quarters in over a decade. What do you put it down to?

Darren Thompson: Well I think late last year there were three major over-arching concerns the market had. There were the Euroland debt issues, whether the US economy would recover or go into double-dip and thirdly, the extent to which the Chinese economy would slow – whether it would be a hard landing. I think over the last six months, we’ve had indications that all three of those issues have been somewhat resolved. We’ve had a co-ordinated response to the Euroland debt issue and a Greek bailout. We’ve had the Chinese Government looking at 7.5 per cent growth and looking like they’ve managed a softish landing rather than a hard landing. And the data out of the US, although patchy, it does point to a grinding recovery rather than a double-dip recession.

Clive Tompkins: One notable underperformer has been our own local market, notwithstanding the fact that the index is now through the 4300 level. Where to from here?

Darren Thompson: Because the markets are trading around the 10 times earnings level, there’s reasonable valuation support, particularly versus other asset classes. So as we move through, think the basis is there for the market to move higher, certainly over the medium term. In the short term, we probably consider it still to be patchy; you know there’s still going to be the odd concern out of Europe. There’s still a heavily indebted position for countries like Portugal, Spain and also the recovery in the US is a little bit patchy. So I guess we probably see that there’s a position for the market to move higher. One of the reasons why our market has been somewhat constrained is that commodity prices have been volatile here. And we have had a situation where the consumer has been quite weak, so consumer facing businesses continue to do it tough in Australia. And the high Aussie dollar which I guess, is one of the out workings of stronger economic growth environment, makes it harder for domestic export businesses to compete.

Clive Tompkins: And Darren, are we beholden to Chinese demand?

Darren Thompson: China’s a key issue for us now. Clearly, particularly in the bulk commodities iron ore and coal; it’s a key determinative of the prices around those commodities, which at the moment are the strongest feature of the Australian economy. So China, at least having a softish landing and not going to a hard landing, is a key for our ongoing recovery.

Clive Tompkins: Thanks and what about interest rates. The RBA kept rates on hold in February when expectations were for a cut. What chance of a rate cut in April?

Darren Thompson: Look the market’s 50/50, so it’s like a - two bob each way. We probably view that they won’t cut but again, it’s not certain. Think that the RBA would like not to have to cut, their concern that the strength of the mining sector – they want to keep that in check if you like, and keep inflation under control. But then there are - some soft data, only today the building approvals number was quite weak, so they will be mindful of that. And as I’ve said, we’ve seen a lot of companies over the last few weeks through reporting season, a lot of customer consumer facing businesses who are continuing to struggle. But I guess on balance, we think the RBA will probably hold at the moment, but we still think that the bias is probably to a rate cut over the next three months.

Clive Tompkins: Darren now to your Australian Composite Fund. Can you just remind our audience about the style and the make-up of the Fund?

Darren Thompson: Yeah look it’s – we’re fundamental stock pickers. So we essentially - we call it style neutral, which means we’re looking to find undervalued companies whether people might call them value stocks or growth stocks. So we essentially have a motto of ‘getting out to find out’, like only in the last two weeks, we’ve had portfolio managers in Europe and the US, Western Australia and Queensland.
We’re essentially looking to get out and find out what companies are doing, what their customers are doing, what their suppliers are doing. Form valuations and essentially back our judgement when we believe that the market’s under-pricing, either the earning stream or the rating of those companies.

Clive Tompkins: Thanks. So what are your weightings across the bigger sectors in the market?

Darren Thompson: At the moment, going back to our earlier conversation, given we are cautiously optimistic, so we have a slight overweight to the metals and mining and materials sector. You know, towards I guess, putting more cyclicality into our portfolio. We’re leveraged to what we believe is a - albeit a grinding, but a recovery nonetheless in the US. So companies like Brambles(ASX:BXB), Amcor(ASX:AMC), companies with leverage to improving growth dynamics, particularly internationally and with good internal drivers – that is where we’re overweight. Those companies I mentioned are in the industrial space. Where we’re underweight is in sectors like property trusts and to a lesser extent, the major banks, is where we’re funding those positions from.

Clive Tompkins: And Darren, did the reporting season just gone, cause a rethink?

Darren Thompson: The reporting season didn’t cause a major rethink, although we did see a continuation of earnings downgrades. Leading into reporting season, a number of companies lowered their earnings forecast for FY12 (financial year 12) and we saw that continue through the reporting season. So for us, the reporting season evidence that we were looking for going into it, and that is the consumer facing businesses on average were doing it quite tough, particularly those that are affected by the high Aussie dollar. Some of the resource companies were affected by either production and/or commodity prices coming back a bit. So really at the moment, financial year 12 looks like being a tough period. At the moment the market’s maintained earnings for financial year 13, which is starting to prove to be a little bit of a stretch or that recovery is required to hit those numbers. So I guess we see a little bit of an earnings risk coming back into the market in terms of FY13.

Clive Tompkins: OK thanks Darren. So how’s the Fund performed over the last quarter, last twelve months?

Darren Thompson: Yeah look Fund performance has over the last year, has been in line with the market. Pleasingly over the period since we started in 2004, the Fund’s done 3.5 per cent per annum over the index, in line over the last year and also over the last quarter.

Clive Tompkins: OK so where have you made money?

Darren Thompson: Over the last year, the stocks which have been best for us are stocks like QR National(ASX:QRN). Unfortunately we didn’t get that in the float, but shortly thereafter we did basically invest in the stock for that growth in terms of commodity movements, particularly Queensland coal – a good cost out story. That’s been a strong performer over the last year. Similar News Corp(ASX: NWS), we upgraded the position quite significantly at the height of the hacking scandal and our belief that the UK issues would not undermine the value in the broader group. So that’s also been a strong performer, particularly in leverage to the US economy as that market has rebounded. And Transurban(ASX:TCL) has been a strong performer for the Fund as well, just a good solid portfolio of toll roads where it just keeps earning and earning and earning, without too much risk around those earning streams.

Clive Tompkins: And what are some of your biggest positions?

Darren Thompson: Yeah the three I mentioned, QR National(ASX:QRN), Transurban(ASX:TCL) and News Corp(ASX:NWS) are three of our bigger positions. We also hold a large position in Brambles(ASX:BXB), as I just mentioned we’ve been over there on a fact finding mission in terms of both Europe and the US, around the jet-ship business. And we remain positively disposed towards that company. I guess another company which hasn’t fared so well more recently is Challenger Financial(ASX:CGL) where we have a significant position. And we’ve actually added to that as the share price has come back more recently.

Clive Tompkins: And Darren on the flipside. Which stocks have detracted from performance and do you still hold them?

Darren Thompson: The largest detractor was Telstra(ASX:TLS) and that is holding an underweight position to Telstra. We actually have added that to the portfolio over the course of the last few months. Telstra is a company which we think has very solid cash flows and is reasonably valued. However, we view that being better capital appreciation elsewhere in the portfolio. And the other stocks which we’ve held that have caused issues were ERA(ASX:ERA), it had issues with rain in Queensland and also with the tsunami affecting the uranium market, particularly with the Japanese situation. We actually had looked to exit that stock in the portfolio. The other one which I mentioned was Challenger(ASX: CGF) which we’ve actually looked to up-weight the position in the portfolio.

Clive Tompkins: And what about new stocks. What have you added?

Darren Thompson: In keeping with increasing a bit of cyclicality into the portfolio, more recently over the last sort of six months, we’ve added Fortescue Metals(ASX:FMG) which is the first time we’ve had that sort of stock in the portfolio. We ultimately believe that they’ve got their infrastructure right and they will be able to lift production. And that provides some protection, even if iron ore comes back in terms of pricing. I mean we’ve added mining services companies in the form of Monadelphous(ASX:MND) Mineral Resources(ASX:MIN) and Campbell Brothers(ASX:CPB) as well.

Clive Tompkins: And Darren last question. What do you think our market will look like by the end of the year?

Darren Thompson: We certainly think the conditions are in place for the market to be higher, certainly in the short to medium term. And that is the markets are at reasonable valuation levels, you know 10/10.5 times earnings for FY13 is certainly not stretched. We are seeing earnings coming through in terms of the mining sector and it’s just some signs that the consumer is starting to at least bottom out, in terms of confidence. So we think the conditions are in place for company valuations to lift and more importantly, a good environment for stock specific stories to dominate, rather than the macro considerations that we’ve had in place over the last couple of years.

Clive Tompkins: Darren Thompson thanks for the update.

Darren Thompson: Great being here, appreciate it.