How Investors Mutual Is Positioning QV Equities In Quality Companies With Sustainable Earnings

By Anton Tagliaferro | More Articles by Anton Tagliaferro

In our previous article, Investors Mutual Investment Director Anton Tagliaferro provided an update on the fund manager’s views on the state of and outlook for the sharemarket. In this piece, he outlines how Investors Mutual is ensuring that QV Equities (ASX: QVE) remains soundly positioned in a diversified portfolio of well-established, quality companies with sustainable earnings.

Our focus with QVE is to continue to underpin the portfolio with well-established, good quality industrial companies outside the top 20 Australian companies which are leaders in their respective sectors. Many of these companies are not as well-researched as many of their larger counterparts and offer good long-term prospects, solid dividend yields and an opportunity for investors to diversify their portfolios away from the top 20 companies.

Our investment team undertakes a detailed company-by-company assessment to identify companies which have a long track record of producing recurring revenues and earnings, which are run by experienced management, and which have sound balance sheets. Given that the economic growth outlook is so uncertain, we’re also focusing on company-specific growth drivers which should enable the company to perform well over the next three to five years.

The table shows examples of these.

Company-specific initiatives to grow in the next 3 to 5 years:
Cost-outs → Coles, Pro-Pac Packaging
Acquisitions → Amcor, Sonic Healthcare
Contracted growth → Shopping Centres Australasia, AusNet
Market share gains → Integral Diagnostics
Restructuring → Ampol, Orora

These examples include companies with an ability to reduce operational costs and become more efficient (such as Coles and Pro-Pac Packaging), companies that can make bolt-on accretive acquisitions (such as Amcor and Sonic Healthcare), and companies that have contracted growth (such as Shopping Centres Australasia and AusNet). We have also invested in companies with the potential to make market share gains in their sector (such as radiology company Integral Diagnostics), and companies which are undergoing significant restructurings to unlock substantial value for shareholders, such as Ampol (formerly Caltex) and packaging company Orora.

Here’s some of the rationale behind the logic as to a number of QVE’s major shareholdings:

• Queensland railway operator Aurizon owns the Queensland rail network, a highly-regulated business which offers a very resilient and recurring earnings stream.
Coles, aside from being a company that has a very strong cashflow and balance sheet, is implementing a $1 billion cost-out programme over the next five years, and is investing heavily in its warehouses as it consolidates and automates its network and replaces legacy IT systems.
• Victorian electricity and gas distributor AusNet has highly recurring and predictable earnings from its regulated and growing asset base, with the growth driven by population growth and more recently from increased renewable penetration.
• Casino operator SkyCity Entertainment has long licenses in Auckland and Adelaide which will allow the company to generate strong cashflows in the years ahead, which will enable the company to continue to invest significantly in its business while paying a dividend as things normalise.
Pro-Pac Packaging is the clear number two in the flexible packaging industry in Australia behind Amcor. Pro-Pac’s products have a resilient demand profile serving end markets in the agriculture, food, and beverage segments, and the firm is set to deliver earnings growth and improve cash generation in the next few years.

Income is also a focus for the portfolio as it is likely to remain a tough environment for investors to earn income, with interest rates set to remain at record lows, rental cuts or deferrals from many residential properties, and reduced dividends from many traditional sharemarket sectors such as the banks and real estate investment trusts. Because of this, QVE’s Board felt it was important to announce its intention to maintain dividend payments for the full year 2021 at the same level as in financial year 2020 – an interim dividend of 2.2 cents per share, and a final dividend of 2.2 cents per share, both fully-franked. This provides shareholders with certainty of income during a period when many companies will be cutting or cancelling their dividends.

Our focus for QVE is on continuing to underpin the portfolio with good quality industrial companies with a history of producing sustainable earnings from a diverse range of sectors, while having cash ready to take advantage of any potential buying opportunities as the result of market pullbacks. The portfolio is positioned defensively, holding well-established companies with management we believe is well-experienced at delivering good returns for shareholders. We’re currently using the portfolio’s cash holding to participate selectively in new stock issues, and using options to enhance the income we can earn from a number of stocks, such as Orica and Amcor.

We anticipate that after the current period of excessive valuations for a number of sectors, such as ‘buy now pay later’ and ‘medi-tech’ stocks, market conditions will at some point return to valuing companies on the basis of their fundamentals as opposed to many investors chasing fads. In this environment we believe QVE, with a portfolio of good quality industrial companies with sound fundamentals in a diverse range of sectors, should perform well for shareholders in what looks set to be an uncertain economic environment in the years ahead.

About Anton Tagliaferro

Anton Tagliaferro is one of Australia's most respected value managers. Anton founded Investors Mutual Limited (IML) over 22 years ago with the purpose of creating a research-driven fund manager focussed on building portfolios of companies that represent both 'quality and value'. Anton remains Investment Director of IML and is Portfolio Manager of QV Equities (ASX:QVE) which invests in the ex 20 segment of the ASX. He recently published the book ’20 Lessons from 20 years of Quality and Value Investing’

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