Exhibit 1: Reporting season fair-value estimate changes for August 2024 and 2023
Source: Morningstar
China weak, banks OK, retail recovering
With big share price swings on earnings ‘beats’ and ‘misses’, there is often an undue focus on the noisy near-term. This is our attempt to cut through the noise, to find the three themes we think are most important for investors.China’s weak economy could mark a sea change for iron ore
Broadly speaking, commodity prices remained elevated during fiscal 2024, supporting strong profitability and shareholder returns for major miners. But concerns are mounting around the global growth outlook, and in particular, China’s demand for our resource exports. The prospects of maintaining steel production and iron ore consumption at peak rates appear slim given the apparent investment excesses of the past two decades. Notably in real estate, and to a lesser extent, infrastructure. Shares in bulk commodity miners have already trended down in 2024 as the outlook sours. But we don’t think the story is finished yet, with near-term iron ore prices of around USD 90 per tonne materially above our midcycle forecast of USD 70 per tonne. While BHP Group (ASX:BHP), Rio Tinto (ASX:RIO) and Fortescue (ASX:FMG) all screen as fairly valued following the recent selloff, we’re yet to update our near-term commodity price assumptions for recent volatility in prices. All three miners have substantial leverage to iron ore prices, but Fortescue is most vulnerable. With iron ore virtually the sole revenue source, it lacks the commodity diversification of BHP and Rio Tinto, and has an unfavourable position on the industry cost curve, at around the 75th percentile once discounts for lower grade ore are taken into account.Borrowers resilient but banks expensive
The health of the Australian borrower was a positive surprise. While stress on bank loan books is rising, arrear rates remain around long-term averages, despite cost-of-living pressures and rapid rate rises since mid-2022. Quarterly updates from the major banks revealed extremely low bad debt expenses. Nonetheless, most major banks look overpriced, with ANZ Bank (ASX:ANZ) the only one of the big four trading close to fair value. Commonwealth Bank (ASX:CBA) remains the most expensive of the bunch. Debate on what supports the bank’s share price rages on, including buyer support from passive funds, interest from global investors, to active managers reducing underweight positions. But we think patient investors can await a better opportunity, and in the past few years there have been plenty of chances to buy our big four, wide moat-rated banks. We see some value in the regional banks, with Bank of Queensland (ASX:BOQ) and MyState (ASX:MYS) most attractive—but most certainly not of the same quality as the majors, given the regionals all lack cost advantages.Green shoots in retail
Fiscal 2024 was tough for the consumer. The national accounts, released this week, cemented that point. In the June quarter 2024, real household consumption grew only 0.5% on June 2023, the slowest annual growth rate since lockdown-affected March 2021. But much-anticipated trading updates for the first weeks of the new financial year—a more timely measure than GDP—show sales are beginning to pick up for major retailers. Super Retail (ASX:SUL), owner of Super Cheap Auto and Rebel Sports, saw like-for-like sales lift 3% in the first seven weeks of fiscal 2025 versus a year ago, and JB Hi-Fi (ASX:JBH) saw 5% sales growth in the month of July. At Kmart, sales are up 3% in the first eight weeks. We expect a discretionary retail recovery in fiscal 2025. We forecast industry growth of 3%, following a year of zero growth in fiscal 2024. At 3.75%, the fiscal 2025 minimum wage increase is still higher than the pre-pandemic norm, but a smaller increase than fiscal 2024 at 5.75%. With labour one of the largest costs for retailers, wage disinflation should support margins in fiscal 2025. Undervalued Domino’s Pizza (ASX:DMP), on our Best Ideas list, stands to benefit.The big winners of reporting season
Drilling down to individual names, we see some significant moves this reporting season. The biggest winner was wide-moat Brambles (ASX:BXB), with a rosier outlook for capital expenditure and margins resulting in a 16% fair value upgrade. The market liked the result too. We had forecast meaningful margin gains in fiscal 2024, but Brambles did better, making our prior medium-term margin assumptions look conservative. Brambles remains on our Best Ideas list, trading at discount of almost 20% to fair value. We made big upgrades to technology names WiseTech (ASX:WTC) and Life360 (ASX:360). We still expect wide-moat WiseTech will dominate its winner-take-most market. But we’ve increased our assumption about the absolute size its market can grow to, and raised our fair value estimate 15%. Shares screen as slightly undervalued. We also raised our fair value estimate for no-moat Life360 by 13%. The cost to acquire new monthly active users continues to fall, which is a key metric for efficiency and future growth. We think Life360 is in a strong position to grow rapidly and build its competitive advantage, but it’s priced accordingly and fairly valued. (Exhibit 2)Exhibit 2: Reporting season fair-value estimate upgrades of 6% or more
Source: Pitchbook, Data reflects FVE changes between close 31 Jul, 2024 and close 1 Sep 2024.
The big downgrades
Corporate Travel Management (ASX:CTD) and Audinate (ASX:AD8) were the biggest disappointments, with both fair values cut 20%. For Corporate Travel, part of the downgrade reflects our underestimation of how beneficial one-off humanitarian projects were to European earnings since fiscal 2019. Those gains are now rapidly unwinding. More important is lower confidence in maintainable earnings from North America, Australia and New Zealand. Shares trade at a significant discount to our revised fair value, but it may take time for investors to look through the near-term earnings uncertainty. Given the group’s track record of earnings growth, efficiency improvements, account wins, and customer service delivery in the still-fragmented corporate travel management space, we think the long-term earnings outlook remains robust. Narrow-moat Audinate’s revenue and profit both met our forecasts, but guidance signaled a dramatic, unexpected slowdown this year. We think this reflects a one-off transition in business model, which is not too dissimilar from what we have seen in many software-as-a-service businesses. Shares screen as materially undervalued, and it appears the market believes the company’s slowdown may signal a loss of competitive position or an exhaustion of its addressable market—a view we don’t share. Megaport’s (ASX:MP1) guidance missed our expectations for revenue and EBITDA, and hints at worsening salesforce efficiency and product/market fit than we thought. The market reaction was severe, with shares falling some 30%. We believe slower revenue growth is partly driven by cyclical factors rather than purely by competitive pressures. We’ve reduced our fair value estimate by 17%, but shares still look cheap, and we see a long, attractive growth runway ahead. We expect EBIT margins to expand materially to 39% by fiscal 2034, compared with 2% in 2024. The primary driver here is the feed-through of Megaport’s highly attractive lifetime value per customer, compared with its customer acquisition costs, as its customer base matures.Exhibit 3: Reporting season fair-value estimate downgrades of 6% or more
Source: Pitchbook, Data reflects FVE changes between close 31 Jul, 2024 and close 1 Sep 2024.
