March 19, 2020
March 19, 2020 | Adviser News
Celeste Australian Small Companies Fund. Market & Portfolio update
Markets have unquestionably entered an unprecedented period of volatility. With the global economy coming to an abrupt halt, central bank and government support is gradually catching up to the severity of the coronavirus pandemic, however investors rightly remain concerned over the outlook for many industries and corporate solvency.
Over the past month the pace of equity market declines around the world have been amongst the worst on record. The Australian Small Companies index has not been spared, having fallen 35.9% over the past 30 days to 19 March 2020.
The small cap market sell-off in March has been broad-based. The indiscriminate selling is typical of markets in panic mode.
Process is critical, especially in times of acute volatility, where earnings surety is minimal, and where equity markets are in panic mode and intensely risk averse. An understanding of a company’s business model, people and balance sheet dynamics will differentiate between conceptual stocks and those better placed to cope in periods of market distress.
o Focus on the business that you are confident can navigate unprecedented challenges to their sales/demand outlook.
o How has the business operated in historical periods of economic dislocation, understanding its durability, its ‘muscle memory’ of hard times.
o Comprehension of balance sheet dynamics is critical when credit markets are dysfunctional and access funding is critical for your business.
o Understand the working capital dynamics of a business in moments when the demand characteristics are unknown.
o Avoiding business where access to working capital may be problematic.
o Understanding how balance sheets are structured, and if the structure is tenable in an environment where demand is impossible to predict for a period. To what extent is the business dependent on external funding, what is the structure of that debt, who are the counterparties providing it.
o Understanding that the AUD has declined significantly against the USD, some 15% in March alone. Understanding where risk may exist as hedges roll off, and where pricing power is minimal. Understanding what risk may exist with your business when your purchasing is in AUD, and you have a customer base that is habituated to buying around very fixed price points.
o Earnings are ( will be ) impossible to predict for FY 2020 and FY 2021 –focus on those companies who can survive, pass through the eye of the storm, and benefit from an altered competitive dynamic / sectoral disruption in the medium term.
PEOPLE – EXECUTIVE & BOARD:
o Focus on Management & Boards with history of navigating challenging economic environments, that have lived and survived extremes, operating environments where there is no history, no corporate playbook.
o Avoid poor business models and conceptual sectors where the equity market value is not a reflection of the cash flows of the business (what is the market capitalisation, against what is the debt that the company can raise?)
o Ensure the balance sheet is conservative, and capable of funding the operations of the business.
o Be very sensitive to consumer sector exposure, be discerning and selective.
Celeste Australian Small Companies Fund: Performance & Actions
Despite negative absolute returns the portfolio has performed well relative to the benchmark over the past 12 months. The portfolio has also outperformed the benchmark over the past month however returns are more benchmark-like given the broad-based selling across the market. This will create opportunities where the market misprices the future value of cash flows of a number of small companies.
Performance to 19 March 2020
Source: Celeste Funds Management
The investment team are increasingly focused on;
- Non-Australian dollar revenue exposure & harder currency exposure such as Breville, IMF Bentham, Codan, ARB Corporation and Graincorp.
- Exposures where the revenue of the customer base is non AUD in nature such as Monadelphous Group and Lycopodium.
- Companies in net cash, have no external funding issues, or where funding is locked away for 3+ years, with a diverse array of appropriate counterparties.
The Small Ords FY20 P/E has derated by 35%
Positions added to
- Breville Group
We have been active in a number of stocks during March. We have been using the current levels of volatility and liquidity as an opportunity to add and trim stocks. The stocks we have added most to are Breville Group and Eclipx.
Eclipx has materially underperformed and has witnessed a 73% derating in its 1 year forward P/E. The sell-off in the stock has been driven by investor fears over Eclipx balance sheet. To fund its operations Eclipx uses Securitised Warehouse facilities and Asset Backed Securities. In late 2019, Eclipx refinanced a number of its facilities, which provides the company with significant capacity and long dated duration within its current debt facilities. With a number of self-help initiatives in place, including well progressed asset sales and a significant cost reduction program, we see Eclipx well placed over the medium to longer term.
Post an extremely strong H1 FY2020 result, we reduced our weighting in Breville Group by one third at a share price above $22. With the sell-off in small cap stocks in March we started to rebuild our position in Breville group at around $13. We like Breville Group’s position in the small electrical appliance market, and to its potential for growth in a global context. Breville Group generates attractive returns and has an ability to fund its R & D, and growth, from operational cashflows. Breville has a global intellectual property (IP) base, and an ability to leverage that base outside of Australia. In the last decade Breville has gone from being an Australian centric business, to one where currently some 80%+ of sales are generated in North America and Europe. Breville has modest market shares in its target appliance segments, and considerable potential to grow its market share for years to come. We remain attracted to the Breville brand, its IP base, its market position and potential for self-funded growth into the medium term
We have taken the opportunity to trim our position in WPP. WPP delivered a reasonable first half result, particularly given the Media Industry in Australia has effectively been in a recessionary like environment for almost 2 years. We remain particularly attracted to the company’s new strategy under the recently appointed CEO, Jens Monsees and expect the stock to be supported by the company’s recent capital management initiative, which is to deliver a special dividend of 6.0cps paid 1.5cps every six months for the next two years. Despite this, we trimmed our position, in effect using the stocks relative outperformance to fund positions that have been materially sold off which has created a buying opportunity.
Celeste took the opportunity to trim its exposure to plumbing products distributor, Reece Limited, post the FY 2020 interim result. Reece reported a strong H1 FY 2020 result with sales in Australia/New Zealand static, in a dreadful market, and in the USA like on like sales grew a stellar 9%. Margin performance was also commendable, with EBITDA margin in Australia off 50bp to 12.2%, whilst in the USA margins edged down by 30 bp to 5.6%. Whilst Reece does have some debt on balance sheet its interest coverage is ample at > 6X at the EBITDA level, with first debt maturities in 2026. We anticipate that Reece will continue to generate best of breed returns in the medium term, with the long-term growth potential of its US business providing a multi decade growth opportunity. The decision to adjust the Reece weighting, from a 3% active, to a 1.5% active, was driven by the valuation of the stock, which we assessed as closer to fully valued, and left modest scope for disappointment.
The content of this publication, dated March 2020, are the opinions of Celeste Funds Management Limited (ABN 78 098 628 605) and is intended as general information only for advisers, which does not take into account the personal investment objectives, financial situation or needs of any person. To the extent that any information contained in this publication may be interpreted as general advice, that information is attributed to Celeste. It is dated March 2020, is given in good faith and is derived from sources believed to be accurate as at this date, which may be subject to change. It should not be considered to be a comprehensive statement on any matter and should not be relied on as such.
The Trust Company (RE Services) Limited (Perpetual) is the responsible entity for and issues the Celeste Australian Small Companies Fund. Celeste Funds Management Limited is the investment manager of the Celeste Australian Small Companies Fund. This information was prepared by Celeste Funds Management Limited. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information. Celeste Funds Management Limited does not guarantee the performance of any Fund or the return of an investor’s capital.
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.Past performance is not a reliable indicator of future performance. GIIN FVHHKJ.00012.ME.036. PNOE-015420-2020