Fidelity Australian Equities Fund

Olivia Hawkes: Good afternoon. I'm Olivia Hawkes, Regional Sales Manager here at Fidelity. I'm pleased to have Paul Taylor, Head of Australian Equities joining me today. Welcome, Paul.

Paul Taylor: Thanks, Olivia.

How is being a manager of a global financials fund really given you some, I guess, lessons for life when you are really looking at Australian companies?

So, first of all, I guess when I think about it within an Australian context, financials are very important. So, our big banks, insurance companies, diversified financials, real estate, is a very large part of the Australian market and an important part of the Australian market.

This is going to sound like a really different connection but recently we had a situation where ResMed in Australia got sold off pretty aggressively on the back of concerns around what the new GLP-1 drugs, basically the weight loss drugs, what they were going to do for Ozempic, etc., what they were going to do for people who have sleep apnoea, that was going to reduce weight, which potentially would reduce the incidence or the total addressable market for sleep apnoea devices and ResMed's the key player in that market. Now, ResMed dropped quite aggressively. It was taking a very big view on what could happen.

Now, maybe it happens, maybe it doesn't happen, but it really reminded me when I was looking at the Global Financial Services Fund, at the time, that was in the late 90s, and at that time, that was internet 1.0, and basically at the time the banks were selling off pretty aggressively because everyone viewed that the internet was going to end the banks. Banks were going to be disintermediated, savers and borrowers would just meet on the internet, you don't need the middleman in that instance, so who needs a bank?

Now, it's a valid, it's actually a very valid comment, but what we didn't know at the time, the banks have ended up being some of the biggest beneficiaries of the internet because it's taken out a lot of costs. So, what was a very, everything used to be done at a very expensive, in the branches, very expensive transaction of the banks is that was taken out, now it's all online transactions, on your phone transactions, which are extremely cheap.

So, what was originally thought to end the bank's life has actually been one of the biggest, banks have been one of the biggest beneficiaries of the internet.

So, if I come back to the ResMed example, yeah, maybe, but also maybe not. And when a stock starts to factor in, all the negative consequences of that concept, you start to get interested in that. So, I mean, we took an initial position in ResMed on that weakness as well.

And still in the portfolio today.

Still in the portfolio today.

Excellent. A question, and it's probably not more, it's a question, it's a statement, if I was an investor 21 years ago and I saw the Fidelity Australian Equities Fund pop up on my radar, I had 10,000 to invest and I did. So, I took a leap of faith on a, not really a tried and tested manager in the Australian market, that $10,000 is worth circa $86,000 today. If you compare that to the market, the market's returned roughly $60,000 cash, despite a very few successful years has been $22,000.

You've been doing this a long time. Have you still got fire in your belly, Paul? To keep going and you've been very successful just reading those statistics out, what still excites you about investing in the market?

Look, as I talked about, I mean, I just love meeting companies. To me, I'm in a very privileged position to meet the chief executives of fascinating companies, and also I've got the backing of fidelity where I can link into the global network and what's happening with those global companies, whether it's US or China or Europe. To me, I just love that, right?

We have a get together what we call review week, and we just got together in China, in Shenzhen in June. The whole Asia Pacific team, plus some global portfolio managers. When we get together, the analysts and the portfolio, we just talk stocks. We just talk about the different companies, what drives those companies, and I find that highly motivating and yeah, just love it.

So, for me, it's much more than a job, it's really a passion. I mean, it's what I love doing, it's what I love learning about, and I'm in a rare position, a rare and privileged position where I get to meet some amazing management teams and get the backing of a global behemoth where I can tap into global flows of information.

And I think that's really important. There's a slide that we often share with investors, and it's Rio Tinto, for example, and it actually captures how Fidelity research one particular company, but it's the customers, the suppliers.

Do you want to just talk a little bit about when you're looking at a particular company, the degree that you will go to to look really under that bonnet and go deep?

Yeah, no, definitely. And I think that's actually one of Fidelity's key competitive advantages.

So, when we look at a company, we're not just meeting with the management team of that company, we're meeting with their competitors, their suppliers, their distributors, their customers, wherever they are in the world. And Australian companies are very global, and Australia's a small open economy, we're very global by nature.

Say BHP or Rio Tinto. Rio Tinto, they sell to a whole range of different industries and different companies, but one of the big ones they sell to are the steel mills of the world. So, we are meeting with Rio Tinto here in Australia. We're going to see their mines in the Pilborough or wherever those mines are in Australia, but we're also going to meet their customers.

Now, we have a team in China, based in Shanghai, and they're looking at the analyst base there, we'll have a steel analyst based in Shanghai that's going to talk to BAOSTEEL. Now, they're talking to BAOSTEEL to see whether we should be investing in BAOSTEEL, but they're also asking, well, what's your steel production profile look like, what do you think about the price of iron ore, what do you think about the price of coking coal? And what do you think about the consolidation within the Chinese steel industry? They're important for BAOSTEEL, but they're all really important also for understanding and investment in Rio Tinto or BHP.

Now, we've got a steel analyst based in Shanghai that's looking at BAOSTEEL. We've got a Japanese steel analyst looking at Nippon Steel, we've got a Korean steel analyst looking at POSCO, and same for Europe and the US, and that's an incredible advantage when we're trying to bring that entire network to play when we analyse a Rio Tinto or a BHP Billiton.

Now, it's always really easy to see it for global companies like BHP and Rio, but it's also relevant for very domestic. So, for a Coles and Woolworths, big supermarkets in Australia, their key competitors are Aldi and Costco. Now, Aldi's a German company, Costco's an American company, so we need to understand what their strategy is in Australia to help us analyse Coles and Woolworths. And having that global network gives us that advantage as well.

A question that we're being asked is more so the shorter term performance, last six to 12 months. And I guess, we tend to look at companies and we think that sounds okay, that looks like a good company.

Has it been specific companies that have been a drag on the performance shorter term, or is it a structural growth environment that hasn't worked for some of the names?

Can you just share, maybe using an example such as IGO, what's been the real challenge for some of the names in the portfolio shorter term?

Yeah, definitely. So typically what we're looking for are, we typically invest in high quality businesses, good management teams, structural growth businesses, the compounders. Warren Buffet always talked about the compounders. So, what we're looking for is business that has a high return on invested capital and can reinvest at that high rate. Typically, that means they're going to continue to deliver good performance for a long period of time. But structural growth businesses, they don't always just go up in a linear direction.

So, the company's got a dollar of earnings today and turns that into $10 of earnings in 10 years’ time. Now, that's going to be a great investment over a 10-year timeframe, but it doesn't go up, one, two, three, there's a cycle around the structural growth and that cycle provides threats and opportunities. So sometimes in the shorter term, when the cycle is turning down, people get nervous or worried about a particular company and maybe that structural growth is gone, but not necessarily recognising that's a cycle rather than a change in structural growth.

So what we spend a lot of time doing is spending time working out, well, what's cyclical and what is structural? Has it changed? Will that company that's got a dollar of earnings today still have 10... Do we still believe it's going to have $10 of earnings in 10 years time? That's where we spend our money. And if we think that's correct, we'll go through shorter term difficult periods, and in fact, if anything, it provides an opportunity to add into those positions when we think this company is going to deliver great returns for shareholders over the long term. to me is a great example.

The lithium market has been very volatile, went up a lot, now, it's come back a lot. Lithium is a key part of electric vehicles, batteries into electric vehicles. Now, we still believe... Now, that has sort of plateaued, that demand for electric vehicles, demand for those batteries has plateaued in the short term as we had this initial take up of electric vehicles, but that's now plateauing, hybrids are coming back a little bit more, people are questioning that long term structural. Now, we still very much think that by 2030, 50% of new vehicles will still be... We still believe that that's the trend that's moving forward.

When you factor in those numbers, the growth in that space will be very significant. What we've focused on is the cost of production and the cost curve. So, if I look at iron ore, BHP and Rio are right... They pull iron ore out of the ground at $20 a tonne. You've got a very steep cost curve.

So, you've got potential iron ore assets that might be $120 a tonne. Now, as iron ore comes back, it's the $120 a tonne iron ore that goes out of business or they mothball or they pull their production back, and that's the same with lithium. So as lithium has come back, we will see supply come out of the market. IGO through their asset in green bushes is one of the low cost producers in that space. So when you're the low cost producer, you make money through the cycle, it's the high cost producers that will mothball that will stop production, and we're already starting to see that, right?

So, supplies coming out, that will bring balance back to the lithium market. We'll still see this long-term structural growth in that market, and most importantly, if you're the low cost producer, you're going to be the winner through the cycle. So that structural growth doesn't just mean you can own any lithium stock, you've got to be focused on the company, the very company specifics, the cost of production of that company.

Other ones like Seek, another example, right? Seek drives the online recruitment market. Once again, we think that they're in a very good position, not just from online recruitment, but from the learning process as well. Like people continually need to upgrade their skills. That's going to be a really important part of it. The job for... The young ones already recognise this. The job for life. So, we talked about me being there 27 years, so I've pretty much had a job for life, that probably is not going to exist as we move forward.

Industries will be disrupted. Industries will be created and destroyed very quickly, and the young ones realise that they're probably going to work in multiple industries over their lifetime in multiple companies. So the learning and the adult learning around that, plus that change, what was once a one time ticket for a group like Seek is now a 20 times ticket. But right at the moment, the job market is under a little bit of pressure because of cyclical factors. Now, we think that present.

Seek is back to a really attractive valuation. We think these are very strong growth companies. The cyclical downturn's provided the opportunity to buy it for the long term. That's the sort of thing that we're looking for.

So based on that, have you been adding to IGO, adding to Seek? How have you managed some of your positions around those names that haven't been doing so well?

Yeah, definitely. So that's exactly what we've done. Now, once again, it's always sort of managing that, there has been some cyclical decline, so you want to add into it, but you probably don't want to go too aggressive. So we've been very steadily buying into those opportunities.

Dominos is a good example. As it did extremely well through 2021, we trimmed the position, it was our biggest position, we trimmed it back to what I talk about being in the belly of the portfolio, one of the sort of average sized positions. Now we're starting to add back into it as well. We have done that for IGO and we have done that for Seek, and it's a matter of managing that exposure and buying into it when you do see the weakness, taking that opportunity to buy into that weakness.

Patient long-term investor.

Patient long-term investor. One of the really interesting points, and it's also been a bit of a symptom of the last couple of years, is investors are nervous about companies that invest.

I mean, we're typically excited about companies that invest. So if they're investing because they see the high returning opportunities, that's costing them now because of that investment, but we actually love that for the next three, five, seven, 10 years. You need to invest to get the. And that's what's going to make you a compounder.

I remember many, many years ago, we've worked together for a long time now, and you mentioned that you always are quite cautious of companies that hold onto cash. It's like burning a hole in their pockets.

So that's exactly, you like to see companies investing? That's a good sign.

I like to see companies investing. I also like to see dividends, as an investor. So, yeah, I don't want to see a cash pile build up because it does. What tends to happen is companies empire builds or, as you said, burning a hole in your pocket so that you don't get a high return, but if you're disciplined with that capital, you pay out a good dividend or you see those investment opportunities that are going to drive future growth, that's what you should be doing.

Before we move to what's going well in the portfolio, I wouldn't mind if you just touched on Ramsay. It's been a... Has a position in the portfolio for quite some time. It seems that health is quite an ugly sector at the moment, particularly for private hospitals.

Could you just share a little bit about Ramsay and how you feel about Ramsay at the moment?

Yeah, so Ramsay, I'd put in the same bucket as the other, structural growth stocks I talked about. I mean, Ramsay always struck us as the ultimate, initially, as the ultimate Covid recovery story. So through COVID-19, basically, private hospitals stopped elective surgeries or discretionary surgeries to help with on the Covid side. They have slowly come back, but what we have seen is they've been coming back. If you need a knee operation, it's not life or death, but you can't put that off forever. You can put it off maybe six months, 12 months, but you've got to eventually do something about it.

So those sort of operations have to come back to the hospitals. But what we did also see through that period was a significant increase in costs. So, their big cost is nursing. Nurses were right at the coalface on Covid, under a lot of pressure and rightly saw a wage growth through that period. We also saw cost growth for a whole range of non-labour related costs as well. So, our private hospital system is one where the federal government sets the rate of increase in the private health insurance.

The private health insurance then passes on rate increases to the private hospitals, but what we've had is a mismatch between the growth in the costs and the growth in the revenues. Now, that's slowly recovering, but it is a slow recovery. We do have a very difficult environment for private hospitals, well, probably hospitals more broadly, but private hospitals in particular. We've got a lot of smaller hospitals that are loss making.

Ramsay is probably the most profitable of all of the private groups in the strongest position, but it's still being negatively impacted by these bigger sort of trends. When we look at the industry, something's got to give somewhere, right? So a lot of the private hospitals are sitting on very expensive and attractive real estate.

So if you start to get a few private hospitals saying, well, it's all too hard, we're not going to make money, we're going to sell the property and make it from the real estate, it just exacerbates the industry issues. So something's got to give there some way, somewhere, whether it's… basically a decrease of supply in a tougher environment and that's going to drive prices up, whether that comes through from some sort of top up or whether it comes through from increases in the rebates, we'll see through time.

But to us, it's sort of an ultimate recovery story. Once again, if you look at demographics in our society, growth in that space is, hospital space is going to be very strong for a long period of time, we're going through a very difficult cyclical phase at the moment, but we see that resolving over the long term.

So despite the detractors that we've mentioned, we've covered a few, we are observing a more positive environment for the fund, especially post February reporting season. Let's talk about what's working in generating the alpha.

What are some of the companies that are doing well?

Our largest overweight position in the portfolio is Suncorp. It's a position we've owned for a while. We've actually thought Suncorp has been heading in the right direction for a long time. Suncorp's always been a very complicated financial services business. They were really all about bank assurance, so cross-selling of assets. The markets never really believed them that the insurance business is going to be able to sell banking products and the banking business is going to be able to sell insurance product. So it never got any value for any of that.

The market loves simplicity, hates complexity, and you could see Suncorp was always trading at a much lower... I mean, a significant discount to the rest of the sector because of that complexity. Now they have been simplifying, we think they're going to close that gap. We think they're going to start to get a premium in their terms of their valuation. Now, they've gone through that simplification process, they've sold their wealth management business, they've sold their life insurance business, they've sold their repairs business and they basically came back to a bank and a general insurance company.

So about two thirds general insurance, about a one third of bank. The sale of the bank, they've now sold the Suncorp bank to ANZ, that sale is about to go through the end of July and they'll just become a general insurance company. We think then, the market will see the significant discount that the stock trades on.

On top of that, insurance is in a really nice place at the moment and we're actually seeing some strong earnings growth on the back of previous sort of difficult periods, we're now starting to see premium growth come into the insurance market. We think that's going to drive insurance earnings. So you've seen a simplification where we'll see that discount will go... We think the discount will go away. You're seeing strong earnings growth coming through in the insurance sector.

On top of that, because of the sale of a bank, they'll have somewhere between four and five billion of excess capital. So we think you'll also see a range of capital returns coming from Suncorp. Now, that could come through in buybacks. That could come through in dividends or some sort of special capital payback as well. And that could happen over multiple years. So we think Suncorp is in a really nice spot. The stock has done well, but we still think there's good upside from here as well.

Goodman has been another great stock that's worked for us. Once again, one that we've owned for a long period of time. I remember back in 2003 when I came back to Australia, the only thing people wanted to invest in was shopping centres and... So probably when shopping centres, office and then industrial property was way at the bottom, there's been a complete turnaround now.

So industrial property has really seen a lot of growth and a lot of improvement and a lot of value accretion as well, as we've moved away from potentially bricks and mortar towards more e-commerce, that's really advantaged industrial property. Goodman is the global leader in industrial property.

So not very strong in Australia, but the global leader. And we think they're very well positioned within this sort of... Once again, a long term structural growth within e-commerce. They've also benefited from a lot of data centres setting up on the back of their cloud, which is also very much industrial property. So their space is growing well and also you're seeing more and more clients look for industrial property opportunities rather than the shopping centres.

So we sit here today, 27 years at Fidelity. The next 10 years, it sounds like you're pretty happy with the way the portfolio is positioned, the names that you've put in there, some short-term pain, perhaps, but also some really strong long-term winners there. I guess the market is coming up to results again. It seems to be very quickly. There seems to be a feel of uncertainty, more so with investors.

Could you just touch on your expectations for the upcoming results season and what you're looking for?

Yeah. So I mean, we're in an interesting point. We've seen interest rates go up in Australia and that obviously has a big impact on a broader part of the population. If it's a family with a mortgage, they've seen the cost of that mortgage go up quite considerably, people that are paying rent, we've seen rents go up, cost of living right across the board has gone up.

Having said that, there are other parts of the population, as interest rates have gone up, probably the older demographic has benefited because they don't have debt or, I'm making a very generalised statement, but they probably have less debt and their money's probably in a bank account, so they're now earning more because the interest rate in the bank account's gone up. So they're in a much better place.

Coming out of Covid people want to travel a bit more, they want more experiences. So there's been a bit more of a focus on travel agents have been doing well, very well, that cost has gone up as well. So I think we'll see, that will continue to play out.

We're now talking about maybe interest rates staying where they are for a while, maybe starting to come off next year, but we'll see. The central banks are doing the right thing, they're just focused on the data. What the data says, then we'll take action. We'll take action based on that. The difficult thing all the time is to work out the catalyst. What is the catalyst? And you never know. The market will just turn one day. It just tightens and tightens and tightens.

I always talk about in commodity space, you've got this thing called the pinch point. So once again, if I go back to my early days back in Australia, back in 2003, the commodity space was people, they were closing supply. The markets were tough, so all of the miners were actually closing supply, there was no new mines coming on. Then China just demanded a whole lot more commodities and it hit the pinch point because now we don't have the supply, we've got a whole lot more demand and the price of commodities shot up.

So I think there's that element that potentially could play out as we move forward as well, as a lot more companies, it's seen a lot more discipline and if we get a little bit more demand, that can actually potentially be that pinch point as well.

But as I sit here today, I'm very happy with the portfolio. It's hard. Like I said, it's hard to know exactly when a catalyst is going to be, when the private hospital cycle is going to improve or the jobs market's going to improve or the lithium market's going to improve, it's very hard to know exactly when, but by investing at these prices, you're really stacking the odds in your favour. You might not get it right in three months or six months, but you know over that three to five year period that you're stacking the odds in your favour, and these high returning businesses that can reinvest at a high rate are going to deliver good returns for long-term investors.

And that's your message to investors to stay invested.

To me it's all about just picking the right companies for the long term.

For the long term.

And like I said, it's very hard, on a three month basis, it's so hard to know what's going to happen.

A lot of luck involved in three months, isn't there?

Well, in the short term you get fads and fashions. You get good luck, you get bad luck. Over a 10 year period, a company that's got a dollar of earnings now and it turns that into $10 of earnings in 10 years time, they'll be volatile in the between because of the cycle, but I've got a very strong view that that's going to be a good stock to invest in for that 10 year period.

Thank you, Paul. I guess just to summarise the key messages, you've definitely still got fire in your belly, the portfolio's positioned for that longer term growth, you're very happy with the names in the portfolio, you're an experienced investor, we can't take that away. You've seen, what, nine, 10 crises over your career, but also too, it's the breadth and access to the fidelity resources that certainly help you understand and pick those winners.

So thank you for joining me today. I really appreciate your time and I'm sure our investors do as well. And good luck for the coming months and reporting season. We hope it fares well.​​​​​​​