Aussie equities: Sector spotlight webcast replay

We're giving you front row access to our analysts in this exclusive sector spotlight webcast.

Join Australia's Head of Investments, Paul Taylor, as he sits down with Investments Analysts, Clare Coleman and Sam Heithersay, to discuss the key trends in Australian Equities and the dynamic industries leading the way as we move forward into the next quarter.

They cover:

Mining sector insights: Discover the forces driving Australia's powerhouse sector and lift the hood on IGO
Spotlight on Seek: The hits and misses of cyclical stocks
Expert analysis: Get actionable insights from our seasoned analysts

If you've ever wanted to be a fly on the wall in a Fidelity investments team meeting, you won’t want to miss this webinar.

You can read the edited transcript below.

Transcript

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EDITED TRANSCRIPT

Paul Taylor: One particularly interesting observation from the recent reporting season is that, despite some cracks, the consumer is still hanging in there. This is surprising given the rise of interest rates and cost of living issues.

We define it as a two-speed consumer. Firstly, those consumers who tend to be in the older demographic where they may already own their own home, they've got no debt, and they might have money in a bank term deposit that is earning higher interest now. These consumers are doing quite well and they're spending money on particularly international travel and experiences.

At the other end of the scale and those consumers who tend to be younger and are being negatively impacted by the cost of living. They are usually paying rent, which has gone up considerably, or have a large mortgage whilst raising young families.

One of the best performing sectors in the market this reporting season was technology, and financial services were okay as well. At the weaker end was commodities, mining, energy, healthcare, and media.

So, we think a couple of these sectors will be interesting to focus on in more detail because we've probably got the bookends; those that did well and those that struggled too.

Mining was probably one of the tougher sectors and has been tough for a little while now. I know costs and productivity are focusses, and China hasn't been particularly strong. So, what did you see happen for mining stocks this reporting season?

Sam Heithersay: You're right in that mining did have a tough reporting season and it's been tough for a while.

For miners, there were net downgrades in the order of 5% for FY25 and that was mainly driven by weaker commodity prices, extrapolating the weakness that we've seen so far. That's been a persistent trend that we've observed since about late 2022; this weakness in commodity demand, weakness in commodity prices flowing through to earnings, downgrades at each reporting season, and this was no exception.

This outcome is mostly China driven, but from our perspective we tend to focus more on what the companies can control and that's why we were very focused on costs in particular this reporting season. We knew the prices going in i.e., the price weakness and the demand outlook but we were trying to understand a bit better how miners were reacting to this price weakness and tailoring their cost profile as a result. We saw that cost inflation is still present, but it is decelerating. BHP called out a cost inflation of 10% in FY23, decreasing to 4%, so still there but decelerating and miners varied in how they addressed that rising cost profile over time.

So overall still a very tough reporting season for miners who are now focusing on what they can control in the form of costs and productivity, but still very much price driven and that's driven by China demand weakness.

PT: We also saw banks do well. Money seems to be always pouring into the banks, can that change given that these are the two big sectors in the market? Can resources make a comeback?

SH: The ASX 200 is very concentrated in financials and resources, and it's all been banks year to date. Banks have outperformed 30%, miners have underperformed 20%. So, we've seen a significant divergence in the performance of those two key sectors in the ASX 200.

From my perspective in what miners could do themselves, there is of course a focus on margin and cost profile, but for miners to really work, it does need to be led by commodity price improvement. We're very focused on what they can do in a weak environment right now, and that's cost control and capital management.

Ultimately to start to outperform against the banks again, they need commodity prices to turn and that's largely going to be China driven. So, there was nothing necessarily in this reporting season to indicate that the divergence between banks and miners would change anytime soon, but we are getting to the point now where consensus is forecasting, and miners won't contribute to EPS growth for the market for another three years.

We've generally seen funds go underweight resources and so we're at the point where miners are beginning to factor in trough conditions for quite a while. There's certainly potential now for a reversion but no green shoots as yet in the commodity demand.

PT: IGO, a high-quality lithium producer, is a part owner of Greenbushes, which is one of its tier one assets - the highest quality and lowest cost lithium mines in the world.

But obviously lithium has been weak and that's negatively impacted IGO. Interestingly, IGO lifted its dividend from six cents up to 26 cents which was against-the-trend. What did you make of the result?

SH: IGO is always interesting and particularly lithium, because we've seen the price has declined so significantly from the highs of $8,000 per ton for Spodumene in 2022 to now under $800 a ton.

Reporting season for IGO really highlighted just how cash generative their core asset is in Greenbushes, in which they have a 25% interest. June quarter, despite the trough pricing, we saw them print EBITDA margins of 68%. As if to emphasise that cash generation being one of the only means to generate cash at this stage in the cycle.

The board decided to pay a higher dividend than consensus expected. They were looking for six cents but got 26 cents which I think highlights the free cash flow generation of this business, of this mine, even in trough conditions, and so it was certainly interesting and against the grain from that perspective.

BHP is the biggest stock in the sector, the real bellwether for the industry. Mike Henry (CEO) has been very vocal in the market about productivity and maybe some of the constraints in the Australian market as well. There was probably a couple of signs of maybe some transitions within what BHP is looking for. What did you make of the result?

The BHP result itself was fairly in line as it generally is. The more interesting part of the result was the discussion on its copper growth optionality. Because you're right, earnings are still predominantly iron ore, but they are spending a lot more time in each result talking about their copper growth optionality as they seek, I think, gradually to transition towards a copper-focused company.

We had Mike (Henry, CEO) in the office discussing that trajectory. He was still, of course, very supportive of their iron ore business and didn't want to downplay that by any means, highlighting that in the short term there's a cost support level at around $80 to $100 a ton.

Rio said $100 a ton. This was quite important because at the time, and through reporting season, we saw iron ore fall to 90, back through 100, back down to 90. So, it was very important to get a read on cost support.

But the flavour of the day was a pivot towards copper growth. He was also very vocal on productivity issues. BHP had been vocal for some time here, calling out the fact that mining wages have doubled since 2000, but mining productivity has stayed flat in that time. This got picked up in the press and is obviously fairly important for industrial relation reform discussions that we're all having and factors into their cost equation as well.

For BHP it was very much a conversation about the transition towards copper while still defending their cash flows from iron ore, but a much more of a focus on cost and productivity.

PT: How are things looking ahead in your sector coverage for financial year ’25?

I think it's important to highlight that we have been baking in tough conditions for miners for some time now. Consensus doesn't expect EPS growth for another three years and so we're focused on China and on any signs of demand strengthening green shoots in the next 12 months.

There really is the potential in the setup for a reversion of some of the trades that we've discussed like banks versus miners. Other than that, it's of course a very important 12 months with a US presidential election in November, and an Australian federal election before May which will be very important to understand miners from a taxation permitting point of view, as well as the interest in developed Western economies to set up an ex-China supply chain with its own demand.

PT: Technology has been a strong space, not just in Australia, but right around the world. What key observations did you make this reporting season for both media and technology?

Claire Coleman: It was an interesting reporting season as it tends to be with technology and high beta names. Generally speaking, overall, it was very positive. Obvious winners like WiseTech, who were the best performers on the ASX 200, but still with multiples high going into reporting season, needed to be a good one for technology.

I think you started to see this reporting season, at least for those tech companies that can't continue to execute, that there's a huge landslide on the other side of that if execution tends to falter and we saw that in a couple of instances like Megaport, for example. So, there is that bifurcation there.

Then thinking about online and media names within the online space, they're all delivered overwhelmingly positive results as well. Those portals tend to have really strong pricing power. We saw names including REA, Domain, SEEK, and Car Group pushed through incredible price rises. That's because these tend to be winner takes all, winner takes most type of markets where you have genuine pricing power.

Within media, that's obviously been a tough time. The ad market remains challenging and ad markets are tightly correlated with consumer confidence. I think expectations were low heading into reporting season and there were no surprises with those companies that struggled.

PT: WiseTech was the standout result of the whole reporting season. We saw huge upgrades for FY25. What were they doing right?

I think it's a culmination of a couple of factors. Heading into reporting season, there was a view across the market that FY25 expectations were far too high and so there was a view that they were going to come out with guidance that would disappoint, and we'd have this huge rebase. In fact, the opposite occurred. They delivered exceptional CargoWise revenue growth for FY24 and we're also guiding to 31-37% CargoWise growth for next year. It was pretty much the perfect result for those market sceptics out there.

Not only that, but their margin also topped consensus expectations. Whilst it's in vogue in tech at the moment to be focused on profitable growth and operating leverage, this has always been part of WiseTech's DNA; they're a profitable growth company run by a founder who's very much aligned with shareholders, and you saw all of those ingredients for success come through at the result.

Further to that, they announced three new products at the result. The market had grown a little bit impatient waiting to see these new products they were working on, but they delivered three at this result.

This amounts to product-led growth plus all of the other usual levers for growth heading into FY25. With a lot of that product growth, second half-weighted, it really sets them up nicely for FY26 as well, where they'll have a full annualised benefit of these new products coming through.

PT: Productivity was a key area that stood out this reporting season across the market. Companies are looking to self-help programs to lower their costs. To me, the beauty of technology and WiseTech is that it helps freight forwarders lower costs. How do you fit productivity with WiseTech and technology more broadly?

CC: Productivity is core to WiseTech’s investment thesis and it’s why we've owned it since pre-IPO. The freight forwarding industry is super complex and riddled with inefficiencies and their customer base constantly need to be focusing on driving incremental margins and improvement in productivity wherever they can. WiseTech is the only tech platform of scale within this space solving a lot of that. Therefore, it stands to benefit.

Further to that, their customers are consolidating as well and just getting bigger and bigger and bigger, allowing WiseTech to ride that tailwind.

More broadly, technology aids to solving the productivity challenges for their customer base and that is the longer-term structural tailwind for the majority of the tech companies that I cover.

PT: In the last couple of years SEEK has been a bit of a weaker stock mainly due to cyclical concerns. Post-results, we’ve seen it back nearer to where it was. What do you think the market is telling us and how do you think about cyclical versus the structural with a company like SEEK?

CC: On the day, it was down six and a half percent and since then, it's outperformed the market by about 1 percent, so it's more than recouped those losses.

SEEK is an interesting one because ultimately, it's a cyclical business at its core and the jobs market is ultimately going to impact its core business in Australia. As the unemployment rate in Australia has ticked up, that's been to its detriment on the volume side of the equation.

Whilst they still have incredible pricing power and drive high single-digit yield growth, the volumes were really hitting (20% declines).

Heading into this reporting season, it was such a well-known downgrade that was coming. The buy-side was well and truly ahead of the sell-side on this one. It was broadly anticipated; you could see what's happening in the employment market, you could see SEEKs job ad volumes, so it was a very well-known thing. Since then, I think the cyclical and the structural might start lining up nicely for SEEK. We have seen, at least in the last two months in a row, month-on-month sequential increases in job ad volumes for them. It feels like, at least on the cycle, we're moving from bad to less bad, which is always when you want to own a cyclical.

In terms of the structural side of the equation, nothing has changed. They haven't lost any market share. There's still $1 billion of a $30 billion term. Additionally, they've got FY28 targets in the market to have $2 billion in revenue and 50% plus margins and consensus expectations - nowhere near those targets. That's only an upside if they get within striking distance of those targets.

A lot of the scepticism on SEEK to date has been around the lack of operating leverage.

Costs have grown in line with or greater than revenues, so you haven't seen operating leverage. We're now entering a phase where SEEK can start delivering the operating leverage. They've just completed their platform unification build and this management team are very much focused on the fact that they need to drive operating leverage to regain the market's favour. We should see that from SEEK now.

PT: How are things looking ahead in your sector coverage for financial year ’25?

I think with tech generally, it's all very idiosyncratic and it's very much bottom-up. Multiples are obviously expensive, which has often been the case for a lot of these high-quality growth businesses, so you really need to closely scrutinise whether the structural growth runway is genuine and intact. We spent a lot of time with management for this reason because execution is so critical for tech companies, and we did see that at the reporting season. We need execution to be on point and obviously maintain those valuation multiples.

I remain positive on tech overwhelmingly because of what we’ve discussed around productivity. These businesses are helping their customers become more productive and in this kind of climate, it's increasingly important.

For media, I think it's a bit more of the same and we're kind of at the whim of consumer confidence but heading into a potential interest rate cut cycle that could be positive.

PT: We’ve discussed productivity in the resources and technology sectors driving the cost of production and benefiting from that growth.

One of the things I've been focused on this reporting season is those companies that have a self-help program that they’ve utilised to deliver productivity and have done very well in the current environment. We have been in an inflationary environment that's starting to moderate, but we still not in the clear. Costs are much higher and those companies that can control those costs better or, pivot to where the growth is, I think have done much better.

We saw Coles supermarket deliver a much better result than Woolworths this reporting season. Notably, this was due to better productivity. Through technology, they were able to lower theft in store. Although they might be small across each individual store, this equates to big numbers when you look right across the whole group. Coles outperformed Woolworths on the back of this better productivity efficiency and control of theft through the technology that they implemented in the half.

Another company that demonstrated a self-help program was Suncorp. Suncorp was a bank assurance model; it had an insurance company, a bank, life insurance, wealth management, repairs business - that never really took off the ground as they weren't able to cross-sell.

They've decided to simplify and focus on general insurance. The general insurance market is in a very good space currently with strong premium growth and strong rate growth. The market loves simplicity and conversely, it doesn't love complexity.

Now, Suncorp sold off all the businesses and the last one they sold off was their bank, which just was sold at the end of July. They now have $4.1 billion of excess capital. So, as well as having a strong earnings outlook from the general insurance side because of the strength in the industry, they now also have this excess capital that shareholders will likely get back in the first quarter of next year through higher dividends and a share consolidation.

Finally, Downer stood out this reporting season. As an engineering and construction firm, it went through a very difficult period, but they've been very focused on coming back to where the profitable projects are and controlling their costs. They were able to do that very successfully in the reporting season, so the market is now starting to look at them more favourably as a strong turnaround candidate.

I saw all these stocks as excellent demonstrations of this self-help program and the focus on productivity - a theme running right through the whole reporting season.