When James Marlay from Livewire recently interviewed Elston co-founder Andrew McKie, it was against a backdrop of volatile global and Australian markets with big moves down, big moves up, and plenty of negative headlines. And yet, Andrew felt there were plenty of reasons to stay positive.  

James: So what are some of the reasons for investors to be positive about the outlook for Australian equities? Here’s what Andrew had to say. 

Andrew: I think we’re very lucky to be in this region, you know, this high growth Asian region. You know we’ve got a lucky country in the sense of ongoing compounding GDP growth. We seem to have year on year. But one of the big ones that we talk about a lot is particularly in large cap is the oligopoly effect. And what we mean by that is, for whatever reason in Australia, we end up with these really concentrated market positions and you’re probably going to find someone who’s a duopoly, oligopoly or even in an monopoly position. 

And that’s great as an owner of those businesses, provided they’re not, you know, abusing that market power because it does drive higher returns on capital, stronger business cash flows and so on. But secondary to that is the ability of those companies, very large businesses to scale and use, digitization. So we’d call this the second derivative of the AI boom. 

It’s the application of technology to their core operations. So if you think of a large cap business, that’s in a dominant market position, it can afford to invest in these applications. And it’s got a huge workforce, probably, you know, white collar, doing a large amount of, say, low value tasks that they can remove from them, and automate, you’ve got typically a large customer base that you can also scale as well. 

So drive better client experience, higher retention rates, and you can use that technology to find more customers of the type of customers that you already have. So we think in combination of dominant market position, plus the ability to use technology investing technology and scale it all and potentially extend their market dominance in Australia. And what would be a couple of examples where you can identify that oligopoly style structure, that market leadership. 

But I guess, more importantly, taking advantage of that second derivative of that progress, we’re seeing it in all the results, to be honest, in terms of reporting season that came through with first the signs of the capital expenditure they’re making in digitization actually coming in to control operating expenses. 

So in reporting season we saw margin expansion. Some key names. You know, call out something like a Brambles which is invested heavily, using technology. They found 12 million pallets, you know, so the business is more efficient from a CapEx point of view, better margins. And we think that’s the trend that we’re going to see in a lot of large cap businesses. 

James: And where are you seeing value in the market at the moment? 

Andrew: As you know, we have we have a relative value philosophy. So, we want growth and value. We don’t want to pay too much for that growth. Equally, we don’t want a value trap. 

So, if we look at 2024, and what were very unique circumstance for 2024 in Australia, and what drove that market, there are two main things. One, momentum. Price momentum fading in or potentially fed by concentration index related buying in some of the big names. Last year on the ASX 192% of the positive contribution came from just six names – and three of those were banks. 

So, if you didn’t own those six names, as an active manager you underperformed last year. And if you like, you were punished for being diversified. What we’d say is it’s like punishing your kids for eating their veggies and doing their homework.  

James: You only have one bank in the portfolio. What’s your thinking there? 

Andrew: So if we look at the 12% return from the ASX, 104% came from dividends, -2% came from earnings growth, 10% came from multiple expansion. That means people have been paying more for the same dollar of earnings over 12 months, driven primarily by the banks. Given the banks mediocre earnings growth, it just doesn’t add up.  

We would say so really that’s just us doing our job and valuing companies. We just don’t see the relative value there. And the banks at the moment, in terms of what that means going forward, the best lesson is history. And I think if we look at what might happen with the banks, so particularly Commonwealth Bank, CSL is a good example. 

So CSL in 2020 peaked at $342 a share. It was $160 billion market cap. It was 9% of the index and everyone who was loading into it was on 50 times earnings. And over the last five years, you’ve seen that stock go nowhere and gradually dried. And if you like, it’s had to grow into that multiple. 

Now if we think of the banks a similar thing. CBA is arguably the most expensive bank in the world. People have been dining out on bank stocks and like the buffet, they’ve probably eaten too much and it’s going to take a long time for it to be digested. You know, we’re going to have to see a lot of earnings growth for those valuations to be supported. 

James: You have a relatively overweight position in healthcare. Take us inside that position. 

Andrew: Yeah, it’s interesting. We’ve been in large caps ASX for 13 years. We’ve never been overweight healthcare. It’s the first time in 13 years that we are overweight healthcare, and we own most of the major names in the ASX 100 in the healthcare – CSL, Cochlear, Sonic, Ramsay and ResMed are all in the portfolio. Why? Well if you think of healthcare, Covid was a big impact to those businesses. 

Understandably. We saw lingering effects there. So, supply chain disruption in case of CSL, cost pressures in the case of say Ramsay – labor costs. But now post Covid we see a pathway to pretty significant earnings growth over a 3 to 4 year time frame.  

We also see digitization being a big factor for companies like Sonic. They’re a global leader in pathologies. They went digital, went from, you know, microscope to digital a number of years ago. Sonic also owns 49% of Franklin too, which is an application that is specific for pathology. 

It’s essentially a second pair of eyes for a pathologist, so makes them more efficient, accurate, I guess, in terms of their diagnosis, particularly, anatomical pathology, which is for, say, prostate cancer and so on. And it’s a lot more scalable digitally rather than running blood samples around the place.  

James: If you look through the current noise and take a three year view what do you see? 

Andrew: There’s a lot of sell side activity that drives short term behavior. And really means that sometimes companies have a share price that deviates from their long term trajectory and gives us an opportunity. One would be Seek. We saw a peak in job placement volumes at Covid. And then job ads have been declining since then, and particularly private sector job ads has been weak. 

And people look at that, but they don’t always look through that and see what’s actually driving the business. Firstly we see that digitization is coming through. They have been working very hard over the last few years on platform unification. Seek is very dominant in Australia and South East Asia. And over the last few years they have been putting up their prices quite significantly whilst simultaneous increasing their market share.  

That is for us a clear indication of a business that is a dominant player, that has market power and has pricing power. And once volumes recover, particularly if interest rates are cut and we see a recovery in in private sector employment, that business is very well positioned to generate good earnings growth over the next 3 to 4 years. 

So we’ve just added SEEK to the portfolio.  

James: In large caps, 75% of your portfolio is mandated as top 50. Why is your investment universe so small?  

Andrew: For a lot of portfolio managers the mandate might be, say, the ASX 300. For us that’s too broad. We think that focusing on a smaller universe gives us an information advantage. We can really get to know just the top 100 businesses and have the detailed intel we need to make informed decisions. 

It also gives us the ability to do a lot of work off the ball. So doing the work on the companies that you dine on, rather than doing the work on the companies you have already bought. 

James: So when you’ve been doing that work off the ball, what have you found?  

Andrew: I think structurally, we’d probably say top down, there’s maybe opportunities in materials. We’ve been underweight materials for a couple of years. That paid dividends last year to be underweight materials, but particularly in the context of the trade war. 

You’ve got the two, you know, biggest economies at each other’s throat. And it’s not going to end easily. There’s going to be disruption. We think that there will be an impact to GDP in China that’s likely to draw some stimulus. And that could be great for commodity prices. And you’ve also got US dollar earnings and you’ve got the Australian dollar at $0.60. And you know that’s probably a good opportunity from a sector point of view, and your majors like BHP. 

Maybe one that’s not been mentioned so far would be Challenger. Challenger is a reasonably new-ish position for us, probably 6 to 12 months old. 

We bought that business because of the growth in annuities, the changing landscape for interest rates and annuities. It can be a lot more attractive for retirees, getting a 5% return. And of course, you’ve got a demographic play in terms of an aging population. 

Retirees need to go to income phase. So they need income security. So things like lifetime pensions will have a lot of growth. The government is saying those products need to be developed. And also, we have recently seen the regulator, say that they’re looking to review the capital requirements for annuity providers. So it’ll be a capital light businesses compared to what they are now. 

Challenger has 90% market share in annuities in Australia. They’re currently about $6 a share. Very good value, good growth still coming through in annuities. And then recently we’ve seen, Digital take a 15% stake in challenger. So we think that, you know, underwrites the share price.  

James: What’s your take on the moves from Trump and the tariffs? 

Andrew: Look, I think tactically he’s sort of rolling out his playbook. But it’s going to be very disruptive for both the US and China. If you think of industry in the US, a lot of the inputs are coming from China. So that’s going to take a while to play out, and markets might be up one day, then they could be down the next.  

The two biggest trading nations in the world are at each other, so it’s going to have some effect. From an Australian perspective, I mentioned resources and how that could have a benefit in terms of stimulus in China. The second potential benefit that I’d mention, being the optimist, is the need for China to redirect some of their products. So it could mean that they look to Australian market, for a lot of those products, makes the US lower prices, helps push down inflation, ease cost of living pressures, housing costs, things like that as input costs reduce. And that goes to inflation and interest rates and that dynamic. So that’s a generally a positive for Australia as well. 

James: You mentioned that you’re an optimist. Are you still optimistic about Australia? 

Andrew: Of course. As I said at the start. we are the lucky country. I would say it’s definitely the place to be. I think it’s a safe place to invest. You’ve seen that defensive nature comes through. You’ve seen some recent performance from US equities and so on, but Australia, long term, still performs very consistently.  

You’ve got a risk premium in franking credits here that’s very unique to our tax system. That underwrites a lot of your return longer term.  

So yeah, I think that for the reasons I’ve outlined, there’s every reason to be optimistic around the outlook for Australian companies.   

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