17 April 2024
Elston Quarterly Portfolio Update Q2 2024
In this video, Portfolio Manager David Seager provides his perspective on the key questions discussed in the recent quarterly asset allocation meeting. Read more
19th April 2021 - Asset Management
This article was originally published on LivewireMarkets.com on April 19th, 2021
If you invested $1000 in CSL on this day 20 years ago, it would now be worth $21,560. In 2001, CSL was a relatively small company and has grown over the last two decades to become the nations third largest company. Twenty years ago, CSL was not even a constituent of the ASX 20 (the largest twenty Australian companies measured by market capitalisation). So if a company can grow this much over two decades to become one of Australia’s largest success stories, you would think they could disappear just as fast… right?
With trends leaning towards tech and healthcare and steering away from petroleum producers and TelCos, I wondered to myself, in ten years, what will the ASX 20 look like? Will the banks still dominate? Will recent IPO AirTasker have a small stake? Will the market go green and decide there’s no more room for Woodside?
In the final instalment of this Collection, our ASX 20 experts will nominate one company that will make its way into the top 20 within the next 10 years, and one company currently there that will make its exit.
Responses come from:
One company which is a global champion taking a successful product from Australiasia offshore is James Hardie (ASX:JHX).
The company has built a 20% share of the exterior siding market in the US with its high performing fibre cement product. Housing stock in the US is ageing with 40 million homes more than 40 years old. We expect JHX to continue to grow market share in the Repair & Remodel (R&R) market as it innovates to become the industry standard for exterior siding, not just substituting vinyl which it has done so successfully but taking market share from wood, bricks and stucco as well. James Hardie acquired Fermacell in March 2018 to establish a platform in Western Europe to grow its share of the European exterior siding market. The company has a goal of turning this €300m revenue business with 10% margins in 2018 to a €1bn business with 20% margins by 2028. Given the levers they have to grow earnings per share over the next decade, we are quite confident that the company will be firmly in the ASX 20.
We would expect Coles Group (ASX:COL) to fall out of the ASX 20 as it has been a COVID beneficiary. Home consumption over the past year has boosted short-term profits and therefore Coles’ market capitalisation.
The last year has resulted in persistent changes to the way we shop for groceries with online shopping having doubled over a one-year time frame. In fact, all of the growth in food retailing is now coming from online which has a lower margin. The risk for supermarkets is that we could see negative operating leverage in the store network, similar to what has happened to discretionary retailing in the last few years as spending shifts online. In addition, the lack of population growth through migration in the coming years, a highly inflated profit base from COVID-related spending in 2020 and the need to spend on its online strategy, we can’t see strong profit generation and cash flow growth relative to the ASX 20.
We don’t expect profit growth due to this high hurdle for a few years. Over the next ten years, Coles has geographically limited itself to Australia, so it is reliant on population growth, consumers making premium food purchases, taking market share and price increases for profit growth. New entrants into the Australian market like Aldi and Amazon have taken market share away from Coles and now consumers are increasingly shopping for groceries online which has increased sales but is not as profitable as in-store purchases. Whilst we expect Coles to grow on a 10-year view, it won’t be enough to stay in the Top 20.
The stock I think could be in the S&P ASX 20 in ten years is Cochlear, the clear global market leader in the provision of implantable hearing solutions and a company that should benefit from many of the big picture tailwinds mentioned in the previous article.
There is no doubt that Cochlear provides quality of life improvements to people suffering from disabling hearing loss, but there are also societal benefits due to improved work productivity for recipients. The addressable market is currently under-penetrated with estimates suggesting less than 5% currently and importantly, with disabling hearing loss prevalent in people over 65, the opportunity set could well double over the next 30 years – so a very long runway supporting future growth. And then given the nature of the hearing solution which includes surgically implanting the Cochlear device under the skin to send sound straight to the hearing nerve, new entrants face tough regulatory barriers before being able to offer competing products.
Aside from these industry tailwinds, we think it’s also an attractive long-term opportunity on a combination of its high R&D investment spend (c.14% of sales) that drives innovation & product development and in turn market leadership, and its Services segment which provides long-term annuity-style revenues from sound processor upgrades on a growing implant base.
And we can see the benefits of the various positives discussed coming through in the financial results with the company certainly demonstrating the qualities we look for before investing – a strong balance sheet especially after the capital raising last year, growing revenues and reasonably stable profit margins (mid-teen %’s) and returns on invested capital (high-teen %’s) in recent years, the exception being FY20 where sales were significantly impacted in the second half as COVID led to elective surgeries being postponed. We think these negative impacts will prove temporary and reverse by FY22.
A tough call this one, it’s a market darling and a company that seems to elicit very mixed views, but I’m going to go with Afterpay. And it’s really around valuation because with a market capitalisation nearing $31bn there is a tremendous amount of expectation already priced in, expectation that may be difficult to deliver for the reasons discussed below.
Sure, the Buy-Now Pay-Later (BNPL) sector has provided innovative payment and credit solutions with attractive economics, and Afterpay has delivered impressive revenue growth and promises to continue doing so going forward courtesy of its international expansion where the scope to add merchants remains enormous. But, it is not the only BNPL provider enjoying tremendous success, so too are a growing list of competitors – and herein lies the first concern, the low barriers to entry into the BNPL industry, though I do acknowledge that the offerings available have different features.
Ultimately it is however not only competing against other BNPL providers, but increasingly against competitors like card provider Visa and digital payments platform PayPal that have both announced their entry into the BNPL space in recent months. Competitors with vastly greater existing merchant footprints and the financial muscle to compete very aggressively – Paypal’s marketing budget alone is more than 3x Afterpay’s total income for FY20.
I for one am surprised! When I had the idea for this Collection, I was sure that the experts would agree that Woodside, being the petrol player of the lot, would slip out of the top twenty due to environmental concerns. That would be my bet anyway… I guess this is why we leave it to the experts! What’s yours? We would love to hear which companies you think will enter into and fall out of the ASX 20 – leave a comment below and tell us!
If you would like more information please call 1300 ELSTON or contact us to speak to one of our advisers.
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