Welcome back to The Rate of Change with York Wealth Management.
As advisors to some of the wealthiest families in the country, The Rate of Change is a podcast
designed to help you in the pursuit of building long-term wealth through the insights of some
of the brightest minds in asset management.
I'm your host Murdoch Gaddi and in today's broadcast, I'm speaking with Tim Carlton,
the Chief Investment Officer at Auscap Asset Management.
Tim, alongside his colleagues Will Mumford and Gavin Rogers, manage two funds underneath
the Auscap banner, both of which target solid, absolute risk-adjusted returns looking to
invest in companies that generate strong cash flows and are trading at attractive prices.
Firstly, the Auscap Long Short Australian Equities Fund, which has returned on average
14.5% since inception in 2012, 11% on average over five years, 12.4% average over three
years, 1.5% in the past 12 months with a 5.8% return in the past month.
Secondly, they have just launched the Auscap X20 Australian Equities Fund as of the beginning
of December 2023.
Both funds are fully invested.
For me, I really enjoyed hearing Tim break down the differences and similarities between
the two strategies.
He discusses what exactly is an X20 Aussie Equities Fund and why they timed the launch
of the fund for October, November 2023.
So join us as Tim gets into the weeds on a number of companies such as Miner Resources,
realestate.com, CarSales, ResMed, Nick Scali, and hear his views on where he thinks markets
are going as we discuss the recent movements of the 10-year bond rate for the past 12 months
and its impact on current markets.
Before we get into the ROC cast, I would also like to encourage you to listen to the disclaimer
at the end of the ROC cast and to keep your feedback coming.
You can reach me at mgatty at ywm.com.au.
So with that being said, I hope you enjoy this conversation as much as I did.
So sit back, relax, and enjoy.
Tim Carlton, welcome to the Rate of Change with York Wealth Management.
Good morning, Murdoch.
Thanks for having me.
It was really good seeing you at Balmoral Nippus.
The kids loved it when the Coast Guard Santa Claus jumped off the boat.
They all screamed with glee.
It was good fun, wasn't it?
Yeah, it's terrific.
We've been proudly a sponsor of Balmoral Nippus for about the last five years.
It's just a great community initiative.
It's the largest Nippus program in Australia.
There's 850 kids that enroll in it, so it's a huge endeavor.
It's one of those community initiatives that the team get really excited that we support.
We support a number of charitable community initiatives across the board, and the team
all get a thrill out of our participation in being able to give back to the community
and to some specific causes.
The Nippus program is probably the most visible one of those, and the kids get such a kick
out of that whole program.
So much self-confidence.
I have the six-year-old girls at the moment, and it was extraordinary to see how far they
swim out.
A lot of these girls are still only five, and they swim out to these boys that you look
at far offshore.
A couple of years ago, they couldn't swim, so it's pretty incredible.
Our kids certainly love it, that's for sure.
That's the Nippus side of things.
They love getting involved in the community.
So why don't we learn a little bit about Tim.
Who is Tim?
How did you get into finance, and tell us a little bit about your formative years?
Yeah, sure.
So I did commerce law out of school at Sydney University, and I did a number of internships
with various investment banks through that program, and ended up at Macquarie Group,
as a lot of graduates do in their investment banking team.
Pretty quickly, I ended up spending a lot of my time on projects that involved Macquarie
buying either the whole or a decent stake in both public and private businesses.
So Macquarie investing its own capital.
I'd done that for a couple of years when Goldman's gave me an opportunity to come across onto
the public market side.
I sat within a team that was called Proprietary Strategies, and what we did was we invested
Goldman's Australian balance sheet into the listed equities market.
That was a reasonably small but very profitable team, and I was there from 2007 through 2012.
And then in 2012, left to set up Auscap, and have been doing that ever since.
So what is Auscap?
Who is Auscap, and what do you exactly do, and what's your investment philosophy?
Yeah, so Auscap is an Australian equities manager.
So we have clients that give us their capital, and we invest that capital into a selection
of Australian companies through a unit trust, so everyone's capital is pooled.
We run two different strategies, one that is a high conviction strategy that's been
going since 2012.
And then just at the start of December 2023, we have launched another fund, an X20 Australian
Equities Fund, and its mandate is a little different.
It's a very vanilla, long-only fund, whereas the fund that's been going since 2012 has
a pretty wide ambit of what it can do, and it only invests in companies outside the 20
largest companies in the Australian market.
The Australian market's a reasonably unusual market in that you have 20 very large companies
that really dominate the market capitalisation of the whole index.
So the top 20 companies make up over a little over 57% of the market capitalisation of the
entire index, which is reasonably extraordinary concentration.
This fund is designed to invest outside of those 20 companies, so primarily in mid-capitalisation
companies, but some small companies as well.
And that's the part of the market where we see the greatest opportunity for returns on
a go-forward basis.
Can you give a bit of colour around that?
Because I remember when we caught up and there was a particular page in the presentation
which showed the average returns for the past number of years for the top 20, the 300 minus
the top 20, and then for small caps.
And I thought that was quite interesting, those numbers.
So do you want to give a bit of colour around that?
Yeah, so it's been interesting since 2000, the mid-capitalisation companies in Australia
have comfortably delivered the best total return.
There's a mid-cap 50 index, which is probably a reasonable proxy for those mid-capitalisation
companies.
And since 2000, it's delivered a return of over 800%.
And that compares to the all-ordinary index, so the broader index, and the ASX20s, the
20 biggest companies, they've both delivered a little over 500%.
And then the small-ords, the smaller companies in the market, they've actually delivered
a relatively poor return of a little over 200% in that 23-year time period.
And so we think that there's a very logical basis for this, and the logical basis is that
they have delivered considerably stronger earnings growth over that time horizon than
either the really large companies or the really small companies.
And if you forget about all of the noise, the market gets caught up on lots of different
things in the short term, and the short term can be six months, it can be 12 months, it
can be a couple of years.
But if you forget about all of the changes in sentiment, which stocks come into favour
and out of favour, over the really long run, the only two things that matter are the dividend
yield that you're receiving from the companies you're investing in, and the earnings growth.
Because if the multiple that the market's willing to pay for a company doesn't change
over time, then your total return is simply dividend yield plus earnings growth.
And so the mid-cap index has delivered considerably better returns than many of the other indices
for the simple reason that those companies have delivered better earnings growth and
considerably better earnings growth.
And we think there's a pretty logical reason for why that's the case, and we're also pretty
confident that it will continue.
And the reason is that at the very large end of the market, a lot of these companies have
run out of ways to grow organically.
So if you think about the big four Australian banks, they are about as dominant in the domestic
market as any four banks in any developed market globally.
They're so dominant that it's very hard for them to organically grow their market share.
They tend to just take market share off one another over time, but they are constrained
in how they can grow their top line to basically how quickly the broader market grows.
On the other side of that, they've got expenses and their expenses are growing and they're
growing quite strongly.
So if you think about the banking sector, you've got increased compliance costs, increased
spend on IT and cybersecurity, increased capital requirements, and now we've got an acceleration
in staff costs.
So you're limited as to how quickly you can grow revenues, but your expenses often are
outpacing that.
So the banks are a good example of one of the four of the very large companies in the
ASX 20 that are really working quite hard just to maintain earnings.
And so if you don't get any earnings growth, your total return from those stocks is a dividend
yield.
And that's what those four companies have exhibited over the last decade.
You contrast that with the mid caps.
The mid caps, they're generally pretty big businesses.
So you're talking about businesses that are most often generating hundreds of millions
of dollars of profit.
They're typically the largest in their sector or sub-sector.
And so they have the economies of scale.
They have efficiencies compared to a lot of their peers.
And yet they've still got plenty of market share room to grow.
And so they're able to grow their top line faster than the competition because of those
economies of scale.
They get the benefits of the operating leverage, so you tend to find the earnings grow a little
bit faster than their revenue growth.
And as a result, we see a very, very attractive total return proposition in that mid cap space.
You then contrast it again to the really small end of the market.
And a lot of those smaller companies, they are at a natural disadvantage to a lot of
the companies in the mid cap space.
Not always, but frequently because they're smaller businesses.
They don't have quite the same economies of scale.
And a very obvious example of that is you compare REA to Domain.
So REA is a much bigger business, substantially higher revenues.
And yet if Domain wants to keep up, they've got to spend the same sort of money on maintaining
their technological progress on improving the experience from a user base.
So it's more difficult for them because they've got a smaller revenue base from which they
can reinvest capital to improve the experience.
And you tend to see that in the differential between the growth rate and earnings over
time.
So we're quite attracted to the mid cap space.
There are also some small cap companies that I'm sure we'll talk about later.
But again, they tend to be small cap companies that are reasonably dominant from a market
share perspective in their particular category, or they have some sort of efficiency differential
to their peers that allows them to earn superior economics.
So that's the investment thesis of why you've gone that particular space.
So before we get into the fun part, which is unpacking where you see opportunity, what
you bought recently, all the goodies, why don't we quickly dig into the mechanics of
the fund, right?
So how much money is currently in the fund in the first fund?
So the current fund, the fund that's been around since 2012 has about 300 million invested
in it.
How big is the team?
So the investment team is three, and it's the same investment team across both funds.
So alongside me is the Deputy Portfolio Manager, William Mumford.
He is a terrific young investor.
He's been with us for between five and six years.
Came out of Macquarie Group, not dissimilar to myself.
And Gavin Rogers is an investment manager in the team.
Gavin and I have worked alongside one another for most of the last 20 years.
We worked very closely together at Goldman's, and he's rejoined me in an official work capacity
five or six years ago at Auscap.
So it's an experienced team.
We find we bring different perspectives to the analysis.
All good stock management is a collective proposition, and we like to think that we
balance each other nicely.
So there's been a lot of volatility in the market the past number of years.
So how's the performance been?
Does the, do you find, you know, when during COVID, when a huge amount of cash went into
the market, you get a very, very large capital growth.
And then does that come off as, you know, free money gets pulled out?
Or do you find, so the portfolio has kind of got to go anywhere strategy, right?
You can do resources, you can kind of move anywhere within that 300.
So how's the performance been?
Has there been many drawdowns or has it been consistent?
I suspect we're going to prefer an environment where interest rates are back in a normal
range compared to history.
And so, you know, if I think about performance, Mercer came out with their analysis of every
Australian equities manager that they track.
I think there are 132 Australian equities strategies in October.
And we were fortunate to rank in the top five across all time horizons.
And we were number one over three years, 10 years and since inception, and number four
over one and five years.
So that the fund has been performing well, but there were, there have been difficult
periods.
When interest rates started their trajectory down to zero, that was a tricky period because
we are a quality and value manager.
So we want to own the best businesses out there, but we are reasonably selective as
to price.
We want to pay fair value or better.
And we went into this strange environment where businesses that had reasonable prospects
for good earnings growth were suddenly trading above valuations that we considered to be
fair.
And that move just kept going into and following COVID with obviously interest rates going
down to close to zero.
And that was challenging for most value oriented managers.
We've come out the other side of that.
And you know, we're very happy that despite what felt to us like a pretty difficult period,
the fund performed quite strongly through those years.
And now we're back in an environment where interest rates look like they're going to
hover in a normal historic range.
So call that interest rates between three and 6% over time.
And as a result, you've seen a D rating in some of the sectors where we found it really
difficult to find investments that we were happy with largely due to the valuation differential
between where they were trading and what we thought was fair value.
So in the last 12 months, we've seen a lot of healthcare companies, they write a lot
of IT companies, they write infrastructure and utilities companies come back from a multiple
perspective.
And so all of a sudden, we're seeing quite a lot of opportunities across the broader
market that we are enticed by.
So as we sit here today, we're pretty fully invested across both funds and quite excited
about the outlook for the businesses that we hold.
What does that translate into historical percentages with the performance?
Just to give people that don't have a chart in front of them just a bit of an idea.
Sure.
So the other question on that is what are you targeting?
Sure.
So the Long Shortest Rain Equities Fund, which is the fund that's been around since 2012,
has delivered about 15% net of fees per annum since we started.
The index that we compare ourselves to, so the All Ordinaries Accumulation Index, has
done a little under 9%.
So the funds delivered about 6% net of outperformance per annum.
And that might not sound like a lot to those that aren't familiar with equity markets,
but the compounding effect of that additional return is quite strong.
So it's probably at the top end of the band for what we hope to deliver.
Over time, we always tell people that are coming into the fund that we look for opportunities
that we think will deliver the fund a 10% to 15% annualised return at the stock level.
So if the fund overall is doing that collectively and towards the top end of that range, then
we're very, very happy with how that fund is performing.
So you mentioned interest rates, right?
Having it back in a band is good for the fund.
And I was just discussing with a client, actually, we're looking at the Australian 10-year bond
rate, and it's been quite volatile this year.
It was round about March, April, 3.25%, came all the way up nearly touch 5% around about
November.
And in line with the rally we've seen in the past few weeks, it's come pulled back to about
4.145% as of today.
Why do you think this has happened?
And do you think this means we're in for a Christmas rally?
Well, I think we've started to see the Christmas rally already, and that has every chance of
continuing if history is any guide.
Interest rates at the long end of the curve, so the 10-year government bond rate, typically
tell you about how investors are thinking in relation to where long-term interest rates
will be.
So if we wind back a few months where the 10-year was significantly higher, it had been
rallying because people's expectations were that interest rates would continue to head
north because the economy looked like it was handling current interest rates quite comfortably.
And to be honest, to us, the Australian economy still looks like it's handling current interest
rates relatively comfortably if the data is anything to go by.
But inevitably, the world pays a lot of attention to what US government bond rates are doing,
and it looks as though rates in the US may have peaked.
And so expectations for the future have changed from a scenario where market participants
thought that interest rates were going up to one where participants now think that interest
rates may have peaked, and the next move, albeit not immediate, will be for interest
rates to go lower.
Why does that matter?
It matters because what our government bond trades is really perceived by a lot of investors
to be equivalent to the risk-free rate.
So most people think that investing in a US Treasury or Australian Treasury note, that
is you are lending to those two respective governments, is about as close as you can
get to a risk-free investment.
In other words, there's a very, very low chance of default.
And so every other asset class is priced off that rate.
So if you can get 4% in Australian government bond, then obviously every other asset which
has higher risk than investing in the Australian government should deliver a better return.
So as that rate moves north, the total return that's being offered by other asset classes
also needs to move north.
And so if the total return that's expected from other asset classes is moving higher,
then that only happens if the prices of those assets is going lower.
And so as rates are rising, you tend to find that a lot of other investments are under
pressure because they need to reprice so that they are attractive in a relative sense compared
to what is a risk-free asset.
The reverse is also true, which is what we've just seen lately, and that is if the rate
that you can get by lending to the Australian or US government is declining, then it's making
a lot of other investments relatively more attractive.
And so you tend to find that in that environment, a lot of asset prices will rally, and that's
what we've seen particularly over the last six or seven weeks.
So normally, this time of year is reasonably strong.
Historically, the market's been very powerful from about mid-October through till the end
of April.
So we're in a seasonal window where, for whatever reason, history has suggested that markets
do quite well.
If you throw into the mix a declining government bond rate in Australia and in the US, then
it would suggest that potentially the Santa rally can continue for the next little while
next year.
Well, when we caught up, I think it was early November or late October, you said it was
a very good time to launch a fund.
And looking back, it probably was a very good time to launch a fund.
In that good, lovely breakfast which we had, you mentioned a couple of companies which
you thought, as you mentioned before, the health care space.
I think you mentioned Miner Resources, Car Sales, Nick Scali, ResMed.
Maybe for you to dig into those, or is there any, what other opportunities are you currently
seeing in the market?
As you said, you're fully invested now, but you said it's been a very good time to get
in, markets had a good rally, look at the bond rate, interested to unpack a couple of
companies with you.
Sure.
Well, there's some good companies to start with.
So why don't we kick off with a number of those companies?
We spent a fair bit of time on the road and we've just been visiting a number of those
businesses.
So one of the members of the same, Gavin, came back from visiting Miner Resources and
some of their sites, in particular, their two major mines in the lithium space, Wodjina
and Mount Marion, and also their latest iron ore development at Onslow.
And we're always very positively surprised by this company.
If I think about our core process, what we're trying to do is find businesses that we think
will reliably and consistently grow earnings over time.
Because ultimately, we're a believer that earnings drive share prices in the long term.
So we want to find businesses that are going to grow their earnings in a measured and consistent
way over time.
And to do that, they need to have superior economics.
So superior economics means that when they invest a million dollars, they typically earn
a better rate on that million dollars invested than a lot of their peers.
And certainly, a lot of the companies that you just mentioned are in that category.
So Miner Resources, it's a cyclical business.
Its core business, going back to its IPO, is a crushing contracting business, the largest
crushing contractor for a lot of the major iron ore and other players in the market.
But they have, over the years, diversified.
And now they also run their own iron ore operations.
They're the fifth largest producer of lithium globally.
And they've got an emerging gas business.
And they, despite being a cyclical company, have generated an extraordinary track record
in terms of growing earnings at an attractive rate over a long period.
So they've compounded earnings at north of 20% per annum since they listed, which is
a pretty extraordinary record.
And we look at that company at the moment, and we have followed this company since close
to IPO at Goldman's and then at Auscap.
We look at that business today, and we think that the growth they have in front of them
in the next couple of years, putting commodity prices to one side, is about as good as we
have seen for this business since they listed.
They are going to see their mining services business more than double in the next couple
of years.
They're going to see their iron ore production quadruple.
They're going to see their lithium production triple.
And they're probably going to emerge with what is a reasonably substantial gas business.
And so, yes, their earnings will be a function of the fluctuations in the commodity prices.
That's something that's outside of their control.
But what is inside their control is how they grow and manage their business over time,
and they've done an exceptional job at that.
The stock has had a very decent pullback over the last 12 months.
So we have been adding to that exposure in the last six to eight weeks.
It's a business we know very well, and we think the market is currently mispricing that
company.
Our valuation is well north of the current share price.
So we have been adding to MIN.
You mentioned ResMed, which is one stock that hasn't been in the portfolio for some time,
but we have recently-
When you dig into ResMed, I find this quite interesting.
A colleague of mine was using the Novonautis product, the diabetes drug.
And I was speaking to a couple of other people regarding this.
And when that came out, there was this panic in the market.
You see it all the time.
Oh, there's a new drug on the market.
This is going to- everyone's going to be healthy now.
We don't need sleep apnea machines.
We don't, because everyone's been healthy.
So you get this gigantic overreactions.
Do you think that's what's happened in the healthcare space, or is it another reason
why they're trading at such low valuations compared to where they were 12 months ago?
If I'm honest, I think part of it is the news flow.
But just as big a part is the fact that a lot of the stocks that have been expensive
for the last four or five years are looking for a reason to derate.
So if we wind back to pre-2018, ResMed didn't trade north of 25 times earnings.
And then we went into this interest rate world where interest rates were close to zero.
And a lot of the healthcare companies, where there was a perception that their earnings
growth was independent of broader economic growth, they started to trend higher and trade
at multiples that they'd never really traded at previously.
So a lot of healthcare companies traded up to 40 to 50 times earnings, even very large
businesses like CSL.
Well, that might be warranted in an interest rate environment where government interest
rates are very, very low.
Government bond rates are very, very low.
But if we're back into a more normal cycle, then you would expect over time that the valuations
would look more similar to how these businesses traded the last time interest rates were between
3 and 6%.
And so if we go back and we look at ResMed between the early 2000s and about 2018, it
traded on a PE of between 16 and 25 times.
So the problem wasn't necessarily the announcement of the GLP-1 drugs.
It was the fact that the starting point for ResMed was a PE of 35.
And so if there's suddenly a question mark about the earnings growth that they might
deliver on a go-forward basis, the question is, well, where does the value manager step
in?
And the value manager doesn't step in at 30 times or 25 times.
The value manager steps in to accumulate a reasonable position at around 20 times.
And that was us as an example.
So we have been accumulating a fair value position in ResMed over September, October,
November, because it was the first time that we'd thought that ResMed was at fair value
or better in at least five years.
And so we weren't going to step in at 25 or 30 times.
So the fall looked very, very considerable, but we would attribute a decent chunk of that
fall to the fact that the starting point was just too high.
And I think to the extent that some stocks are still trading at very elevated multiples
compared to their own history before interest rates had this trajectory down to zero, we
suspect that over the next 12 to 24 months, a lot of those stocks are going to find an
excuse to derate back to the sort of multiples that they traded on before we went into this
sort of free money world of interest rates being at zero.
And I think ResMed is just an example of that.
So do we think that the concern over the impact of these drugs is overblown?
Yes, for a whole variety of reasons.
That's why we've been comfortable to buy into the business.
But it took a reasonable derating of the business before we were happy with the valuation.
So from our perspective, it's not screamingly cheap here.
It's around fair value.
In fact, it's had a little rally in the last couple of weeks.
So it's probably a little above fair value, if we were being completely honest.
But it's certainly such a quality business that we certainly think it warrants a fair
value size position.
I was quite surprised when you mentioned Nick Scali.
I've never had personally much success investing in furniture businesses besides our Temple
and Webster historically.
But can you walk us through Nick Scali because I live close to our time and walk in, you
always see how their operations.
But when you're breaking down the numbers and specifically the owner of the business,
how we negotiated those current contracts, what do you have like five contracts which
you use and you just went in there and go, no, prices aren't good enough, boys.
Can you do me better?
Can you walk us through that?
And what was the other business, is it SoftPillow or something and the margins were huge?
Yeah, I've looked into that business a lot since you mentioned it and I was quite stunned
at how well it works and the profit margins.
Yeah, from our perspective, it's a beautiful business.
So if you think about most retailers, most retailers, they go out and they purchase a
whole lot of stocks.
So all the money goes out the door.
And then they've got these shops which they typically lease and they fill them with product
and then they hope to sell the product.
And for a lot of companies, that's a pretty difficult proposition because quite often
they're trying to get to guess what's on trend, what's fashionable this particular season.
And if they get it wrong, you've got to remember they've already bought the product.
So they're then going to discount it to get rid of the product.
So it's a lot of cash out the door and then you're trying to get the cash back with a
return.
Nick Scali is a different model.
So they're Australia's largest furniture supplier and you typically pay a 50% deposit when you
go and buy a couch with it.
So couches is the main category that they sell and they're custom made.
So you walk in and you saw on a three and a half seater in this particular fabric, this
particular design.
And so it's custom made for you.
The beauty of the business model is that when you sign up for that couch, you give them
a 50% deposit, but their margins are such that that 50% deposit has more than paid for
the construction of that couch.
So you've given them more money than it'll cost them to go and actually make that bit
of furniture.
So they then put the order in, they then buy it off a bunch of manufacturers, primarily
in Vietnam and China.
And then the product is delivered to you and on delivery, they'll charge you the other
50%.
And a large part of that other 50% is their profit margin.
So it's working capital is positive.
They get more cash all the time coming in than they actually have going out.
So they're not trying to guess any seasonal trends or what might or might not be fashionable
this season.
They're a very, very good retailer from a presentation perspective.
So the Nick Scali stores always look fantastic.
And because they're the largest furniture bar in Australia, their economies of scale
in terms of the deals they drive with their suppliers, which is what you were referencing
earlier, is clearly better than any of the other players in the market.
And that leads to superior economics.
A couple of years ago, they used the windfall gain that came from a surge in furniture demand
through COVID to acquire Plush.
And it's a slightly different business in that they cater for a different customer.
It's more traditional, whereas Nick Scali is more designer led Italian style furniture.
But it's given them an opportunity to now expand to brands into the domestic market.
The incredible thing about the Plush acquisition is just what they've done with that business
since they bought it.
So they have completely reconfigured the economics of business.
They have taken a lot of the product away from the existing suppliers and put it through
their own channels.
And the end result of that is today, the average price point in Plush is down on where it was
before they bought the business.
And yet the quality is up.
So that's a pretty incredible customer experience if the price is down and the quality is up.
And yet their margins are considerably better than how the Plush business was operating
before they acquired it.
So that is an incredible trifecta.
They're the only business that's listed on the ASX that we're aware of.
What is the profit margin of Plush?
Well it depends on how you define it.
At the EBIT margin level, they're typically generating about a 15% EBIT margin on their
product.
And they're the only business that we're aware of in the Aussie market that's got a return
on equity that's averaged over 50% since they listed.
So they've been listed for 15 odd years.
And that is an extraordinary record.
What does that mean?
That means that when they go and set up a new shop, if the new shop costs them a million
dollars, they're earning $500,000 worth of net profit after tax on that million dollars
invested every year thereafter.
So that is better than a lot of the really high return on equity businesses that you
might otherwise think of, think REA or Car Sales, two very, very good businesses that
we both own.
So their metrics are very, very attractive and from an investor's perspective, because
everyone is quite fixated on how cyclical the retail market is, you often get opportunities
to buy this business at high single digit, low double digit, multiple of earnings, which
is considerably cheaper than the rest of the market, despite the fact that again, they've
compounded earnings since they listed at over 20% per annum.
So from our perspective, one of the best management teams in retail in Australia and a very, very
good business to own over the long term.
Yeah, it's very interesting.
Car Sales.
Always loved this business.
Just sold a car with Car Sales recently.
You know, got a four-drive, kids, good fun, run around, holidays are coming.
But I was interested to hear about their expansion.
Was it into South America?
Yeah, so they've owned this.
And how that worked.
Yeah, well, I mean, again, Will just came back from visiting Car Sales, or two of the
three major Car Sales overseas operations.
So he went and visited Trader Interactive in the US with the company and then flew down
to Brazil and spent some time with their Brazilian business, Web Motors.
So they've had a 30% stake in Web Motors for quite some time now, over a decade.
And recently, they took that ownership stake from 30% to 70%.
So they switched positions with Santander, the large global bank who had previously owned
70%.
They now own 70%.
They own 100% of Trader Interactive, which is the US business.
And the interesting thing about those two acquisitions, it now means that Car Sales,
or Car Group as they're called today, have more than 50% of their revenues coming from
international sources.
So the Australian business is obviously incredible, very, very dominant in the domestic market.
But they own three international businesses, those two and one in Korea, that are again
the number one players in the market and have a very, very long runway for prospective growth.
And the exciting thing coming out of those two trips to North America and South America
was the fact that after Car Sales took 70% of Web Motors and 100% of Trader Interactive,
they are now really inserting their intellectual property into those two businesses.
And what we expect that you'll see out of that is an acceleration in revenue growth
in those two countries, which is significant because as I mentioned, the international
businesses are now more than 50% of the group's revenue.
And we should therefore see some positive operating leverage because there's quite
a lot of low hanging fruit by adopting some of the practices that have been evident in
the Australian business for over a decade now into both of those businesses.
So things like dynamic pricing, where you price your ads according to the value of the
product you're selling, that gives you an automatic uplift on how much money you're
making from different categories of auto in the Brazilian business as an example.
So at the moment, that international business has EBITDA margins around 50%.
The Australian business, their EBITDA margins around 65.
And we can't see any reason why those two won't converge over time.
And we don't think the Australian margins will pull back.
In fact, we think there's still some scope for them to improve marginally from here.
So we should see pretty strong revenue growth and some operating leverage dropping to the
bottom line.
So it's a very, very high quality business, very high return on capital.
It always trades at a relatively expensive multiple.
So we're pretty picky about when we add to that position.
Broadly, it's when we see big market sell offs or sell offs in its particular segment.
But certainly a business that we're very, very happy to own through the cycle.
Yeah, it's a very strong, interesting business.
It's a good customer experience as well using the platform.
You mentioned REA a number of times, and I assume that like most Australians listening
all own Aussie property or don't and want to get in or been renting, waiting for this
crash that's meant to be happening for the past 18 months that hasn't actually occurred.
So when you're looking at REA as a business, do they give, in your opinion, is there any
insights onto where the property market's heading or the current state of affairs in
Australia?
They tend not to give opinions on property prices.
What's important for REA is property transactions and listings.
So they make money when people list their properties for sale.
So if turnover is low, then you'll tend to find that listings have been low and that
has a depressive effect on their business because the more listings there are, the more
money that they make.
If house prices fell, do we expect it to negatively impact their business?
Not particularly.
The amount that REA take as a percentage of the house price is still very, very small.
In fact, it's very small by comparison to how much the real estate agent takes.
And yet, if you think about the starting point for most people in their property journey,
whether they're looking to buy a house for the first time, whether they're looking to
upgrade their house, whether they're looking to downsize, whether they're looking to rent,
whether they're looking to sell, all of those journeys typically start with REA and quite
frequently domain as well.
And so they are a critical part of that whole property transaction process.
And at the moment, their share of wallet, the amount that they're charging as a percentage
of the total transaction costs is pretty low.
So we don't think that they would need to adjust prices lower if property prices fell.
In fact, they've consistently over the years raised prices and we think that there's still
a very, very long runway for that to continue.
But there are other exciting parts to that business.
It's going to sound like Will has been everywhere lately and that is partly true.
I think he told me that he's been on four continents in the last four months lately,
but he did just come back from India as well.
And REA have 80% of the number one portal in India.
And that is a very, very exciting proposition.
It's actually detracting from earnings at the moment because they are investing very,
very heavily to cement their number one position in what is a very, very large market.
But it's a market that's got used to paying for listings within the real estate space.
So similar in some respects to Australia on that front.
So the revenue growth is very, very strong at the moment.
They're reinvesting more than they make to make sure that they extend their lead as the
number one player in that segment.
At some point in the next couple of years, you're going to start to see the economics
of that business come through because as the revenue growth accelerates, their cost growth
will start to increase at a slower rate, which means that you move to becoming a profitable
business and then a very, very profitable business.
So we think that that Indian business has quite considerable potential and considerable
value at this point in time.
And that's not reflected, for instance, in the multiples that you might look at when
you look at the business as we stand here today.
So you need to separate out the value that we would ascribe to the Australian business
and the value that you might ascribe to the business in India.
And there was nothing within that site visit that left us anything but impressed with the
progress and drive within that business.
And it is obviously an enormous market.
If it's not already soon to be the most populous country in the world, it's democracy, it's
English speaking.
So there are a lot of reasons that we should be quite excited about REA's involvement.
Yeah, that's really interesting.
I didn't know that was expanding into India.
Where else are you currently seeing opportunity?
There's a number of companies that I'm familiar with that you guys own or picked up recently.
Surprise me.
What else have you picked up or where is the opportunity?
Listen, I think there's more opportunity in the market at the moment across sectors than
we have seen for some time.
So the real opportunity, I think, lies in the mid and small cap space.
And it's a function of two things.
One, there's much stronger earnings growth that you're going to see from some of the
companies in the mid and small cap space.
And you're going to see at the very large end of town.
And that's going to continue for the next decade and beyond, in our opinion.
And then on the other side of that, valuations have pulled back.
In fact, valuations have pulled back considerably in the last two years in those same parts
of the market.
So mid and small caps have underperformed the large caps for nearly two years now.
And we don't think that that's a function by and large of the underlying performance
of the businesses.
So if we think about our portfolio, our portfolio holdings are doing very, very well at the
company level.
And we spend a lot of time on the ground with those companies.
I spent four weeks in the US, only a couple of months back.
And that was visiting around 15 Australian listed companies and their operations.
The businesses that we own, we're very relaxed, are performing well and growing their earnings.
And so the fact that prices have gone lower just means that valuations today are more
attractive than they were a couple of years ago.
And so that's an exciting time to be investing because at the end of the day, you make your
money most of the time from buying at attractive levels and then holding for long periods.
And that's exactly what we do.
So the portfolio that we have, portfolios that we run, tend to be invested for many,
many years in the stocks that we hold.
You can see that because we report the top 20 positions in both funds every single month.
And what people might notice is that those positions don't tend to change very much over
time.
So we're a long-term investor in these businesses.
We try to pick our point of entry.
We want evaluation that's fair value or better.
And then we'll be invested for some time.
But there are many opportunities that we've been nibbling away at recently.
And obviously, the X20 fund has only launched at the start of December 23.
And so we have been investing the funds in that vehicle.
And we invested them reasonably quickly into what has been a pretty strong market.
So we're certainly happy with how that fund has started.
So with the new fund, how many stocks are currently in the portfolio and your position
sizing?
Yeah, so there's 48 positions in the X20 fund.
So it's slightly different to the Long Short Australian Equities Fund.
The Long Short Australian Equities Fund is a high conviction fund.
So it's not uncommon to find some positions that are around 10% or maybe a little above
10% if they've gone up and we still have as much conviction in them as we did when we
first purchased the security.
And our holdings are concentrated in companies that we have the highest conviction in.
So we're completely sector unaware.
We might have some considerable sector exposure.
In fact, at the moment, we've got a 34% exposure to the consumer space, which is considerably
above what the index looks like.
And so it's appropriate for people that want to invest in a relatively concentrated fund
that will often behave quite differently to the market, but is invested in what we think
are the best ideas in proportion to how good we think that the opportunity is.
The X20 fund is a little bit different.
And for those investors that care about performance compared to an index, we have tried to make
this fund so that it is sector aware.
So its sector exposures look quite similar to the X20 index.
There's an ASX300 X20 index and its sector exposures will look pretty similar over time
to those of the fund.
So it'll be more of a function of the stock picking within the sectors as opposed to the
sector allocation as to how that fund delivers performance.
And it has a very particular market again.
And the aim of that fund is to have consistency of outperformance over time.
So rather than having years where it outperforms by a lot and then potentially the following
year gives a little bit of that back, the aim of the X20 fund is to consistently deliver
returns that are a bit better than the index in the broader market over time.
So we're very excited about that fund.
I was a considerable co-investor in that fund from the day it launched.
So I have considerable exposure to both funds and importantly both me and Will and a lot
of other people for that matter, their sole equity exposure is in the two funds that we
manage.
So we certainly eat our own cooking.
We invest in accordance with how we think an equities portfolio should be best managed
for the long term and we're considerable equity holders in the two funds.
Thanks for that.
The other reason I quite enjoy having these conversations is active fund managers, it's
all people and how do you think, how do you make decisions?
Like they say when you're sitting at a poker table, you read the player, not the cards.
And I would love to discuss mineral resources again, but more in lines on how you invest
in that position, what percentage you got up to, when did you trim it, why did you trim
it?
You used, I believe, lithium carbonate price as a leading indicator and then why you went
back into it and why this is important is a number of investors using funds have been
informed that some fund managers are actively managing the positions internally, but some
people they hear that and they go, what exactly does that mean?
So using mineral resources, do you mind giving an overview and just saying the percentage,
what it was, where it got to, how you trimmed it and then that'd be great.
So if we think about mineral resources, it's in the resources space.
And so the number one driver in the short term of its earnings are the commodity prices
for the commodities that it is exposed to.
So we are more active around the management of our commodity related exposures than a
lot of other stocks in the portfolio.
So if we think about any boring industrial company, we will typically just let that position
sit in the fund.
And the only reason why we would change our exposure to that position typically are if
the stock price gets well ahead of itself and we can't justify the current valuation,
in which case we will reduce that a little bit.
Or if everyone gets particularly depressed about the particular business, in which case
we will ordinarily look through the cycle.
And if we still like the business and nothing has changed in the investment thesis, then
we will be adding to that exposure.
There is obviously the third scenario as well in which a change in circumstance or a change
in opinion in the investment team results in us exiting that position entirely because
either we have realised that we were wrong in our investment thesis or the facts have
changed such that it invalidates our investment thesis.
But thankfully that last point doesn't happen too often and most of the change in the portfolio
are at the edge with those industrial businesses.
It's a little bit more active than that for businesses that are exposed to commodities
and mineral resources is a classic example of that.
So when this stock was down at $15, it was around a 5% or a little bit north of 5% position
for the fund and we thought it was remarkably cheap.
It then went from that sort of level up to $90 and it did it in a relatively short time
price and there were a lot of things going in its favour during that period.
Most obviously an explosion in the lithium price north and it was in the fortunate position
where it could capitalise on that because it had two significant ready to go lithium
operations.
One that had been in care and maintenance and one that had operated throughout that
period.
That were two of the more significant lithium mines globally.
So it benefited very strongly.
And then about a year ago in December 2022 we saw a few things that we were concerned
about.
One was the build up of inventories within the supply chain for electric batteries and
a majority of the new lithium that is being produced today is going into EV batteries.
So as we saw this build up in inventories both at the battery end but also at the carbon
end at various stages along the production processing line.
We became a little bit concerned and at the same time the lithium carbonate price which
is one of the different types of lithium product, it had started to turn down and was dropping
and it has lead, spodumene which is the base product that a lot of the Australian miners
produce and lithium hydroxide which is a lot of the battery grade product that a lot of
the spodumene goes into consistently over the last five or six years.
At the same time there was also negative news around iron ore because housing starts were
dropping precipitously in China and China is the major consumer of steel globally and
therefore the major consumer of iron ore.
So its two commodity exposures were suddenly facing headwinds and yet the stock was hitting
new all time highs.
And so by that stage despite select trimming along the way the position had grown to around
14% in the fund and when we saw a change in circumstances we acted and we cut that position
considerably.
In fact I think we ended up cutting it by over 70%.
So it went all the way back down to between 4 and 5% in the fund.
And over the last year you've seen this excess in lithium inventories in the supply chain
play out by way of lower prices.
So the lithium prices have dropped precipitously.
In fact many of the indices are down 80% in that last 12 months which is extraordinary
and that has retraced most of the upward move that we saw in the year or so prior.
But we're currently seeing some signs that the inventory levels are normalising within
the channel.
We certainly think that the lithium carbonate and lithium hydroxide producers are back to
the sort of normal levels of supply that we expect to see of them in a typical environment
about 30 days worth of supply of the base product.
There is still some excess supply in the battery channel.
We think we'll work through that over the next three to six months.
And obviously the stock prices have now pulled back considerably to reflect more conservative
assumptions around the price of lithium on a go-forward basis.
In the meantime, mineral resources have been very, very busy at managing what they can
control.
So in that 12-month period they've gone and bought off a receiver a third lithium operation
at Bald Hill for what we think is an incredibly attractive price.
And they have continued to progress this move to become a very, very low-cost producer in
the iron ore space.
They're going to go from a small-scale iron ore producer that is high-cost to a much larger
scale low-cost producer.
And that's the onslaught development that I referenced earlier in the chat.
And that iron ore operation is due to come online by June of 2024.
So that's now about six months away from starting production.
And as we get closer to that date, we think the market's going to focus more and more
on that side of the business.
Because if iron ore prices hold at current levels, that business should produce between
$1.5 and $2 billion worth of iron ore at spot prices.
So it's going to be a very considerable earner for the broader men business.
But as we've seen, the pressure on lithium eased somewhat just in the last four or five
weeks.
And as we get comfortable following our site visit that their iron ore expansion is going
according to plan, we've become more constructive on the position again.
And so we've been buying back some of the stock that we sold.
Not all.
It's unlikely that we will go north of 10% through purchases.
But certainly we've been adding at what we think are very attractive levels.
And we're very constructive on the outlook for that business over the next couple of
years.
We think it's going to be a very exciting time for Chris Ellison and the team.
Yeah, it's quite interesting watching the prices play out.
But listening and hearing the decision about what do you do when these particular circumstances
and supply chains and the specific price plays out and how do you actually react and the
decision making.
I suppose that's the reason why people look for active managers.
But just to paint the picture for people that don't have a chart in front of them, lithium
carbonate price in what mid 2021 was about 100,000.
When you reference November, December 2022, it's 600,000.
And now it's all the way back down as of today, 97,500.
And then with the iron ore price, looking at a five year chart, wow, it's done something
similar.
So the iron ore chart 2020 was practically 100, cycled all the way up to 230 July 2021,
came all the way back down into the 80s and now we're at 137 US dollar a ton.
So yeah, I see what you mean.
So if the US iron ore holds the trajectory around about here and all that supply comes
on next year, there's still a hundred dollars a ton nearly from the recent peak two years
ago, a year and a half ago.
Yeah, we don't need to see iron ore prices move higher.
So mineral resources, new production at onslaught should have an operating cost of around $40
a ton.
So yeah, right.
$40 a ton is the operating cost.
Yeah, so at 137, there's a lot of margin in that for what should initially be a 35 million
tonne per annum operation.
But we think looking at the infrastructure set up that they've established has the potential
to be considerably larger than that over time.
Yeah, very interesting and good old disclosure.
I do own mineral resources personally, you know, have to always say that in case people
are listening.
So what keeps you up at night and what gets you out of bed in the morning?
To be honest, it's both the same thing.
It's financial markets and it's not keeping me up at night because I'm worried.
But I think if you're investing in the market, you know, broadly a managed fund is a good
way to go.
For the simple reason that the best investors in the market are typically those that are
very passionate about it.
I don't have to think about coming to work with any sense of dread.
I love it.
I love reading about all of the businesses that we own and many that we don't own.
We love doing, you know, I speak for the whole team.
Gavin Willa just as passionate about it as I.
No one needs to tell us to do the work because we love doing the work.
So it doesn't feel like work to us.
We love going on site visits.
We love drilling into companies.
And so half the time I'm still reading about things as I'm going to bed that relate to
companies that we're invested in or that we're thinking about.
And when I wake up, I can't wait to get to work because it's passion of mine.
It's passion of Will's, it's passion of Gav's.
It's a real team effort.
You need to be surrounded by people that keep you humble.
And we'd like to think that we keep each other in check and make sure that we always consider
every investment proposition carefully.
And in that sense, the team has very good balance in how we approach opportunities in
terms of having an appropriate level of bullishness where appropriate, but also being considerably
skeptical about many of the things that we see and read and hear.
So our view is the passionate team is always going to deliver better returns because you
end up just spending a lot more time on investing activities than you would if it was just a
job.
So from our perspective, it's not a job, it's a passion.
Love it.
If you want to learn more about Auscap or yourself, how is it best for them to get in
touch?
What's the learning?
Well, you can go to our website, which is Auscap, A-U-S-C-A-P-A-M for assetmanagement.com.
Or you can reach out to Lauren Murphy, who's Auscap's head of distribution, and she will
give you any information that you like.
But you can read about the team's investment philosophy with, we continue to have every
newsletter that we have ever published present on our website.
You can see what we were saying last month, last year or 10 years ago, and hopefully you
find a consistency in our approach and message.
A lot of those newsletters have been crafted by different members of the team.
So certainly Gav and Will have both written a considerable number of those newsletters.
I've drafted many of them as well, particularly in the early years.
But hopefully you won't be able to tell who has written which one, which gives you an
indication that we all think about investing in the same way and we're looking for the
same high quality businesses.
We'll try to be a little bit picky about price.
That is our attitude.
And if that resonates, then feel free to inquire further.
Fantastic.
Well, Tim, it's been really good having you on.
I really enjoyed this conversation.
And you got much planned over the Christmas break?
You're sticking around?
You're heading away?
We are sticking around over Christmas.
My children are very, very excited about Santa.
And then we'll head down to the South Coast for a couple of weeks in early January.
It's an important time to recharge and refresh.
Let's get ready for 2024.
I hope it's a good one.
Absolutely.
All right, Tim, great having you on and have a great day.
Thanks Murdoch.
You too.
Thanks for having me.
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