Australian Foundation Investment Company Limited (AFI) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to the AFIC Full Year Financial Results Briefing. [Operator Instructions] And just please be advised that today's conference is being recorded. But without further ado, I'll hand the conference over to our first speaker for today, chairman of the Australian Foundation Investment Company, John Paterson. Thank you, and please go ahead.

Thank you. Good afternoon. I'm John Paterson, Chairman of Australian Foundation Investment Company, and I'd like to welcome you to this full year result briefing. I have joining me today on the webinar Mark Freeman, the CEO and Managing Director; David Grace, a Portfolio Manager from the investment team; Nga Lucas from the investment team; Andrew Porter, our CFO; Matthew Rowe, our Company Secretary; and Geoff Driver, General Manager, Business Development. Before we start the presentation, a bit of housekeeping on the webinar. This briefing is based on the material available on the company's website. If you're using your computer to access the presentation via the webcast, the slides will change automatically. If you're accessing by phone only, the PDF of the slides with page numbers is available on the website. I'd like to make a couple of short observations before I pass to our team for the presentation. Given where we started early in the pandemic, this has been a surprisingly strong year in the market, up 29%, including franking credits. We're very pleased that we've beaten the index by 2.8% over 1 year when franking credits were included, but now our 3-, 5- and 10-year records are also again ahead of the index. We're also pleased that alongside the significant capital gains delivered to our shareholders, we've been able to sustain our $0.24 dividend despite earning around $0.16 before the special dividend from the Woolworths demerger. This reflects our ability to draw on a store of past freeload gains and franking credits. I'd like to briefly touch on a number of Board changes over the last 4 months. In April, Julie Fahey joined our Board, bringing deep experience in technology areas, which have been a large part of her executive career. She sits on the Seek, IRESS and recently Vocus boards. At June 30, also, Ross Barker retired after a long connection with AFIC since being appointed an alternative director in 1987. He was the key person involved in implementing the move of AFIC away from dependence on [indiscernible] to stand independently on its own. Also, on the 1st of July, Craig Drummond joined the Board. He brings deep investment experience and has considerable senior management experience in financial services companies and has recently been the CEO of Medibank. The appointments broaden the skill and experience set of your Board for the future. I'll now hand over to Mark and the team to run through the presentation. Thank you.

Thanks, John, and just moving to the slides. Just starting on Slide 2. Sorry, it's Mark Freeman speaking, the Managing Director. We've got our usual disclaimer, just to state that we're here to talk about the company. We're not here to give advice. Just moving to Slide 3. We have an agenda. I'll give some overviews of the company. Andrew Porter, our CFO, will then talk about the financial year in summary. David Grace and Nga Lucas will talk a bit through the portfolio and the outlook, and then we'll move to questions. So moving on to Slide 4. I always like to reaffirm what AFIC is about. So AFIC primarily invests in Australia and New Zealand companies. We're looking for quality businesses that we can invest in for the long term. It's the largest listed investment company on the ASX at over $9 billion, around 160,000 shareholders, and our structure as an LSC means it's transparent, and we have an independent Board of Directors that provides strong governance. The shareholders own the management rights to the portfolio. There is no external funds management business deriving income from the company or the portfolio. This keeps the costs low to our shareholders who own the business. Management expense ratio is coming at 0.14% with no performance fees. We're a long-term investor with a low turnover. We understand that tax can have a negative impact on shareholder returns, particularly compared to many other high-turnover funds in the market. We have a long history of growing or stable fully franked dividends that we pay to shareholders, and the investment team also manages 3 other funds, Djerriwarrh, Mirrabooka and AMCIL, which add significantly to the effectiveness of the investment process and idea generation. The returns we also generate come at a very low volatility. When we look at the volatility of our returns against the index and indeed against our peers in the market, our volatility is extremely low. And just to reiterate, we run this company for the shareholders because the shareholders own the company. Moving to Slide 5. Just on to the investment objectives. The company aims to provide shareholders with attractive investment returns through access to a growing stream of franked dividends and growth in capital. In that regard, we want to increase our dividends over time at a faster rate than inflation and provide attractive total returns over the medium to longer term. I'll now pass to Andrew Porter to talk through our results.

Thank you, Mark, and good afternoon, ladies and gentlemen. So the next slide is the full year results summary, and I'll quickly run through some of these highlights. The profit for the year, $235 million. Now that looks on first site to be down only 2.2%. That does include, as we made clear in the release yesterday, $36.5 million of demerger dividend from the Woolies and Endeavour Group demerger. I don't want to get overly technical on this, although happy to either in questions or at a later date. But that dividend, we need to improve our accounting standards. It includes no cash and no franking credits, and therefore, we don't really look at it in terms of our own dividend-paying capacity. If you were to exclude that, our profit was $198.6 million, so down 17% on the year or equivalent to $0.16 per share. Now that is obviously a fall, but I think it's probably a better result than many would have anticipated at the beginning of the financial year. That figure excludes the realized gains on -- that we've made on the portfolio during the year, which we will have to pay tax on, and coincidentally, that almost replaces that demerger dividend. So if you add those $0.03 on, realized gains and profit for the year, we've made about $0.19 per share. So that brings us down to the dividend, $0.24 per share for the year; final dividend, $0.14. That's consistent with prior years. As Mark explained in the release yesterday, we have had to dip into reserves, but that's what an LIC is for in order to be able to do that and hopefully smooth over the dividend in troubled times as long as they don't go on forever. The shareholder return, 35%. That includes franking and assumes reinvestment of the dividend. That is a [ path ], that's a technical term, above the portfolio return of 32% because the premium over the MTA slightly increased at the end of the year. So as Mark has explained, we are a low-cost vehicle. The management expense ratio, which is the expenses as a proportion of the total portfolio, 0.14%. So what that means is $0.14 for every $100 that you had invested. It has creeped up a little bit for the year. A lot of that is to do with a number of things, but as I said, a lot of it to do with the starting to have a look at the international investments that we've talked about, and John, as Chairman, had mentioned at the AGM last year. And as Mark mentioned, the portfolio now over $9 billion. That's as at the end of June. So that's it for me. Happy to take any questions on any of that in more detail later on, but I'll hand over to the portfolio manager, David Grace.

Thank you, Andrew. So moving on to Slide 7. We endeavor to hold a diversified portfolio of companies we consider to be high quality. Ideally we want companies that have a strong industry position, holding unique assets with a definable competitive advantage. These companies are best positioned to generate meaningful cash flow through the full investment cycle. We want our companies to be run by strong management teams and boards, have recurring predictable earnings and to maintain a strong balance sheet. We want our investments to deliver earnings growth, and we undertake detailed analysis of the future growth prospects for all our investments, how well the company is positioned to capture this growth and ensuring they have a supportive balance sheet, able to fund the opportunity in front of them. We aim to keep portfolio turnover low, which aligns with our long-term investment horizon as we look to capture the benefit of compounding returns that quality companies tend to deliver. On to Slide 8. For early-stage companies where we recognize they are developing our preferred attributes, we aim to make an early-stage investment, or nursery stocks as we define them. While initially only small, the growth potential in these businesses remains large. Importantly, and consistent with our long-term investment approach, we only look to buy where we perceive the share price represents good, long-term value. We're happy to be patient waiting for the opportunity to emerge in our preferred companies. Moving on to Slide 9, which outlines the recent performance in the market. The chart on the left-hand side shows the performance of the ASX 200 over the last 5 years. It gives great context to the extent the market pullback as COVID emerged, and encouragingly, the strong market rebound post the initial COVID shock to now being above prior levels. While COVID is still with us, as investors, we need to use periods of share market volatility to buy quality companies at attractive prices. The market is always forward-looking and prepared to look through short-term weakness, particularly for high-quality companies that have strong growth prospects. Having increased our buying activity during the dip, we are now more cautious, which we'll talk to in our outlook statement later on. The chart on the right-hand side shows the strong sector performance over the last 12 months, led by the banks being the orange line, and just below that, the technology sector, the gray line. Around 8% of the portfolio is currently invested in technology companies, led by holdings in Realestate.com, Seek, Carsales, IRESS and Zero. We consider all these companies continue to have significant, long-term growth opportunities. Banks have rallied more than 50% in the last 12 months as the impact from COVID proved to be less severe than originally expected. The result is that all banks now have excess capital. The CEOs of all 4 of the major banks have spoken about potential capital management, either increasing dividends or some form of share buybacks with ANZ announcing a buyback last week. Timing and quantity for the other 3 majors remains unknown. So following strong performance last year, the valuations of the banks are now more in line with long-term averages. Returns from here will likely be more about income. Resource companies have also had a strong last 12 months. We have large holdings in both BHP and Rio Tinto with both offering a diversified commodity exposure operating low-cost Tier 1 assets. With market conditions remaining positive, both companies are expected to deliver strong dividends in the near term. On to Slide 10. So following a very difficult FY '20, the 12 months ended June 21 has been really positive in equity markets. Market conditions of lower interest rates and rising corporate earnings provided perfect conditions for a rising share market. Including franking, the market rose 29.1%, delivering consistent performance with 11 of 12 months delivering positive returns. Also, including franking, the portfolio delivered a return of 31.9% being 2.8% ahead of the ASX 200. The strong performance reflects the benefit of holding a diversified portfolio with a mix of high-quality companies, together with a number of businesses benefiting from economies reopening. It's also pleasing to see longer-term performance exceeding market returns with both the 5- and 10-year performance now above the ASX 200. While the market is always presented with challenges, the key concern or unknown for the market today is rising cost inflation and supply chain disruption. We think about inflation, and its potential impacts on markets in 2 ways: firstly, cost inflation leading to a higher cost of business for companies as raw materials, labor and supply chain costs increase; and secondly, the potential for a change in stance in monetary policy in the end of the rate easing cycle. The flow-on effect of this is likely lower equity valuations. In relation to the first point, a key attribute we look for in selecting companies we invest in is finding those that offer a sustainable competitive advantage. While never immune to rising costs, these companies are best positioned to have pricing power, the greatest ability to pass through cost inflation via price rises to their customers. On the second point, should rates begin to firm, share markets are likely to be more volatile, which may present the opportunity to purchase high-quality companies at attractive valuations. We know the companies we want to own more of, and we have recently been increasing our cash balance, so we're positioned to buy at attractive prices eventually. So overall, we feel comfortable with our portfolio positioning today, having significantly increased our capital allocation to what we believe are high-quality companies over the last few years. Moving on to Slide 11. The chart on this slide reflects data from a Mercer survey of 115 large-cap Australian equity fund managers displaying their risk and return metrics over the last 3 years. The green lines represent the median manager who has delivered a return of 8.8% per annum with a standard deviation of 18.2%. The standard deviation is a measure of risk or the volatility of a portfolio. The AFIC portfolio is represented by the blue dot and has returned 10.5% per annum; while the ASX 200, being represented by the purple dot, returned 9.6% per annum over the period. Notably, AFIC standard deviation of 16% is well below the risk of the market and the median fund manager. So in simple words, the chart indicates the AFIC portfolio has delivered a higher return with less volatility. We believe these metrics reflect the higher quality of the holdings in the AFIC portfolio while maintaining a diversified exposure across the various market segments. Moving on to Slide 12, which outlines the largest contributors and detractors to performance over the last 12 months. All of the largest contributors are owned by strong management teams and boards, all have strong market positions in their core markets and all have supportive balance sheets able to internally fund growth opportunities for their businesses. Reece Group is 70% owned by the Wilson family who were first involved with the company 50 years ago with second-generation Peter Wilson, the current CEO. The business has clear market leadership in plumbing supplies in Australia and New Zealand. The company's investment in technology has been a meaningful growth driver, improving the experience and speed with which plumbers can source materials. Three years ago, Reece expanded into the U.S. market and has been developing an understanding of the local challenges and opportunities. We believe Reece has significant, long-term growth opportunities in both Australia and the U.S. James Hardie is the leading manufacturer and distributor of high-quality fiber cement siding products for the U.S. housing market with the company holding 90% market share of the segment. The company has consistently been increasing market share with a strategy centered around deep knowledge of its customer. Market trends remain favorable as long-term labor and environmental issues for the lightweight building materials like fiber cement away from traditional brick and concrete. The business has a strong balance sheet and is run by a strong management team and board. And ALS is a lab testing business, analyzing and testing samples from commodities through the food, pharmaceutical and environmental. The company has a global footprint operating in more than 65 countries. With the need for compliance increasing, ALS as one of the market leaders, is well positioned to capture the growing demand for sample testing.

Mainfreight is a logistics operator that has a strong track record in both New Zealand and Australia. They're specialized in less than a container load of freight with a focus on food and beverage, DIY hardware and health care products. The company has, in recent years, also expanded into the European and U.S. markets. We regard the management team highly and we value the opportunity to co-invest with the founder of the business, who remains the Chairman today and still holds a meaningful share of the company. ARB is a market leader in manufacturing and distributing 4-wheel drive parts and accessories globally. The business was founded in 1975 by the Brown family with Andrew and Roger Brown still running the company today. The company distributes products in over 100 countries and has recently signed an agreement with Ford U.S.A. provide equipment to their new 4-wheel drive range. Management have done an excellent job, and the business still has significant opportunity to grow over the long term. Over to the right-hand side of the slide, we have listed the main detractors of performance over the last 12 months. I'll talk about Afterpay, and Dave will touch on Fortescue and Transurban. Afterpay has been an incredible performer this year, rising almost 100% over the period. The business pioneered the buy-now-pay-later sector and has consolidated its first-mover advantage by rapidly growing its network of customers and merchants in Australia, and more recently, they have expanded into the U.S., U.K. and European markets. The product resonates strongly with its target consumers, and retailers view the platform as an effective way to attract new customers. We've been watching the company for some time and will continue to monitor its progress. Whilst many of our questions around the business model have been answered, we still remain concerned about the sustainability of the company's competitive advantage, particularly as their success has now attracted some very large, global competitors.

Fortescue is a pure-play Australian iron ore producer, who has benefited from the strong run in the iron ore price over the last 12 months. The business has been extremely well run under CEO, Elizabeth Gaines, consistently growing iron ore production while lowering costs. While we missed the opportunity last year, not forecasting the strength in the iron ore price, we feel comfortable at this point in the cycle that the majority of gains are likely to have been made because we don't consider an iron ore price above $200 to be sustainable long term. As mentioned earlier, over our long-term investment horizon, we remain comfortable with our exposure to Tier 1 diversified miners, BHP and Rio Tinto. Transurban holds a portfolio of strategic road transport assets along the Eastern Seaboard of Australia and within the U.S. Business underperformed last year, reduced mobility during COVID led to lower traffic volumes. We use the short-term share price weakness to increase our holding. Traffic volumes are showing continual improvement as economies gradually reopen with the company's balance sheet remaining in strong shape. Moving on to Slide 13, which outlines the major portfolio changes over the last 12 months. All the purchases shown on the left-hand side are of companies with strong industry positions in their core markets. As outlined earlier, for some of the earlier-stage companies like Temple & Webster, Nanosonics and FINEOS where the market opportunity is significant, the range of potential outcomes is wider than say for Woolworths and ASX. For these early-stage companies, we invest a small initial holding and look to increase our weighting as confidence levels increase. Short-term share price weakness gets the opportunity to materially add to our holdings in Woolworths and ASX. Both have been long-term holdings in the portfolio, and both have market leadership positions with strong, long-term growth prospects. Nanosonics is a leading manufacturer in the health care industry of ultrasound disinfection products. The company has developed a leadership position in the U.S. market and is expanding globally with the potential to increase penetration as it broadens its product offering.

PEXA is a recent portfolio addition, having listed on the ASX only this month. It is Australia's leading cloud-based property settlements platform with over 80% market share. Their long run -- growth run rate is underpinned by their dominant position in Australia, and we believe they are well placed to replicate this success in the U.K. Domino's Pizza holds a strong market position in Australia, but it's the long-term opportunity in the European and Japan markets that have attracted us to this company. The business is exceptionally well managed, and we believe that there is still a huge growth opportunity in the underpenetrated European and Japanese markets. Temple & Webster is a pure online furniture retailer, utilizing a very capital-efficient drop-ship model. The company has developed a dominant market position in an industry that is still in the early stages of shifting online. Encouragingly, the business is already profitable despite its rapid growth. FINEOS is a leading software provider that services the life, accident and health insurance sector. The global opportunity for FINEOS is large as the insurance sector shifts from legacy systems to modern cloud-based operating systems. The company has a strong balance sheet and continues to invest in their product and technology well ahead of their competitor.

On the sales side, we exited our positions in both resource companies, South32 and Alumina, filling a strong run in underlying commodity prices. We additionally exited our holding in Brickworks as the share price ran up strongly, supported by government stimulus efforts to the housing market. Moving on to Slide 14. Slide 14 to 16 outline the top 30 holdings in the portfolio. Nga and I will talk to a few of these companies we consider topical today, either due to current operating challenges, progress on business turnarounds or recent M&A activity. On Slide 14, CSL is the third-largest holding in the portfolio. The company is the market leader and lowest-cost producer of collecting plasma donations to produce life-saving biotherapies. While demand for CSL's therapies remain strong, reduced donor mobility during COVID has led to a growing shortage of plasma supply. We believe the current tight supply issues will prove temporary. And CSL as a market leader with the lowest cost base stands well placed to benefit from any normalization in plasma volumes. Increasing donor mobility, as vaccinations are progressively rolled out, should result in improved earnings growth for CSL. Moving on to Slide 15. Sydney Airport is a fantastic, strategic infrastructure asset, which has faced significant challenges in recent times as a result of travel restrictions. The company has recently received a takeover offer, which highlights the benefit to shareholders of holding strategic assets and taking a long-term view. While it's too early to determine how the potential takeover plays out, we recognize the excellent, long-term prospects for these gateway assets to Australia's most populous city.

Telstra is Australia's leading telecommunications company with extensive telco infrastructure assets. After a period of earnings pressure driven by mobile competition and the migration of its fixed line business on to the NBN, we believe the company has reached an inflection point in earnings where they can now sustain and grow its $0.16 per share dividend. This will be driven by a return to growth in mobile and cost-out initiatives. Telstra recently also announced the sale of 49% of their mobile tower assets at a very attractive price. The proceeds will be used to pay down debt and buy back shares. Over the page to Slide 16. Carsales is Australia's leading online automotive classifieds business. They also operate similar businesses in South Korea and Latin America that are growing strongly. We are excited by the growth opportunities in these international markets. The company recently also announced the acquisition of a 49% stake in Trader Interactive, a U.S.-based online nonautomotive business that has dominant market positions in RV and power sports. We believe the Carsales management team will be able to leverage their experience and IP to drive this business forward as they have done so in previous overseas acquisitions. I'll now hand back to Dave for some outlook comments.

So moving on to Slide 17. We feel positive about the holdings of the portfolio, but our sense is markets may prove more volatile in the near term than what we have experienced in the last 12 months. This reflects the uncertainty around the ongoing pandemic, rising supply chain disruption and costs and whether inflation proves transitory or more long term. There are always macro challenges for share markets, and today's issues are not necessarily any more pronounced. We feel comfortable that the core of the portfolio is investing in high-quality companies holding strong industry positions where long-term prospects remain attractive. We've recently increased our cash balance, and we look to purchase our preferred companies, should attractive share prices present. So at this point, that concludes the presentation. I'll hand over to Geoff to coordinate the Q&A.

Thanks, David. [Operator Instructions] So we'll just go to a few online questions first, and then we'll head back to the phone and then see where we head after that. So I will start with, once more, about the market in general, in terms of, when so much of the economy has been, I guess, decimated in the last year. Why do we think the ASX could justify being at all-time highs? Is it because only small businesses really suffered through COVID-19, and large companies have, I guess, been the benefit of some of the stimulus that's occurred, both from government and also from a monetary policy?

Okay. Thanks, Geoff. It's Mark Freeman here. Look, it is one of our observations that it's an unfortunate -- a very unfortunate situation we're in here, particularly that the -- most companies have been impacted by this environment, smaller businesses, a lot of mom-and-dad or SME-type companies, restaurants, small travel businesses, entertainment companies. They've been hit the hardest, and we've, sort of, pointed out that a lot of the companies in our portfolio are really international businesses. If you look across our health care sector, stuff like ResMed, [indiscernible], CSL or David talked about the Rio, BHP, some of these companies are actually performing pretty well in this environment. So it is an observation that the companies listed on the share market are probably doing better than the small companies in the economy. I think we were pointing out, though, that we are expecting further volatility. Another factor around that going forward is the fact that we are on high valuations. As many people on this call would remember, back in March, we did a shareholder briefing, and we highlighted at that point when the market was down 30% but looking at long-term market factors such as price to sales or price to book, the market was looking very low by historical standards. We also had a chart there showing every time there's been a significant pullback like the one we've been in, it was inevitably a buying opportunity. Well, that's completely reversed now. So factors like price to sales and price to book are now at very high levels. So that's leading into our caution on where we sit in the market at this point.

Thanks, Mark. A question about Qube, so specific, and why did we sell it? What was actually thought -- what are our thoughts about Qube as an investment?

Sure. So we have reduced our holding during the period. It was really around a change in the investment case. A large part of our reason for holding that business was the investment that Qube was making in developing Moorebank in suburban Sydney, and now having sold that asset, they've realized an attractive price. Our sense is the risk profile is heightened with the remaining business, which is really around logistics and ports. So we feel comfortable that they do own strategic assets going forward, but a large part of our investment case was around Moorebank. It is no longer part of the story for the business.

Thanks, David. question about the international LIC. Mark, just the potential time line if that's what's going to happen. So you might actually comment -- the Board comment about our expectations there and what we see, sort of, going in the future with that particular [indiscernible].

Yes. Well, thanks, Geoff. It's obviously very early days on this, and there's a lot to play out, but certainly, we'd be wanting to see another 12 months of how we go with having real money in the stocks. We think actually having some of these businesses will actually benefit the portfolio because they are very high-quality companies. And again, touched on the point I made earlier, a lot of our businesses are international companies, and I think it does benefit the team to have that broader perspective on the world. They're seen through the eyes of some of the companies that we've actually now brought into the portfolio. So there's lots of positive benefits for the group overall, but as I said, track record is really important. The key thing we're looking to do with it, though, is apply the same frameworks that we apply to analyzing our companies in an international sense, and that's what we need to be able to do to -- if we were to develop this into a product to, say, we are taking the same approach to investing that we will be in international and some of the things that we look for are businesses that have strategic assets, strong market position, strong competitive advantage. We'd like to get some of the owner-driver companies that we talk about. We've got a skill set in that, good-quality growth companies, so the same sort of things that we talk about. So we need some time with it.

And I guess just, sort of, question on that. I mean how big do you think it would be in the portfolio?

Well, look, at this point, we've got, sort of, Board approval to do, just over 1% of the portfolio. So it's quite small in that sense. But even having a percent or 1% to 1.5% in our portfolio of high-quality global businesses, I think, can be a benefit to the overall portfolio. So we haven't invested all the money yet. We're just waiting -- it's a bit like the views we had there we're a bit cautious on valuation. So if we see some weakness in global markets, we'll look to put some more money in.

A question on -- well, it's an interesting one, a question on stagflation or potential inflation in terms of the impact on the portfolio. Dave, would you like to make some comments around that?

Yes. Sure. So really difficult for us to predict the rate or the level of inflation going forward. But as equity investors, the way we're really viewing that is through 2 angles, if you like. The first of those is just having ownership of businesses that have pricing power or strong industry positions and their ability to be able to offset any cost increase, and we really feel we do have a number of those companies in the portfolio currently. The second part to inflation is if we do see any change in policy stance from central banks and a move away from the easing cycle, that will lead to -- or we expect it to lead to increased volatility within share markets. So our view of that would be if we see volatility emerge, and we see attractive share prices, we look to increase our holdings in our preferred holdings.

Thanks, Dave. It's a collection of questions here about how we assess companies both in terms of environmental and other ESG factors, the impact of climate change and how we look at that in the context of how we're managing the portfolio. So Mark or David, would you like to give some comments around that?

Yes. Well, look, ESG has really been embedded in our process, assessing stocks ever since I've been involved. So as a long-term investor, we want businesses that are going to be around for the long term. We want businesses that don't have structural headwinds on that business. We don't -- we're not a trader, and so when we're thinking about that, and we have a system of ranking the quality, and sustainability of the business is one of the key factors we think about. So we think a business has challenges because of environmental issues, that comes into our assessment of the companies. Governance issues, well, I mean I've got told on the first day I joined here, "Look at the people. Look to see who's on the board." So governance has been a big part of what we consider in assessing a company. Social issues, we've always had it. Well, we talked about that we don't invest in pure-play gambling stocks, and that's a social issue that we consider. So we consider ESG factors, but they're embedded in the way we look at and assess companies.

I suppose specifically around BHP and Rio, well, particularly BHP has been pretty interested in oil and gas. How does that factor into that thought process as well?

Yes. Well, I think the companies themselves are really thinking through that issue. So -- and where they take that going forward. I mean the pure-play oil and gas stocks, we have Oil Search, Woodside and Origin now it's less than 2% of the portfolio in those 3 companies. So it's actually reduced over time. So we have done quite a bit of internal research on, I guess, our thinking on the future, and it's probably fair to say we're cautious on the sector still from here on a long-term basis, but we're not, sort of, rushing to of exit our balance of holdings because the sector has been under a fair bit of pressure recently. But I think our reasonable expectation is that they'll probably become a smaller part of the portfolios over the long term rather than bigger.

Thanks, Mark. We might throw some telephone questions now, Myles, if you've got some there.

Yes. Certainly. We sure do. The first question I've got on the line comes from the line of [ Paul Gusafton ].

We miss you not having a physical visit to Queensland, but you would be aware that AFIC finished at an all-time high today. That's mutually exclusive to my question. I'm old enough and wise enough now from 1991 when I first became a shareholder to remember one of your policy objectives was to have parity with your dividends, while secondly equated by [ 10 10 ], but this year, it was 10 14. Is that still a medium- to long-term objective of AFIC?

Look, I think for those that -- just to reiterate the question. It's about the balance between interim and the final dividend. Look, it's something we're definitely conscious of. We have these discussions internally. I mean, obviously, there's always going to be a little bit of a bias towards the final because you don't know how the year actually finishes off until you close off the books at the end of the year. But it's not something we're looking to keep tilting in the way of the final. So I think adjustments of the dividend, once we get through this period, I don't think we'd want them any more tilted than what we're seeing at the moment. [ I bet sort of inaugural point with that ].

We've got another telephone question, though. I'll next go to [ Stephen Mayne ], a private investor.

Two questions. The first is what are we going to do with Endeavour Group. We've got our unwritten policy of not owning pure-play gambling stocks, as you've mentioned. And whenever Woolworths was mentioned in the past, the comment was always made that poker machines were a small part of the business. Now Endeavour has got 12,500 poker machines almost and takes about $1.5 billion from gamblers. It's Australia's biggest poker machine operator. So are you going to apply an ESG lens to that investment or -- and dispose of that? So was 0 weighting like with Crown, Star and Tabcorp? Or are you looking to retain that? And also, what do you make of the Milton, Soul Patts merger? Is there any implications for AFIC from that? Because it's a strange deal to take out our second-biggest competitor in the pure LIC space. Has anyone ever proposed a similar merger with us?

Yes. So just on Endeavour, that was obviously spun out about a month ago from Woolworths as a stand-alone investment now. We have actually reduced our holding since it has been a stand-alone company, and it's not a business that we see long term for the challenges around the poker machines, as you mentioned.

So just on Milton and Soul. I mean, obviously, they have taken a view on that, probably scale is important, I guess, and you're getting a larger, more consolidated business. So I guess that's what they have chosen to do. I guess if you want to understand that strategy, I guess you can ask them that question. But it's -- well, we don't have any objective to take over other LICs. I've had this question in the press, too, because obviously, there's a little bit of activity going on in this sector, but we are pretty comfortable with the 4 companies we're running, and the reasons for having those 4, I think, are pretty clear. So we just need to keep focused on what we're trying to do, which is find great companies to investing for our shareholders rather than worrying about taking over LICs.

Okay. There are no further telephone questions at this stage. So I might hand...

I've still got quite a few on the webinar, so we'll get through some of these as well. So now one of the questions coming through is about looking at the top holdings we've seen live on in tech stocks. Given the current buy opportunities, is there a plan to increase tech stocks, given the recent advances in tech stock performance in the last 12 to 24 months?

Yes. Thanks. Geoff. As Dave highlighted earlier on, we own a bunch of technology companies, including REA, Carsales, Seek and Zero. We're also seeing a number of businesses come through in -- through the nursery in the tech area, but that's a fast-moving sector, and we are assessing these companies as they come through. So as time passes, I'd imagine we will be owning a larger proportion of tech-based businesses as that's the way businesses are evolving going forward.

Thanks, Nga. So one of the questions coming through, Dave, is we -- well, I think we did talk about some of the stocks that did unperforming in the portfolio. But what are we seeing about those, the nonperforming stocks in the portfolio? What were your, sort, of comment around that and the reasons for that?

Yes. Thanks, Geoff. So the underperformance in the portfolio have really been that those sectors or stocks that have been impacted by the rolling lockdown. So it's really companies within the travel space, and in that area, we hold Auckland Airport and Sydney Airport and also the energy companies, which Mark touched on earlier, which are really leveraged to mobility within economies. It's interesting, in both those sectors, really our ownership of those assets is really about strategic assets that we think hold good, long-term value, and interesting, only in the recent little while that we've seen a bid for Sydney Airport as well as the potential Santos Oil Search merger. So what's encouraging for us is if the equity market doesn't realize the full value of these companies, then someone else will.

Thanks, David. A couple of questions around dividends. So the question about what we're thinking would pay next year, which clearly [indiscernible]. But we might talk about what goes [indiscernible] dividend, Andrew, and how we consider that. The other question was around the -- in the context of the DRP discount that we provided. How did we come to the 3.5%? And another question around dividends is, have we ever thought about paying quarterly dividends?

So starting with the first question. What goes into the discussion, and it's a Board decision that they take each time, would be looking at what's been paid before, what we are currently earning, and that's the profit figure, and the level of realized gains that we've had. And the last element is what do we expect earnings to be in the short, and particular, the medium term. Those are all of the ingredients that go into the dividend recipe, I would say. And it's looked at each time, but we're very conscious, and John, the Board is very conscious of the importance of dividends to shareholders. With regard to the second question on the DRP discount...

Yes. Do you want to make a...

Yes.

Yes. It's one of these things that we take advice from the executives, but it's a Board decision. We kickstart with looking at where the share price is trading relative to the ASX backing, and at the moment, it's trading at quite a strong premium there. We try to set a position, which is fair to the people who are participating in the DRP in that we try not to have them paying too much out of the NTA, but also the people who aren't participating that we don't end up with a situation where they're being diluted. So the discussion this time around was it was going to be somewhere between 2.5% and 5%, and we felt the appropriate spot was broadly pretty close to the [indiscernible] range.

I'd also note that history tends to show that when AFIC, and this is past performance is no guarantee of future performance, as we often say, but in the past, what has often happened is when the stock goes ex dividend, the stock price falls by more than the dividend, normally the dividend and the franking credit. So we'll have to take that into account. And don't forget, we set that DRP price in the period that the stock goes ex, so not the current price. And with regard to the quarterly, something we have discussed before, it's a question of expectation. There is a cost involved in paying out a dividend. So it's -- we have to look at all of those things in tandem. I wouldn't say -- I'd never say never, but at the moment, it's not something I think we'll be rushing in to do, but certainly understand people's concerns about certainty of cash flow, particularly in these times.

For the other question, Andrew, associated with that, given the investment in some of the international stocks, how will it impact the, sort of, availability of franking for us in terms of the portfolio?

The investment would be -- obviously, it's 0.5% of the portfolio at the moment, so really very, very small. These stocks do tend to be lower yielding. So you wouldn't be getting a bunch of dividend. Don't forget, we do have to pay tax on the dividend income that we do receive from those stocks. We [ won't ] get a credit for any withholding tax. But despite COVID, there are still a few countries that have got a tax rate as high as 30% here, and of course, there will be capital gains tax that we need to pay on any disposals from that portfolio. So it's -- at the moment, at this level and even at future levels going up to the levels that we're envisaging, it will be a very small part of the portfolio and wouldn't have much impact on AFIC as a whole.

Thanks, Andrew. -- comment around Sydney Airport and potential acquisition? Dave?

Yes. So early days at this stage. So clearly, the bid has come through at a price of $8.25. Our own view around that is we think that this is a fantastic, strategic asset that still represents very good, long-term value, and no doubt, travel will return. We're not sure of the timing of that, but our expectation is certainly on the leisure side that we'll see travel returns to where it was, maybe less so on the business side. So we're supportive of the company or the Board's stance to reject the first bid that has come through since that's opportunistic at a time when travel has been particularly challenged.

So now a question back on the technology stock. I'm going throw these all to you. Comment around Zero. I mean, why do we hold Zero, given that Zero is obviously used quite extensively through small business, and they're the ones that have suffered the most, I guess, through these slowdown in terms of the pandemic.

Thanks, Geoff. Just on Zero, they tend to be larger, small businesses that use accounting software. So in terms of the exposure, the companies are a bit more resilient. JobKeeper has certainly helped, and there's an equivalent obviously, in the U.K., which is their other major growth market. Interestingly, small business formation accelerates out of a downturn, so they should benefit from that as we emerge out of COVID. So -- and then finally, Zero has continued to grow quite strongly, driving penetration of cloud accounting. So that is a real tailwind for the business.

Thanks, Nga. The questions come through on -- a couple of questions come through about investing in, I guess, sustainable energy production, those minerals that are used in sustainable or renewable energy, generation of renewable energy. Looking at the opportunities, what do you see there in terms of potential opportunities around lithium, nickel and copper?

Yes. Difficult when you think about our investment time horizon, really been a long-term investor in looking out over 10 years, our focus really is for Tier 1 low-cost operating mines, and it's really difficult in the lithium space to invest in companies that meet that criteria. So while our expectation is that demand will remain strong as demand for electric vehicles increases, it's really difficult with our investment focus to be able to get exposure to that into the portfolio.

Thanks, David. There's also a question around Brambles. What are our thoughts around Brambles?

Yes. So...

Also asked a question about ASX as well. The context is not the same. But a question around ASX is why don't we hold more, given its strong position in the market.

Sure. So on Brambles, look, it's been a long-term holding within the portfolio. We see the business set to deliver reasonable growth. So to be low single-digit growth is our expectation for that company. There are some inflation challenges for them at the moment within the U.S. market. So whether or not they're able to pass them on to their end customers will be the challenge going forward. We do like the management team. Their strategy is very focused on trying to reduce costs and to improve margins and cash flow out of that business. So Brambles remains a holding in the portfolio. And in ASX, similarly, we're expecting low single-digit growth from that business. We materially increased our holding throughout the year when the share price fell to around $70, and we're very confident long-term holders of that business going forward.

Thanks, David. This one is an interesting one. It's comparison of AFIC versus Djerriwarrh which is one of the other companies in which we operate, which we do operate. So how is the difference performance and different -- well, how is the performance different, I should say. And how has that been determined that AFIC has probably done a little bit better than Djerriwarrh over the last few years, particularly in terms of portfolio growth and share price growth?

Yes. Well, Djerriwarrh has much more of a focus on distributing the total returns that it makes in form of fully franked dividends to shareholders. So the longer-term total return numbers have been higher out of AFIC, but you've had a much higher yield out of Djerriwarrh. The 12-month figures for Djerriwarrh have been very good, and that was really on the back of a shift in strategy. I won't go into too much detail on that because that's really about Djerriwarrh, but we, sort of, perhaps have been writing too many calls in Djerriwarrh and it impacted our total return. We've shifted that policy now. So expect returns for Djerriwarrh to be better going forward. But as I said, Djerriwarrh is really targeting people who want to get a much greater proportion of their returns as franked dividends, but historically, AFIC had a higher total return when you include dividends and capital growth.

Thanks, Mark. A question around Hardie's and, I guess, the claims it has in terms of suitability for investment. Yes. What do you sort of comment around that?

Yes. So a long time ago, an agreement was reached with New South Wales government where 35% of the free cash flow of Hardie's was set aside to compensate [indiscernible] with the company still generating significant free cash flow. It's able to adequately meet its requirements under that facility, but also to continue to invest in growth in the business. So managing the growth in the manufacturing footprint as well as R&D that really has set itself apart from its competitors in having the best product in the market. So we feel the strong market position and the cash flow that this business generates a strong management team. We still recognize the long-term opportunity in front of the business as well as meeting all the liabilities.

Thanks, David. So a couple of questions here about Australia's relationship with China and iron ore prices and potential impact if there's further deterioration. If you have any comments around that, particularly in terms of the effects on the portfolio.

Look, there's probably not a lot we can say, that's out of our control, really. So clearly, the demand is still there from China, and Australia still have, I guess, the best quality ore at a very low cost. So while that situation's there, it suits our portfolios, have such high-quality assets there. I guess always a risk is now there are going to be alternate sources of supply to China over the long term, and I guess there is potential for that to occur out of Africa. But that's certainly years away, but that's probably something we look at pretty closely with those companies.

Thanks, Mark. Back to dividends, Andrew. We get this question on a regular basis in terms of coverage and earnings to support [ COVID ] and dividend payouts. Do you want to comment around that?

Looking at the notes to the account, at the end of the year before we paid the final dividend, we essentially had franking credit. Profits are an issuance solvency and not an issue. Franking credits would be a limiting factor with regards to the payment of any dividend. And at the end of the year, before payment of final dividend, we had $0.34 worth of franked dividend that we could pay. Now obviously, once one pays out the final dividend, that brings it down to 20, but that's before any franked dividends, profits, taxable realized gains this year or next year. So in the short to medium term, I'm comfortable with the reserves that we have. Obviously, we will have to take each year as it comes and see how long the downturn from COVID lasts in terms of company payout ratios and if there's any deterioration with it.

Thanks, Andrew. Myles], are there any further questions on the phone or...

No. No further telephone questions. [Operator Instructions]

Okay. I've got a few more here we'll go through. And just to remind everyone, if we don't get to the question through the webinar, we'll get back to you directly via your email in context to answer the questions as best we can. A couple of [ quick ] questions here. One is about the premium to NTA. And as John alluded to earlier on, we are trading quite a reasonable premium to NTA at the moment, and again, as Andrew pointed out, we tend to do that coming up to payment of the dividend. So -- or the record date for the dividend. So the [indiscernible] drop away a little bit with that, and I suspect also the consistency of dividend frank that AFIC provided over the last 2 years has also led to that premium. The second question, John, I'll hand to you around, this is, are we thinking about doing any capital raising where shareholders can participate. Giving us further money.

Dealing with those 2 questions. Historically. over time, we've traded varying times between about 8% or 10% above NTA and 8% or 10% below, usually when there's been some tax threat to dividends, et cetera. I think it's a function of the fact that it's a strong market. There are a lot of new investors who have come on [ as series ], and I think a lot of people like that as an initial way into share investing in Australia. So it's not something we would see as permanent. These things fluctuate, but it's a sign of support for our stock at this time. In terms of capital raisings, we're in the very comfortable position that with the scale we've got, we don't have to do capital raisings to reduce the management expense ratio. We've got a very low ratio already. So really, the times when we think we should raise capital are primarily when we think we can raise capital and utilize it in a very effective way in the marketplace. And I think at the moment, our position is that we're happy to raise capital through DRP or the DSSP, but with markets at fairly high prices, we're pretty much of the view that we're happy to just use our existing funds. If we get an opportunity like March last year, we'll use some borrowing facilities, but we don't think the market is that compelling that we should be raising more capital.

Okay. I might wrap it up with this question. There's no others on the phone. I guess the question becomes, what level of cash do we currently have and what do you think we would do in terms of that, if there was sort of market dislocation for the volatility going forward.

Sure. So the current cash balance is just under 2% of the portfolio. And for context, say, 6 months ago, that was around 1%, so that has been increasing over the last 6 months. We're looking for any volatility in share prices. We have a whole range of companies that we would like to own more of if the right price were to present, and if volatility does play out, we look to deploy the cash as and when those opportunities arise.

And as John mentioned, we do have access to debt facilities should we need to dip into those, for those purchasing opportunities.

Myles, is there any further questions on the phone?

No further telephone questions. No, sorry, we do have one. Sorry. Sorry.

Make it the last question. As a reminder, the webinar questions we haven't got to, we'll certainly answer directly via e-mail.

We've just got a quick follow-up question from Paul. I'll turn it over to Paul.

Look, when you talk of capital management, is it likely you'll trigger your share market buyback to reduce capital and possibly improve yield this year?

No. It's -- usually, I think we've only done it once or twice in the history of the company and only to a small degree, and it's only when the share price has traded at a significant discount to NTA. So it's not an environment we envisage, and even in those circumstances, it's usually in a bad market where there may be some very cheap opportunities to invest the money in stocks that we really like. So it's not -- while we've got the facility, it's not something we envisage we're likely to use in the foreseeable future. But look, we might finish up now. We thank you all for your participation. We've had a lot of shareholders interested. We'll obviously have the opportunity in 3 months' time at the AGM to give you another update, which will be, I think, very interesting when we see what companies are saying, particularly as they're traveling through the lockdown in half of this company and how that reflects in their comments. But thank you very much for attending, and we've sort of -- we think it's been a great opportunity to communicate with you. Thank you.

Ladies and gentlemen, that does conclude today's conference call. Once again, thank you all for participating today, but you may now all disconnect. Thank you.