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

Hello, and welcome to the Australian Foundation Investment Company Full Year Financial Results briefing. [Operator Instructions] I would now like to hand the presentation over to Ms. Alison Gibson, Managing Director of AFIC. Please go ahead.

Thank you, and good afternoon. Welcome to this full year results briefing. I'm Alison Gibson, the CEO and Managing Director of the Australian Foundation Investment Company. I've just recently rejoined AFIC having spent the past 5 years at HESTA as portfolio manager, helping to establish the Australian equities team there. I say rejoined as I was a portfolio manager with the company from 2011 to 2021. I'm very excited to be back with the team here and look forward to speaking with shareholders over the coming months. Firstly, I'd like to begin by acknowledging the traditional owners and custodians from all the lands we are gathered on today and pay my respects to their elders, both past, present and emerging. I have joining me on the webinar today, Brett McNeill, Portfolio Manager for AFIC; Winston Chong, Assistant Portfolio Manager for AFIC; Andrew Sutherland, Portfolio Manager for International; Andrew Porter, our CFO; Matthew Rowe, our Company Secretary; Claire Aitchison, Head of Business Development and Investor Relations; and Suzanne Harding, Business Development Manager. This briefing is based on the material available on the company's website. The presentation slides will change automatically via the webcast. I'll now turn to the first slide, which is the disclaimer, which says we are here to talk about the company and not to provide individuals with any investment advice. Turning to Slide 3. This outlines who will be speaking this afternoon. I'll cover the key features of AFIC and then pass on to Andrew to talk about the results. Brett and Winston will cover markets, the portfolio and then the outlook. We'll circle back to question and answers after the formal presentation. You can ask a question via the webcast using the tab at the bottom of the screen. Turning now to Slide 5, the key features of AFIC. AFIC predominantly invests in Australian and New Zealand companies with a focus on quality, which means companies with a sustainable competitive advantage, attractive returns on capital, solid balance sheets and quality management. AFIC is one of the largest listed investment companies on the ASX with approximately 150,000 shareholders and an independent Board of Directors. Importantly, shareholders own the rights -- the management rights to the portfolio. The company operates at a low cost with no additional fees. We seek to be a long-term investor with low turnover, which is more tax effective for shareholders. AFIC has a long history of paying stable to growing fully franked dividends. The team manages 3 other funds: Djerriwarrh, Mirrabooka and AMCIL. Turning to Slide 6. AFIC's key investment objectives. These are to pay stable to growing ordinary dividends over time and to provide attractive total returns over the medium term. Moving on to Slide 7. A key objective of AFIC, as I said, is to provide stable to growing ordinary dividends over time. The amount of any ordinary dividend remains at the discretion of the Board and depends on the level of earnings and the amount of realized capital gains generated for the year as well as the balance of franking credits. Outlined in the chart is the long-term history of the dividends paid to shareholders. Over the long term, the company has delivered on its objective of paying stable to growing ordinary dividends irrespective of any special dividends that may have been paid. The Board considers special dividends to be the most appropriate way to distribute the franking credit reserve that has built up in recent years. Despite the recent payment of these special dividends, further generation of realized capital gains during the year means the franking credit balance remains strong. Directors will continue to consider further capital management initiatives for future financial years, taking into consideration the balance of franking credits and the generation of realized capital gains. We anticipate providing an update regarding any special dividends for financial year 2027 at the AGM in October this year. The final slide I will talk to is Slide 8. This speaks to AFIC's other objective of providing attractive total returns over the medium to long term. These figures include the benefit of franking. Over 25 years, the portfolio performance has been ahead of the index, notwithstanding performance has lagged more recently, which the team will discuss later in the presentation. Turning over to the next slide, and I'll hand over to Andrew Porter, our CFO.

Thank you, Alison, and good afternoon, ladies and gentlemen. So our usual results summary slide with some additions this year just to try and make it a bit more exciting. As you can see from the first box, our profit was up some $8.5 million on last year. There was an increase in dividends, including specials from ARB, BlueScope Steel and Wesfarmers, and a change in dividend timing from one of our larger holdings ALS. We also had a reduction in costs from last year, which included some changes in staffing and non-vesting of incentives. This impacts the MER, or management expense ratio, which was at 0.14% this year, down from 0.16%. So this is equivalent to $0.14 for every $100 invested. It's a ratio of the cost to the average portfolio value over the year. So although costs are a key determinant of the MER, obviously, and we do keep a close eye on them, the biggest factor in the MER itself is the portfolio and how it moves during the year. We're often asked what franking cover do we have for future dividends, so I thought that this year would actually include it in the presentation. So currently, after paying the final and special dividend, which, as you can see here, are set at $0.145 and $0.025, respectively, so $0.17 in total. We have sufficient franking credits to cover $0.55 per share of future dividends. As long as shareholders will know, and as Alison has shown on the previous chart, AFIC did not cut its dividend during the GFC or COVID when many others did. One of the benefits of the LIC structure is that we can keep reserves for a rainy day, which ETFs, which a trust cannot. So we do need to keep some franking credits in the tank for the next GFC or COVID. Having said that, $0.55 is a healthy number. And as Alison has previously mentioned, the Board will be looking at the best way to distribute any excess franking credits, and we'll have more to say on that at the AGM. The total portfolio was down from $10.5 billion to $9.8 billion, and I'll come on to that in the next slide, as we have been asked before, how come the return is flat for the year if the portfolio and the NTA is down. The dividend we talked about -- but I should also note that we've been actively buying shares back when it has been prudent to do so, which is the last box on here, some $243 million worth during the year. The Board will continue to keep this under review. So the next slide shows how the NTA has reduced. I should note that for the return figures, which we talk about, this includes dividends. It is what is called an accumulation return. The gross up return figures that we quote also include the franking credit on the dividends. So you can see here that although the portfolio fell in value, this was effectively covered by income. So the real fall in the NTA is mainly the dividends paid plus tax and expenses. So I hope that's clear for everybody. These slides will be available on the website. The next slide shows the history of premium to discount. I should note, and many shareholders are aware of this, we do show the premium to discount every month with the NTA. So we always try to remind shareholders and other investors to look at this. And that was 11% at the end of the year. The Board remained very conscious of the discount. And as previously discussed, we've increased our marketing activities, and Claire and Suzanne, both here, as a tribute to that. And the share buyback plan remains active. So with that, and I'm very happy to take questions, of course, at the end of the presentation, I'll hand over to Brett.

Thanks, Andrew, and good afternoon, everyone. So after joining the AFIC Group of companies nearly 7 years ago and being appointed as the Asset Portfolio Manager in October last year, it's great to be here today presenting my first full year results for AFIC. Now whilst the company continues to deliver on its dividend objective, as we've shown in some of the earlier slides, it was another tough year in terms of our total return, and we'll give some more detail about that on Slide 14. So starting with the 1-year number, which is AFIC's total return, including franking, and including all costs and taxes paid, that was 0.9% for the 12 months to 30th of June 2026. And that was clearly behind the total return of the broader share market as measured by the ASX 200, also including franking, and that was 7.2%. So the underperformance over the last year has now dragged down our longer-term performance numbers with our 3-, 5- and 10-year performance also behind our benchmark. On the left-hand side of this chart, though, we give a bit more detail on the 1-year number splitting it into first half and second half performance for the financial year. And as we can see, whilst it's a short time frame, performance has improved in the second half of financial year 2026, which has been encouraging. Slide 15 gives some more detail on what sectors have driven the performance of the broader share market over the last year. We show here the total returns not including franking this time of the ASX 200, which was 6% for the year to 30th of June 2026, alongside the key sectors of the share market. As we can see, the material sector was the key driver of market returns over financial year 2026, with very strong performance coming from the major miners, both BHP and Rio delivered a total return of 68% for the year. Gold and lithium stocks were also strong as were small and midsized resource companies. So the materials sector very strong and clearly the best performing sector within the market of 52%. Energy, consumer staples and utilities also performed well, and their performance was driven mostly by stocks such as Woodside, Ampol and Coles. At the other end, health care and information technology were the worst-performing sectors as stocks such as CSL, ResMed, Cochlear, WiseTech and Xero all delivered significant negative returns. So hopefully, that gives a bit more detail on portfolio and market returns as well as what sectors drove it. And I'll now pass over to Winston, and he's going to talk through the key stock drivers of our recent performance as well as key changes in the portfolio over the last year.

Thank you, Brett, and good afternoon. On Slide 16, I'll cover on some of the key drivers of portfolio performance at the individual stock level. Starting with the positive contributors, the strong resources market was a feature of the financial year '26, and our portfolio benefited from holdings in Rio Tinto and ALS, which were up 68% and 38%, respectively. Rio enjoyed resilient iron ore prices and a strong appreciation in the copper price supported by demand linked to the AI infrastructure build-out and electrification. ALS, which provides testing services to the life sciences and mining industries, contributed strongly to portfolio returns owing to the strength in its commodities testing business. Woolworths was another strong contributor as the company recovered from issues in the prior year. Improved sales trends and a sharper management focus on costs supported better earnings and a re-rating in the stock. CBA contributed positively in relative terms due to our underweight position. While the underlying business remains sound, the stock underperformed the broader market as it derated from an elevated valuation at the start of the year. Turning to the negative contributors on the right-hand side of the slide. CSL and ARB both declined significantly during the year following earnings downgrades. CSL was particularly disappointing with multiple earnings downgrades driven by competitive pressures, weaker vaccination rates and underperformance in Vifor. The company also announced CEO and CFO transitions during the year. And together, these factors resulted in a significant derating in the stock. ARB was also impacted by earnings downgrades, reflecting a softer domestic market and margin pressures, which similarly led to a sharp derating in its multiple. We retain holdings in both CSL and ARB, as we continue to regard them as quality businesses with attractive long-term prospects. However, while the valuations are now lower, we have not added meaningfully to either stock in the last 6 months, as we are waiting for clearer signs of improvement. The negative share price moves in ResMed and CAR Group stand in somewhat contrast from CSL and ARB. Both companies have consistently delivered strong earnings outcomes driven by growing penetration in their respective markets. The market concerns around longer-term disruption have weighed on valuations. For ResMed, that concern relates to the potential long-term impact of weight loss drugs on the obstructive sleep apnea market. For CAR Group, it relates to the possible effect of artificial intelligence and large language models on classified businesses. At this stage, we are monitoring these risks, but are observing limited evidence of impact to date. And we believe that current valuations more than reflect those concerns. As a result, we have been net buyers of both stocks during the year. More broadly, in managing the portfolio, we continue to look for opportunities to add to quality companies with good long-term prospects, where we believe the market is under-appreciating that outlook. We highlight some of this activity on the next slide, which we'll move to now. On the top left-hand side of the slide, you can see that we've added to Sigma during the year, the owner of the Chemist Warehouse franchise. Sigma is delivering exceptionally strong sales and earnings outcomes underpinned by growth in health and beauty categories and a store rollout. We added to our existing position at various points of weakness during the year, at what we regarded as attractive valuations relative to other consumer staples. We also added to portfolio stalwarts JB Hi-Fi and Woolworths at appealing valuations. In both cases, weaker share prices reflected issues we believe were more likely to be temporary than structural, creating attractive long-term buying opportunities. We also added to the position in Telstra during periods of share price weakness over the year. Telstra continues to offer an attractive and growing stream of fully franked dividends, supported by the strength of its mobile network position. The portfolio also increased positions in CAR Group and REA Group as artificial intelligence-related concerns drove significant weakness in classified stocks despite continued solid operating performance and limited evidence of the disruption to date. In addition, market concerns around artificial intelligence created opportunities to initiate new positions in software and technology names, including Pro Medicus, Life360 and Temple & Webster at more attractive valuations. To fund this activity, we trimmed positions where share prices have moved ahead of fundamentals. This included selected bank holdings, where valuations are looking expensive, particularly CBA, Westpac and NAB. In addition, we trimmed some of our resources and industrial-related exposures, where valuations have become stretched, including ALS and Wesfarmers, while our position in BHP also reduced due to option exercises. We also exited smaller positions in Sonic Healthcare, WiseTech and Worley, primarily reflecting a reduction in conviction in their long-term quality characteristics. And with that, I'll hand back to Brett for an overview of the portfolio.

Thanks, Winston. Slide 18 gives a snapshot of the AFIC portfolio as of the 30th of June 2026. Portfolio's total value of $9.8 billion was across 59 Australian and New Zealand listed stocks, and this amounted to a net tangible asset value of $7.93 per AFIC share. We also show here on the slide the top 25 holdings in the portfolio led by BHP, which is our largest holding, followed by Commonwealth Bank, Macquarie Group, Wesfarmers and Westpac. Overall, we feel that our key holdings are diversified across quality companies, and we've got a good balance between stocks owned primarily to income such as Transurban, Telstra and JB Hi-Fi, and also, those owned primarily for growth, including Goodman Group, ResMed and Fisher & Paykel Healthcare. Before we move to our outlook comments, we give an update on our international portfolio and strategy on Slide 19. Pleasingly, the portfolio has continued to generate value for AFIC shareholders since inception, but as we've previously announced, at this point, we aren't considering the listing of a separate international equities investment company. We believe the better option for now is to continue to invest in the international companies within AFIC, but to do it in a more concentrated and complementary style. So given that we show some of the key portfolio statistics here. We now own 19 stocks in the international equities portfolio, and that's led by the biggest holding, which is Schneider Electric as well as household names such as Amazon, Visa, Netflix and Microsoft. Overall, the international portfolio was worth $149 million at the end of the financial year, and that equates to 1.5% of the total asset portfolio value. So turning now to our outlook section, which begins on Slide 21. Firstly, just to note that this financial year 2026 was actually the fourth year in a row of positive returns to the Australian share market. And we think that's noteworthy and somewhat surprising really, given the shocks that have occurred to economies and markets over recent times from events, including the Trump tariffs last year and, of course, the current Middle East conflict. So with that backdrop, we show here 2 widely used valuation metrics for the Australian share market, the first being the price-to-earnings ratio, which is on the left-hand side of Slide 21. The Australian share market is currently valued at just over 17x forecast consensus earnings for the year ahead. And whilst this is below the recent high for the price-to-earnings ratio of 20x, it is still above the long-term average of 15.1x. In terms of the dividend yield, which we show on the right-hand side, the market only offers a forecast dividend yield at the moment of 3.7%, which is measured before franking credits. And that dividend yield is below the long-term average dividend yield to the Australian share market of 4.5%. So both of these valuation metrics indicate to us that overall, the broader Australian share market is what we call moderately expensive at current levels. Turning to Slide 22. So against this valuation backdrop, our focus remains on ensuring that the portfolio has the right balance across key sectors, such as resources, banks and consumer staples, which we expect will continue to generate a solid level of fully franked dividend income. And we continue to believe that owning a diversified portfolio of high-quality companies can continue to deliver the attractive dividends and capital growth and total returns that have been produced over the long term. And finally, just to reiterate our update and position on capital management, as Alison and Andrew mentioned earlier, our franking reserves remain very strong. And given these directives, we will continue to consider further capital management initiatives for future years, and we'll give an update on this at the Annual General Meeting in October 2026. And with that, I'll hand over to Claire, who is going to conduct the question-and-answer session.

Thanks for your questions everybody. We've had quite a few questions on the capital gains tax changes. So Andrew, could you maybe explain what impact will the changes to the capital tax settings have on LICs and maybe speaking more to traditional LICs?

Yes. Difficult to say at the moment, LICs require separate legislation. Now, treasury are aware of this, and we are part of an industry group that will be having discussions with treasury over the coming months, and we'll obviously keep shareholders informed when that legislation is issued. The original intention of the LIC legislation, which many shareholders may recall, was to keep shareholders in an LIC in the same position tax-wise as taxpayers who own shares directly or through a trust. So that will be the starting point of our discussions. In the meantime, nothing has changed, and the LIC gain paid with a final and special dividend, which is $0.10 of the $0.17, is paid out in the normal way, and shareholders will be able to put that through on their tax return in the normal way. And AFIC's policy has always been to pay those LIC gains out as and when they arise.

Okay. Thank you. We've also had a number of questions on dividends. Andrew, to you again, could you tell us how AFIC sets the ordinary and special dividend?

Yes. The ordinary dividend is obviously at the discretion of the Board. It depends on the level of earnings for the year and the forecast level of earnings. And earnings for this year were $0.235 and the ordinary dividend of $0.265. So added to that, we've got to have a look at the realized gains that we've had that we have in the year and the amount of franking credits. And then, the Board will look at all of that and say, okay, what can we reasonably expect to do in terms of the ordinary dividend keeping in mind our policy of paying a stable to growing ordinary dividend over time and how much should we be paying out now as special dividends. And as we've said, we'll have more to say on that in October at the AGM when we've had a chance to look at how this year is shaping up.

Thank you. And as a follow-up, we've also had a number of questions about the frequency of dividends. Would we consider paying quarterly dividends?

It's something that has been discussed, but not at the moment. Djerriwarrh is paying a quarterly dividend. And I suspect that's where many shareholders have both. There are different types of beast in terms of an income fund and what AFIC is. So we need to be conscious of the cost of paying a quarterly dividend, the dividend that we get in from the companies that we invest in and when they come in. So I never say never, but it's not something that's on the immediate agenda.

Okay. And just sticking with you for the meantime, you mentioned about the share buyback program earlier, what's the maximum number of shares that can be bought back under the program?

The maximum number of shares as per the Corporations Act Legislation, and Matthew can correct me if I get this wrong, is 10% of the issued capital. So that's the maximum event that can be bought back. A company can buy back more of that, but it would have to go to a meeting of shareholders to get approval for that. So at the moment, the buyback plan is within that -- well within that 10%.

Thank you. This one is for you, Brett. As we saw earlier, CSL was attractive for performance on a relative basis. Do we still have confidence in CSL?

Thanks, Claire. So I mean, I think the first thing to address is that it's been an incredibly disappointing and frustrating investment for us. It was previously one of the biggest stocks in the portfolio. We continue to hold the stock. But because of the decline in the share price, it slipped down to -- I think it was #12 in terms of the biggest holdings in the portfolio as of the end of the financial year. So how we're assessing the company at the moment, we do have confidence in the core business, so the bearing business because of what are really essential life-saving products that they produce there and its role in that industry. The part where we do lack confidence at the moment, and this is particularly when it comes to would we buy more are around the future strategy and the management. So CSL is in transition at the moment. It's got an interim CEO, and the Board is progressing a search for a more permanent CEO. So for us, given backing quality people is one of the hallmarks of our investment approach, it's very hard for us to buy more at the present time given the company's declining returns on capital when they don't have a permanent CEO. So for us, it's firmly in the turnaround camp at the moment. The share price has derated significantly. And so the valuation at the moment, we think, is undemanding. And overall, it justifies a hold in the portfolio. We're not prepared to give up on it down here, and noting that it has had a small, but albeit welcome bounce in the share price in recent months, our position at the moment is to hold and really wait for further signs, particularly on the CEO appointment and their strategy before we might have the confidence to buy some more.

Thank you. And we've got a question here about gold. And with the recent gold price correction, does this provide an opportunity for AFIC to add it to the portfolio?

Yes, it's a very timely question because we've never ruled it out. And clearly, we haven't owned gold over the last couple of years, which has been one of the contributors to the underperformance of the portfolio. So the lower total return versus the benchmark. Now, pleasingly, we didn't chase that gold -- the gold stocks up when the gold price went over $5,000 an ounce, but it has come back significantly recently. So we've had physical gold price fall almost since we -- a lot of us saw the headlines of the people queuing up to buy gold bullion in Martin Place, which coincidentally was about the top in the gold market. Since then, a lot of the heat seems to have come out of the market, both the physical gold price and the gold stocks have even underperformed that. So given we can see the benefits of investing in this almost a separate asset class in a sense over the long term, looking at it through our quality lens, there's quite a few companies that we think do meet our quality criteria. So we're looking for gold miners that own a well-diversified portfolio, high-quality, low-cost assets run by management teams that we can trust, and really importantly, are able to demonstrate disciplined capital allocation, which has arguably been missing from the sector at certain points in its history. We think a number of stocks line up on that now. So we're looking at it really closely and expect an update on that towards the end of the year, so at the AGM.

And Brett, sticking with you, can you talk to us a little bit about the use of mid- to small caps in the portfolio? And has that changed since you've come on board as a portfolio manager?

Yes, sure. It has, not in a material sense in terms of percentage of the portfolio, more so in terms of our strategy in this part of the market. So when we reviewed the performance of the portfolio, and we do that continuously, but I think you do it more after a period of underperformance because that's when you learn, I think, your greatest lessons. Our experience in small and mid-caps was a key focus there, and we really felt that the AFIC portfolio hadn't benefited to the extent that it should have from some of the team's best calls in the small and mid-cap part of the market. So to that end, we've changed the strategy in that, which is we want to have more of a dedicated portfolio of small and mid-cap companies within the asset portfolio. So whilst -- like I said, whilst the overall amount of small and mid-caps won't change materially, we think it will be spread across a greater number of stocks, so approximately 10 stocks. So we're not relying on trying to pick the best 1 or 2 small and mid-cap companies and to really get more involvement from the small and mid-cap experts within the investment team here. So the team acted on a lot of opportunities we saw in the market sell-off in February and March this year and added a number of names, and that was some of the stocks that Winston mentioned have been added to the portfolio. So we're very confident now about the strategy and expect it to deliver better results from this part of the market over the medium and long term.

Okay. Great. And just following on with the international portfolio. So at the end of June, it was about 1.5% of the AFIC portfolio. Is there any limit to what that portfolio size will be?

Yes. We haven't put a number on it yet other than we're really excited about the updated strategy. And clearly, we believe in this space because we want to persist with this strategy of investing in high-quality international companies despite not currently planning to list a separate international equities investment company. So we think with a more concentrated portfolio and really investing in the AFIC way and having a dedicated team within our broader investment team doing that, that over time, it can add more value to the AFIC portfolio. So whilst it would be natural to expect that the percentage of international equities will grow in the AFIC portfolio over time, we're not putting a number on it. We obviously like to do things slowly and carefully, and we'll see how it goes, but it could be a source of growth over time.

Okay. Great. Andrew, what actions are being taken to manage the discount to NTA?