Spheria Emerging Companies Limited (SEC) Earnings Call Transcript & Summary

Well, good morning, shareholders. It's 11:00 a.m., and I think we should get started. Welcome, everyone, on the call to the Spheria Emerging Companies FY 2021 Half Year Results Presentation. We'll refer quite a lot today to the company's SEC by its ASX ticker. My name is Amelia McKinnon, and I work in the Listed Products team at Pinnacle Investment Management. Pinnacle is an equity partner of Spheria Asset Management, the manager of the SEC portfolio. Pinnacle manages all marketing, sales distribution and Investor Relations on behalf of SEC shareholders, and I'm delighted to be the host of today's call. Today, we are joined by Jonathan Trollip, the Chairman of the company. Jonathan, if you wouldn't mind waving your hand? He's on the left of your screen.

Good morning.

Jonathan will provide an overview of the financial year-to-date, and he'll be followed by Marcus Burns, to the right of your screen, if you wouldn't mind us waving, Marcus, the Portfolio Manager and Co-Founder of Spheria Asset Management. Marcus will provide an overview of the company's portfolio and give us an update on how he sees the small-cap market. At the end, we'll take some questions from shareholders. [Operator Instructions] I'll also take this opportunity to mention that the presentation slides for today's presentation are also made available on this dashboard, together with other relevant links to learn more about the company. I will, of course, be flicking through today's presentation up on the screen for you to be able to follow. Presenters, if you could please just refer to the slides you're speaking to so that listeners can also follow who aren't watching the video. And if you aren't, please remember these slides also been made available on the ASX under the ticker, SEC, and on the company's website. So without further ado, I will hand over to the SEC Chairman, Jonathan Trollip. Jonathan, over to you.

Thank you very much, Amelia, for that introduction, and also to you and your team for organizing this on behalf of shareholders. And a very big welcome, and thank you to all shareholders who've logged in to this presentation. The Board is very keen and committed to engaging with shareholders. So we do thank you for participating in this. And also, on our website, you will see that we have information available. If you have any queries or have any suggestions on what we should be doing as a Board or a company, at any time, please feel free to reach out to us. Amelia, if you could just put up the agenda slide quickly, please. And really, as Amelia has already said, the format today is pretty simple, I'll give an update on the half year to 31st December 2020; Marcus Burns will then give you a portfolio update; and after that, there'll be opportunity for you to ask questions, which hopefully we will be able to answer. So if we could move to the next slide, which is the half year results, and it really has been a wonderful performance. It's a pleasure to be able to take shareholders through the results for the last 6 months. If you have that slide in front of you, you will see, going from left to right, that the half year profit was $25.6 million, and that's on basic funds under management of about $145 million. The company performance was 35.3%, and that outperformed the benchmark, which is the ASX accumulation ordinaries index by 15%. And I think it's relevant if shareholders can note here that the Spheria and the company provides its company performance figures on an after management and performance fee basis. There's a variation of practice throughout the LIC industry in Australia, I think it's fair to say, and a number of LICs present performance pre-fees, but this is after fees. So 15% outperformance for the 6-month period. Also, another metric that we use to measure performance, and you will see in our half yearly financial statements and also in the annual report, we also look at the total shareholder return over the period. And that very simply is the opening share price, the share price on 1 July 2020 and the closing share price on 31 December 2020, and you adjust it for dividends paid, which in our case is $0.025 dividend. And the return for shareholders over that period was an absolutely stellar, 50.8%. So it really was a very encouraging performance for that 6 months. During the period, we paid an interim dividend of 3 point -- sorry, 3 -- we haven't actually paid it, but the interim dividend of $0.035 fully franked has been declared in respect to that period, and I'll come to the dividend later, and that represents a dividend yield of 3.1%, which including franking, takes it to 4.2%, and that's based on the closing share price as of 31 December 2020. During the 6 months, we also embarked on -- or rather continued the share market buyback, and I'll come to that in more detail later, but that added $0.005 of NTA per share. And since the buyback started, the total amount added to 31 December is $0.028 per share. And Marcus will take you through the performance since 1 January 2020, but encouragingly, it has also continued in a very positive manner. So Amelia, if you could just go to the next slide, which I think is the dividend, if memory serves me correctly -- sorry, NTA breakdown. This slide shows to shareholders just the components of the movement in the NTA on a pretax basis from 1 July 2020 to 31 December 2020. So if you see on that slide, we started with the pretax NTA of $1.73. Most relevantly, the light blue bar that you will see there added $0.59 during the 6 months. So really, most extraordinary performance. There were some minor adjustments for tax provided. That's actually a positive. It looks a little counterintuitive, but it is that the company pays provisional tax as it goes. And because the year to 30 June 2020 was adversely affected by the market conditions in February and March, there was a slight overpayment of tax. So it's only $0.005, but that was retained from the tax losses. Company expenses were $0.003, dividends paid were $0.025 and as I mentioned, the buyback added $0.005. So that got us to our pretax NTA of $2.30. And as of 31 December, Marcus will update you, but as at announcement yesterday, it was $2.39. So if we could move now to the dividend slide, please, Amelia. That shows the dividends paid by the company since inception. And most relevantly, as I mentioned earlier, we have declared a dividend of $0.035 per share with an ex-dividend date of the 9th of March and a payment date of 24 March 2021. It's true to say that as a Board, we are very conscious that shareholders and LICs invest in part -- in significant part and expectations of a stream of steady dividends, and we're pleased that we've been able to deliver that. We're also cognizant of the need to balance the steady stream of dividends with keeping an appropriate reserve for uncertain market conditions. But we have announced previously that we intend to pay a dividend of at least $0.06 a year going forward if the performance continues as it has. Obviously, there are no guarantees we would hope to be able to increase that dividend. And encouragingly, if you look at that graph and you look at the dividend for March 2019, which is the second bar, and then again for March 2020 and March 2021, you will see that the interim dividend has been increasing in each of those years. So subject to market conditions and have been prudent and having profit reserves, we would like to be able to keep increasing our dividend return to shareholders. Amelia, if you could just move to the next slide, please. And I'd probably sound like a broken record, but we do have a discount to NTA in terms of our share price. It is a perennial issue. We are aware that we are not the only LIC in this position. I think it's very common across the Australian LIC market at the moment, especially with the small LICs. But we do grapple with what we can and should be doing to narrow this discount. The most important initiative we have embarked on in this area is the on-market share buyback. And since 1 July 2019, when we started with that, we've purchased approximately 9.3% of the company's shares and that's 6.17 million of shares. As mentioned, the buyback has added to the NTA. We bought back at an average price of $1.59 and at an average discount to NTA of $0.177 (sic) [ 17.7% ] and that's added a total of $0.03 per share to 24 February 2021. We've recently refreshed our dividend -- sorry, our buyback capacity for a further 1.5 million shares, which is 2.5% of the shares in issue, which would take the buyback in total to $0.116 -- 11.6% of shares on issue since 1 July 2019. So we see that as a central plank in the platform of what we're trying to do to close our NTA discount. The other initiative we'll -- method that we've embarked on is the dividend commitment. As you've seen from the previous slide, we've had a steady stream of dividends. We're committed to paying dividends of at least $0.06 a share. And we do hope very much that over time, particularly if the results of the last 6 months continue in any similar form, that shareholders will have the confidence that this is, in fact, a very good investment from them -- from both a dividend -- steady dividend point of view and from some capital growth opportunities. Shareholder engagement is very important. We realize that with every shareholder there, we would like to keep you on the register and keep you engaged, have you buying more, and we would like to attract new shareholders. So we put a lot of effort into providing you with updates and insights from both the company and the manager. And we've also moved partly in response to feedback from shareholders, actually, so thank you for that. But we've moved to daily NTAs in May 2020. And we also disclosed the portfolio's top 10 holdings and their weighting on a monthly basis. And we think that we're one of the few LICs to do both. And we're all aware of a number of initiatives in the market, both in Australia and elsewhere in terms of both LICs and their discounts. We continue to explore most of those. And if, as and when, we think that there are measures which are appropriate to this company, then we would implement them. So that's probably more than enough for me. And now, to the really interesting part of the presentation, I hand over to Marcus for his thing. Thank you.

Thanks, Jonathan. So on Page 7, thanks, Amelia. Just a quick summary of performance of the portfolio since the -- over the last 6 months and since inception. We kind of report performance here in 2 ways. First, on the top of the slide here, it just shows people, our investors, the returns of the portfolio as we manage at Spheria, and you see the different time frames, the returns there, and then the bottom chart there shows the company performance. So effectively, as an investor in the company, what you would -- the actual returns you are getting on sort of look-through basis before tax. And really, the difference there is simply the portfolio returns less fees. And unless -- so there's a relatively small overheads to the company. So it's a small decrement to the portfolio performance, but it's not a big discount. And I guess, the key summary, key takeout here is 2 things. Last year was really a sort of -- almost a game of 2 halves for us. The first half of last year was obviously challenged by COVID and the market was challenged by that. And so we had a number of stocks that got particularly badly impacted by COVID. Even though they're cash generating, we had exposure to some areas that got probably disproportionately impacted at the time, particularly in media and the tourism leisure stocks were the 2 areas that were pretty badly hit last year on a fairly temporary basis. And that caused a lot of share price disruptions. When we spoke last year into June, July, August, the team was flagging that there's a lot of stocks that were really, really good base, incredibly cheap. And we're quite pleased to see the rebound in the second half of last year. So that 6-month performance to the end of December really captures a lot of that upside. The team is quite busy with capital raisings during the year and moving portfolio around to find good opportunities but those 2 areas, particularly media and tourism leisure sector were very big contributors to the performance overall of the company. And I'll take you through a couple of examples of that a bit later on the presentation. Next slide. Thanks, Amelia. Graphically, this just shows the performance of the portfolio since inception against the index. And then the green line, sort of blue line is the performance of the portfolio. The light gray dotted line there is a smaller -- the accumulation index, which we benchmark against and it's on a post-fee basis. And then the green line is the relative performance of the SEC portfolio against the market. You can see that this rolled around a bit. Obviously, middle of last year was our most challenged relative performance, but it's grown back pretty hard since that period of time. Obviously, it's pleasingly for us and for all investors, I'm sure. Just a couple of comments on the sort of macro environment, the environment we're seeing, the small-cap investments on the next slide, thanks, Amelia, Page 9. And I showed this chart last time, and I think it's an interesting gauge of almost a Fear & Greed gauge, if you like. And what this chart summarizes is the number of stocks effectively in our investment universe, so in a market cap range of between $50 million and $3 billion. We currently have -- we have a sort of trailing EV, or enterprise value, to sales multiple over 10x. And that's considered historically been pretty high valuation per stock. Not many large companies trade on multiples like this. So what's interesting about that is, when you look at the last 20 years or so, the number of stocks trading on the kind of multiple is at all-time record highs. And since I last showed this graph, it's up another 50. So there's roughly 200-odd names. Last year, roughly a bit under 10% of marketplace. And since July, August of last year, top another 50. So there has been a very big speculative run at the bottom end of the market, particularly with stocks that don't make revenues or have very low revenues and in many cases don't have cash flows. The next slide, thanks, Amelia. And again, this kind of continues from the conversations we had last year, and I did a presentation on this. But effectively, what we're seeing is very bizarrely stocks have a negative operating cash flow. This is simply just screening the universe between the half of the universe that has positive cash flow, positive operating cash flow, not even after CapEx and comparing to negative operating cash flow businesses and just saying what the arithmetic average of our performance is over the last 12 months. And again, rather bizarrely, the negative operating cash flow companies materially outperformed positive operating cash flow companies. So if you just pull out the average positive cash flow, small-cap last year, you did a pretty decent return of 30%, 40% over the last 12 months, but you did far better by buying sort of money-losing or cash flow-losing businesses, which is fairly diverse. And over a very long period of time, [indiscernible] the next slide on Page 11. This is back testing of positive operating cash flow, negative operating cash flow businesses against the Small Ordinaries Index. Over the very long run, you can see that the weighing machine does outweigh the voting machine and some speculative runs and sort of interesting concept stocks. The stocks that lose cash flow tend to be kind of in the long run. And the dark gray line there is the positive operating cash flow stocks materially outperforming the index and obviously massively outperforming the negative operating cash flow. So it's a pretty unusual sort of circumstances we're dealing with from a macro point of view. And it's pleasing for us that the performance of the portfolio is still holding up pretty well and actually doing quite well despite the fact that we are, as investors know, investing purely in positive operating cash flow businesses with good balance sheets and supported by good valuations. On the next slide, let's take you through a couple of examples of stocks that have contributed to the portfolios in the company over the last 6 months. The first of those is a stock called Asaleo Care, which was -- basically a partly listed business of a company called Essity. Essity is a Swedish company that does a lot of paper products. They spun off the business about 6 years ago in Australia and went through some challenging times. To put it bluntly, they had a very high margin when the business floated, some cost pressures, and they were investing up in advertising promotion. Stock price struggled for many years. And then we looked at the stock again in the back end of 2019 when they sold up their paper business. They have a tissue business in Australia that sold toilet paper. It's a very low end, more commodity kind of product, which they divested and reduced a lot of the company gearing and the price to that. And so we started to go back and look at the core business remained. And as a pilot process, this is where -- whenever there's a material corporate transaction or the change in strategy direction, we go back and try to keep our mind fresh and look at the facts as they apply the business then. Stock was trading with a materially detailed balance sheet on much lower multiples. And yet, what was left behind post the sale was a significantly superior business with brand-leading businesses, much higher-margin company going forward and a management team that was looking to reinvest in advertising, promotion and drive business on to a much high quality and much more stable footing going forward. So we entered the position around about 1.5 years ago at about 10x EBIT. The business has performed very well since then under the new management team. And as I said, as I indicated materially at that period of time and that resulted in a bid being logged to the company by Essity. It was the majority shareholder. So Essity was kind of the parent company. They license some of the brands to Asaleo domestically. They had crept up to a 36% ownership of the company at that period of time, mainly due to buybacks. Asaleo was buying back the stock in the company and so shrinking the shares outstanding, driving up the ownership of Essity. They put in a lowball bid originally. It was trading around about $1 a share. So towards the end of last year, could be around $1.22, $1.23 initially -- sorry, $1.26 initially, and then subsequently came out with some -- a higher offer of $1.40 plus a $0.05 dividend once some pressure from a few shareholders was realized, and they paid a price, we think, was closely then the balance. So that was a good outcome for investors. And again, in a fairly low risk, cash generative, stable business that we thought was very unappreciated by the market at the time, especially post that investment of paper -- of the tissues. And on Page 13, thanks, Amelia. And this stock is relevant because, obviously, it went through a very challenging period last year. It's corporate travel management. So it provides travel services to corporates in Australia and through Asia and into Europe and to the U.S. And it's very -- you can see from that chart, we typically show to investors over time, we show the cash flow dynamics of these companies, where we started to look at the free cash flow and compared that to the earnings of the company to see how well they reconcile. You can see from that chart on the left. It's been a very cash flow positive business. And the reconciliation of earnings and cash flow has been incredibly good over time. Clearly, in 2020, with travel being effectively banned, especially international travel being very limited, corporate travel struggled massively last year and saw a dramatic fall in their revenue and obviously, their earnings. Fortunately, the management team is incredibly good at trimming costs back and reduce the cash burn to very, very low rates. And unlike several other stocks in the travel sector, it did not raise capital last year despite the fact that there was pressure from investors to raise capital. They had a good balance sheet and they trimmed that cost to very low level. So there was no need to actually raise capital during the end of the year of the marketplace, which means that they didn't dilute the shareholders materially. They did a deal around about September last year when they bought a large competitor of theirs out in the U.S. called Travel & Transport for $275 million at a material discount to what that business would have traded at going back a couple of years. So they bought a competitor, consolidated the industry in a foreign market at a great price. And when they did that deal, they also raised enough capital to both pay for that and provide a bit of additional capital to the balance sheet, giving it some more firepower, assuming that COVID issues took longer to recover. So the stock price has bounced well off the bottom. And we believe, especially with the revenue, the economy, is likely to trade very well looking forward. Obviously, the cost reductions are both -- at corporate travel have -- and actually cost base is much lower than what was previously. So if the revenue recovers to the levels we think, it will -- it's likely to do a medium-term. The earnings could be well in excess to what they reached previously. So that stock has been a very strong contributor to fund -- sorry, to the company over the last 6 months, 12 months. And as an example of the company where we've been finding during the dislocation in the marketplace. So just to finish my bit of the presentation on Page 14, we just outline the top 10 stocks as at the end of January. We're surely updating the marketplace with every performance and the holdings as they are to act in February. Suffice to say February has been a strong month for the company. We've outperformed the market again, and a lot of the stock I just flagged. Tourism leisure stocks and media have performed very well and continue to give the company good returns. So with that, I will hand it back to Jonathan and Amelia to open up for questions.

Thank you, Marcus. Amelia, over to you. Do we have any questions from anyone?

Indeed we do. Thank you, Jonathan, and thank you, gentlemen, for your prepared remarks. We have had a couple of questions in. [Operator Instructions] The first question, which is coming from Michael, is directed to Marcus. Marcus, what's the outlook for small-cap IPOs and equity issuance? And is there a sign of a bubble or some good opportunities there?

Thanks, Michael. Good question. Yes, both -- yes. So the outlook for IPOs is very positive in terms of the number of IPOs coming down. We've got a very quiet period where, obviously, first half of last year during COVID when no one was raising capital to a bit of a rush to get IPOs down towards the back end of last year. And that pipeline of IPOs remains pretty rich into the first part of this year, and I think is likely to remain pretty strong. You've got a number of kind of IPOs coming down. You've got the traditional sort of PE exits coming out. You've got so much entrepreneurs listing and selling down. We look through them and typically invest in probably 1 to 2 out of 10 of the IPOs we look at. So we are partaking in some of the IPOs as they come out, and we've been very judicious and selective and we like ones that have consistent histories rather than balled together for the IPO. Is there a bubble forming? Look, I mean, with super low interest rates and abundant liquidity drive by Central Banks, it's a very positive backdrop for equity markets and asset values, in general. And I think you can probably get it from the flavor of the comments around EV sales multiples and cash burning companies performing really well. But there are definitely parts of the market. They look to us to be showing speculative excess, and there are definitely areas we've been avoiding. But in the flip side of that, some of the other sectors of market have been a little bit behind, and we're finding still actually pretty good opportunities in the part of the market we play in, and we are moderately -- we are pretty constructive on the market and our best opportunities at the moment.

Thank you, Marcus. A couple more questions that have come in. And a second one from Graham. Thank you, Graham, for your question. Graham's asked, you mentioned that corporate travel management is a large contributor to current performance but doesn't sit in your top 10 holdings. Are you able to shed some light on this?

Yes, sure. It's been -- so we've probably trimmed back a little bit. I mean stocks more than doubled over the last 6 months or so. So even to [indiscernible] 200 basis points of relative performance, we've traded out a little bit of the position because it's really pretty high. So just an example of the cash generating business with a good balance sheet, good management team and obviously, a short-term level, but a long-term positive outlook and dislocated by market dynamics, including COVID and people's fear and one that we've bought into. So it's probably just as how our top 10 marketing, 11 in terms of holding. It would be roughly 2.5% of the company at the moment. So we have trimmed back to position a bit in the last month or so.

Thank you, Marcus. And just one last question before we wrap up today's session. This question is directed at you, Jonathan. What factors does the Board consider when setting the levels of dividends for SEC?

The factors we consider are threefold, really. One is we need to have a sufficient profit reserve, and that's not negotiable. And we have that, we have a very healthy profit reserve. We also look at the franking balance that we have. And ironically, although we've got a very healthy profit reserve, the franking account balance hasn't quite caught up with that because, as I mentioned earlier, in -- as to 30 June 2020, the performance was not that's been in the last 6 months. We haven't paid tax on the performance in the last 6 months and we haven't generated the franking credits. So those are the 2 main factors. The third factor we obviously consider is the objectives stated in the prospectus and consistency repeated of seeking to provide a steady stream of fully franked dividends to shareholders. So we weigh up what we think we can afford, keeping reserve. And within that, try to maximize the return being sensibly prudent, we believe, in setting those level of dividends for shareholders.

Thank you very much, Jonathan. And look, we are out of time today. So just a big thank you to all shareholders for dialing in. Just to remind you that a replay of today's presentation will be made available on the company website. And thank you Spheria Asset Management and Jonathan for your time today. Should you have any questions on the back of today's presentation, please do not hesitate to reach out to the company using the Contact Us button found on the dashboard. Thank you.

Thank you.