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

Good morning, everyone, and welcome to the annual results webinar for the Spheria Emerging Companies Limited. My name is Chris Meyer. I'm part of the Listed Products team at Pinnacle. We are the distribution partner for Spheria Asset Management, the manager of the SEC portfolio. My role today is to emcee the webinar. We will take some questions at the end. [Operator Instructions] Joining me today is Jonathan Trollip, Chairman of SEC. Jonathan, if you want to just wave your hand, so we all know who you are. There he is. And Marcus Burns, Founder and Portfolio Manager of Spheria Asset Management. Marcus, if you want to do the same. There we go. Okay. So the order of play today is Jonathan will run through an update on the company and with a particular focus on the dividend, where we have some big and exciting news that we announced as part of the results. And Marcus will give us an update on the portfolio and how they see the Aussie small cap market. So again, we should take around about half an hour in total. Please feel free to ask your questions as we go along, and we'll probably get to them at the end. But you are welcome to put them in as soon as we get started. So Jonathan, with that, I will hand over to you to start the presentation.

Thank you very much, Chris, and thanks to the team, as always, for putting the presentation together. The agenda is there, and Chris has already run through that. So I'll do the company update, Marcus will do the portfolio, and then we'll seek to answer any questions you may have. This presentation was released to the ASX, so the numbers are there for you to look at it. Also, it follows pretty much what we announced with our results on the 24th of August. So turning to the first slide, you should have in front of you the full highlights for 2021. Suffice to say, it was an excellent year, an outstanding year. One swallow doesn't make a summer. I will deal with the specifics of the year. But I think it's opportune at this stage to note that when SEC listed in November 2017, it had a few objectives: preservation of capital was critical; and then to outperform the benchmark, which is the accumulation -- Small Caps Accumulation Index; and to provide a stream of fully franked dividends to shareholders. And it's gratifying that so far, we've achieved that objective. Past performance is obviously no necessary base for future performance, and there's no complacency, but it is, as I said, gratifying that we're currently in the position that we're in. So looking at those FY '2021 highlights, we had a net profit after tax of $40 million. There was a huge turnaround from 2020 financial year, which obviously was very adversely impacted by the market meltdown after [ COVID ] around February, March 2020. So it was a big turnaround. The NTA performance was 55%. I'll take you through a slide of that NTA in a second. We did declare a final dividend of $0.05. That takes the full year deal -- dividend up to $0.085, a yield of 3.5% on the share price as at 30 June 2021, which is $2.40. And that grosses up to 4.8% when one includes franking. We've announced a new dividend target, and I'll deal with that a little bit later. We had announced pre-2020 a buyback program to seek to address the discount to NTA. That did continue in FY '21, but not to the extent of the previous year, and that added $0.028 to the NTA on a per share basis. So just moving on to the NTA breakdown. This is a waterfall chart or a cascade chart which just shows what happened during the year. So we started at the beginning of July with a pretax NTA of $1.73. The main contributor by far to the increase in NTA was the portfolio performance, and that added $0.935. The buyback during the year added just $0.01. And then the cost that came off the NTA with a tax paid of about $0.10 company expenses at just under $0.01 per share and the dividend of $0.06 per share. So that got you to a pretax NTA as at 30 June of [ 60 ]. Moving on to the dividend stream. We -- as mentioned at the beginning, the intention has always been to pay fully franked dividends, subject to the usual caveats of sufficient profit reserves and franking credits and prudent business practice. The bar chart on the left shows our dividend history. We've paid a total of $0.24 so far. And the most recent dividend to be paid is the $0.05 dividend, which will be paid on 22nd of September. And the record date of that is today. So that shows the history of our dividends. We were conscious as a Board, and I guess with the support of the manager, that our dividend yield is relatively low compared to other LICs. So we announced with our results on the 24th of August that we're targeting a dividend yield going forward of 4% of NTA. On a posttax basis, that's 5.4% if one includes franking credits. And also that we'll be paying that dividend quarterly starting with the September 2021 quarter. So just to explain in practical terms what that means is at the end -- after the end of the September quarter, we'll know what the NTA is. Let's say, for argument's sake, it's similar to the NTA at the moment of $2.60. We will look to pay 1% of that. That would be $0.026 during the Q4 2021 quarter. Similarly, in January 2022, we'll look at the NTA as at 31 December 2021, and again pay a 1% dividend during that Q1 2022 calendar year. And if you look at that chart below, that shows the yield of various LICs in the domestic equity sector on the ASX. And you'll see that we've -- pre this announcement an increase to the right hand -- to the right-hand side, we're not in the top half. But after this dividend now being paid, we do move into the top half of dividend pays. So we think that, that is an important initiative. It seems that the combination of the performance of the manager, the buyback possibly, hopefully, better shareholder communications, and the dividend has led to a material decrease in our discount to NTA. And it's not about just under 3% of the posttax NTA at the recent level. And that's a great improvement and one the directors and the Board are very pleased about because when it was blowing out to about 15%, we were -- even 20%, we were extremely concerned. The final slide, which I put up before I hand over to Marcus, shows the SEC company performance over time. So if you look, you'll see that the last 6 months have been very impressive, the last year, even more impressive. And since inception, we -- the portfolio on an after-fees basis, so this is after the management of performance fees, has still outperformed the benchmark, and that is the intention we had when we started. So well done to the management team for that. And that seems a pretty good time to hand over to Marcus. So Marcus, over to you.

Thanks, Jonathan. Thank you for that. And it's my intention just to give investors in the company just some flavor on -- as to how we've seen in the market and I guess just put into context why the performance has been so strong and where it's come from. So this is the chart showing Spheria's performance since inception. And relative to the index, which is the Small Ordinaries Accumulation Index, which is the lighter color line, and then the green line is really the comment -- is really the relative performance of the SEC Limited postal fees compared to the benchmark. And you can see there that there was a period towards the end of -- just after COVID last year where the performance lagged a little bit, and that was a bit of an interesting phase where, frankly, the market was seeing a lot of -- this has returned to market, pumping back into fintech and highly liquid names. And some of the names we had that were sort of more value-based were left behind a little bit. But obviously, towards that end of last year, we saw a big recovery in that liquidity as it filtered down the marketplace. And we saw a resumption of a lot of M&A activity, followed by the IPO market reopening towards the end of 2020. And that's the combination of M&A activity, IPO market and just market being down looking for interesting opportunities saw portfolio significantly rerating. We're fairly busy during that period undertaking capital raising as well. When COVID was hitting pretty hard, we were supporting the companies who are raising money at discounted rates, and we're taking the portfolio to find -- take advantage of that and find interesting opportunities and good ideas that I think definitely saw us perform strongly, particularly within the last year and early part of 2021. In terms of the actual stock contribution and some of the names that contributed to that, you can see that there's a bias here to some of the names that we've taken over. So Mortgage Choice, I'll call that as being a particular -- particularly large contributor to that -- to the portfolio of the company over the last 12 months. That had lagged for a period of time and it's got bought up by Realestate.com.au at a very healthy premium to the share price at the time. And then we've seen general recovery in a lot names that were well oversold last year. So stocks like Seven West Media that were quite [indiscernible] last year that were undergoing an asset sale program earlier last year. And as we put on hold during COVID, they tore a massive resumption of cost cutting. The revenue recovered there, and they've sold a few assets that have definitely seen the business recover to much more factor levels. We're still think the stock is very cheap and offers good opportunities in medium-term. Corporate travel, which is obviously flights -- affected by the lack of flights, did a capital raise late last year which we went for and then bought a large business to add to the U.S. operations. That was very accretive to the operations long term, and they've done a great job cutting costs. So they're now back into operating profit. And we still think that business, despite the very strong recovery, is offering compelling opportunities for us and for our investors. And then you'll see a bit of exposure to the cyclical side there, Fletcher Building and GR Engineering, which have recovered very strongly. And then a couple of retail names like City Chic and Beacon Lighting, they really added to the performance over the last 12 months. On the negatives, we underweight stocks that don't make cash flows typically or we find very expensive. So names like Pilbara Minerals and Lynas Rare Earths, which are mining names that we found very expensive, we have not taken some of that or rallied those shares. We've [indiscernible] when we looked in last year, and we don't see any valuation opportunities there. So they have cost performance of the fund or the firm company on a relative basis over the last 12 months. And just to give investors some flavors to what we're seeing in the micro end and the small and the large cap end, you can see this is a chart showing performance from beginning of -- it doesn't really -- for some reason, there's a problem at the bottom of the chart a bit, from January 2019, it just charts the relative performance of smalls, micros and large caps. And really, I'd highlight there that from the midyear, which was the bottom market in late March of 2020, micros, which is the yellow line, to the smaller caps of the marketplace really got hit and then had a tremendous outperformance as investors have sought growth and liquidity has returned to marketplace. The small caps are the dark blue line there. They've performed better than the large caps. And the large caps have lagged a little bit since -- over that period of time. So it has been an interesting period where money has flown back into -- or being attracted back into the smaller end. A lot of that growth in micro caps in particular has been into names that we would consider quite speculative. A lot of them don't cash flows or material earnings to speak of but have rapidly growing, albeit fairly small top lines. The market has definitely put those names up to very high levels. What I can show on this chart is the bifurcation we're seeing in the marketplace, whereby some names are incredibly overvalued in our opinion or have attracted a lot of capital based on short-term growth but don't necessarily flow that through with great cash flows. And conversely, you're seeing a lot of talks in businesses that we consider very good opportunities long term. Although it performed pretty well once, there's still, we think, a lot of relative opportunity to invest in small to micro cap of the marketplace that -- and stocks have been left behind that incredible rally. And again, this chart here just shows you the number of names in the small cap space, small and micro cap space that trade on an EV to sales ratio over 10x. We've shown this chart before, but it does look very peaky to us. EV to sales above 10 is a very high multiple for most sort of established companies. Obviously, it's an incredibly attractive long-term business and might trade above that for a period of time. But they have 250 names in the small company space trading above that, is a very high number indeed, especially when you put it in the context of the entire market, going back 25 years in market history. It does seem, to us, like there's a lot of money flowing down into the parts of the market that don't make a lot of sense to us. What's hard to show in this chart, a bit like the last one with the micros and smalls, is just what businesses have been left behind and what opportunities there are. But whilst there are a lot of stocks that have had incredible reratings over that period of time, there's also a lot of stocks we're finding that have been left behind where, for some reason, investors haven't found them as -- necessarily as high growth, but do generate great cash flows, have attractive balance sheets. And it's -- those are names we're rotating the company to when we find compelling opportunities. And they're still [indiscernible] in that part of the marketplace. Just to put on a -- give you one example of the stock we own and we still think is very attractive, Monadelphous Group. And we can see 2 things that this -- this one for us -- on the left-hand side is a cash flow conversion chart, which shows the conversion between EBIT and free cash flow over time. 97% is an incredibly cash generative business. It has gone through a bit of margin compression over the last couple of years as the business has swung from engineering construction to maintenance, which is a lower-margin component of the business. But equally, that is a more reliable earnings stream than engineering construction. The stock had rallied very aggressively in the first half of this year and then came back on the back of people being conservative about inflation and their inability to pass on the costs in WA. We kind of view that as a bit of a temporary phenomenon, and we think that there will be an ability for these guys to pass on pricing, at least for new projects. And there's been a lot of claims put in against current clients where they're doing work and they've seen a material move in inflation on the labor side to recoup costs. On the right-hand side, you can see that EBIT -- so that multiple business is down at some -- just sub 9x EV now on the balance sheet's net cash. And we think [indiscernible] and Monadelphous are real well positioned to trade attractively through a very strong resources cycle and a CapEx cycle that's still pretty strong and not reflected in the share price of Monadelphous. And just to finish off, these are the top 10 holdings in the SEC at current levels as at the end of July. We've still got a fairly strong cyclical exposure to building materials, as you can see there. Acquisition of Healius, City Chic, Seven West, Flight Centre. And we see IRESS in there, which has also attracted a potential bid from EQT at the Nordic country. So there's another stock in there that we bought fairly recently that has attracted the attention of private equity. And as I said before, we are managing record [indiscernible] portfolio into fresh ideas further down in the list there that we think are attractive and offer good opportunity long term for investors. And just to conclude, it's been a recovery year for SEC from our point of view in terms of the stock market in general and the reliquification of stock markets. We found we've had a lot of the benefit of quite a few takeovers in the last 12 months, Village Roadshow, Asaleo. Mortgage Choice clearly had been -- has been a big help for us. And we see that M&A activity cycle likely to stay elevated while rates are low and Board confidence is pretty high. And we think we should reap the benefit of that. And then finally, the bifurcation of the market so that an incredible run in some parts of the market has left us trading well under levels that we think are attractive, and we think those areas are offering compelling opportunities for us despite the fact that we've had a pretty good run the last 12 or 18 months. And with that, I will hand back to Jonathan for some Q&A.

Okay. I'll probably take it from there. Thanks, Marcus. And there are a few questions coming in. And maybe while I have you, 2 questions to you. One is, as a business, Spheria Asset Management, it feels like you've stepped up your communication with retail investors this year. And I know you've got a new website. Do you want to talk a little bit about how you're communicating your messages out to retail investors?

Yes, sure. Thanks, Chris. That's definitely true. We have upgraded the website. It's going to be -- I mean it's refreshed brand image. The hope is to just continue to add transparency and clarity for what we're doing with investors' money. We've done that, obviously, with SEC in particular. There's a tab in the website that goes through and shows our monthly commentary there. We give top 10 disclosure. And then there'll be some webcast and some forecasts with Matt, myself and the other team members going through the philosophy of the firm, the opportunities we see in the marketplace and stock ideas to bring that process alive. And also, we focus to try and expand the coverage of analysts that have exposure to the marketplace as well. So we have people running articles in Livewire. So yes, the idea is just generally to give exposure to -- from marketplace to all the team members and hopefully how we're investing and what we're seeing in the marketplace.

And just to remind listeners, Spheria -- the website, spheria.com.au, is where you can find lots of information both on SEC as the company but also on, as Marcus said, other information that they're distributing about small caps and their view on the market. So there's lots of insights and news flow that you can find on that website. Marcus, just a question on the markets from [ Kate ], which is you -- there's obviously a lot of talk about lockdowns at the moment, particularly if you live in Melbourne and Sydney, as we do. When we came out of lockdown last year, there was a big sort of spike in demand, and the market's recovered pretty strongly. What is your expectation as we come out of lockdown this time? Is it going to be similar? Or is it going to be different?

Chris, look, I think it'll be similar and different in some ways. I think there's a real pent-up demand to spend money on services, so going out, travel, et cetera, as opposed to hard goods. So part of the reason that we're seeing problems with inflation and distribution of goods now is there's so much demand for goods because people can't spend money on services. So I think we will see a spike in services, travel, eating out, et cetera, accommodation being areas we think we'll see a major recovery in, depends on how big the lockdown -- how obviously -- how they're opening up when the economy pans and really whether it's -- whether you can travel domestically or internationally. But as it opens up, there'll be definitely a movement back towards services. And then obviously, what we don't have this time is JobKeeper to the extent we had last year. So there's a lot of money being rained down from governments last year that won't necessarily be repeated this time. I think there'll be some support for people, hopefully, but not necessarily as broadly as it was last year. So it won't be necessarily quite the same degree of money being spent, I suspect. But it will definitely shift from goods to services, we feel, as the economy reopens.

Okay. There's a question here again for you, Marcus, from [ Pete ]. I think you maybe want to refer back to the slide where you -- I can do that actually for you, where you talk about the performance, good performance, bad performance. I think it was Slide 9 so we'll just go back there. On the blank bar lines, the ones -- are these the stocks that you avoided or did not own? And can you talk a bit about mining stocks in that context? Yes.

Yes, yes. Sure. So the blue bar, the stocks are in the portfolio. Obviously, a positive line is a blue bar, the stock is owned and it's contributed. And negative is the stock that's been owned that's hurt in a relative basis. And then the ones that are blank are the unowned stocks. So Regis Resources, we didn't own, for example, last year, it made us relative money because it underperforms, it fell a long way last year. We didn't own that. ARB Corp., Virgin Money, MinRes, we didn't own, and they rallied and outperformed. So that hurt us on a relative basis. Same with Pilbara Minerals and Lynas Rare Earths. So yes, that's exactly right. We were -- we had a bigger exposure in mining services, and we did do mining stocks. Obviously, that was not necessarily the best call over the last 12 months. We've made up returns elsewhere. We've found it very hard to justify the lithium names or the rare-earth stocks, where we think there's a lot of hype built into the share prices currently. So we're not attracted to those even though we see a lot of demand for lithium as is everybody else. It's a very abundant mineral. And we feel there's a lot of supply coming on that will definitely keep the price -- keep a lid on prices even though there's a lot of demand for that. And that's not really factored into the share prices of all of these names. So interestingly enough, there's stocks in here that hurt us last year or that we've made relative money on and we're finding attractively valued now. So yes, Regis Resources, which has been underperforming aggressively, could be an opportunity for the fund or for the company. So we don't not look at resources. We do include them in our purview. They just have to have good balance sheets, good cash flows and the reason [indiscernible] for us to be attracted -- and a good valuation for us to be attracted to them.

Okay. Thanks, everyone, for all your questions. We'll get to a few more here. Maybe, Marcus, to give you a break, one for you, Jonathan, from [ Sandy ], which is the dividend change is welcome and a sort of a big move. How much of a factor was the strength of the company's balance sheet in the decision to pay more regular and a higher level of dividend?

I think when you talk about the balance sheet, Chris, or when [ Sandy ] talks about the balance sheet, I think it's the strength of our profit reserve. The key thing we had been conscious not to do is elevate dividend expectations and then find that we didn't have the profits to pay them. As a result of the performance last year, we have a very healthy profit reserve, and that's why we feel very comfortable doing 2 things, which is, one, increasing our dividend -- we preannounced that we're being paid on the 22nd of September; and two, committing -- when I [indiscernible], put it in commerce obviously with the usual caveats, committing to a 4% NTA dividend going forward. We've got the profit reserves even if we have a few down years and that the markets are going to go up, the markets are going to go down. We hope Marcus and the team continue to outperform. But nevertheless, we're not going to have a run like this in perpetuity. We do have sufficient profit reserves that we're comfortable that even in the downturn, we're going to be able to continue to pay that level of dividend for some time.

Okay, Marcus, maybe -- I see a final question coming in here for you from [ Simon ]. He asks, [ AllBright ] doesn't appear in your chart of -- I think maybe he means Adelaide Brighton. But let's say Adelaide Brighton doesn't appear in your chart of performers last year. Can you tell us if it made any meaningful contribution given it is a top 3 holding in the portfolio?

Yes. Yes, it's a good question. It is Adelaide Brighton, I think, that [ Simon's ] referring to. It didn't make a meaningful contribution to the return. It's sold off first half of the year on the back of a loss of loan contract, supplying Alcoa lime on the West Coast and lost that contract to importers. So its stock got sold off. It's since recovered pretty much all that and actually traded through that price. So it's recovered well, but it hasn't contributed necessarily massively to the performance of the company in the last 12 months. We feel it's still very attractively priced and well positioned. There's a lot of infrastructure spending coming down the pipeline from governments, housing cycles in full swing, as I'm sure everyone knows, with house prices stimulating demand for fresh building of property. And we think there's some opportunity for them to win back a bit of that volume in lime that they lost with Alcoa. And they're a second-tier supplier to them as a backup. So yes, we think that there's, yes, still modestly good opportunity for that business going forward. And hence, it's a pretty big weighing fund in the company. So...

Okay. Good. Well, that's it. I mean again, I encourage shareholders to visit the Spheria website where you will find lots of information on the portfolio and the company. We thank you for your time. Thank you to Marcus and Jonathan for your time as well today. A very insightful presentation. And thank you for your questions. That concludes our presentation this morning. We will, as Jonathan mentioned, come back to you early October with what the dividend will be for the September quarter. So that's the next sort of news event that shareholders can look forward to. So with that, I thank you for your time and attention. And Jonathan, I'm not sure if you want to make any concluding remarks.

Just thank you, Chris, and thank you, Marcus. Just 2 things. One, coming out of the questions, I think we will look at whether it's appropriate to put on the SEC company website some of the information, which is very -- the manager is putting out in the market generally. It seems that 1 or 2 shareholders may feel like we're not communicating as optimally with them as we could be. We take that feedback on board. We'll look at it and see whether it's appropriate to make any changes. And the other thing I would mention is just in our annual report, we do look at total shareholder return for the year and -- which is the change in share price from 1 July to 30 June of the following year. And it was an incredible performance. It was 92%. And that is in our annual report released. As I said, we don't expect that to continue, but it's been a great period. We very much hope that the good news does continue for shareholders. So thanks very much, everybody, for attending. Thank you.

Okay. Thank you all. Have a good day.

Thanks, everybody.