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

Good morning everyone and welcome to the Spheria Emerging Companies Limited 2021 Annual General Meeting. Thank you for joining us today. My name is Jonathan Trollip, and I'm Chair of the company, and I'm chairing today's meeting. Before we begin with the business of the meeting, I'd like to introduce my fellow Board members, here in person, Lorraine Berends; and on the screen, we have Adrian Whittingham and Matt Booker. We may also have Alex Ihlenfeldt who's an Alternate Director. Calvin Kwok, the Company Secretary, is present here as well. And we also have the company's auditor, Scott Whiddett from Pitcher Partners, very keen to answer any questions on the financial statements. I'm being informed by the Company Secretary that we have a quorum and I now declare the meeting open. I'm advised there are no apologies received prior to the meeting. I'll now turn to the agenda for today's meeting. It's pretty simple and straightforward and follows the format of previous years. I'll give an address, which will give an overview of the company's performance. I will then move to the formal business, which is the matters to be considered by the -- by shareholders and the resolutions to be considered. Matt Booker will then provide an investment update, and then Matt and I will be available to answer any questions shareholders may have either on the company itself or on the investment portfolio and the performance. So moving now to the Chairman's address. I'll provide this overview as a reminder to long-standing shareholders and also as a welcome to our new shareholders. As shareholders may be aware, Spheria Emerging Companies or SEC as the ASX ticker was established in December 2017 to provide shareholders with exposure to an actively managed Australian and New Zealand small-cap portfolio. So it listed on 5% of 2017, it had -- having 32 million of assets at listing. It now has, as at 31 October 2021, $163 million of net assets. So there's been accretion of net assets. And bear in mind that during that time, we've also had a buyback which has reduced the assets and we've been paying dividends. And I'll come to the dividend [ pennies ] a little bit later. As you're aware, the manager of the investment portfolio is Spheria Asset Management Limited. Matt will speak later today on his investment presentation. In summary, the management considers free cash flow, guides valuations in the medium to long term, and that risk assessment is a very critical overlay. And so the manager seeks to identify companies where the future value of cash flows can be recently ascertained and the companies are assessed to be trading at a discount to their intrinsic value. And that strategy has played out extremely well over the investment cycle that we had for the full year since we listed. We'll go through the performance figures shortly, but I'd like to inform shareholders that they're not aware that the team at Spheria was recently awarded the Australian Small Cap Manager of the Year by Zenith, and that's a very prestigious award from a preeminent research firm and a really well-deserved accolade. Matt and the team really acknowledge your efforts on that front. Moving to the investment objectives of the company. It's pretty simple. It was set out in the prospectus in 2017 and it's pretty pleasing to see that those objectives have been achieved. The first is to outperform the benchmark, which is the S&P/ASX Ordinaries Accumulation Index over the investment cycle, which, again, we've always said is typically 3 to 5 years. So from December 2017 to December 2021 as of -- [ when it's there ] will be full year, so we're right in the middle of that typical investment cycle. And provide capital growth, which we have done when you look at the share price of $2.69 as opposed to a listing price of $2; and income, which we've been provided by where it was so a stream of fully franked dividends which are paid to shareholders. So moving to the company structure, the Board of Directors. Taking you through and introducing the Directors, myself and Lorraine Berends are the Independent Directors. Adrian has been a director since inception, is now retiring; and Alex has been his alternate. And we're delighted that Matt Booker has agreed to join the Board. He's up for reelection later in the formal part of the meeting. But I think it's really important in my experience for a listed investment company, very valuable to have a manager on the Board. So Matt, a very warm welcome to you. And also thanks -- very sincere thanks to Adrian and Alex for your services since inception. Looking at the company itself. On the right-hand side of that slide, you will see the 60 million shares -- the share price of $2.60. That was as at 31 October 2021. And coincidentally, that was the same closing price last night, $2.60; and market cap of $156 million. The pretax NTA, as shown on that as 31 October was $2.71. It's dropped marginally as of -- the latest announcement is $2.69 as of the most recent announcement that we made a few days ago. It is very pleasing to see that the discount, the share price to the NTA has -- sorry, the NTA to the share price has narrowed. In the dark days of March, April 2020 when the coronavirus hits and the small-cap sector was under huge pressure, generally, the discount was as wide as well over 20%. And now we're at the stage where it's almost line ball with the pretax NTA, $2.69 versus $2.60. And on the post-tax NTA, slightly ahead, there's a very small premium. So that's a terrific outcome. And I think it's really a reflection primarily the performance of the manager in -- and the outstanding performance which the manager has delivered for shareholders. I think also the fact that we've moved to quarterly dividends is a help. And I think the clinical team that are here in the boardroom today, their shareholder communications have also been a material factor in narrowing that discount. So if we can move now to the dividends section on there. You'll see that that's the history of the dividends that we paid. We declared an FY '21 annual dividend of $0.085. That's an increase of 55% on the FY '20 annual dividend, which is $0.055. And it is in recognition of the strong profit for the year and it's pleasing that shareholders have been able to be awarded and benefit from the overall very strong portfolio performance. We announced recently a target dividend yield of 4% of NTA, and that's 5.4% of your gross for franking credits to be paid quarterly for FY 2022, and we paid our first dividend of that on the 29th of October 2021. The total dividends paid since the IPO had been $0.265. And I'm also pleased to announce that we expect to commence for the March 2022 dividend, a dividend reinvestment plan, and we'll provide more information on that to shareholders in due course. Looking at the company's performance, again, very strong. We've outperformed the benchmark. If you look at those figures, the company performance, which is the top line, is importantly after the management fee. And you'll see that since inception, the company has provided a return annualized at 12.6%. The benchmark at that time is 9.8%. So the difference is a very impressive 2.9%. The total shareholder return performance, that's another metric that we use to keep shareholders informed how their investment in SEC is progressing is 10.8% annualized from the listing date to 31 October, and that's based on the opening share price, the closing share price at 31 October 2021, and then accounting for the dividends which have been paid. So 10.8% annualized return, I think, is extremely impressive. And as I mentioned, the NTA discount has narrowed and a very small discount to pretax NTA and a very small premium to post-tax NTA. So the financial metrics are very encouraging as a Board. It makes our job pretty easy, I think, so long it may continue. So I'll now move to the next slide, which is the formal business. So that concludes my presentation as Chairman, updating you on the company. And obviously, as I mentioned, Matt will be giving you his investment overview after we've concluded the formal business, and we're then available for questions. There are 3 matters to be attended to today, which is the tabling of the 2021 financial statements, then the adoption of the remuneration report, and then the election of Matt Booker as Director. I just will run through some formalities in terms of voting and questions. [Operator Instructions] In terms of voting, persons entitled to vote are shareholders, representatives and attorneys of shareholders and proxy holders. As noted in the Notice of Meeting, resolutions will be decided by a poll, which I now declare open. To vote online, you must be logged into Automic's investor portal and detailed instructions in this are on the Notice of Meeting. When I put the resolutions to the meeting, it's pretty simple, just to cast your vote, you select either for, against or abstain. And there are voting exclusions applicable to the resolution relating to the adoption of the remuneration report, obviously key management personnel, they're excluded. These are detailed in the Notice of Meeting. And I confirm that all open proxies directed to me as Chair will be voted in favor of the relevant resolution. All proxies received have been recorded, and these will be reported to the ASX after the meeting. We'll also display on the screen the proxies received so far in terms of voting for each resolution. So moving now to the first item of business, and that's the financial statements for the year ending 30 June 2021. That encompasses the directors' report and the auditor's report that's been made available to shareholders. No vote is required. But if anybody has any questions in relation to the financial statements, the auditor's report, the intents of the auditors or the accounting policies, please submit them now. There might be a little bit of a delay. So I'll allow a few seconds to see if we have any questions. And then if not, we'll move on to the next matter.

No questions.

No questions? Okay. We'll move on to the resolution for the adoption of the remuneration report. And that's -- that does require a vote and that the remuneration report of the company for the financial year ended 30 June 2021 be adopted. Shareholders will be familiar that this is a statutory requirement. And if you get a vote of 25% against, if you get a strike against you -- as set out in the financial statements. So the remuneration report is part of the financial statements. Are there any questions in relation to this resolution? Calvin, any questions? If we could just show the proxies on the screen. Those -- that looks pretty healthy, 93% in favor, 6% against. So that should pass. All right, please cast your vote on this resolution if you're voting online. The second and final resolution is the reelection of Matt Booker. He was appointed to the Board to fill a casual vacancy in -- earlier this year. And he's obliged to retire for himself after reelection, which is exactly what he's doing. Matt, I think, without notice, but would you like to say a few words about yourself before I put this resolution to shareholders to vote?

Of course. So I've had 25 years in the industry, 16 years running small company funds, and at the last 6 years as Co-Founder at Spheria Asset Management. We're obviously a specialist in the small company investment, something I have a passion for. And I'm looking forward to the role as Director on SEC. I think it's an exciting time in the markets as there's a lot of opportunity. And I think there's a lot of success going forward.

Thank you very much, Matt. And if we could now look at the proxies and see how your reelection chances are looking.

Looking good.

Pretty healthy. 99.53% and not a single person against it.

0 against, I have never seen that before, Matt.

I've never seen it either. You must be an outstanding candidate. So thank you.

Thank you so much. Thanks for the support. Hopefully, it continues.

I'll formally put that resolution to the meeting as well. Okay. Please, can shareholders ensure that you've voted on those 2 resolutions? And please press confirm once you've done so. Okay. I now declare the poll closed. The results of the poll will be announced to the ASX as soon as they are available. And so that concludes the formal business of the meeting. And Matt, back to you for an investment overview and update.

Excellent. Yes. So I titled this Fundamental Investing Shines Through. And I think you've seen that in the past 12 months or so, we've had a stellar performance period. The market was obviously very inefficient last year when COVID hit. And coming out of the COVID lockdowns, et cetera, there was a lot of inefficiency, which we prayed on. And you've seen that come through in the performance numbers. If we go to the next slide. So just a bit of background. I think we all know that SEC is -- we're using that to emulate our smaller companies fund. How we invest is we look for cash-generative companies, and we overlay that with a lot of industry analysis, company meetings, fundamental assessment of the business and where that business is headed in the industry. And at the end of the day, we try and forecast cash flows. Why we forecast cash flows is we try and derive valuations, and we believe valuation is important. I think that sort of mindset has been lost for a while, but we believe it will play through, and you've seen that more recently in our numbers. I think you're going to see -- continue to see that going forward because there's a lot of companies that will never generate cash flow. We will never buy them, and they've got huge valuations out there. So those sort of companies, we avoid. We take -- we're a concentrated fund. We currently own around 40 stocks. It can wax and wane a bit depending on what the opportunity set is. But we do try and have high conviction with sizable-type positions in stocks, and you see that reflected in our portfolio. The good thing about the product is we do pay -- or we were paying distributions every 6 months and now they're every quarter. And I think that quarterly payment is actually quite attractive. I know that it is meaningful to me to see that dividend every quarter. And I guess it reflects the portfolio as well. The portfolio, the companies pay dividends and they generate cash. So invariably, you get cash flow and dividends coming from the companies, and you see that in the list of company that we have. If we move on to the next slide. Here's the performance. Particularly over the last 12, 18 months, you've seen strong performance. Before that, it was challenging. I'm not sure why, but we did kind of mirror the index, and that's pretty hard to do when you only own 40 or 50 stocks, but somehow we did that. Obviously, the downturn was very difficult early last year. But as I said before, we've had a huge run out of that. And I think that will continue. There's not -- it's not as inefficient as it was, but there's definitely pockets of inefficiency in the market and particularly the small cap end. And that's where we really -- that's where we really find [ alpha ], I guess, is searching amongst those companies that sometimes that have been discarded or sometimes just people just don't see through the noise. And there's lots of noise in the small cap market. There's lots of noise in the markets generally. We try and be objective and focus on the numbers and focus on the company and its position within the industry. So we think there's good performance to come in the small cap space, particularly with a fundamental-faced investor like ourselves. If we move forward to the next slide. Just in terms of process, just to give you some background of how we invest. You can see that this is Michael Hill Jewellers, and you probably know Michael Hill. It's been around for 40-odd years. More recently, I guess through 2016 through 2020, the company really struggled. It had a management team that is basically mis-executing. Profitability was volatile, was heading down. What you saw in 2020 -- or 2019, 2020 was a reinvigoration of the franchise. And what they did is they brought a new management team in, someone we know really well, Daniel Bracken, who was at City Chic before, which was called Specialty Fashion. He restructured that business. It's a company that we made a lot of money out of, City Chic. We still own it in the portfolio, not to the degree we had before. But Daniel really put in place the building blocks to turn around that business and create City Chic, which is now a $1.5 billion business. I think we bought it when it was $60 million and is doing the same at Michael Hill now. He's optimized the business, restructured it. And what you saw in 2021 was actually a record year despite all the lockdowns across its geographic locations, Canada, New Zealand and Australia, the company has actually had a record year in 2021 and delivered $70 million of cash flow and $70 million of EBIT. So it's an unbelievable turnaround given the backdrop that they are managing through. And we think there's more coming. The stock is cheap. It's trading at about 4 or 5x earnings, which is incredible, as we think there's significant upside within the current locations they're operating in from store optimization, from selling more product online, from just making this business better than it was. And we think there's huge upside in the business still and yet the multiple just does not reflect that. If you look at the company and the balance sheet, it's got $70 million of cash. It's never had this much cash. It's never earned this much money, and yet the share price is still well below previous market highs, which set in 2016. So we're very excited by this type of company. And it's one of a number of opportunities that we're seeing out there in the market at the moment. So it's quite exciting to actually have this opportunity to invest money at this point in time. We move to the next slide. Just looking at the portfolio just to give you an idea of how diverse it is. You can see some of the names there. I think most would be well known. Some may not be well known, but they're software companies that are critical to everyday needs and requirements or for companies or just to keep the economy going. And you can see there's concentration there, but there's breadth in name and industry. And that's what we look for. We're looking for a diversified portfolio. And I think we get that -- those sort of characteristics, and you can see that reflected in our top 10. We're not out there hunting speculative companies. Each of these companies has a track record of delivering cash. And sometimes, they're going through transition periods because there's a new management team or there's a change in industry structure or there's a backdrop which has been negative, and we found an opportunity to invest in it. For example, if you look at Vista Group, it's an ERP software provider. You've probably never heard of it, but pretty much every cinema in the world runs off Vista Group's software. And obviously, the cinema market has been through a challenging period with lockdowns and COVID, et cetera. But we believe there will be a mean reversion in that industry, and Vista is a key player in that market. Well, it is the key player in that software market. So eventually, it will recover the lost ground. The stock still trades at about half of where it was trading prior to COVID. So it just gives you some idea of what we're finding out there still. We move to the next slide, please. So just on outlook, I think we said at last year's AGM, there is a shift from speculation to valuation that did occur. We think it's going to continue to occur, and we think traditional fundamental investors like us will benefit from that. I don't think the market going forward is going to be the one we've seen in the past, and the one in the past has been very concept-driven, has been very speculative-driven. I think this is going -- I think you're going to see a significant change in the environment. And I think one of the reasons for that is you're seeing inflationary pressure. I don't think it's transient. I think it's here to stay for a while. And interest rates, I believe, which is structurally and cyclically low, will start to head higher, and that's going to drive some differentiation and some change in investment behavior. So I think there's some big change coming through to the market, and I think we're going to benefit from that. I think business models that are self -- that are not self-funded -- so they rely on capital markets to survive. So these are the kind of concepts, speculative stocks. I think those capital markets are going to tighten up. So it's going to get more difficult. These companies are going to find it harder to get funding. And I think you want to steer clear of those sort of companies. So we will continue to exploit the market inefficiency. We're seeing that. We use traditional measures and traditional-type investing, and we'll continue to apply that in a disciplined manner and continue to find, I think, good opportunities in the market despite the backdrop changing. I think, like I said, it's going to be a much more difficult environment. I think first order, investors are going to really struggle going forward. I think you really need to dig beneath the numbers and be objective and really use valuations to underpin every decision you make going forward. So I think the prospects are quite good for us, but it is going to be a much more difficult market overall. And I'll move to the next slide. Any questions from the floor?

Yes. Thanks very much, Matt. We have a burning question on the left here.

Matt, I was really interested in the top 10 stocks. There are 2 travel stocks, Corporate Travel and Flight Centre. And maybe just an idea of how long you've had those in the portfolio and whether they're bouncing around much at the moment.

They are bouncing around a lot, Lorraine, particularly over the last few days. So we try not to get caught up in all the noise. We try and focus on the long term. It's not easy sometimes because -- it's been a pretty wild ride, particularly in the last 18 months or so. What we've seen -- when did we invest, I guess, in these companies? Flight Centre, we had a small investment in a couple of years ago. When COVID hit and the lockdowns hit, we basically increased our holding substantially, and that was mostly through a capital raising. So the company did a raising at $7, I think it was $7.50 at the bottom of that sort of first lockdown. And so we took quite a large position in that. We have traded around the edges a bit on that, but we've maintained a core position. We've increased it lately because we think that particularly with vaccine rates, et cetera, have been high. I think you're going to see a return to a more normal environment, and travel will benefit from that. So I think despite all the media headlines, et cetera, I think travel as a whole will normalize. And therefore, Flight Centre will benefit from that. What they've done during this period is they've addressed their cost base. They are running 2 big store network. And if you went to any Westfield, you would have seen 3 Flight Centres in a Westfield or 2 to 3. They've ripped out 2 of them. They've kept 1 of them. So they've really streamlined their leisure -- the leisure side of their business. And we think the business will benefit from that cost out going forward. It's not well known that Flight Centre actually didn't make much money out of leisure. It made [indiscernible] basically pre COVID. So it needed to go through this process of streamlining. And I think COVID has actually brought forward some good change for the business. Where Flight Centre did make a lot of money was actually on the corporate side found in one of the largest corporate travel businesses in the world. So we expect corporate travel to bounce back pretty quickly. And you're already seeing that with Flight Centre. So that core business of corporate travel has bounced back, and we believe the leisure business will be in a much better state post the cost remediation they've gone through. So we're quite bullish on Flight Centre. They've got plenty of cash. They've raised a lot of money. We think we're coming out of the worst of it now. In terms of other travel exposures, we do own Corporate Travel. We bought that pretty much in the downturn. So we started buying, I think, at $12, and we brought it down to about $5. It's now trading at, I think, in the 20s. And what you've seen, as I discussed before, is that Corporate Travel has actually -- Corporate Travel spend has actually bounced back first. And Corporate Travel, it's got a good balance sheet. It's got a good geographic spread. It's seeing a really big pickup in North America and Europe. Europe obviously could be a bit sidelines now. But we think that the long-term outlook there is for some normalization again of that Corporate Travel demand. And we think Corporate Travel is pretty well positioned. It's not as big a position as Flight Centre for us, but it is a core position for us.

Thanks, Matt.

Thank you. Calvin, do you have other questions?

No other questions.

No inquiry. Okay. Thank you very much, Matt, for that, and thank you to all shareholders for attending. Thank you to our host here, which is Blake and the team at Automic. You run this very well, Blake. Thank you very much. Appreciate it. And thanks to Pinnacle for organizing these meetings. This is the end of the AGM for 2021. So on that basis, I'll declare the meeting closed and look forward to seeing you next year I hope in person. Thank you, meeting closed.