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

And good morning, fellow SEC shareholders. It is 11:00, and I think we should get the webinar underway. Welcome. Hopefully, you are staying dry wherever you are. This is the half year FY '22 results webinar for SEC. My name is Chris Meyer. I am the Director of Listed Funds at Pinnacle Investment Management. I'm also an alternate director of SEC. I'll run through the section today on company updates. Joining me today is Matthew Booker, who many of you will remember, is Founder and Portfolio Manager of Spheria Asset Management. He's also a Director of the company, SEC, and he will be giving us his views on the markets and the portfolio today, which is great. They've been doing a cracking job in the last 18 months. So we look forward to hearing his current view on the market. Just so that you know, the slides today will be up in front of you. So we'll scroll through them on the screen. If you don't have them in front of you, maybe you're on your phone or somewhere else, you can find the slides on the ASX. We'll put them up this morning, and you can follow them there. We will refer, Matt, if you can as well, please, to the slide numbers to aid those who may not be following on screen. We'll also record today's session, and we'll send you a recording of it. So if you happen to jump out or miss parts of it, you can always listen to the replay. [Operator Instructions] Right. So let's jump into it. First of all, just the disclaimer slide, if you could cast your eyes over there, mainly just to say we're not here today to provide personal financial advice. We don't know your personal financial situation. So please, when we talk about SEC or Matt talks about particular shares, that should not be construed as giving advice. So as I said, we'll really have 2 sections. The first will be a company update, which I'll present on and we'll talk about results and dividends. And then Matt will give us a portfolio update, and we'll hop into questions. It shouldn't be more than half an hour, and we'll let you go. So just on the first section on our company update. This slide really is the highlights of the financial year end of -- our financial year ended December 2021. And the results are on the ASX. So we're not going to spend too much time on it, except to say that company is in good shape. You can see it grew 8.1% for the 6 months. That was an outperformance against its benchmark of 2.7%. So a really good performance from the portfolio. And then importantly, there is a greater focus [ where ] as a Board taking on providing income to shareholders of the company. So dividends and the dividend yield figures there are higher and we're providing more regular dividends than we have in the past, and we'll spend a fair bit of time on that this morning. On the NTA, you can see that the NTA ended the year at $2 -- just shy of $2.70. So that's at the end of December. That's the pretax NTA. It grew about $0.10 over the period. That's despite paying $0.075 of cash dividends. And that $2.70 of NTA compares to an IPO price, if you remember, of SEC of $2. So that's a pretty good return over the approximately 4 years the company has been in existence. It's about a 9% per annum total shareholder return, which is -- which is really a pretty good return in what has been quite a volatile market. This chart compares -- and this is Slide #7 for those of you who aren't following on screen. The blue line is the share price of SEC and the gray line is the pretax NTA of the company. And so you can see during the first half of 2020, the gap between the blue line and the gray line, so in other words, the discount to NTA that the share was trading at, was quite wide. It was not something we as the Board or the company were particularly happy about. And 2 things really have changed that. So you can see the lines are much closer together today. So the discount has narrowed substantially over that period. Two things, I think, have contributed to that. One is investment performance. It's really been good, as I said, and we'll get into that shortly with Matt. Second one is dividends. And we know that shareholders of the company and of LICs, in general, really like high and regular and fully franked income. And so we've made a concerted effort in the last 6 months to have a greater focus on income. And you can really see that on this Slide 8. So while SEC has been a consistent dividend producer throughout its life, it has paid 6 monthly dividends up until the September quarter of last year, where the company moved to paying quarterly dividends and introducing a new dividend target of 4% per annum on the post-tax NTA of the company. So every quarter, the company will declare 1% of its post-tax NTA at the end of that quarter and pay a dividend in the month following the end of the quarter. So we've paid 2 to date, $0.025 at the end of September, for the end of September quarter, and it was paid on the 29th of October, and a second one for the December quarter paid on the 31st of January of $0.026. Hopefully, most of you would have seen that hit your bank account on the 31st of January. So the dividends paid for the company since inception or since IPO was $0.29 per share. That's a significant part of that 9% total shareholder return per annum since inception. And the final chart for me on the company before we get to the portfolio is just this chart here on Slide 9, which shows you the dividend yields of the Australian equity LICs that are listed on the ASX. So in the blue bars are the cash yields, so that's taking the 12 months dividends paid up until the 31st of December last year, divided by the share price of those LICs, and the gray bar is the same figure that grossed up for franking. And what we've highlighted there in the blue box is SEC, which you can see is now with this 4% yield on NTA, 5.8% grossed up for franking is now in the top half of that industry peer group of Australian equity LICs, which is pretty good for a company that's only 4 years old. We have a strong balance sheet to sustain the payment of such dividends and we have committed to pay those dividends more regularly. As I said, we will be paying them quarterly. In addition, and finally, on dividends, we will introduce a dividend reinvestment plan for the March dividend coming up. It's pretty easy to register for the DRP. In fact, I did it this week. It's pretty quick, a couple of clicks of a button on the Automic portal. If you are interested in participating in the DRP, essentially, what it does is it enables you instead of receiving a cash dividend, you can get your dividend paid in shares -- extra shares in the company. And when the share price is at a discount to its NTA like it is today, even though the discount is not that wide, we will buy shares as the company in the market, and we will distribute those shares at that discount to NTA to you. Importantly, though, we will not issue shares at a discount to NTA. So that's it on the company. Matt, I will hand over to you for a portfolio update.

Thank you, Chris, for walking through that. It's great to have you on board and having your experience in the business. If we just move on to the performance slide, Slide 11. You can see that -- we beat the index since inception and over all time frames. I guess it is a point in time and the markets are volatile and dynamic. We have had a significant return to positive performance in the last 18 months. And some of that has just been -- most of it is market driven. I mean the market was one-way traffic for a while. It would pay anything for growth. Profits were very secondary in the market, and we saw that with growth managers and growth stocks outperforming during that period. So what we've seen in the last 18 months or so is a big shift, and profitability has become important and valuation and fundamentals. And that shift has definitely helped us with our performance. And you can see that how it's materialized in our numbers over the last 18 months. We're hoping this continues and we see no reason why, I guess, the market dynamics do look favorable for us in terms of what we own and how we're positioned. Another way to look at it is the next slide. And you can see, again, just that change in performance. The green line just shows our relative performance, the dark blue is our absolute performance, and the light blue is the index performance. You can see the green is the most important thing. And you can see that the change, I guess, in dynamics in terms of our relative performance. So there has been a huge shift in performance for Spheria as a whole. And like I said, I think this -- I think fundamentals will continue to play in our favor. We move to the next slide. We do like to show the wins and the losses over time frames. And this is only 6 months, and you will get volatility over shorter time frames. We think over the long term, the way we invest our process and philosophy is such that we tend to get -- the majority of our performance is positive relative to the benchmark. So this is a 6-month period. During that period, we had good outperformance in 4 names in particular. One was Class Limited, which is a software company, which was taken over by Hub24; Michael Hill Jewelers, which is a big position for us. Also, we've seen a significant improvement in the fundamentals of that business with a relatively new management team being really successful despite a very challenging environment. And then we've had Seven West Media, which has continued its -- I guess, it's bounced out of living, I would say. And we've had significant outperformance in Seven West Media. The management team there has done a fantastic job replenishing the balance sheet, fixing up the business and have really turned that business around. And we think there's more -- there's prospect for more returns out of that business, particularly given how it's rated. And then GR Engineering, which is an engineering company that supports the mining sector. It has also performed really well, and it's been a huge performer across our strategies and in SEC. At the other end of the spectrum, we are going to have losses. They are paper losses. We believe those companies are good companies. The reporting season was good for most of those companies. Adelaide Brighton in particular, which was the worst performer that we owned, came out with what was a very good result and rallied on the day. And we think the prospects for Adelaide Brighton were very strong. The cycle's in its favor, the cost base is in order, and the competitive environment has improved dramatically for Adelaide Brighton. So we're quite positive on those ones that have exhibited losses in the last 6 months. And we think over the long term, we'll make money out of these companies. Just moving on to the next slide, just gives you a snapshot of the portfolio at the end of January. So that's our top 10 positions. And we do run concentrated portfolios. We have high conviction in what we do. And you can see where we were positioned at the end of January. There has been some change to that since, I guess, with the results season, we're very dynamic. And we do -- we tend to use the result season to increase our holdings in names. And so there have been some positions that have been increased within this set of numbers. But our biggest holding at the end of January was InvoCare, and that is the biggest funeral home provider in Australia and New Zealand. It's gone through a very challenging few years where they've had to spend money on refurbishing a lot of their sites. They're at the end of that program, and we think we're going to see a benefit of that going forward. Plus despite a pandemic for the last 2 years, we've actually had -- which is a good thing, we've had not the pandemic, but the good thing is we've had negative excess deaths in the market. So relative to the 5-year average, we've actually had less deaths in the last 2 years despite the pandemic. And so it has been a very tough macro environment for InvoCare, plus you've had restrictions on funerals. A lot of these issues will mean revert in the next few years. With the refurb behind them, we think there's good returns set for InvoCare shareholders. So it is our biggest position in the fund. Similar to Flight Centre as well, where obviously, the business has been through one of the most challenging periods in history given the restrictions on travel. We believe there's going to be a pretty quick mean reversion in terms of spend on travel. And Flight Centre has reconstituted its business and taken out a lot of cost. I mean, if you walk around the city or suburbs and you can see a lot of the stores don't -- aren't there anymore and they consolidated into bigger stores. So there's going to be less cost in the business. We think you'll see travel being revert. They also have a very strong online presence. So we're very excited, I guess, over the next few years owning these companies. We think the economy will revert to normal, and there will be significant upside in playing. I guess people call them reopening trades, but I think you'll see some -- a lot of mean reversion over the next few years. I think if you look at our top 10, you'd recognize most of those companies. They're brands that you'd associate with, and we're very excited by the prospects for those 10 companies. I guess one, which we actually think has the most upside is Blackmores, and the share price has reacted quite negatively since the result, but we actually saw the result as one of the best results in the half year. And we are very surprised by the negative reaction. The company grew its top line at 15% in the first half, which is extraordinary. It's organic growth. The company will benefit from that growth going forward. They're growing at 50% in a couple of the big Asian markets they operate in. They are the #1 supplement provider in a number of Asian countries. And what people don't understand that the businesses of Asia now represents more than 50% of sales for that business. So we're very excited by Blackmores' prospects. We think it is a true growth company in this market, and true growth companies are hard to find. So we're very excited with the opportunity there. So it's pretty exciting for us. We don't get caught up with the volatility in the market. We stick to fundamentals, and we think there's a lot of opportunity in the market. Just in terms of outlook, despite the share market rally, there is a lot of inefficiency still. And we're seeing that play out. As I said, the growth portion of the market is shrinking. It's effectively been vaporized. And you're seeing a rotation to more valuation-led names in commodities, industrials where valuations actually are meaningful and are relevant because the companies are profitable. So that favors us. What we also are seeing globally is inflation rising and higher interest rates. So again, we think that's good for valuation-centric investors, which is what we are. I think the easy gains from buying growth at any price or over. I probably said it a dozen times in the last 10 years. But I think finally, the nail is going into the coffin on that front. And there's going to be a lot of pain still to come for those sort of growth style investments. I always say to the team that it's tortoise versus the hare. We're the tortoise. This is a marathon. It's not a sprint. If we get the long-term fundamentals right for the businesses, we'll make money. And slow and steady wins the race. And that's how we think about investing. We're not out there to hit home runs. We're out there just to grind away and find good opportunities. Invariably, the market is a weighing machine. It's a voting machine in the short term, but in the long term, it's a weighing machine. And that's exactly how we invest. So very exciting times. Thank you for supporting us with SEC and hopefully, the returns can continue. I think we'll move on to questions, if we can.

Great, Matt. Thanks for that. And certainly, congratulations on grinding it out, as you say, in the last few months. It's been a stellar portfolio performance. Market seems to be much more suited to you at the moment. Matt, we've got a couple for you and I think one for me. So first one, I think it's directed to you from Raymond is please remind us of the -- have you been remunerated -- how you are remunerated? And have you been remunerated since inception? Slightly strange one, but I presume it just means what are the fees on the SEC and maybe talk a bit about the performance fee and are you earning a performance fee now?

Yes. So the fee structure was set at the IPO, and it's 1% plus. So it's 1% base fee, plus 20% of outperformance relative to the benchmark. There is also a high watermark, so we need to recoup any underperformance during -- in the measurement period. Are we earning performance fees? We are now earning performance fees. We reached we -- I guess, we went through the high water mark, I think, some time last year. And we also had to recoup the initial cost of the IPO. So there were costs involved when the company listed, and we chose to forego performance fees until those costs were recouped, which happened last year. And so now we're actually in a performance fee paying state in terms of we are earning performance fees from the LIC. And that, at the end of the day, means we have alignment to the listed companies. So obviously, we want the company to outperform. The more it outperforms relative to the benchmark, the more the shareholders win, and therefore, we also win from a performance fee perspective.

This one, I'll take the next one, give you a bit of a break. It's a question from Samuel. He asks, how much dividend cover, based on your balance sheet, and I presume he means franking balance, do you have at the moment to cover the 4% per annum dividend yield? So I don't actually have the exact numbers in front of me, but we did discuss it at the most recent SEC Board just a couple of weeks ago. And the thing I remember, Matt, you may also remember, was about 9 quarters worth of dividends. So it might just over 2 and a bit years is the franking balance cover of the current run rate of dividends.

That's correct. So we paid -- yes. So we've got about 2 years if the Board continues on that path in terms of the 4% yield on NTA, which is good coverage, I believe. So there's good franking level availability within the listed company.

That's right. And I think given the rise in the portfolio value, the profitability or the profit reserves are also very healthy. The financials are on the ASX, if anyone would like to take a look at them. And then final one here is from Amanda. Matt, this is for you. You showed the chart showing how your 0 weight in Zip have added performance in the 6-month period. Obviously, the buy now, pay later sector is a bit of a poster child for that growth part of the market that you were referring to that you're underweight. Now that those share -- the question is now those shares have fallen as much as they have, is it a sector that's now of interest to you? Or are you still in avoid?

Yes, we're still in avoid. We just don't see the path to profitability for these companies. They burn cash. They basically -- the barriers to entry are very low in terms of the space they operate in. And there's substitutes for what they do. So it's a very difficult industry to make money out of. The biggest player doesn't make any money. I guess it's difficult to envisage how these companies recover. I guess you're going through a rationalization process now. And maybe it does consolidate into a few players. And that becomes -- and then you're able to extract some profitability, but there's so much potential competition from other players, including credit card companies, payment companies that can simply tick a box and do the same thing that the buy now, pay later providers are providing. So there's a lot of substitution as well. It's -- we think it's very difficult, and we think it's an avoid. We'd rather buy companies that have a long-term track record of generating profit and return. It's much easier for us to buy them and sleep at night, knowing how the industry is structured, how the businesses make money and how sustainable that is versus buying something that's fresh off the block that has no history or sustainability. So yes, that -- it's not our cup of tea. And I think anyone that owns shares in SEC understand how our process works. And that's -- we just don't buy those sort of companies.

Okay. Last one is just coming here from Jonathan. Also, I think Matt, one directed at you, and it's clearly topical this week in the press is what impact, if any, could the war on Ukraine have on your portfolio and the sector in general?

Yes. I guess we're seeing the volatility in the share market at the moment, and we're having big up days and big down days. So today, it looks like a fairly big down day, but yesterday, it was a big up day. So from that perspective, there's volatility. We like volatility. We find opportunity in it. If people want to sell us companies cheaper, that's good for us, and we take a long-term view on that. In terms of geopolitical risks, look, we were just discussing some of that this morning and the sustainability of some of the commodity price movements. And look, yes, there is -- I guess, just talking about thermal coal, for example, Russia is an exporter of thermal coal. They can just divert thermal coal to China. And then that coal that was going to China from, say, Australia or somewhere else, goes to a different market. So I guess the market adjusts in that space. So we think at the moment, some of what's happening is transient. And we believe that I think after this volatility ends, I think it's just -- for us, it's just a mechanism to get in and out. We don't get too caught up in these macro events. It seems like there's a macro event every second month these days. If you get caught up in it, you just -- you're going to struggle to make money. So we just think it's more a buying opportunity in the names we like. But yes, there will be some impacts on freight rates. There'll be impact, et cetera, but we think it's mostly temporary. If it does go on for a long time, yes, it will impact some of the companies, but a lot of the companies we own have the ability to pass on those cost increases. So we're very comfortable at the moment. I think we're well positioned for the environment we're operating in. This is a bit of a left field event, but it's nothing that we haven't seen before.

I suppose Australian Small Caps of all the sectors in the world that are impacted by war in Ukraine, it's probably one of the least impacted I would have thought. Matt, then just -- I think, let's take a final question here as we come up to that 11:30 bell. And Michael asks Vita. You mentioned you see lots of upside in Vita. Can you explain this given the business has changed a fair bit in the recent past?

Yes, we think -- we actually think the business is in good shape. It's got $45 million of cash. That's where the market cap is trading now. The exit costs they're talking about are de minimis. So they've got a lot of cash. The first half was difficult for them. The business has been facing some challenges with lockdowns being a cosmetic-facing business. Lockdowns and restrictions, obviously, don't help the business. And also just staffing. And staffing has been an issue across the economy, and it is a service business. So yes, we think these are short-term issues. The business has huge upside. If you look at their clinics, they're only at 50% capacity, and that means in terms of basically therapists, they've only at 50%. So if they can infill the clinics, you can easily double the revenue from here. You get scale, the business will go quickly from loss-making to profitability as you scale up those centers. And at the moment, there's been no value attributed to the ongoing business. The value is purely in the cash in the bank, and there's excess franking credits in the business as well. So this is one of those situations. It's not going to be an overnight turnaround. We're here for the long term, but we believe that the management team has the business well positioned, and there's huge upside in those clinics. So yes, we're excited by the business. Obviously, the market is not. We've been through this situation many times. It's not a big position for us, but we believe will lack significant returns out of it over the next few years. In the meantime, we've received a huge special franked dividend from the sale of its Telstra stores, and we have a very viable ongoing business going forward that's priced for nothing.

Great. Matt, well, thanks for that. And shareholders, thank you very much for your time and also your questions. It was great, interactive questions coming through today. Hopefully, you've left this webinar with a sense that your portfolio manager, Spheria Asset Management led by Matt, is investing in companies that are likely to withstand any volatility we're seeing in a good way and that they are seeing the market quite well as represented by the performance in the recent past. And secondly, that the dividend also provides quite a nice underpin even if the markets themselves are not going up as much as they were. So with that, I think we will say thank you very much for your time. Some of you have asked if the replay will be made available. The answer is yes. We should get something to you on the e-mail probably tomorrow, and it will certainly also go up on to the SEC website where you can find it at your leisure. And Matt, just thank you very much for your time. It's great to have you also on the Board of the company and as the face of the portfolio to the market. So thanks for your time.

Thanks, Chris. And thank you, shareholders. Like I said, it's important that you hear our story, and you continue to support us. We believe in what we're doing.

Great. Thanks a lot.

Thank you.