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

[Audio Gap] which is our starting time. So a very warm welcome to everybody. It's great to see some shareholders here in person, not too many, and a few online. So welcome to the Spheria Emerging Companies Annual General Meeting for 2024. My name is Jonathan Trollip, and I'm Chair of the company and chairing today's meeting. I would like to introduce my fellow Board members probably known to you anyway. But we have Lorraine Berends, Independent Director, like me; Matt Booker; from Spheria Management; and Chris Meyer, who is an Alternate for Matt. We also have Calvin Kwok, the Company Secretary, who was here and seems to have vanished already, but he's around; and Shaw, his colleague, who's running all of the IT stuff today. So if anything goes wrong, you know who to hold responsible, but she's got everything under control. We also welcome Scott Whiddett and Aidan Evans from Pitcher Partners, and they're here standing in for the company's auditor, Chris Chandran, who's unavailable. So if you have any questions on the financial statements, which are here for 2024, please feel free to ask them. We have a quorum present, so I now declare the meeting open. And I'm advised that there are no recorded apologies for the meeting. Is that right, Shaw? Good. Okay. I'll turn to the agenda for today's meeting. If you can get the slide up, if it works. This is what always happens. It's pretty straightforward. It's usual format. We'll have the chair's address, which was released to the ASX earlier this morning, and I believe some of you have already read. Then we'll have the formal business, which is the resolutions, then what is, to me, the interesting part of the meeting, and that's the update from Matt on the investment side, and then after that, you're welcome to ask questions of me on behalf of the company, or any of the directors and then from Matt on the investment side. I will also provide an update when we get there on the conditional proposal to exchange the units in the company for units in -- Australian Small Caps Fund. I'll table the notice of meeting, and I propose to take the notice as read. So if we could now move to the Chair's address. Thank you very much. As you're probably aware, on 5 December this year, we celebrated our seventh anniversary since listing on the ASX in 2017. As we did at last year's AGM, it seems an appropriate time to reflect on the investment objectives, which we outlined in the prospectus in 2017. And there are 2 primary objectives, which was to outperform the benchmark, which is the ASX Small Ordinaries Accumulation Index with S&P in the front of it, over each full investment cycle, which the Manager believes is typically 3 to 5 years, and provide capital growth again over each investment cycle and income. And we aim to generate shareholder returns via a combination of capital growth and income and to pay regular fully franked dividends to shareholders. So if we could have a look at the company performance over the time. I think it's very pleasing to see, and it's all credit to the manager that the income objective -- sorry, the performance objective has been achieved. So after fees, and it is interesting to note that we do report our portfolio performance after fees. Some other fund managers don't report it after fees because they said the benchmark doesn't have fees in it. But we think it's appropriate that shareholders do see the performance on an after-fee basis. So after fees and company administration costs, but before tax, the company outperformed the benchmark by 1.9% per annum since inception to 30 June 2024. And if you extend that to 31 October 2024, the outperformance was 2.2%. You will hear more from Matt on this later, but this is an excellent outcome for shareholders and is consistent with the first objective. We move to the second objective, which is to provide capital growth and income. We can please get that slide up there. You will see that since inception, the performance has been 6.2% per annum to 30 June 2024, updated to 31 October 2024, and aided by a strong performance in recent months. This has increased to 7.4% since inception. We also provide in our financial reporting total shareholder return, known as TSR, which, as you're probably aware, measures the combination of shareholder returns from a change in the company share price and then adjusted for any dividends paid. And since listing in December 2017 to 30 June 2024 was 5.8% per annum and updated to 31 October 2024 is 6.7% per annum. The company's share price on 31 October 2024 was $2.33, it dropped a little bit since then, I think yesterday, it closed at $2.28, and that compares to an issue price of $2, and that shows a positive capital return of 2.4% per annum. During that time, dividends of $0.586 have been paid, and that's to equivalent an income return of 4.3% per annum. Over the year to 31 October 2024, and that's measuring from 1 November 2023, so the last 12 months, the total shareholder return was a very robust 37.9%, driven primarily by capital return, which was particularly strong at just under 32%, supplemented by income return of about 6%. So the conclusion I would hope shareholders will draw is that we have achieved the objectives which we set out in the IPO in 2017. If we could please look at the next slide, and this is just a graphic representation of the cumulative returns, which shareholders have received over the period broken down into NTA, which is the dark blue, the dark blue column, the dark blue component of the column; and then the dividends paid, which are broken into light blue, which is the dividends actually paid; and the lighter blue or the gray, which is the franking credit component of that. And that has also been a strong additional driver of returns to shareholders, and it's particularly true since we increased dividend payout in the third quarter of 2021. We could now move to the slide on dividends. And that slide shows the dividend history of the company since inception. And I'm sure you're all aware, one of the primary benefits of a listed investment company is the payment of regular fully franked dividends. And for FY '24, the company declared quarterly dividends totaling $0.12 per share, and they're all fully franked. And as you would have seen in our financial reports, we have a very healthy profit reserve, and we have a very healthy franking credit reserve as well. So we're expecting that to continue. Commencing in the final quarter of FY '24, the Board set a new dividend target yield of 6% of post-tax NTA per annum, and that grosses up to 8.6% per annum when you include franking. And this is paid at a level of 1.5% of post-tax NTA per quarter and based on the NTA at the end of each quarter. We think that the move to a regular and a high level of income has been very favorably received by shareholders, and we remain committed to paying quarterly dividends at the guided 1.5% level, subject to the usual caveat of the financial resources and it being prudent to do so. Finally, on dividends, I note that the first quarterly dividend of FY '25, which was $0.035 based on the 30 September 2024 post-tax NTA was recently paid on 12 November 2024. We could please move to the next slide, Shaw. Thank you very much. And that shows, if you can read it, it's always sort of hard to see these colors going across the page. But this is the premium and discount of the share price to the NTA. And as shareholders will be very well aware, closing the NTA discount has been a focus of the Board, and it continues to be so. We're very pleased that it's narrowed substantially since January 2024. And hopefully you can pick that up on the graph on the far right-hand side, and that was when we announced our conditional proposal. And the conditional proposal was as agreed between the company and the investment manager, that's very -- in the capacity as an investment manager -- to pursue avenues for an exchange of shares in the company for units in Spheria Australian Smaller Caps Fund, should the average discount of the company's share price to pretax NTA during the period 1 October 2024 to 1 December 2024, exceed 5%. And we're currently in the middle of the measurement period. And as at 15 November 2024, the average running discount since 1 October is 4.4%. So we're within that 5% target, but there's still 6 weeks to go. And if there are any questions on any of that, please ask me at the end when we've done the formal business, and we've had Matt's investor presentation. I'll now move to the formal business part of the meeting, which is pretty simple, it's the tabling of the financial reports; adoption of the remuneration report; and reelection of Matt Booker as Director. Shareholders attending in person should have received a yellow voting card, and I see a few yellow voting cards there before you registered. If you're in possession of a yellow voting card or a blue nonvoting card and you're welcome to ask questions. While anybody with a red visitor card is kindly requested only to observe. And I presume we don't have many shareholders here, but it seems like you've got the correct cards. Shareholders joining online to vote must have logged in to Automic's investor portal. And detailed instructions on this were on the notice of meeting, which was circulated earlier. Shareholders joining online who would like to ask questions, you're very welcome. Please type your question in the Q&A box displayed at the bottom of the Zoom screen. If you do want to ask a question, please let us know via the Q&A box and provide us with your shareholder reference number or holder identification number. [Operator Instructions]. And I request shareholders to ask questions only in respect of matters relevant to the business of items being considered. As I mentioned, Matt will provide an update from the investment manager after the formal business has been dealt with. There will then be an opportunity for shareholders to ask general questions. As noted in the notice of meeting, resolutions will be decided by poll, and I now declare the poll open. I will put the 2 resolutions to the meeting shortly. In order to cast your votes on each resolution, please select for, against or abstain. And all valid proxies received have been recorded, and these will be reported to the ASX after the meeting and shareholder's information will also display on the screen, the proxies when we come to each resolution. The first item of business, if we can move to the next slide, please, is the consideration of the financial statements and report. This doesn't need a vote, but it's an opportunity if shareholders have any questions to ask me or the auditors on the 2024 financials. So I might check if those -- if there are any questions on the financials. Everybody happy with them? Auditors happy? Shaw, no questions on line, I presume? Okay? All right. There are no questions on that, I'll now move to the next item, which is a formal resolution, and that's the adoption of the remuneration report, and that's contained in the 2024 annual report as part of the director's report. And we're required by law to put that to the shareholders for a vote. And I will now ask if there are any questions on the remuneration report for the company. Any questions, Shaw? Maybe we could just show the proxies and see if we're going to get a strike against us. No? It looks like we should pass. The remaining resolution is the reelection of Matt Booker as a Director. And as you're probably aware, the company constitution requires 1/3 of directors to retire by rotation and be elected, and Matt is up for reelection this year. I will get him to say a few words, if you don't mind, Matt, as your capacity as a director. But I think from Lorraine and my side, I think it's fair to say that we're absolutely delighted to have Matt on the Board, and he's made a huge difference since he joined. So I think there's no right or wrong necessarily, and some listed investment companies don't have a manager representative on the Board, but I think it's really useful in being very valuable. So I'll hand over to Matt to say a few words.

Thanks, Jonathan. It has been a privilege to be on the Board for the past few years. I guess, to see the inner workings of business and also just the interactions with some very professional directors and people in the actual listed investment company. So it has been a pleasure. It's been a challenging few years from an investment perspective, but it's always been interesting turning out to the quarterly Board meetings. So thank you.

Thank you, Matt. Does anybody have any questions for Matt in his capacity as a director as opposed to as an investment manager? Okay. If we can please show the proxies. Good news, Matt, you've got a good chance of being reelected. So we'll announce the results to the ASX in due course. And these are the proxies that we received 48 hours prior to the meeting. So that concludes the formal part of the meeting other than if you could please vote. And if we could get Automic to collect the voting cards from you. And people online, please cast your votes, and you've got to select confirm to confirm you've completed your votes once you've cast it. Do you need my Chair's proxies to all voted in favor of the resolutions. Thank you very much. Okay. Thank you very much. I'm delighted to say that concludes the formal business of the meeting. I now declare it closed and hand over to Matt. Thank you.

Thanks again, Jonathan. Just in terms of investment manager update, can we move to the next slide, Shaw? So just some background, when we set this product up nearly 7 years ago, it was to emulate the Spheria Australian Smaller Companies Fund. And in terms of how we invest is we look for highly cash-generative businesses, and that's been the focus of -- that's been our focus since day dot. Ideally, we want lowly geared companies. But sometimes we need to take some risk. And when there's high levels of gearing, as long as there's cash flow to support that gearing, we'll take a position in those sort of companies as well. And it has been an easy few years to buy simple growth stories and those reratings that have occurred have been healthy and like unprecedented sort of reratings that we've seen in the market. And that's been an easy story for many growth-type managers. I think we tend to sit somewhere in between. We have a valuation lens, but we'll also buy good growth companies where the valuations are supportive. We typically own around 40 to 50 stocks. We're currently about that 50 number now. Our maximum sort of weight in a stock is about 5% relative to the index. So we're never taking on huge positions from a single stock selection perspective. And the good thing about the product is it pays regular quarterly dividends. I think we all appreciate that as a shareholder. I certainly do. And our companies produce cash. So that helps fund those dividends every quarter. So I guess that's the background to the product. Move to the next slide, please, Shaw. In terms of performance, we did have a tough period coming up to the end of December. I think it was November -- October, November last year. It was a very difficult period for anyone sort of with a valuation-type philosophy. The market went into a very growth-type phase and away from anything that was kind of cheaper or had valuation support. At the back end of calendar year last year, we had 4 takeovers, which boosted performance, and you can see that in that blue line there. So there was a big jump in performance. And that did help us for this financial year. And the portfolio has actually been able to maintain some strong performance since that end of December last year. And you can see the relative performance over time in terms of the green line. So the cumulative alpha that's been generated by the product has been quite significant. So we're very proud of that track record. We think we're at a positive point in terms of junctures in terms of performance. There's a lot of opportunity in the market. The market has bifurcated between sort of growth and value, and we have tilted the portfolio more to value, but I'll talk about that in the next couple of slides, please. Just in terms of an example, and this is our biggest holding SNL, which is supply network. You probably never heard of it, but we bought this company when it was a micro cap company. I think it had a market cap of somewhere in the $100 million to $200 million market range. So we found it very early in its life cycle. It's grown over time. You can see that chart on the top left there, you can see the earnings growth that the company has had, and the cash flow has followed that earnings growth. So it's been generating strong cash flow to support that earnings. But the supply network is now the #1 player in the truck and bus park market. So it supplies independent mechanics with truck and bus parts. And from a very small base, 20 years ago, it's become the leading player in the market. It's got 25 branches across Australia and New Zealand. It's got about 15% market share of that space. And the good thing about that space is its actual customers are growing. So independent mechanics are taking share from OEMs. So OEMs are a big manufacturers of trucks and buses. They are losing share in terms of the servicing component, which is a high-margin type business. But the independent mechanics are taking share. SNL is the leading player in that market. They support the independent mechanics. So they're very aligned to the growth in that independent mechanic market. And you can see that the sort of revenue growth and earnings growth the company's had over the years, the return metrics are incredible. For every dollar they -- that's reinvested, they make $0.50, which is a remarkable type equation. And the company continues to grow. It will run into some headwinds this year. We're not shy in saying that. The economy is struggling at the moment, and transport is a bit softer, and that means the actual underlying sort of market dynamics are going to be a bit weaker this year, but we think the company continues to take share and still grow their top line even in a weaker market. So the company used to trade on sort of the 15 to 20x EBIT. It has rerated recently to about 25x EBIT, which is a bit more expensive relative to the past. But in the scheme of the growth that the company is delivering and its position in the market, we think that's pretty attractive. But that's the sort of company we own. And it's not often we get a company that grows from a micro cap to a small cap and hopefully graduates even higher at that sort of market value chain. But when we do find them, we stick with them, and it's got a very -- it's got a very pleasing market structure and high return sort of business. So we're very happy with that investment as the top investment in portfolio. Next slide, please. So you can see supply network is there. We have a fairly eclectic top 10, I would say. We have some companies that are in turnaround modes, and we have some companies that are growth companies. So technology. One is a company we owned it since it was a micro cap as well. And that's our ninth biggest holding, but that's grown from a micro cap to a small cap to a mid-cap company. So it's graduated up the market chain. There's some other companies in there which are currently in turnaround. So Fletcher Building is a position we bought recently at very attractive levels, and we think there's a good turnaround opportunity in that business. It owns a very privileged position in the building material space in the New Zealand market. In some verticals, it has dominant market share. For example, plasterboard in New Zealand. Fletcher Building has got over 90% market share in plasterboard. And in concrete and cement, it has over 50% share in New Zealand. So it's a company that's had difficulties in terms of management. We think they've got the right people in place now and the right Board to affect a good turnaround into a potentially improving market. The economy in New Zealand has been pretty dire for the last couple of years, but we think there's a turnaround coming in that market. Insignia is a position we've taken recently as well, and it's already paid off in terms of performance. We're up significantly since we bought that. But we think there is a good turnaround opportunity in Insignia. It's a big platform business. It's probably one of the biggest players in the wealth management market with $300 billion in funds under advice. And it has about $1.4 billion in revenue. At the moment, it's not generating much cash, but there is a strategy to improve the cost side of the equation there, and we believe that company can earn 20%, 30% margins on $1.4 billion of revenue, which is a significant uplift in earnings over the next few years if they can get it right. IRESS is a company we bought several years ago. It's effecting a turnaround, and we're already seeing -- we've seen a significant improvement in the share price over the past 12 months. Healius is a business which has been struggling. They've sold off their second largest asset, their Imaging business recently for a big price, and they're going to be in a position where they have -- the way they extinguish all of their debt, and have $400 million in cash plus $160 million of franking credits, which will be returned to shareholders, which I think is a good thing. So anyway, you can see that we've got various companies in there from cyclicals to turnarounds to growth companies. And I think that puts us in good stead in terms of the next year or 2 performance. Next slide, please. So I guess what we've seen in the small caps sector is industry fund is moving out of small cap, and they've been moving up the market cap spectrum. And that's inflated valuations for large cap companies. So banks, for example, are trading at very high levels, and other sort of growth companies are trading at very high levels as well. But the small cap sector has been left behind. And we think that inefficiency lends itself to opportunity. And that's where, obviously, we're investing. The other thing that we've seen is the market is just very momentum-based. Anything with warts or any issues, the market is selling off to levels which we think are way too cheap. And anything which looks perfect is getting priced to perfection. So the market is kind of repeating those past cycles of hiding in perfect companies and shying away from companies which have challenges. But often, the opportunity is where the challenges are because that's where the valuations are the lowest. We think we're well positioned in a diverse range of companies across different sectors, and we think that the product has good performance ahead of it. I'll leave you with that and open up to any questions.

[indiscernible] Any questions online?

And I hope so, Jonathan. Thank you.