WHSP Holdings Limited (SOL) Earnings Call Transcript & Summary

Welcome, everybody. First of all, thanks for taking time out to come to the Soul Pattinson half yearly presentation. I think you've met these guys before, but I'll just introduce you to Todd, our Managing Director; David Grbin, our Financial Controller; and Brendan O'Dea, our COO. An excellent result, generating good cash, which, again, we're being able to increase the dividend quite substantially. So I won't steal any thunder, so over here, Todd.

Thank you, Chairman, and good afternoon, ladies and gentlemen, and welcome to everybody who's joining us online. I get this thing working -- here we go. That helps. Well, firstly, I'd like to mention that 2023 represents the 120th anniversary of our company's listing. We believe that there's only one company on the exchange that has been listed longer than Washington H. Soul Pattinson. It's been a remarkable journey from a few pharmacies to the $10.5 billion investment house that we have today. . What's more impressive is that WHSP has proven its ability to reinvent itself, whilst remaining true to its core values and the approach to investing that has been successful for so many years. Our purpose and the thing that drives each of the employees of WHSP is to build enduring value for our shareholders. What does that mean? Three things. We look to grow the value of the portfolio and aim to exceed market returns over the long run. We seek higher income from the portfolio, which enables us to pay increasing dividends to our shareholders. And we aim to manage risk, which means that our approach protects downside and ensures that our portfolio is resilient through the cycle. We're able to achieve this through 6 pillars. A disciplined approach may seem like an obvious thing that any investor should adopt, but we are particularly careful to invest only in things we understand, not getting caught up in the latest trend or hysteria, ignoring the noise and making considered rational investment decisions. We're in the fortunate position that we are unconstrained in what we can do. That allows us the flexibility to alter the portfolio into different asset classes and invest in a way that we think is suitable in any given environment. We own a variety of asset classes and large positions in uncorrelated assets, which reduces risk and increases performance through diversification. This is to be contrasted with the view that diversification simply means spreading events across the market. This will surely result in market performance. Our long-term focus comes from not being worried about short-term performance. We are happy to think about the long-term trends and invest to build businesses of the future. We are active and opportunistic. We've always kept funds available so that we can take advantage of situations where other pools of money lack our flexibility and ability to move quickly. Finally, we value our reputation in the market and believe that our opportunity set increases when people are attracted to our long-term patient and flexible capital. We are a trusted partner with all of our stakeholders. In terms of how the company is performing, I'm pleased to say that all of the metrics are very strong and support the strategies we've adopted over the last few years. The further diversification and liquidity from the Milton acquisition has improved the business in all the ways we outlined it would. Looking at the performance through the half year ended 31 January 2023, as the Chairman alluded to, the Board has declared an interim dividend of $0.36 per share fully franked. This is 24.1% higher than the 2022 interim dividend, reflecting the strong growth in cash flows across our investments. Net assets grew 5.3% throughout the half. And if we add back the dividends paid, the total return for the half was 7.4%. That's a very strong result. However, we saw a particularly strong performance out of the market over the half and the total return across the market was actually 2% higher. In January alone, the market was up 6%. At the start of the financial year, we were trading at a discount, which closed throughout the period. This led to a total shareholder return of 14%, which was 4.3% higher than the market. And when we compare the first half of FY '23 to the first half of FY '22, we can see that we have materially improved in each of our 3 key objectives. And the first half of FY '22 was by no means about half. Cash generation from investments increased 35%. One of the main drivers of this were higher dividends from New Hope, though it should be said that we don't include New Hope special dividends in our regular cash flows from investments. Secondly, we acquired Milton in the prior corresponding period. And by the time we completed the transaction in October, we missed some of the final dividends that Milton received prior to completion. In this half just past, we received a full contribution across the portfolio. Between 31 January 2022 and 31 January 2023, net asset value of the portfolio increased 16%. That's over 10% higher than the All Ordinaries index, which returned 5.8% over the period. So you can see that our portfolio performed extremely well through the volatility of the last year. And through this volatility, we continue to take a cautious, defensive approach, increasing our cash levels by over 2.5x. We also continued to reduce our exposure to cyclical businesses and discretionary consumer companies. WHSP has consistently performed over the long term. Over the last 20 years, we've been able to outperform the market by 3% per annum. The data tells us that this is remarkably hard to do and the majority of fund managers actually do worse than the market, particularly once you overlay their fees. In fact, WHSP has been able to maintain this kind of performance for a very long time and has generated a compound annual growth of 15.2% for the last 4 decades. Consistent long-term outperformance creates a lot of additional wealth. That 3% per year above index for the last 20 years means that an investment in WHSP has grown over ninefold, whereas the investment in the market has grown by just 5x. And these numbers do not take into account the value of the franking credits passed on to shareholders. All of our dividends have been fully franked compared to the market at around 75% franking. As I mentioned earlier, the Board declared a $0.36 per share fully franked interim dividend, which is 24% higher than last year. And this is in addition to the final dividend paid in November 2022, which was up 19% on the prior year. These higher dividends are reflective of higher cash generation from the investments and a positive outlook on continued growth across the portfolio. As you can see from this graph, we have increased dividends every year for the last 20 years, and the average compound growth across that 20 years has been 9%. We're extremely proud of our history of paying increasing dividends year-on-year and aim to continue with this objective. The payout ratio of dividends to cash flow was about 50% for the half, but that's quite low due to the seasonality of the way that we receive our cash flows. Our first half generally receives more cash given the tendency for companies to pay higher final dividends, which we received in our first half. The interim dividends hit our books in our second half. So if we look at the full year dividends as a percentage of cash flows, we generally pay about 70% to 80% of the cash that we received from our investments. Those are the highlights. I'll now invite David Grbin to go into a little bit more detail about the financial results.

Thanks, Todd. Just before I get into the numbers, I'm just going to make some introductory remarks about some of the changes to the format of our statutory half year report. This is largely driven by accounting standards. But the close readers of our financial reports would have noticed that we deconsolidated New Hope at the end of last year on the 29th of July. And New Hope is no longer a subsidiary from that date. So this means that the financial results and the investment in New Hope is now equity accounted by WHSP. So what does that mean? It means that we don't -- no longer book the revenues and expenses and the assets and liabilities of New Hope. Instead, we take up our share of its net profit after tax and show the investment as an equity accounted associate. So in this half, you'll see no revenue from New Hope, just our share of net profit after tax. And in the cash flow, we account for just our dividend that we receive out of New Hope, not their receipts and payments. So it's important to note that this change in accounting method doesn't change the net profit contribution from New Hope nor the net asset value or our net cash flow from investments. So -- but clearly, when you see it, it's quite stark that revenue in this half is $1 billion less than the same time last year, and that is largely driven by this now moving to equity accounting for New Hope. It doesn't change the net profit after tax, but the structure of the P&L, the balance sheet and the cash flow. So turning to our first half results. You can see on the slide there that regular NPAT was up $132 million to $475 million. And the major contributors to that increase were New Hope, up about $104 million off the back of high coal prices, and you just heard from the team at Brickworks their results. Our share of their results was up $21 million from a strong contribution from their Property division. And we got increased dividends in our large-cap portfolio largely as a result of the Milton acquisition getting a full 6 months of dividends. The acquisition took place in October 2021, so we missed out on a lot of the final dividends that investees paid to Milton just before we took over. And finally, we've got higher interest income coming out of the structured yield portfolio of about $11 million as the book grew during the half. Now this was offset partly from no contribution from Round Oak in the first half of 2023 because, many of you will know, we sold that investment in July '22 to Aeris. So there is no contribution from Round Oak for the half. Statutory reported profit, you can see, has increased by $1.1 billion over the first half of last year. And that's made up of really -- that $1.1 billion turnover -- turnaround is made up of 2 parts. Firstly, in our first half last year, we wrote off all of the goodwill that arose, the accounting goodwill that arose from the Milton acquisition. That was a function of the whole high sold share price at the time that drove the purchase consideration up above the fair value of the assets that we acquired for Milton, and there was no future benefits attached to that. So we wrote it off in the first half last year. That doesn't reoccur, so that's $995 million of the $1.1 billion improvement and the balance around just over $100 million is just what I've outlined in terms of improvement in regular profit. If we look to the -- as Todd mentioned, the things that we drive performance by in the business, and it's not necessarily earnings, our accounting earnings are not our primary focus. We're all about growing the value of the portfolio as measured by NAV and the cash income that the portfolio generates. And we measure that through our net cash flow from investments. So as Todd mentioned, it was up 35% on the half with improved dividends coming out of the strategic and large cap portfolio and increased income out of structured yield. These increases were partly offset by no distributions, as I mentioned, because Round Oak was sold during the half. And we ended up this half paying cash tax, which we haven't done for many years and higher corporate costs. This consistent growth in net cash flow from investments has enabled that 24% increase in the interim dividend to $0.36 per share. The net asset value of the portfolio stood at 31 January 2023 at $10.5 billion, and that compares to the $9 billion at the same time in the previous corresponding period at the end of January 2022. Over the last 12 months, the key movements there is really the value of New Hope. It's gone up $1.2 billion, and TPG has come off about $300 million. That gives you the key drivers of the major changes there. So I'll hand over now to Brendan, who will take you through the portfolio in detail.

Thank you, DG, and good afternoon. So I'm pleased to present the portfolio results and the highlights for the 6 months to January 2023. For those of you who have joined our presentations recently, you will recall that we've been focused on 2 key goals, these being increasing the financial flexibility through stronger cash generation and defensively positioning the portfolio considering a complicated economic backdrop. We also flagged a reduction in the size of our public equity portfolio to grow investments in private equity and credit. We believe this approach supports risk-adjusted returns and more agility to react to new opportunities. During the 6-month period, we have continued down this path with the focus remaining on long-term growth in capital and cash production, driving increased dividends for our shareholders. I will now touch on each of our strategies, their performance, construction and changes in the period. The value of our total portfolio is now $10.5 billion, which grew 5.3% during the recent half. Noting this is without adding back the dividend paid in December. On a per share basis, the pretax debt asset value was $29.05. As you have heard us say before, we do not run any of our portfolios to meet a benchmark or hug in index. We are able to be dynamic and flexible in deploying capital across all asset classes due to limited tax friction. We were active in the half with $1.3 billion in transaction activity. Right now, we are defensively positioned where possible and focused on investments with strong cash generation for risk-adjusted returns. We believe these investments will perform well in a rising rate environment. In the period, we have made new investments in agriculture and grown our exposure to credit instruments. We have reduced the size of our listed and property portfolios, raising cash for future opportunities. Our large-cap portfolio is now 28% of the overall portfolio, down from 31% in the prior period. We hold a material cash position with cash at bank of $597 million, and our net working capital position has increased by 74% in the period. We believe markets will continue to be volatile and unpredictable but are confident that we are well positioned. In contrast to many of our peers, all of our portfolios are invested to take advantage of specific opportunities. We invest in individual companies and securities over the longer term. Turning now to our strategic portfolio. Sorry, jump to there. There we go. The strategic portfolio comprises large ownership stakes in publicly listed companies where we have Board representation and a close alignment with management. Our strategic investments represent 49% of the overall portfolio. We aim to grow opportunities in other parts of our portfolio and find new investments that could be considered strategic in the future. The portfolio delivered a total return of 11.6% and outperformance of 1.9% compared to the index. In terms of the larger investments in the portfolio, New Hope had very robust returns in the 6 months due to thermal coal prices remaining strong, allowing them to report record earnings this week, notwithstanding challenging production conditions. There were solid gains also from Brickworks and Apex in the first half. Our investment in TPG Telecom had a more challenging half as it undergoes a transformation to improve its balance sheet and competitive position. Our strategic portfolio remains the core of our cash generation, and we expect this to continue in the future. The large-cap portfolio now represents 28% of the overall portfolio, down from 31% at the end of FY '22. It generated increased cash flows of $62.7 million in the period as we had a full contribution for the half. The Milton merger became effective during the second quarter of the prior period. The portfolio delivered a total return of 5.6% compared to the index gain of 10.3%. Defensive shares underperformed the market over the 6-month period. The portfolio itself has been actively rebalanced to be more defensively positioned, reflecting a cautious view with rising interest rates, increased volatility and slowing economic growth. We also took the opportunity to sell certain investments into buoyant market conditions. The portfolio is now increasingly underweight retail banks and materials, which negatively impacted performance in the first half but has positively contributed to outperformance in recent months as markets turn lower and become more volatile. Whilst the portfolio underperformed in the first half, we remain comfortable with our positioning in light of the economic backdrop. Nearly 93% of the portfolio is now represented by the top 30 holdings. We have continued to concentrate the portfolio, noting that this will result in greater divergence of portfolio performance from public indices. During the period, we have reduced or exited investments in retail banks, including CBA, Bank of Queensland and NAB. We have also exited investments in Woodside, Endeavor, Cube, Computershare and Domino's. We have increased investments in Coles, ResMed and IDP Education. Our focus remains on investing in companies that deliver us growing earnings and dividends over the long term. We're also looking for a strong management team that is shareholder friendly, businesses that are best-in-class providing pricing power in an inflationary environment and exposure to positive long-term trends. In our private equity portfolio, we seek to invest in businesses looking for a capital partner to grow. We are not active in the parts of the market that use higher levels of debt. These parts of the market are becoming harder due to the impact of interest rate rises. What we are aiming to do is patiently develop a portfolio of platform assets that can grow with further investment over time. We hope to find and grow the strategic investments of the future. In fact, many of the investments in Soul's strategic portfolio evolved out of former private equity investments, such as TPG and Aeris. The current portfolio value is $810 million and has generated income of $13.7 million over the period. Our agricultural investments increased by $118 million with the acquisition of Bottle Tree Farms, a citrus and table grape producer. We continue to see a lot of activity and have a pipeline of interesting opportunities, both new and additive to existing investments. The emerging portfolio provides exposure to fast-growing companies and is currently more active in public market opportunities given a slower pre-IPO market. The portfolio value at 31 January 2023 was $545 million. Cash flows in the 6-month period were $24 million. The emerging companies portfolio had a strong 6 months, with growing cash flows and a solid outperformance against its relevant index. We have rebalanced the portfolio over the last year to be more defensive, which is now tilted towards industrials and materials with less exposure to technology. Our emerging portfolio remains a source of multiple opportunities across the entire WHSP platform. We do remain cautious regarding small cap equities, which can underperform in periods of volatility or low liquidity. Structured yield, our fastest-growing portfolio comprises investments in quality companies through instruments that carry a high cash yield to maturity, are downside protected and can often provide some equity-linked upside. These credit investments can often provide excellent risk-adjusted returns. We now have $438 million invested in the portfolio and 15 individual investments across a range of industries. The portfolio produced $18.8 million of cash in the period and has a yield of approximately 12%. The structured credit market in Australia continues to grow, and it is already well developed globally. We have recently witnessed regular rises in interest rates and a sharp widening of credit spreads. WHSP has been investing in our credit capabilities and have a strong, well-connected team of professionals. $268 million has been deployed across 7 new investments in the period, and we continue to have a well-developed pipeline of new opportunities. Wider credit spreads should result in better returns on our new investments, and we expect that this current market uncertainty will increase the number of opportunities for well-priced portfolio growth in future. Our direct property portfolio comprises 7 assets with a value of $113 million. During the period, we settled the sale of a property in Castle Hill for $88.5 million, a return of 4.5x the original value. We continue to look for industrial property opportunities in a market that has been disrupted by rapid interest rate increases. From a broader portfolio perspective, we are mindful of our look-through exposure to industrial property in Brickworks. Also in the portfolio is our retirement development in partnership with Provectus in Cronulla. Our joint ventures in Ellenbrook and Huntley continued to perform strongly, but with slowing sales volumes. Finally, since we last met, we have continued on the path of raising cash from our portfolios. We've done so for 2 reasons. Firstly, it allows us to position our portfolio in a more defensive fashion against a challenging economic backdrop. It also allows us to respond rapidly to opportunities caused by market dislocations without the need to borrow or liquidate investments. Our net working capital position comprises cash at bank of $597 million and low-cost debt of $235 million. The financial flexibility of our company has been transformed over the last 18 months, and we are confident that this positions us well to build a portfolio of assets that generate strong returns for our shareholders in the future. Thank you very much, and I will now hand back to Todd.

Thank you, Brendan, and David. So just to finish off and summarize, the portfolio is performing just as we hoped it would, with impressive increases across all of our key performance indicators. We previously outlined that we do better when the market is poor, and we've just experienced a half where the market was particularly strong. Nevertheless, total shareholder return outstripped the market by 4.3% during the half. We maintained our defensive stance and increased our cash holdings. Those portfolio settings are already delivering for us with the portfolio outperforming the market by 2% in February alone, which is the first month of the second half. As you've heard, we've strong cash reserves of around $600 million. In addition, we have undrawn facilities and liquid assets that would allow us to invest up to a couple of billion dollars in new opportunities. After a long period where growth assets have outperformed value given low interest rates and buoyant economic conditions, we believe we are entering a stock pickers market. While we've been able to more than hold our own through this period, traditionally, these types of markets provide us with even greater opportunity to outperform. The dislocation in the market and the increasing price for risk plays to our strengths. We have the liquidity, flexibility and speed to be able to invest in various asset classes and partner with fundamentally robust businesses that can benefit from our capital. Thank you for listening, and we'll open it up to some questions. We've got some online?

Yes, we do, Todd. I've got a handful regarding the same topic of international equities. So the questions are, is the company planning to deploy capital offshore via listed international equities. And another question is asking how you might resource this using Pengana M&A, the Milton team or like the BKI model. And another one was, yes, again, branching out into in-house managed international equities as one of the reasons highlighted in the Milton merger.

Thanks, Courtney. International is obviously a topic that we've touched on ever since the Milton merger was conducted and remains an area of focus for us. I think we've made it clear all the way along that we're not intending to approach international with an allocation view of the world. In fact, we don't do that with any of our portfolios. We don't take our portfolio and segregate it down into asset classes and assign money that way. And we won't do that with international either. We do recognize that there are good reasons why you would go internationally. You will get access potentially to investments and profiles you may not be able to get onshore or we may be able to get access to better priced opportunities. So it's very much the case that we intend to grow our international portfolio. The portfolio size has grown over the year. At the moment, it stands at about $600 million. Some of that is undrawn at this stage, but it's about $600 million, which is up materially on the year. I expect that to continue to grow over time, but we will approach that in the same way that we're approaching all of our portfolios, which is on an individual case-by-case basis. I don't think it's our attention at this stage to build the team offshore or build the team onshore for that matter. We're looking for opportunities to partner with people who have expertise and presence in the markets that we're interested in. And at this stage, we're quite focused on the credit markets and private equity, which shouldn't come as a surprise to anyone because that's what we've been focused on in our primary portfolios as well. So international remains an area of focus for us. It will grow over time, but we will be selective about how we grow it, and we'll be taking it from an opportunity-led approach.

Thank you, Brendan. While you're at the mic, I've got one more question directed at you. The large-cap portfolio underperformed the index for the first time in a while, what gives you the confidence to be overweight financials, health care and staples when an argument could be made as money supply is rolling off that cyclicals could be more attractive?

Yes. I mean, let me correct the question slightly in terms of overweights and underweights. We're overweight diversified financials. Our largest diversified financial position's in Macquarie, and that's definitely a part of our portfolio. We're underweight the retail banks in Australia, so the big 4, if you want to think about it that way. And they've been the largest positions that we've sold down over the course of the last 6 months to a year or so. We're sort of unapologetically defensive really. So we are overweight in health care because we believe that is very defensive. We are overweight in staples because we believe the same. We are underweight materials, and that is something we're keeping a close eye on. We are conscious of the cyclicality there. We're conscious of the economic sensitivity there. But I think we have more of an open mind with that position, but we're very confident and comfortable being underweight financials at this stage of the cycle. We do recognize the cycles can turn quickly. So if we were to see a change in the interest rate outlook or anything that suggested that we were through this period of potential recessionary activity in developed economies, we may change our mind. And the good news about the portfolio now is that we can change our mind. So we are able to trade the portfolio actively and we'll continue to trade the portfolio actively. So yes, we are defensively positioned, but yes, we could change it, should we choose to.

No other questions?

Yes, there are a couple more on the line. How big is the opportunity in structured yield in quality unlisted private companies over the next 5 years? And how much is the weighted average cash yield of 12% per annum enhanced by equity upside?

So that 12% is our cash yield. The equity upside, it's hard to quantify. But I would say most of the instruments that we have at the moment are weighted to cash yield with limited equity upside, but there are a few. In terms of the overall size of the opportunity, that's hard to say, but we basically started on our journey in structured yield only a little over a year ago. At the end of 31 Jan. Half, we were at $500 million. We had another $200 million of committed and undrawn facilities, and the pipeline is -- since the end of Jan. has probably grown by another $200 million to $300 million. So we're up to $1 billion in a bit over a year. The velocity of deals is strong, and the opportunity is getting better, not only in terms of the rate that we are able to charge because, obviously, the base rate, the bond rate has gone up, but also our credit spreads are widening. And with the dislocation happening in global banking industry, the need for these kind of flexible capital is also increasing. So we think the opportunity is very large. Not -- and as Brendan said, not just domestically, but internationally as well, we think now is the right time to actually deploy some of our capital into offshore providers of this asset class. So I would say that, over time, we're certainly looking to grow our exposure here.

I've also got a question for the private equity portfolio. Does the team still intend to meaningfully add to private equity this year? And is the expectation that the current holdings eventually IPO?

I mean that's something that traditionally we have done. We think that we are a good incubator of growth businesses, and we can add size and scale to a business through our access to capital, our deal flow and M&A capability. Once a business gets to a certain size, we also think there's good discipline in putting that business into the public markets. One, it gives a valuation look-through. But two, it then creates an environment where the management team of that business are on the treadmill where they're having to answer to shareholders every day and keep growing the business. So it adds a nice discipline. And so we think that at some point, there would be a great opportunity to at least some of the businesses that we have. But all of the things that we have at the moment, we feel like we're early stage in the incubation process. In terms of our allocation to private equity, we'd certainly like to add significantly to that over the next couple of years; whether that happens this year or next year, I don't know. But I think that the market is coming to us in that regard. We have a unique opportunity to partner with people to grow our business. We don't buy out funds traditionally competing with a lot of the well-known private equity houses around town. We tend to provide growth capital and happy to be a sort of passive long-term partner for people to grow their business. I think that becomes particularly attractive in this kind of market. We've seen that the IPO market has been closed for over a year now. As I mentioned, debt markets are getting harder to access. So that kind of capital becomes particularly interesting. No other questions? Thank you, everyone, for your attendance, and I really appreciate your support.