How managers respond to challenges sometimes defines a company’s success. Faced with similar circumstances, some managers take very different paths. SAMIR MEHTA explores four examples

• Strong management critical to a company’s success
• Effective response to challenge the key
• Find out about Samir Mehta’s Pendal Asian Share Fund

FOR all the market’s focus on macro-economics, it can sometimes be forgotten that one of the key factors determining a company’s success is the actions of management.

That’s why understanding a company’s leadership, strategy and the industry dynamics in which it operates is critical to successful long-term investing, says Pendal’s Samir Mehta.

“It is important not just to know management mindset, but also understand industry dynamics, customer profile, competitive intensity — those externalities lead to substantial difference in business outcomes,” says Mehta, who manages Pendal Asian Share Fund.

Investors should seek to understand two main dynamics: industry-wide challenges like slowing growth, new competition and the rationality of competitors; and management’s response to these challenges.

“Companies and managers in different industries and different countries face somewhat similar challenges. But their approaches can be so different.”

Here are four examples:

Haidilao International Holding – China

Haidilao is a popular restaurant chain in China that specialises in hotpot, a communal meal where diners cook ingredients in a shared pot of simmering broth.

After nearly two decades of strong growth, the COVID pandemic forced a reckoning.

Haidilao’s management closed nearly a fifth of restaurants and let go more than a fifth of staff, something rare in China.

“Hotpot is not a cuisine that is amenable to home delivery because you have to be present in the restaurant, typically in a group, to enjoy it,” says Mehta.

“COVID forced them restructure. Staff compensation structures were changed from fixed to variable; they spun off their fast-growing, cash guzzling, international business.

They focused on generating cash flows, right-sizing costs, and bought back a part of their outstanding US dollar bonds.

Haidilao last week posted a 12% lift in revenue for its first half and profit of CNY2.26 billion — almost 30% higher than market expectations — compared to a loss in the same period a year earlier.

Sunny Optical Technology – China

Sunny Optical makes components used in optical equipment like cameras and vehicle lens sets and is a major supplier to the mobile phone industry.

“The last 10 years were an era defined by mobile phones and Sunny was one of the poster boys of that trend.

“However, mobile phone growth has now plateaued.

“More importantly, one of their largest customers, Huawei, has been caught up in geopolitics. Combined, Sunny faces a very uncertain future.”

Yet management is investing heavily in R&D and new capabilities to find new avenues of growth.

One area of focus is self-driving vehicles, which need lenses for the LIDAR components that help the vehicle understand its surroundings. Another is virtual reality headsets.

“Contrast this with Haidilao,” says Mehta. “Sunny has just kept on investing, spending money on R&D even as their gross margins have come off quite sharply and even as their growth has come off.

“I met their management team recently and my conclusion was that their DNA is to think about growth.

“They have increased their R&D budgets and moved employees across divisions but do not want to accept a future without growth.”

Asian Paints – India

Asian Paints is India’s largest paint company. Paint is unique worldwide among consumer goods because it has largely resisted digital disruption, says Mehta.

“Almost every other consumer good has been disrupted by ecommerce, but paints are still primarily bought by going to the store,” he says.

But Asian Paints is facing a challenge. The industry so far is a benign oligopoly and highly profitable. One of India’s largest commodity based manufacturing companies, Grasim Industries, is making a play for the decorative paints market.

“Grasim is a commodity producer and for them capital expenditure is the solution to all problems. So, have spent tonnes of money getting a foothold in the industry,” says Mehta.

“But Asian Paints, recognising the nature of this competition, was well ahead of the curve. They too invested in the business aggressively, contrary to what they had done in the past, and have built on their brands and accelerated their growth quite dramatically in the past three years.

“They have generated so much cash flow that they have built up a fortress balance sheet which will allow them to survive years of intense and in my view potentially irrational competition.

“The unfortunate outcome of this is that the smaller players in the industry are going to get wiped out by the impact of Grasim — but the impact will be felt less on Asian Paints.”

SEA Limited – Southeast Asia

US-listed SEA is an e-commerce leader in Southeast Asia. It’s flagship app Shoppee is the largest online shopping platform in the region.

“The stock skyrocketed during COVID as people went online, peaking above US$350,” says Mehta.

“As was the wont of those times, they were subsidising customers and losing money on every trade.

“When inflation became an issue and investors started focusing on profits not growth at any cost, the shares collapsed.”

Management’s response was to dramatically change strategy to control costs.

“They mandated everyone to fly economy. They went to single ply toilet paper in the bathrooms. These were extreme changes,” says Mehta.

And for a while, it worked.

SEA shares doubled from their lows of $30 to almost $60 as management prioritised cash flows and profitability.

“Despite best efforts, they never achieved it,” says Mehta. “And they changed direction again last quarter because even though they wanted to do the right thing, their competitors have refused to follow.

“Shoppee was starting to lose business to competitors who were willing lose money to gain customers.”

Contrasting fortunes

“These four companies faced similar kinds of challenges, yet took completely different approaches,” says Mehta.

“This is the contrast I want to present. My focus on owning stocks in our portfolio is on profitability, cash flows, and high returns on capital employed.

“Asian Paints is a very good quality business run by management who understands the long-term dynamics, take into account competitive changes and addresses that to the benefit of shareholders.

“Contrast that with SEA which unfortunately is in an environment in Southeast Asia where growth is not as robust and consumers aren’t as rich — while the competitive intensity accelerates.

“Sunny Optical continues to invest despite a fall in growth, margins and profits.

“But Haidilao recognised that times have changed. They resized their business, cut expenses, cut capital expenditure, focused on cash flow, bought back their debt, and prepared themselves to be in a situation where things might remain tough.

“For investors, it is important not just to have the management mindset, but you also need to understand your industry, your customers and those externalities that make a big difference to the business.”

“It’s not difficult to guess which two of the four names I own in our fund,” says Mehta.

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About Samir Mehta and Pendal Asian Share Fund

Samir manages Pendal Asian Share Fund, an actively managed portfolio of Asian shares excluding Japan and Australia. Samir is a senior fund manager at UK-based J O Hambro, which is part of Pendal Group.

Pendal Asian Share Fund aims to provide a return (before fees, costs and taxes) that exceeds the MSCI AC Asia ex Japan (Standard) Index (Net Dividends) in AUD over the medium-to-long term.

Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management. 

Contact a Pendal key account manager here

China’s economic outlook and differing inflation outlooks for Australia and the US are leaving investors unsure where to turn. BRENTON SAUNDERS has details

• Australia lags US on inflation
• Chinese stimulus on hold
• Find out about Pendal MidCaps Fund

THE fate of markets over the remainder of the year will largely depend on the answers to two key questions: the outlook for interest rates and inflation, and the resilience of the Chinese economy.

“It’s a tough period for macro,” says Saunders.

“There are different thematics driving different stocks and sectors. From a macro perspective, it’s much more of a mixed bag than we’ve seen for quite a long time.”

Inflation

One key distinction that makes projections difficult is the differing outlooks for inflation in Australia and the US.

“Australia is still at least three to six months behind the US inflation cycle,” says Saunders.

“In the US, we have a reasonably high degree of confidence on where inflation is headed. We understand the various constituents and makeup of inflation — and most of those inflation drivers have peaked.

“But in Australia, we’re still seeing some fairly aggressive inflation in certain parts of the economy, mostly labour related.”

Compounding that is a softer approach from the Reserve Bank of Australia which has been notably less aggressive than other OECD economies in raising interest rates.

“That has put us a fair bit behind in terms of the evolution of both the inflation cycle and interest rate cycle.

“Therefore, we can realistically expect to see rates go higher and inflation remain an issue in Australia for a while.

“In contrast, in the US it feels like the inflation has peaked and is making its way down — albeit more slowly than many had expected.”

China

The second big challenge investors are grappling with is whether Beijing will deliver meaningful stimulus to its property sector to boost the flagging Chinese economy.

“There’s been some frustration that the expected stimulus hasn’t been forthcoming,” says Saunders.

“Any kind of incremental stimulus could be translated quite positively in the market. But China remains quite convinced that it’s not something they want to do.

“They’re still trying to hold that line — they don’t want to re-stimulate the property sector unless they absolutely have to.”

Chinese growth is a key factor affecting metals prices, which directly impacts Australia’s big miners.

“There’s a lot of two-way opinion on how that plays out in the mining sector.

“The mining sector is quite precariously positioned — we have seen some weakness in metal prices and a failure to recover in some that were already in pretty bad shape like aluminium.

“If we don’t see stimulus forthcoming in the next little while, it places some of the traditional mining sectors like iron ore somewhat at risk.”

Ironically, the one area where Beijing is offering stimulus — electric vehicles — is also seeing weakness.

“Electric vehicle raw materials like rare earths and more recently even lithium have been a bit indifferent at a time when you would expect them to be quite strong given the regulatory support for the sector.”

The AI boom sweeping stocks has all the makings of another market mania. That means caution is required – but there are also useful lessons for investors, says Pendal’s SAMIR MEHTA

• AI boom sweeping tech stocks
• Ultimate winners uncertain
• Find out about Samir Mehta’s Pendal Asian Share Fund

HOW should investors think about AI?

There is little doubt that advances in artificial intelligence technology promise to fundamentally disrupt how business is conducted, says Pendal’s Samir Mehta.

But the question investors should ask is not whether the transformation will occur, but when and at what cost — and who might benefit, he says.

“People have been overly excited by AI. But the reality is that it is not going to be instant. We are talking years before the full benefits start to materialise,” says Mehta, who manages Pendal Asian Share Fund.

AI stocks have been on a tear in 2023.

Microsoft’s US$10 billion investment in OpenAI, the high-profile creator of ChatGPT, has sent its shares up 40 per cent this year.

Taiwan Semiconductor Manufacturing Company — which makes silicon chips for companies like AI giant Nvidia Corp — is up more than 20 per cent this year as investors back its exposure to the AI boom.

But the market’s excitement is divorced from reality.

Speculative fervour

Microsoft disappointed investors last month when it cautioned that revenue growth from AI would be gradual, but spending would be aggressive.

At TSMC, AI accounts for just 6 per cent of revenue, with the balance of sales coming from making chips for laptops and phones — a market that is not growing, says Mehta.

“There are many other examples — companies like Quanta Computer and Wistron Corp make the servers that mostly go into data centres for the operations of cloud businesses.

“Only a small part of it is being used for AI-related services. But just that association has meant that even though growth is negative in 2023 — and expectations for 2024 and the perception that demand for AI-related servers is high — some of these stocks have doubled in the last two or three months.

“That’s a speculative fervour.”

Mehta says one factor counting against investors in AI is that the technology’s very success could curtail demand.

Many AI services are priced on a per-user licence, leading analysts to create long term industry revenue forecasts by assuming a take-up rate among employed people.

But if AI succeeds in its promise of making business more productive, companies will reduce staffing.

“The effect of raising productivity is going to mean fewer people will need that software because fewer people are employed,” he says.

Lessons from AI mania

So, what lessons can be taken from the AI mania gripping markets this year?

Mehta says the main lesson is that the ultimate beneficiaries of technological changes like AI are not always apparent early on.

“The winners are going to be quite diverse and may not turn out to be the ones that we think of intuitively,” he says.

But another more immediately useful lesson for investors is that rising interest rates and tightening monetary policy may not be squeezing off liquidity as quickly as conventional wisdom would suggest.

“It is a truism that when you have a speculative mania or bubble, at the heart of it is always massive liquidity.

“The housing bubbles in the US and China, the credit card bubble in Korea, the cryptocurrency and NFC mania, those shared scooters and bikes — invariably they are a manifestation of tremendously loose liquidity.

“So, in 2023, any perceptions that we’re in a tight market environment have clearly turned out to be wrong.”

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About Samir Mehta and Pendal Asian Share Fund

Samir manages Pendal Asian Share Fund, an actively managed portfolio of Asian shares excluding Japan and Australia. Samir is a senior fund manager at UK-based J O Hambro, which is part of Pendal Group.

Pendal Asian Share Fund aims to provide a return (before fees, costs and taxes) that exceeds the MSCI AC Asia ex Japan (Standard) Index (Net Dividends) in AUD over the medium-to-long term.

Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management. 

Contact a Pendal key account manager here

Aussie midcaps are a good hunting ground for fast-growing sectors such as minerals sands and rare earths. One example is producer Iluka Resources, writes Pendal analyst JACK GABB

• Mid-cap miners offer diversity
• Iluka a leader in mineral sands mining
• Find out about Pendal Midcap Fund

WHEN you put sunscreen on your face, reload your printer with new ink or paint a wall at home, you are probably benefiting from the mining of mineral sands.

Mineral sands are old beach, river or dune sands that contain concentrations of rutile, ilmenite, zircon and monazite.

They have a variety of uses from paint and paper through to toothpaste, sun cream and ceramics — and the biggest mineral sands producer in Australia is ASX-listed Iluka Resources.  

Iluka is a holding in Pendal Midcap Fund, which focuses on the 100-biggest companies outside the ASX50 – a good hunting ground for fast-growing sectors such as mineral sands and rare earths.

Iluka was formed in 1998 through the merger of RGL and Westralian Sands. Between them, the companies have been mining mineral sands for more than 70 years.

“Three competitors control 60 to 70 per cent of zircon supply and Iluka is the number one player in the market,” says Pendal Aussie equities analyst Jack Gabb.

Zircon is particularly attractive because one of the three top players – Rio Tinto – has had challenges mining mineral sands at its Richards Bay site in South Africa, Gabb says.

Zircon prices have historically been highly cyclical, and Iluka has been able to stockpile the mineral to better manage peaks and dips, Gabb says.

In more recent years, zircon prices have gained steadily amid tight global supply.

“Spot pricing can still be volatile, but Iluka has started to fix prices for three to six months, and that provides more price stability than we’ve seen historically.  

“We like the demand environment. It’s been stable over the past few years and demand in China is rebounding.”

“On the titanium dioxide feedstock side — which goes into paint and the high-end welding market — there’s been record pricing announced and we’re seeing some pigment plants restart in China and Europe.

“Demand in the US remains more muted, but we see tight supply continuing to support feedstock pricing.”

Iluka’s management team have been headed by Tom O’Leary for nearly seven years and has been relatively stable.

Push intro rare earths

Company management is very experienced in mineral sands and the company is now pushing into rare earths, Gabb says.

Rare earths are a group of 15 metals used in a range of goods, from smart phones and computers to batteries of electric vehicles.

While mining mineral sands and rare earths is similar, processing is different — though there is some overlap in the first part of the process involving cracking and leaching.

“These is certainly some risk in Iluka getting up to speed in processing rare earths. But the management team have proven themselves capable of delivering projects in the past and we expect that to continue.”

Gabb says the key risks around Iluka involve project delivery.

“There’s a lot of growth coming through on the mineral sands side and also in their foray into rare earths. They are building a $1.2 billion project in Western Australia so there is delivery risk particularly around inflation,” Gabb says.

“This will be only the third rare earths separation facility outside China. It has a lot of strategic value, but it also means that there is a relative paucity of experienced people who know how to run a rare earths separation plant,” he says.

“The mineral sands business is a steady business that Iluka has grown up doing. It’s a stable source of free cash flow for the business and has a great industry structure. Iluka’s push into rare earths is new, but it’s very strategic and diversifies the business.”

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About Pendal MidCap Fund

Pendal MidCap Fund features 40-60 Australian midcap shares.

The fund is managed by Brenton Saunders, a portfolio manager with Pendal’s Australian equities team. He draws on more than 25 years of expertise in resources, derivatives, investment banking and private equity. He is a member of the CFA Institute.

The fund leverages insights and experience gained from Pendal’s access to senior executives and directors at ASX-listed companies.

Pendal operates one of Australia’s biggest Aussie equities teams under the experienced leadership of Crispin Murray.

Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management. 

Find out more about Pendal MidCap Fund here

Contact a Pendal key account manager here

Renewed negativity about China’s growth is creating opportunities to buy good companies that are focused on delivering for shareholders. SAMIR MEHTA explains where to look

• China’s re-opening disappoints 
• Quality opportunities emerging  
• Find out about Samir Mehta’s Pendal Asian Share Fund

CONTINUING negative sentiment towards China stocks is an opportunity to invest in companies with market-leading positions that offer strong cashflow, argues Pendal’s Samir Mehta. 

Beijing’s lifting of its draconian Covid restrictions late last year raised hopes of a return to growth for the Chinese economy, but investors have been disappointed by the country’s mixed performance. 

Luxury goods makers like Burberry and LVMH Moët Hennessy Louis Vuitton are posting strong sales in China as the wealthy pick up spending, but other important sectors like real estate are still performing weakly. 

“It’s a very mixed bag and there is tremendous choppiness,” says Mehta, who manages Pendal Asian Share Fund. 

“The Chinese stock markets were doing quite well until about January-February but have now handed back almost all of their returns this year.” 

Mehta says the weakness offers opportunities for investors willing to take a stock-by-stock view of the Chinese market. 

“My outlook towards China is that I see shades of similarity in what happened to Japan after their big bubble burst in 1991.

“We’ve enjoyed decades of fantastic growth in China, primarily funded by debt, towards an asset — property — which can be quite unproductive. 

“Over the next few years, maybe even a decade or more, we should expect China’s GDP growth to be significantly lower than in the past. 

“However, the quality of the growth in certain sectors will be significantly better if company manager’s recognise what is ahead of us. 

“And that’s how I position my portfolio — to find companies in sectors with concentrated market share positions, or they possess pricing power and better still, where companies are focused on cutting costs and generating cash flows without affecting growth.” 

Two Chinese stocks that look promising

Mehta says two Chinese companies stand out as meeting those criteria: Tencent Music and Netease. 

Tencent Music

“Tencent Music is one of the bigger holdings in the portfolio. You can think of it like the Spotify of China.” 

Mehta says Tencent Music’s attractiveness lies in its ability to cut costs without hurting sales. 

In 2020-21, Tencent Music was spending approximately 650 million RMB per quarter in selling and marketing expenses. By the first quarter this year, that spend has been cut to 225 million RMB. 

“That’s a dramatic cut. You would assume that when you cut down on sales and marketing there would be a negative impact on the ability to reach customers and generate revenues.

“ But the net paying customer base is the highest that they’ve ever had at about 95 million, and it’s grown more 15 per cent per annum — that’s a very strong increase.” 

Mehta says the point for investors is not in assuming this growth will continue, but instead in demonstrating the latent capacity in certain companies to create cash flow. 

“This company has adjusted its expenses while growth remains on track and is now generating significant amounts of cash flow. They finished US$1 billion dollars of buyback and they just announced another US$500 million of buyback.” 

Tencent Music has net US$3.5 billion in cash on its balance sheet compared to a market capitalisation of US$12.5 billion, sauys Mehta. 

“That’s an enterprise value of about US$9 billion; by my estimates they will be generate around US$800 million of cash every year.” 

Netease

At gaming giant Netease, a similar story is playing out.

Netease recently posted slowing top line growth of 6 per cent but an improvement in gross margin to close to 60 per cent – an improvement from a past average of 56 per cent. 

Driving the change has been a shift away from lower margin licensed games to higher-margin internally developed games, plus a shift in sales and marketing to use direct channels rather than third party sales. 

“You can see management’s thinking: growth is going to be slow but what can we do to get more profitable net results,” says Mehta. 

“An initial plan to buy back $500 million of stock has gone up to $5 billion. They are one of the few companies in the tech space that has a 30 per cent payout ratio for dividends. 

“They have a market cap of about US$55 billion and US$13 billion in net cash and will generate between US$3.5 and US$4 billion of cash flow every year.” 

Mehta says this new focus on shareholder returns and cashflow is a change for Chinese companies, which have traditionally been focused on growth and market share. 

“This negativity on China continues to present an opportunity for people like us to continue owning and, if possible, adding to these names, because they represent what all investors should be looking for: reasonably cheap valuation, moderate top line growth but very good quality margins and cash flow growth. 

“And the right use of that cash to buy back shares or pay out dividends.” 

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About Samir Mehta and Pendal Asian Share Fund

Samir manages Pendal Asian Share Fund, an actively managed portfolio of Asian shares excluding Japan and Australia. Samir is a senior fund manager at UK-based J O Hambro, which is part of Pendal Group.

Pendal Asian Share Fund aims to provide a return (before fees, costs and taxes) that exceeds the MSCI AC Asia ex Japan (Standard) Index (Net Dividends) in AUD over the medium-to-long term.

Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management. 

Contact a Pendal key account manager here

Pendal has visited China to explore the state of the electric vehicle and battery metals markets. BRENTON SAUNDERS explains the latest

• China visit shows strong signs for lithium investors
• Find out about Pendal MidCaps Fund

A RECENT rebound in lithium prices should persist in coming months as an oversupply in key Chinese markets dissipates, says Pendal’s Brenton Saunders.

They could underpin good prospects for Australia’s lithium producers.

Pendal recently visited key players in the battery metals supply chain in China, finding evidence that overstocking was starting to end and supply and demand for lithium was coming back to balance.

The price of lithium — a key component in batteries for electric vehicles, mobile phones and laptops — peaked late last year before falling sharply in the first quarter.

But as this graph shows, the price of lithium carbonate (99.5% purity) has risen some 80 per cent this month:

Lithium Carbonate 99.5% China spot price

“The falling lithium price was largely due to quite a significant de-stocking in China, principally in the battery part of the lithium value chain,” says Saunders.

“That seems pretty close to clearing now.

“The clearing is driven by a step-up in demand for electric vehicles again, partly due to extended support from China’s government in terms of subsidies and incentives.”

Saunders says the result is a more balanced supply chain of batteries and battery precursor materials, which has allowed prices for lithium to start to rise again.

“We expected this to happen, but it’s possibly coming through a little bit earlier than then we had expected.”

Saunders manages Pendal MidCaps Fund which invests in the hundred biggest companies outside the ASX50, with market capitalisations ranging from $1 billion to $10 billion.

The lithium price has also been weighed down by concerns about the potential for new Chinese supply from the mineral lepidolite, an abundant but relatively inefficient alternative source of lithium that China has been seeking to develop.

“Our finding on the ground is that some of the alternative supply of lithium from China’s lepidolite deposits has been significantly deferred due to environmental constraints including permitting and disposal of waste and tailings.

“That means the big Chinese procurers of lithium feedstock that had become increasingly reliant on domestic production are now going to have to go and find that material externally.

“That should underpin an already reasonably tight market.”

China is by far the world’s biggest electric vehicle market, forecast to produce 8.5 to 9 million electric vehicles this year, compared to 6.5 million last year.

“More importantly, an estimated 75 per cent of all the world’s EV batteries come out of China,” says Saunders.

“Even with most developed countries  trying to diversify EV supply chains, the reality is today they’re still very, very exposed to China.”

Outlook for Steel and iron ore

Pendal’s China visit also explored the outlook for steel and iron ore markets, which look set to come under further pressure in coming months.

“Residential real estate in China continues to battle and that is playing out in steel markets,” says Saunders.

“A lot of the private property developers are battling to fund new projects and declining house prices have hurt sentiment.

“It is not helped by the fact the government continues to stay away from stimulating property development because they want to de-emphasise speculation in property and make property more affordable.

“What that means for second half of this year is that steel and, by inference iron ore and other industrial metals, are likely to remain soggy.”

China is the biggest player in the global seaborne iron ore market, taking about three quarters of the world’s seaborne iron ore imports, and is also the world’s largest producer and consumer of steel.

“They drive the price action,” says Saunders.

ASX-listed lithium producer Allkem – which is held in Pendal Midcap Fund – has struck a merger deal with US rival Livent. Pendal analyst JACK GABB outlines its growth potential

• Lithium prices could rebound
• Allkem merger reflects quality of assets
• Find out about Pendal Midcap Fund

AMONG Australian mid-cap stocks, few companies get more media attention than lithium producers.

And as the recently announced $16 billion merger of ASX-listed Allkem and New York-listed Livent shows, they’re getting plenty of corporate attention as well.

Australia is a significant supplier of lithium because we possess vast quantities of lithium raw materials, leading to substantial industry growth in recent years.

In large part that’s because the fastest growing use of lithium is in batteries, and demand for lithium batteries is growing as economies shift away from fossil fuels.

“Our view is that there is a rebound coming in lithium prices,” says Pendal investment analyst Jack Gabb.

“Destocking in China has run its course… There will be a more normalised demand environment by the middle of 2023 which will drive prices to rebound,” Gabb predicts.

Allkem — which is held in Pendal Midcap Fund – is one the purest ASX-listed lithium plays, he says.

The Argentina-based group was known as Orocobre until November 2021 — and now will likely be rebranded again assuming the merger with Livent goes ahead.

Advantages of diversification

One of Allkem’s advantages is its diversification of products, says Gabb.

“It’s majority lithium carbonate but also has exposure to spodumene and lithium hydroxide. That’s all three lithium products while other producers are picking one or two.”

Spodumene is a mineral that’s the primary source of lithium.

Lithium carbonate is a white powder used in a variety of applications, including batteries, ceramics, and glass. It’s made by extracting lithium from spodumene ore or brine.

Lithium hydroxide is a white powder used in batteries and other applications. It’s typically made by reacting lithium carbonate with water.

“Allkem has one of the highest growth potentials of all the lithium companies,” argues Gabb.

The group forecasts that long term, its assets have the potential to produce up to 250,000 tonnes of lithium carbonate equivalent per annum.

“These are very large, very long-life assets, that are going to be expanded multiple times.

“That brings with it a huge amount of delivery risk and a huge amount of capital that needs to be spent. But the potential prize is huge production.”

Keep an eye on Argentina

Allkem owns lithium assets in Argentina, Australia and Canada.

The key risk for Allkem, and any future merged entity, is its Argentinian exposure, says Gabb.

Allkem’s flagship brine-based lithium project Olaroz (pictured above) is based in northern Argentina.

Inflation is rife in Argentina’s economy and the local currency, the peso, has been devalued.

“It sells in US dollars but at some time it has to take money out of the country and how it manages that is key,” Gabb says.

“There is a lot of strategic value in the lithium story.

“Companies like Allkem provide huge potential, but at the same time, it has a lot to do in terms of projects over the next decade, and particularly the next one or two years. It has to deliver on these.”

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About Pendal MidCap Fund

Pendal MidCap Fund features 40-60 Australian midcap shares.

The fund is managed by Brenton Saunders, a portfolio manager with Pendal’s Australian equities team. He draws on more than 25 years of expertise in resources, derivatives, investment banking and private equity. He is a member of the CFA Institute.

The fund leverages insights and experience gained from Pendal’s access to senior executives and directors at ASX-listed companies.

Pendal operates one of Australia’s biggest Aussie equities teams under the experienced leadership of Crispin Murray.

Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management. 

Find out more about Pendal MidCap Fund here

Contact a Pendal key account manager here

Global equities investors might be wary of US and European bank stocks right now. But don’t let that turn you off south-east Asian banks, says Pendal’s SAMIR MEHTA

• Asia looks to be weathering the banking crisis
• Strong regulators reducing investment risk
• Find out about Samir Mehta’s Pendal Asian Share Fund

INVESTORS may not have noticed the resilience of banks in southeast Asia amid a string of failures among their US and European counterparts, says Pendal’s Samir Mehta.

It’s due to a growing maturity of regulators and governments in the region says Mehta, who manages Pendal Asian Share Fund.

It wasn’t always that way.

Southeast Asia’s currencies, markets and banking systems were heavily impacted during the 1997 crisis as well as the GFC.

A dash to safety — the tendency for capital to be withdrawn in favour of safer investments — led to macroeconomic instability.

But this year’s slow-burn banking crisis in the West — which has seen the collapse of three US banks and the demise of Credit Suisse — has so far left Asia relatively unscathed, says Mehta.

What’s changed

“This is very different from the pre-1997 crisis in Asia when this region would typically be the worst hit from a macro instability during a dash to safety.

“What people are missing is the genuine change in the approach by central banks and governments in most parts of Asia to reign in indiscriminate borrowing resulting in unbridled speculation.

“Whether it’s Singapore, which is leading the way, Indonesia, Malaysia or to some extent even Thailand, regulators have really tightened down.”

Singapore

Mehta highlights Singapore’s lending and housing policies which have been significantly tightened in recent years to clamp down on speculation and prioritise housing for owner occupation.

The highest profile of these policies is the immense stamp duty faced by foreigners buying property or locals buying second properties.

Stamp duty of 20 per cent of applies to locals buying a second property, rising to 30 per cent for the third and subsequent properties.

But for foreigners buying any residential property, stamp duty is now a staggering 60 per cent of a property’s purchase price.

Singapore also charges sellers an additional stamp duty if they sell a property within three years of buying.

“Now, all of this is draconian,” says Mehta.

“Regulators have made it so difficult so that the only those who have savings for their equity contribution, the ability to repay, are willing to pay additional taxes and importantly will hold the property for the long run can buy property.

Mindset change

“This is reflective of a mindset change that central banks in this part of the world incorporated from the lessons of the past.

“That is why it is now such a different regulatory regime in this part of the world.”

The Monetary Authority of Singapore (MAS) — the island state’s central bank and financial regulatory authority — has also directly regulated leverage available to borrowers, cracking down on banks’ ability to make risky loans.

“Human nature is such that if I work for a bank, profits I make are shared to me as a bonus but losses I make are borne by shareholders — it’s a disproportionate risk reward situation,” says Mehta.

“We have seen it time and time again. Banking crises are almost always driven by significant increase in leverage because the payouts from leveraged speculation are disproportionate for the person who takes the risk.

“This is a lesson that central banks in this part of the world — particularly the MAS — have learned.

What the MAS does is something the Federal Reserve and Western banks have rarely done — directly tweak margin requirements and loan to value ratios.”

This control over the lending market curbs banks’ ability to make excess profits but also dramatically reduces the chance of a bank failure.

“If and when there is a crisis, the probability of Singapore banks being badly affected has come down sharply,” says Mehta.

“So, among all the universe of banks out there, as an investor I want to find those banks in a regulatory environment where I won’t lose my shirt.”

The security provided by tight regulation also plays into why the Singapore dollar remains so stable and why Singapore is attracting so much foreign capital, says Mehta.

“That’s a virtuous cycle — these actions demonstrate the willingness of the central bank to take draconian measures to provide stability and that stability which by definition then encourages more people to invest capital in this region because they know it enhances stability.”

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About Samir Mehta and Pendal Asian Share Fund

Samir manages Pendal Asian Share Fund, an actively managed portfolio of Asian shares excluding Japan and Australia. Samir is a senior fund manager at UK-based J O Hambro, which is part of Pendal Group.

Pendal Asian Share Fund aims to provide a return (before fees, costs and taxes) that exceeds the MSCI AC Asia ex Japan (Standard) Index (Net Dividends) in AUD over the medium-to-long term.

Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management. 

Contact a Pendal key account manager here

Investors should look beyond the largest ASX companies to get exposure to the market’s fastest-growing industries, argues Pendal’s BRENTON SAUNDERS

• ASX midcaps offer exposure to fast-growing industries
• Watch a recent webinar about ASX midcaps and the lithium sector
• Find out about Pendal MidCaps Fund

INVESTORS should look beyond the biggest ASX companies to get better exposure to the market’s fastest-growing industries, argues Pendal’s Brenton Saunders.

Medium-sized companies — known as mid-caps — tend to offer higher earnings growth than large-cap companies, often with less risk than small caps, says Saunders.

Saunders manages Pendal MidCap Fund, which invests in the 100 biggest companies outside the ASX50, where market caps typically range from around $1 billion to $10 billion.

Mid-cap portfolios tend to be less concentrated, offering access to fast-growing industries such as cloud computing, medical innovation and battery metals such as lithium.

Companies in this segment also usually feature proven management teams, time-tested business concepts, a history of dividend payments and a strong focus on their core business operations, says Saunders.

“Mid-caps — the ASX50 to 150 range — historically have done better than the ASX50 large-cap universe and better than the S&P/ASX Small Ordinaries,” says Saunders.

“It’s quite an easy part of the market to select good companies from because most of them are fairly well-established businesses, but higher growth — and there’s a huge range of sub-sectors or different industries to choose from.

“So, you’re pretty much spoiled for choice in terms of both quality and breadth.

“It’s really the sweet spot of corporate Australia. “It’s a very useful addition to any balanced portfolio.”

Better access to lithium producers

Saunders recently appeared at a Pendal webinar alongside Ken Brinsden, the former head of lithium industry leader Pilbara Minerals and current chair of lithium explorer Patriot Battery Metals.

Lithium — a key ingredient in batteries for electric vehicles — is a good example of a fast-growing industry that can be difficult for investors to get exposure to through investing in large capitalisation companies.

“It has been the domain of relatively small companies,” says Brinsden. “Lithium was a niche industry only seven years ago so none of the incumbents are really that big.”

Lithium has become the rechargeable battery of choice for electric vehicles, laptops and mobile phones and a key part of the transition away from fossil fuels to a net-zero carbon emission futures.

“The reason that’s happened is because a lithium-ion battery carries so much more energy density than the classic rechargeable battery — that’s what motivates the expanded lithium raw material supply base,” says Brinsden.

Australia is a significant supplier of lithium to the world because it possesses vast quantities of lithium raw materials, leading to substantial industry growth in the past seven years.

Saunders says the demand for lithium is forecast to grow substantially.

Just this month, the Australian federal government announced a national electric vehicle strategy to “encourage greater use of cleaner, cheaper-to-run vehicles”.

“Currently we have about 17 per cent global penetration in electric vehicles,” says Saunders.

“As a global average, we would expect that to gravitate towards about half by the end of the 2020s.”

Despite the growth, lithium production has long been the domain of smaller companies.

“BHP has always held the line that it’s not big enough for a business of their size. Glencore has said it’s not the kind of industry they want to get involved in.”

As a result, investors focused on the large-cap end of the stockmarket can miss out on the opportunities offered by the transition to EVs.

“In our benchmark, about 11 per cent of that total investment universe of the ASX 50 to 150 are lithium and lithium-related stocks.

“In our fund we have a 13 per cent exposure to lithium and lithium-related stocks.

“In the ASX300 small cap universe, there is a large cross section of names of very early-stage exploration and development lithium companies.

“So we’ve got quite a healthy pool of juniors starting to grow and feed up into the mid and large-cap space and become more and more investable.”

Company earnings may slow in the second half — but some sectors are better placed than others, says Pendal’s BRENTON SAUNDERS

• Earnings season strong on revenue, weaker on profits
• Economic cycle stronger for longer
• Find out about Pendal MidCap Fund

AUSTRALIA’S economic cycle has gone on longer than expected – and it shows in the recently ended ASX earnings season.

Somewhat surprisingly, most parts of the economy are still in reasonably good shape despite a string of interest rate rises.

The strong jobs market is a factor, helping prop up consumer spending.

“But the expectation is that higher interest rates will likely hurt earnings in the rest of the financial year,” says Brenton Saunders, who manages Pendal MidCap Fund.

“Across the market as a whole, revenue beats were pretty widespread even though many companies missed earnings forecasts at the bottom line,” says Saunders.

“Revenue beats were much higher than profit beats.

“We saw profit margins reduce and that relates to higher costs.

“In many cases, despite high product price increases, costs increased at a faster rate resulting in margin pressure.”

Revenue beats came in at 25 per cent versus misses of 17 per cent, according to Barrenjoey research. In contrast, the research shows earnings per share (EPS) misses of 38 per cent and beats of 35 per cent. The EPS misses are elevated by historic standards.

“We saw profit margins reduce and that relates to higher costs,” Saunders says.

“In many cases, despite high product price increases, costs increased at a faster rate resulting in margin pressure,” Saunders says.

Earnings season also demonstrated that companies have significantly higher interest costs as a result of the rates increases — which consensus forecasts underestimated in many cases, Saunders says.

That has also contributed to bottom-line misses.

“Companies have different mixes of fixed and floating interest rate exposure and that’s difficult for the market to model.”

In terms of individual sectors, it was a “mixed bag”, Saunders says.

Here’s a quick sector snapshot:

Resources

Profits in the resources sector were weaker for the December half, with a few exceptions such as lithium, nickel and coal.

Other commodity prices were lower, year-on-year in the final six months of 2022 driving profits lower.

“Similar to a number of sectors, the main negative for resources companies was costs.

“Unit cost guidance from the vast majority of companies has gone up and for a number of companies that’s resulted in a downgrade of earnings expectations.”

“In resources we also saw some lower dividend outcomes after the bumper payouts last year.

“That’s because profits weren’t quite as good as they were a year back, and increased capital expenditure as new capacity is built.”

Banks

The banks – half year from Commonwealth Bank, Bendigo and Macquarie Group, and quarterlies from National Australia Bank, Westpac and ANZ – reported strong net interest margins.

“The main negative across the banks is competition, especially in the home-lending and term-deposit markets, as fixed rate mortgages roll-off.

That is putting pressure on earnings forecasts.

“Cyclically we are close to peak interest rates and alongside higher competition means the banks are close to, or at peak net interest margins which many of the banks alluded to.”

Consumer discretionary

It’s a similar story with many consumer discretionary stocks.

Interim profits were mostly strong, though the current half year looks softer as the impacts of higher interest rates dampens spending.

“It’s been a case of stronger for longer for consumer discretionary though it wasn’t quite as ubiquitous across discretionary retail companies, compared to the June 2022 half.”

Construction

Building and construction was mixed, Saunders says, with surprises on the up and downsides, in part depending on where the bulk of business was undertaken – locally, in the US or in Europe.

Consumer staples

Consumer staple stocks reported strong results with Woolworths being the stand-out, in part thanks to higher goods inflation.

But costs also compared well to last year’s COVID impacted costs, which meant some margin expansion.

Tech and healthcare

Technology was relatively strong, Saunders says.

“Many of the tech and growth companies rolled out some kind of cost reduction program with a bigger focus on cashflow which the market took well.”

Healthcare stocks results were mixed in part because of comparisons to the previous, COVID-impacted half year, Saunders says.

That worked against some companies, and advantaged others.

Property

Finally, stocks in the real estate investment trust (REIT) sector broadly announced lower-than-expected-revaluations.

“The weakest part of the property sector is office while industrial is strong, and so too some niche areas like storage and convenience.

“The second half of this financial year is likely to see property revaluations increase putting some incremental pressure on REIT balance sheets. ”