One of the emerging themes of this reporting season has been the ability, or otherwise, of management teams to navigate deteriorating operating conditions.
MST Marqueeinvestment strategist Hasan Tevfikcompares the results of theexperienced management team at JB Hi-Fito theuntested team at newly-listed Coles Groupas an example. Shares in JB Hi-Fi are up 4 per cent after CEO Richard Murray unveiled a 5.5 per cent improvement in first-half profit to $160.1 million while shares in Coles are down 10 per cent after it revealed multiple challenges, including costs rising faster than sales, fast-changing consumer shopping habits and margin dilution from the shift to online shopping.
“There have been a few domestic-demand stocks that have weathered the slowdown quite well,” adds Tevfik. “More than anything it reflects how good management has been.”
Retail experts such as Andrew Gorecki from consultancy Retail Directions is critical of the management of both the big food retailers, Woolworths and Coles, for not staying in tune with their consumers – putting them at risk in any consumer downturn, especially as new lower-cost competitors enter the Australian market.
“Times of severe economic stress favour businesses which have two core characteristics: operational excellence and a wide consumer market. The easy times for the incumbent supermarket kings are definitely over,” he says.
Shares in Cleanaway rose 8 per cent after management said positive earnings momentum would continue into the second half while shares in Bingo dropped 40 per cent after it said it had been hit by a faster-than-anticipated softening in construction activity.
Tevfik says Cleanaway CEO Vik Bansal had done a good job restructuring the business over the past three years. “Vik is very highly regarded,” he adds.
Tevfik says another executive team that has weathered previous downturns well is that of Nine Entertainment (owner ofThe Australian Financial Review).
“Hugh Marks, the CEO, has already successfully dealt with a cyclical and structural downturn in TV advertising,” says Tevfik. “He cut costs and changed the structure of the business and, in doing so, won the admiration of his shareholders. Investors were happy to support Nine’s acquisition of Fairfax.”
Testing their mettle
But determining whether a management team is good can be tough especially for retail investors who – at best – might see management once a year at an AGM.
Tevfik agrees with the sentiment of the parable that good management teams are a little like tea bags. (You only find out how good they are when they get into hot water.)
The ability to manage costs, change product mix offered to customers and take advantage of weakened competitors are all signs of good management in a downturn.
“Management get tested in a downturn. It’s when they actually earn their credibility. They have been given a poor revenue line and they have done much more with that poor revenue line than other managers have. It’s easy to perform in an upturn,” Tevfik says.
Centennial Asset Management portfolio manager Matthew Kidman says having regular access to management is an important part of judging the quality of management for a professional investor. But reading widely and meeting with industry peers also helps.
In an environment of increased share price volatility, assessing management is an important part of outperformance, Kidman says.
But he cautions that the turning of a cycle can undermine the returns of even the best-managed company.
“Regardless of who they are, you are still going to get wacked around. If you are in the building materials game, you are going to go through cycles. When the market turns and it’s slower growth, their multiple will contract no matter how good they are,” he says.
He also notes that there is a limit to which the share price of a well-managed company can outperform less-well-managed rivals.
Kidman notes that the market tends to group companies into valuation bands depending on their sector. While a best of breed management team might be highly-prized, the company is likely to remain within the top end of the price-to-earnings band of its sector.
“People talk about management being so important when the reality is the multiples are attached to the type of business as opposed to the type of manager,” he says.
In the year ahead, Kidman says beaten-up consumer-related businesses such as building materials companies, banks and retailers are starting to look interesting.
So far this reporting season has proven relatively benign but there have been some big swings in stock prices even if results and guidance have deviated only marginally from expectations.
According to UBS, consensus for growth in Australian listed company earnings this calendar year is expected to slow to 4.5 per cent from 5.8 per cent last year. But unlike major offshore markets, there has been an aggregate upgrade of earnings estimates for Australian stocks, driven by a stronger-than-expected resource sector. This has contributed to a bright start to the new year in terms of total shareholder returns.
Some professional investors say it’s too hard to predict the fortunes of individual stocks or sectors. Rather they focus on timing investment to various asset classes.
Michael Furey is managing director of Brisbane-based Delta Research and Advisory, which advises financial planning firms on investment decisions. Furey says it’s much easier to pick the right asset classes in which to invest than to pick stocks likely to outperform.
“Picking stocks is a very tough game. It’s a lot harder to stuff up asset allocation than security selection. It’s very easy to pick the wrong stocks and have serious underperformance,” he says.
Furey says the age-old rules about having a well-diversified portfolio still apply.
“If you live by the rules of diversification and choose asset classes that have lower valuations compared with history and vice versa, then the odds are in your favour,” he says.
Furey believes the prospects for bonds and equities are evenly poised. Taking a global view of equity markets, he favours Australian and emerging markets compared with a lower exposure to US equities because they look more expensive.
Stewart Oldfield is a director of industry intelligence firm Field Research.