- The month was dominated by developments in Europe as a Greek debt default became more likely, when opposing sides failed to negotiate a compromise. There was also growing alarm over the unravelling Shanghai stock market. For the month the Small Ordinaries fell by -7.8% with resources falling most (ASX Small Resources -11.3%).
- Following numerous earnings downgrades last month, there were further earnings downgrades as financial year end approached, including from Bradken, Qube, Nine Entertainment, Virtus, Affinity, and GWA. Although largely stock specific in origin the downgrades also reveal the competitive economic climate.
- In an environment of low funding costs and constrained growth, corporate predation has increased. In the month takeover bids were made for Kathmandu and Skilled Engineering. We expect takeover activity to continue. Early in July the portfolio benefitted from a takeover bid for its shareholding in Vision Eye Institute.
- Portfolio holding Slater & Gordon (SGH) fell in the month constraining relative performance. SGH has been held in portfolios for several years and has generally performed well with 7 year growth rates of EBITDA +29% pa and EPS +13% pa. Following strong price appreciation the position was reduced at the end of CY14. Primarily a personal injury law firm, the company has used an acquisition strategy to drive growth, in addition to underlying organic growth. Reform of the UK legal industry encouraged SGH to extend operations to the UK. Their latest UK acquisition is the Personal Services Division of troubled UK company Quindell. Some analysts have been critical of the acquisition due to: the size of the acquisition ($A1,225m); the price paid (6.9x EBITDA); and Quindell accounting (although more conservatively restated by SGH). Company guidance that first half cash flow would be soft also unsettled markets. We share the concerns and are wary of acquisition models but these fears are mitigated by the: increase in UK market share from 5% to 12%; +30% eps accretion; and SGHís track record of acquisitions. At month end SGH was trading at a prospective 5.7x EBIT making the stock attractive.
- The portfolio outperformed the benchmark in June. On the negative side, law firm Slater & Gordon (see above), Monash IVF and G8 Education underperformed. Monash and G8 were both impacted by the earnings travails of rivals, Virtus and Affinity respectively. On the positive side salary packaging company Smart Group re-signed major customer the Department of Defence causing the price to appreciate. Also generating positive performance was billing software company Hansen Technologies and marketing group STW Communications.
- Three significant international events cloud the outlook. They are the Euro-debt crisis focussed upon Greece, the gyrating Chinese stock market and the impending rise in US interest rates.
- Domestically the mining investment bubble continues to deflate while housing is the main bright spot on the industrial side of the economy. Earnings growth is likely to be moderate.
- Low interest rates support equity valuations which also have been improved by the fall in June.
- We expect stocks with sound valuations, solid balance sheets and recurrent earnings to outperform.