Yarra Ex-20 Australian Equities Fund (JBW0052AU) Report & Performance

Key Contributors

United Malt (UMG, overweight) – the global commercial malt processor and distributor outperformed as Malteries Soufflet signed a binding deal to acquire UMG at $5.00 a share (a +45% premium to the undisturbed price) following an extensive period of due diligence.

Worley (WOR, overweight) – the leading provider of global engineering services outperformed during the month as the share price reached its highest level since 2020. We attribute this outperformance to the increasing market awareness of the margin expansion opportunity that the company detailed at its recent investor day. We remain attracted to WOR, and expect strong revenue growth and margin acceleration over the coming years as the company benefits from a more consolidated industry structure, operating leverage, and active mix management.z

Tyro Payments (TYR, overweight) – the payments terminal provider outperformed during the month following the exit of strategic holder Grok Ventures from the register. Grok’s 12.4% shareholding had been an overhang on TYR’s share price and the stock rallied post the selldown transaction.

Key Detractors

Iluka (ILU, overweight) – our overweight position in the mineral sands company was a detractor during the month. Despite the company’s solid June quarterly production report, ILU expects demand to be softer during 2H23. Competitor Tronox also highlighted this trend which led to market concerns. While we see short-term demand risks, traditional supply sources – particularly in South Africa – appear to be in decline, supporting ILU’s expectations for flat pricing in the second half. We continue to favour the mineral sands markets for long-term investment, and specifically ILU as the world’s largest Zircon producer and fifth largest producer of titanium feedstocks. Iluka is moving into Rare Earths production through its Eneabba refinery, adding potential for the company to become a critical component producer for the EV industry.

Tabcorp (TAH, overweight) – the wagering operator underperformed in the lead up to its August result, led by concerns that market turnover has remained soft (likely down 5-10% in 2H23). We continue to see an opportunity over the medium term, and view TAH as a net beneficiary of the upcoming Victorian wagering license tender and regulatory alignment between retail and digital operators. In our view, the company also remains well positioned to benefit from its refreshed TAB25 strategy and gradual consolidation in the sector, which we expect will assist in delivering on the company’s medium-term 10% ROIC target.

Link Group (LNK, overweight) – the administration services provider underperformed during the month following the announcement of a major contract loss in late June in its Retirement & Superannuation Solutions (RSS) business. Whilst the revenue and earnings loss from this specific contract – which will roll off in FY25 – is manageable (approximately 4% of group revenue and 6% group EBIT), the loss in confidence around LNK’s ongoing major client renewal cycle has seen the stock de-rate further.

Key Contributors

NEXTDC (NXT, overweight) – following the announcement of the data centre operator’s largest ever individual contract in April and subsequent regional expansion into Malaysia and New Zealand, NXT continued to outperform as the market’s conviction in Artificial Intelligence (AI) applications as a driver of demand growth grew. Most notably, global leading specialist chip maker Nvidia’s commentary around AI driven demand growth supported previous comments made by NXT management.

Xero (XRO, overweight) – the online accounting software provider outperformed during the quarter after announcing a solid result, with subscribers and revenue in line with expectations and EBITDA ahead of estimates. The result saw XRO’s new CEO provide more detail about the company’s shift towards more disciplined growth, with an increased focus on yield as a growth lever along with subscriber growth. Insurance Australia (IAG, overweight) – our position in Australia’s largest personal lines insurer added value over the period following a positive investor day update, which demonstrated more conservative setting around reinsurance and perils allowances, de-risking the growth outlook.

Importantly, personal insurance providers are continuing to demonstrate excellent pricing power this CYTD (with doubledigit premium rate increases y/y) which is offsetting increased cost inflation and supporting margin trajectory. This, in turn, is supporting an appealing stock valuation (16.0-times forward P/E).

Key Detractors

Link Group (LNK, overweight) – the diversified superannuation administration provider underperformed over the period following an adverse update in late June specific to its Retirement & Superannuation Solutions (RSS) business which confirmed that a superannuation customer representing approximately 4% of the business’ revenue would not be renewing their contract in FY25. Notwithstanding LNK calling out that FY23 was overall tracking ahead of expectations, the share price weakened as investors queried if LNK may need to trade off margin for renewal certainty in future years. James Hardie (JHX, underweight) – the leading fibre cement sheeting manufacturer to the housing industry outperformed in the period following the release of its FY23 financial results.

While the result was broadly in-line with expectations, the company provided forward profit guidance for the Junequarter that was 10% ahead of market expectations, underpinned by solid volume and margin outcomes. While JHX is a quality building materials name, we remain cautious of the sustainability in its end markets (a portion of discretionary renovation spend), making it difficult to support the stock at its current valuation of 20.9 times forward P/E. Instead, we maintain a preference for plumbing supplies company Reliance (RWC), which trades on 14.2 times forward P/E. United Malt (UMG, overweight) – the global commercial malt processor and distributor underperformed during the period.

UMG received a takeover bid from peer Malteries Soufflet priced at $5.00/share (+45% premium to prior closing price) in late March but has retraced modestly from its highs as a degree of deal risk began to be priced. Our view has been that Malteries Soufflet has required time to undertake sufficient due diligence and that the likelihood of a deal proceeding remains high. Positively, following end of the June period on 3 July, UMG received confirmation of the bid proceeding at $5.00 subject to a number of deal requirements. This saw the stock up +8.6% on the first trading day in July.

Key Contributors

NEXTDC (NXT, overweight) – following the announcement of its largest ever individual contract the previous month, the data centre provider continued to outperform as the market’s conviction in Artificial Intelligence (AI) applications as a driver of demand growth grew. Most notably, global leading specialist chip maker Nvidia’s commentary around AI driven demand growth supported previous comments made by NXT management.

Xero (XRO, overweight) – the online accounting software provider outperformed during the month after announcing a solid result, with subscribers and revenue in line with expectations and EBITDA ahead of estimates. The result saw XRO’s new CEO provide more detail about the company’s shift towards more disciplined growth with an increased focus on yield as a growth lever along with subscriber growth.

Key Detractors

Tyro (TYR, overweight) – the domestic payments provider underperformed in May after prolonged takeover negotiations came to an end. During the nine-month period that TYR has been under takeover, the stock has delivered four upgrades to it FY23 earnings guidance, demonstrating strong operating leverage and allaying prior concerns on the ability of the business to grow profitably. The stock now trades on 13.4 times FY24 EV/EBITDA which we regard as relatively undemanding given the company’s growth profile.

James Hardie (JHX, underweight) – the leading fibre cement sheeting manufacturer to the housing industry outperformed in the period following the release of its FY23 financial results.

While the result was broadly in-line, the company provided forward guidance for the June-quarter that was 10% ahead of market expectations, underpinned by solid volume and margin outcomes. While a quality building materials name, we remain cautious of the sustainability in end markets for JHX (a portion of discretionary renovation spend) making it difficult to support the stock at current valuation of 20.3 times forward P/E. Instead, we maintain a preference for plumbing supplies company Reliance (RWC), which trades on 15.3 times forward P/E.

Key Contributors

Reliance Worldwide (RWC, overweight) – the manufacturer and distributor of plumbing and heating parts outperformed following the release of its March-quarter trading update. The trading update was broadly positive, demonstrating the resilience of its repair-focussed end markets (total sales growth of +14.2% for the nine months ending March-23) and a robust margin outlook supported by cost-out plans and easing raw material cost pressure. We view RWC as a compelling opportunity, with the market pricing for a significant decline in earnings (P/E of only 14.9 times vs 17.0 times mid cycle) whereas we remain constructive on the demand environment given the defensive nature of RWC’s revenue base, the majority of which relates to repair and remodelling sales.

Mineral Resources (MIN, underweight) – our underweight position in the mining services and lithium producer outperformed in April. Lithium prices continued to weaken during the month on excess supply chain inventories, with both lithium hydroxide and lithium carbonate prices falling around 50%. In addition, MIN’s March quarterly report released during the period was below consensus expectations across all divisions. Our preferred lithium exposure is IGO, given the higher quality of the company’s low-cost Greenbushes asset.

Northern Star Resources (NST, overweight) – our position in the gold miner was a positive contributor during the period, as gold prices rose 8.8% during April to close at US$1,988/oz. We see further support for the gold price given macro uncertainty, and an expectation that the current interest rate hiking cycle is nearing an end. We continue to favour NST’s solid assets and strong cost control. Aspirations to grow the business from current production of ~1.5Moz p.a. to >2Moz p.a. by 2026 are achievable within the current portfolio, led by the Thunderbox mill expansion project and improving grades at Pogo (Alaska). In our view, NST remains the quality name in the gold sector.

Key Contributors

United Malt (UMG, overweight) – the global commercial malt processor and distributor outperformed during the period after receiving a takeover bid from peer Malteries Soufflet priced at $5.00/share (+45% premium to prior closing price). It emerged that Malteries Soufflet has submitted four bids for UMG since December 2022, indicating strong interest in UMG’s assets. We believe that the likelihood of a deal proceeding is high.

Key Detractors

Incitec Pivot (IPL, overweight) – the manufacturer and distributor of fertilisers and explosives products underperformed over the period, as the price for Tampa ammonia fell 55% over the last three months on weaker gas prices in Europe and weaker demand. After IPL announced the sale agreement for its WALA asset (20 March 2023), the group is now much less exposed to movements in ammonia pricing going forward. IPL achieved a better-than-expected sale price for WALA of U$1.68bn and announced a value accretive offtake agreement with CF Industries. We expect that IPL will be able to commence its previously announced buyback of A$400m after its 1H23 result and may upgrade the buyback program with the A$1.25bn of net cash proceeds from the WALA sale.

Liontown Resources (LTR, underweight) – the lithium developer outperformed during the period, despite falling lithium prices, following a takeover offer from US-listed lithium producer Albermarle. The $2.50/share offer represented a 63% premium to last close, with the company trading above terms on expectations of a further bump in the bid following its rejection of the initial proposal. We continue to see further downside to lithium prices and prefer existing operator Pilbara Minerals (PLS) given its lower risk profile, strong balance sheet, and low capital intensity growth profile.

Key Contributors

Link Administration (LNK, overweight) – the outsourced services provider appreciated during the month as the company made material progress in resolving the uncertainty overhanging it UK Fund Solutions business. LNK announced that it had an in-principal agreement with potential acquirer Waystone to purchase its Fund Solutions business, with the UK regulator (FCA) agreeing that the proceeds from the sale would be sufficient to cover its restitution claims for unitholders in the collapsed Woodford funds.

Origin Energy (ORG, overweight) – the energy retailer outperformed during the month after updating the market on the proposed purchase of the business by suitors Brookfield and EIG. Despite speculation of the deal being repriced lower, the deal was recut only to include part of the consideration in US dollars. At the close of the month, the value of the deal was above the initial $9.00 offer. The company’s update increased the probability of a binding offer emerging in the near term.

QBE Insurance (QBE, overweight) – the general insurer performed strongly during the month, reporting a solid full year result which was largely in line with expectations, with guidance for gross written premium growth for 2023 of mid to high single digits leading to upgraded earnings expectations. QBE has made material progress in de-risking its portfolio which, combined with the strong revenue environment and the benefit to earnings from higher interest rates, have led to strong earnings and return outlook.