FY24 was another positive year for domestic equity markets, with the benchmark S&P ASX300 index gliding up to record highs during the fiscal year. Sentiment improved with the interest rate hiking cycle coming to a pause, after a number of rapid interest rate hikes during FY23. The financials sector buoyed returns, while the resource sector languished against a backdrop of weaker commodity prices.

The portfolio recorded a gross return of +7.2% for the 12 months to 30 June 2024, underperforming the benchmark ASX 200 Accumulation Index’s return of +12.1%.

Despite delivering a positive absolute return for the 12 months to 30 June, portfolio underperformance versus the benchmark largely reflected a couple of underperforming stocks during the year that outweighed positive momentum in others. The Financials sector was the major contributor to portfolio returns. However, valuations are beginning to look stretched after a strong FY24 period, so continued outperformance, particularly the Banks, is unlikely in FY25.

The portfolio benefited from its positive tilt towards low carbon companies in FY24. The portfolio holds three major Gen-tailers in New Zealand (Contact Energy, Meridian Energy, and Mercury), which all have significant renewable generation, while the portfolio has a material underweight position in the carbon intensive Resources and Energy sectors. The Gen-tailers performed well as operating conditions were mostly favourable throughout the year, while the conclusion of a long-term agreement between the Gen-tailers and the New Zealand Aluminium Smelter was a major de-risking event that provides the platform for growth and/or increased capital management initiatives going forward. Additionally, the portfolio’s underweight position to Resources and Energy stocks contributed to positive relative performance versus the benchmark, with two index heavy-weights, BHP and Woodside, underperforming the market over the year.

Within Consumer, stock selection was favourable, with the addition of Coles into the portfolio over Woolworths a positive contributor as Coles gained market share over Woolworths throughout the year. The addition of Webjet was another positive for the portfolio as strong growth in its B2B business and plans to demerge its B2C division were taken positively by investors. We think the outlook for both businesses looks favourable into FY25.

Despite a number of positives, a handful of stocks drove overall portfolio underperformance versus the benchmark. The Healthcare sector was a microcosm of this portfolio effect. While Cochlear, Fisher & Paykel Healthcare, and Resmed all contributed positively to performance, their contribution was outweighed by weakness in the portfolio’s pathology investments, Healius and Australian Clinical Labs. Healius in particular was the single biggest detractor from performance over the year, as the company suffered from earnings downgrades driven by soft volumes and an ineffective acquisition strategy, resulting in a discounted equity raising to bolster a weakened balance sheet. With ongoing concerns around the outlook and fundamental valuation, we divested the stock.

On a sector basis, the Real Estate sector was the largest detractor from performance with the portfolio holdings in Mirvac and Dexus underperforming as property valuations took a hit during the year. However, we believe FY25 will be an inflection point for valuations. Not owning Goodman Group also weighed on relative performance versus the benchmark, as the company was rewarded by investors for its planned pivot towards data centres.

Australian Shares SMA Portfolio Performance

As at 30 June 2024^*

Source: Praemium portal.

^Benchmark: S&P/ASX 200 Accumulation Index. Past performance is not a reliable indicator of future performance.

Inception date: 16/04/2020.

Contributors

• Cochlear (COH) performed strongly this year as the defensive nature of its earnings remained evident in its 1H24 result. Cochlear continues to benefit from favourable regulatory tailwinds and competitor weakness. Cochlear’s strong balance sheet and outlook are helpful in supporting its valuation and we believe it remains an attractive asset given it is a truly global medical device company with limited competitors.

• Suncorp (SUN) is a well-run general insurance company. Near term margin expansion is expected as pricing increases to offset claims inflation and higher reinsurance costs start to earn through. Earnings have recently benefited from high levels of investment income which will moderate with any rate cuts. The sale of the bank to ANZ requires Federal Treasurer approval. Once approved, this should result in return of capital through share consolidation and a special dividend.

• Qube Holdings (QUB) performed strongly over the period reflecting the strong and recently upgraded earnings outlook, highlighting the company’s operating resilience and benefits of diversification across operating segments, including a very strong contribution from the Patricks joint venture. In addition, cost mitigation efforts and benefits from recent acquisitions added support to the earnings strength.

Detractors

• Healius (HLS) shares fell throughout the period amid diminishing Covid-19 testing revenues combined with solvency concerns around its balance sheet. These factors resulted in an emergency capital raise required by lenders to pay down debt. The equity raise, which was priced at a 30% discount, was accompanied by full-year guidance that implied a material 1H vs 2H skew at the midpoint. We divested our shareholding during the period and did not participate in the capital raise.

• Fletcher Building (FBU) detracted from performance in the period following disappointing earnings updates, legacy issues and concerns around the building company’s balance sheet. In addition, there was significant management and board disruption. We do see long term value in FBU, which has a strong market position in the NZ Building products industry, and expect that there will be progress towards resolution of their legacy issues by the end of the calendar year.

• Domain (DHG) has been a weak performer compared to its competitor REA which had upgraded its listings growth guidance to 5-7% for FY24, ahead of Domain’s 2-3% listings growth guidance. Domain’s underperformance in listings and yield growth has continued to weigh on the stock, though we maintain our position on the basis of relative valuation attractiveness whilst its fundamentals in particular cash flow and earnings growth potential remain solid.

Cochlear performed strongly this year as the defensive nature of its earnings remained evident in its 1H24 result.

Portfolio changes

Additions to the Portfolio

• IPH Ltd. (IPH) – IPH is an international intellectual property services group and is the largest filer of patents and trademarks in Australia and Canada. We believe that IPH is trading on an undemanding valuation and an attractive dividend yield.

• Webject Limited (WEB) – Webjet is a digital technology travel business, with a strong balance sheet and trading at an attractive valuation considering the growth profile in the B2B hotel marketplace division.

Divestments from the Portfolio

• Australian Clinical Labs (ACL) – ACL is the third largest pathology services provider in Australia. Along with other pathology providers, ACL has been challenged in recent times by lower volumes driven by a reduction in GP referrals. While we think this situation will improve over time, trading liquidity in the stock has fallen below our threshold to remain in the portfolio and we have therefore divested the position.
  
  

Webjet, a recent portfolio addition, has a strong balance sheet and attractive valuation considering the growth profile of its B2B division.

On a sector basis, the Real Estate sector was the largest detractor from performance... However, we believe FY25 will be an inflection point for valuations.

Sector allocation

Sector overweights
Cash, Communication Services, Health Care, Industrials, Information Technology, Real Estate, Utilities (Renewables)

Sector underweights
Consumer Discretionary, Consumer Staples, Energy, Financials, Materials