January 2019 | Market Commentary
Markets returned to a risk-on stance after commentary from the Fed suggested they were “listening to the markets” and were likely to hike only a further two times this year. Additionally, the Fed Chairman was quoted as saying he “wouldn’t hesitate” to adjust the pace of the Fed’s balance sheet contraction. Within the benchmark – growth and momentum style names led the charge – after having been sold off heavily in the final quarter of 2018. Paradoxically, we think we are heading into a fairly weak reporting season. The Australian economy has undoubtedly slowed and the cyclical side of the economy – retailers, housing related stocks and media – have all come under pressure.
Early in the month Healius (HLS.ASX) – formerly Primary Healthcare – received an unsolicited takeover offer from Jangho group at $3.25 a share. The Board rejected the offer as being too low, which we agree with. We suspect given the strategic nature of the assets (second largest Australian pathology operator) that it will attract the interest of other parties. The takeover attempt another indicator that the public market is not recognising the long term value of many strategic assets, particularly in the healthcare sector. The BGH Consortium (consisting of the Navitas founder, BGH Capital and Australian Super) also raised its original offer for Navitas (NVT.ASX) from $5.50 to $5.825 and received the blessing of the Board as a result. To date M&A activity has been confined to the larger end of the small cap spectrum, which has left many smaller and micro companies trading at very low multiples relative to the market and their historical levels.
Strong contributors included Mt. Gibson Iron (MGX.ASX) and Invocare (ICX.ASX). MGX has performed strongly on the back of a strong rise in the Iron Ore price and is close to completing the re-opening of its Koolan Island iron ore mine after the pit wall collapse of 2014. Its high-grade Iron Ore achieves a premium to spot prices due to the low impurities. IVC recovered in January after a torrid year in 2018 which saw a reduction in death rates following a very benign flu season (regrettably for the broader community a factor that is likely to prove temporary). IVC is also in the middle of a major revamp of its sites with a $200m investment. Unfortunately, this refurbishment is accompanied by a shortterm reduction in volumes. While these factors have hurt near term earnings and the share price, they have also provided the opportunity to acquire a remarkably consistent business and an enviable generator of free cash flow (93% average cash flow conversion over the last 14 years).
Most of the negative relative contributions in January came from shares the Fund didn’t own. Beach Energy (BPT.ASX), Afterpay (APT.ASX) and Wisetech (WTC.ASX) all rose over 20% in January, whilst A2 Milk (A2M.ASX – not owned) rose 17% and Bluescope Steel (BSL.ASX – not owned) rose 13.5%.
The market rally in January saw the momentum and growth style names broadly re-rate to levels they were at prior to the sell-off in October last year. Having said this, there are now some interesting opportunities opening up in the highly cyclical segments of the markets that have taken a beating over the past six months. We think there is scope for good returns in the medium term in some of these names.