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Date : 12/02/2021

H1 FY2021 Earnings Update – Volume 1

On the back of a fantastic start to February 2021, it has been a rather flat week as far as the ASX 200 index is concerned. It is earnings season and we have had some of the biggest companies already report their performance for the first half of FY2021. Commonwealth Bank, the largest bank reported their earnings on the 10th and it was a rather flat performance that the market was pretty much expecting. The complete dissection of CBA’s earnings and their outlook was published by our research team yesterday and the report can be found here.

As a result of popular demand among our members, we have decided to publish weekly reports during earnings season and analyse the latest announcements and what the future holds for some of the largest/best/most talked about stocks on the ASX. Kicking off Volume 1, we have had some of the juggernauts on the ASX such as – Magellan, Challenger, AGL, and Transurban grabbing our attention.

Magellan Financial Group (ASX: MFG)

Magellan is the largest and historically the best fund manager on the ASX. Their business model is fairly simple – funds under management is the top line metric that needs an eye on. As FUMs increase, Magellan generates a fixed management fee and a performance fee based on the returns they deliver to their clients.

The average FUMs increased by 9% to $100.9 billion. This figure is compared to the previous corresponding period, that is H1 FY2020. An increase in FUMs resulted in an 8% growth in management fee to $311.4 million. The performance fee is where the damage has occurred. In our latest report on Magellan, we did say the expectations of Magellan’s performance fee was around $12 million for the half year. The interim result showed that the performance fee that Magellan earned was $12.4 million – representing a 70% decline. We cite two reasons for this underperformance:

  • Magellan’s Global Equities Fund underperformed the benchmark index as the firm shifted its investment strategy to defensive during the pandemic. However, global markets and especially the US market surged and were seen at all time highs as technology stocks surged.
  • A couple of the largest holdings in Magellan’s Fund were hit hard. Alibaba and SAP are two such companies that were put under immense selling pressure in 2020. It is worth noting that Alibaba was Magellan’s largest holding in its fund at that time.

Subsequently, Magellan reported a 3% dip in adjusted revenues to $327.1 million. However, the firm has been trying to increase efficiency of their operations and as a result, their expenses have reduced by 6% – offsetting some of the losses that were caused by the dip in revenues. The net profit after tax (NPAT) for the half has increased by 3% to $202.3 million – keeping their margins healthy.

Why do investors particularly love Magellan? It is for their dividends and also the ETFs that they now have on offer at low costs. Earnings per Share of Magellan increased by 2% and Interim dividend has been increased by 5% to 97.1 cents a share.

What’s in store for the second half?

That was the gist of the entire earnings call summed up in a few short paragraphs. While FUMs can vary month-on-month due to various reasons, the average FUMs are growing at a healthy rate. Performance fee is the area that Magellan needs to address if the firm wants to have a good full year FY2021 performance. So what are they going to do about it?

  • The investment strategy will be changed from defensive going forward. While nobody knows how well the strategy will pay off, all any investor can do about this is trust the stellar management team that comes with an impeccable track record.
  • Institutional FUMs will grow slowly given how big Magellan already is. The retail FUMs is where the extra growth is there for the taking. We have already talked about the restructuring and the addition of several low-cost ETFs that Magellan has launched and in the process of launching in our report from last month.

All in all, this performance was not surprising in the least. Members who viewed our January report on Magellan will find that this was in store and the outlook quite frankly has not changed since then. The increase in dividends during a flat performance brings a smile to investors holding Magellan in their portfolios.

Challenger Limited (ASX: CGF)

The Challenger share price is trading at very desirable levels since the firm announced its half year earnings report. Yes, despite the net profits being down 10%. Let us explain:

Challenger has 2 businesses – the Life and Funds Management.

In the Life segment, Domestic annuity sales were up 11%. This is the strongest growth in lifetime annuities. The boost came as a result of Challenger benefitting from an increase in new institutional clients, stabilisation in the advisor market and a further penetration among independent financial advisors. EBIT reported was $193 million and total life sales was $3.4 billion – up 10% compared to H1 FY2020. The segment reports a very strong capital position with $1.5 billion of excess regulatory capital. The firm is expected to invest $1 billion of the excess capital in the second half of the year – further supporting earnings growth.

Coming to the Funds Management segment, Net flows in FUMs were $6.4 billion as both retail and institutional investors contributed to strong growth. THe EBIT of the FUM business segment saw a growth of 18% during the period as management fee and expense control initiated by Challenger looks to have worked. The average FUM was also 7% higher than the previous corresponding year at $85.9 billion.

Similar to Magellan changing their investment strategy to defensive, Challenger decided to do the same to navigate the turbulent markets. Given that Challenger’s clients are retirees looking to fund their retirement, the firm has to be ultra careful during times of market and economic uncertainty. This added pressure means their defensive strategy involved increasing cash and liquidity levels in their portfolio.

We expected Challenger to post negative figures as far as profits go. So did the institutional investors and the market. Normalised net profits before taxes were down 14% to $196 million compared to H1 FY2020. Normalised net profits after taxes was down 10% to $137 million. This result has dipped below the expectation of few institutional investors that were forecasting NPBT of $200 million. Challenger announced 9.5 cents in interim dividend per share. Again, this has fallen below the expectations of a few institutional investors, as their forecasts suggested a 9.8 cents dividend per share for the half year. Given the shift in investment strategy and a lot more liquid assets being invested in order to deliver a better performance, the dividend payout seems reasonable.

Where to from here?

It is a bad result, yes. But it is in line with expectations. The financial service industry is one of the most impacted during the crisis. We have to remember that these businesses are severely impacted and it can be seen in the share prices that these institutions are all trading at. Is there a way out? Of course there is. But the road is long and rocky.

  • Challenger is expected to shift its investment strategy and increase its liquid holdings in the second half of the year.
  • It is a cyclical stock. The economy is recovering and Challenger will recover with it. Even with a below par performance that the market seems to have made this to be, Challenger is on course to meet its full year net profits before tax (NPBT) guidance of $390 – $400 million.

With increased investments by Challenger going into the second half of the year and the economic recovery going to plan, Challenger remains a top stock for a financial services play. Let’s not forget the dividends that add on to the potential growth in EPS that is in store.

AGL Energy Limited (ASX: AGL)

AGL is a very exciting stock. There has been so much happening and the stock price has been sliding since a year now. This is how the performance is looking at the time of this report:

  • 1M – 5.44%
  • 3M – 14.59%
  • 6M – 26.43%
  • 1Y – 45.91%

The chart is an exact opposite of the run that Afterpay has been on during the same time. Which is actually funny given how AGL is deemed as a safe investment. Our short answer – Stay Away from AGL! The long answer – is below:

AGL reported another downgrade in earnings. Let’s start from the top line item:

Power generation volumes decreased 4.5% as the demand for electricity further reduced. AGL has also faced unexpected outages during the period. There was a sharp decline in wholesale electricity prices and low gross margins in wholesale gas. This resulted in 14% decline in revenues – coming in at $5.41 billion. The underlying net profit after tax (NPAT) was down 27% and it came in at $317 million. There were several asset impairments that have affected AGL during the half year and the performance has been very negative. The statutory loss after tax for the half year is $2.28 billion after the $2.68 billion in onerous contract provision and impairment charges that were announced on the 4th of February 2021.

Dividends took a marginal hit as well. AGL announced an interim dividend of 31 cents a share and a special dividend of 10 cents a share. Despite the poor performance, AGL’s dividends remain relatively high.

Their Outlook?

Well, AGL has been beaten down and they look like they will continue to be beat down for another year or two. The firm’s guidance was where the major focus was and we saw the market relieve some of the pressure the stock was under just a couple of days ago.

For the full year FY2021, AGL maintains guidance as below:

  • Underlying EBITDA between $1.5 and $1.8 billion
  • Underlying Profit after Tax between $500 million and $580 million.

These figures have remained unchanged from the December update that AGL provided. By running the numbers, the only chance AGL can meet these guidance numbers is by the firm receiving the $100 million insurance claim for the outage.

The narrative with AGL is that it is becoming too much of a yield stock. AGL is one of those stocks that continued to slide even when their CEO increased holdings. The root of their problems are structural and there are heavy headwinds going forward.

We don’t see energy prices going up anytime soon and the government will be pushing for renewable energy sources as well – adding more pressure to AGL. Renewable energy is flooding the market and even though AGL saw this coming a while ago and is trying to position itself, it does not make sense for investors to deal with this risk and also the costs associated with the restructure. The only solution here would be a demerger. While the yield does look attractive at these prices, investors chasing yields from AGL look like they would be making very bad long-term decisions as far as investing goes. AGL has slid so much recently that we wouldn’t recommend AGL unless there are proven signs of positive performances rather than bank on expectations.

Transurban Group (ASX: TCL)

The road giant was impacted a lot during the pandemic lockdowns as there was no traffic on its roads. Sure, Australia recovered quicker than expected, however, the USA still remains impacted. The weak performance that TCL released in its half-year FY2021 earnings update was in line with market expectations. Investors knew exactly how impacted Transurban as the firm is transparent on its traffic figures.

Average daily traffic (ADT) declined 17.8%. The firm did go on to say that the numbers are getting better though as we and North America recovers from the pandemic. The ADT has risen from 1.8 million in July to 2.1 million in December. The road ahead is slightly muddy, but there is light at the end of the tunnel (no pun intended). Before we get to it, let’s look at the results announced by the group:

  • Toll decreased by 16.6% to $1.17 billion
  • EBITDA decreased $840 million – 23.2% drop off
  • Statutory loss came in at $448 million compared to $65 million profit in H1 FY2020

The losses were slightly offset as Transurban received $43 million as the firm opened new road assets. Transurban also declared a 15 cents per share interim dividend that will be paid on 16th February and it will be funded from the $467 million free cash flow that was generated during the period.

Recovery on the road?

There is not a lot we can explain here that you do not already know. Traffic is crucial to Transurban making money from tolls. With government lockdown restrictions imposed, it has been a major hindrance. Melbourne and the Greater Washington area were impacted the most. The traffic data is rebounding. As of December, traffic declines are only 19% in Melbourne compared to 66% during August. Brisbane and Sydney show traffic levels closer to the pre-pandemic levels and this is a very positive sign for TCL.

New opportunities are also on the horizon for Transurban. There are projects in its development pipeline that will support its growth. The firm’s GoToll mobile tolling app expanded in January to an additional 47 toll roads across North Carolina, Florida and Georgia through a partnership with the North Carolina Turnpike Authority.

To sum it up, there has been an impact on Transurban’s financials and the extent of the impact is largely what the markets have predicted for a long time. Structurally, there are no shifts in dynamics that have affected TCL, as was the case with AGL. The shares have been hovering in the $13 range for a while now and unless we see further lockdowns or unforeseen events occurring that may impact Transurban, it looks like the light is visible at the end of the tunnel.

 

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