Income Report / Income Note: Reviewing 5 key positions in the MM Income Portfolio (IGL, XARO, TLS, IFL, ABP)

The local market is pushing on higher today as banks continue to find buyers– the market is starting to believe in the better than feared story for the Australian economy, and a good way to play that is through the banks. Another recent gainer in energy isn’t finding as much love today while tech trades flat. Rotation out of growth into value looks to have slowed, but outright buying clearly remains across the board.

Overall, the ASX 200 is currently trading up +40pts / 0.62% to 6538

ASX 200 Chart

The Income portfolio continued the positive momentum of recent weeks adding +2.46%.Topping up the bank equity allocations helped with CBA & NAB both up over 4%, as was SYD however the standout was IGL climbing over 44% in the week. NAB also paid a dividend of 30cps FF. The portfolio remains well ahead of its benchmark for the current financial year, up 10.04% vs the RBA + 4% target of 1.61%.

Today’s note will look at 5 interesting aspects of the MM Income Portfolio

1 Worst Performer

When we started Market Matters many moons ago, one of the key differences we wanted to bring to the newsletter space was a level of reality that in our view at least, was lacking. The reality in the market is that stocks don’t always do what you expect them to, and disappointments happen. Running real portfolios, writing about our positions good and bad and sending alerts whenever we made a change ensured accountability and transparency in our actions, and cast aside the all too common act of ‘cherry picking’ the good ones, and burying the bad ones.

Ive Group (IGL) has certainly been one of the ‘bad’ ones, however there are now signs of improvement, and patience could well be rewarded here.

About a year ago, the integrated marketed business made a large acquisition from Salmat which came on the back of a number of other acquisitions as they worked to consolidate a fragmented mass marketing and catalogue sector. They entered COVID with a significantly larger business in transition phase, exposed to discretionary marketing spend, carrying too much debt. They lost a large contract from Coles and while their assets were good, the balance sheet became an issue as earnings declined. Like many businesses, they benefitted from Government assistance and that support has now given them the platform to tap into the recovery that’s building steam across the Australian economy.

The stock is on just 6x FY21 forecasted earnings and they have now guided to a dividend being paid in the 1H21. Last week they reconfirmed guidance for EBITDA to be in line with FY20 and importantly, they launched a share buy-back of up to 10% of the stock on issue (about 14m shares). Forecast net debt will end FY21 around $95m, which is manageable.

MM believes IVE remains a cheap turnaround play at current levels.

Ive Group (IGL) Chart

2 Most defensive position

Hybrids are more defensive than equities, and bonds in most cases (but certainly not always) are more defensive than Hybrids. The most defensive security we hold in the MM Income Portfolio is the ActiveX Ardea Bond Fund (XARO). This is an interesting, listed fund that uses a relative valuation strategy targeting high quality government bonds with 70+% exposure in Australia. It’s very defensive and provides a stable consistent yield that is low in terms of their target, but in reality, has been higher over time.

They actively manage exposures through buying relatively cheap bonds and selling relatively expensive bonds, therefore eliminating risks around interest rate duration which is obviously a major consideration when investing in bonds at this low point for global interest rates. The managers have a strong track record over the past 10 years, they manage around $13b across fixed income markets and many well-known Australian Institutions invest with them. It’s a lower risk strategy with a return target of CPI +2%, although they paid a ~5% yield over the past 12 months. The fund charges 0.5% pa with no performance fee.

MM remains positive XARO as a defensive holding

ActiveX Ardea Bond Fund (XARO) Chart

3 Best fully franked income stock

Telstra has delivered a world of pain to most holders over the past few years; however this is about to change in MM’s view. We see value here based on 3 key areas:

-       The dividend is sustainable: TLS reported FY20 earnings mid-August, they met expectations for the current year however they poured cold water over earnings guidance for FY21. They maintained the dividend at 16c; however, this is made up of 10c ordinary and a 6c special which is related to NBN payments. The concern is that the ‘real’ dividend will be closer to 10c than 16c however in MM’s view that’s unlikely. On an earnings basis, the 16c dividend is not sustainable given TLS will likely generate around 14c EPS in FY21 & FY22 before rising from there, however TLS have shifted their dividend focus to be more heavily aligned with free-cashflow (FCF). In terms of that number, which seems to now be the key for the dividend, it’s expected to be 20c in FY21, 21c in FY22 and rising from there, making 16cps for the foreseeable future highly likely. Telstra yields 5.12% fully franked (7.3% gross) based on current prices, or 5.55% / 7.9% based on MM’s purchase price

-       There is value in their assets: TLS will be legally restructured by the end of CY2021 into the three business units. InfraCo now becomes InfraCo Fixed and InfraCo Towers. Inside these sit passive and active assets. These assets valued separated are worth a lot more than is currently being implied by the Telstra share price. The 3rd business will be ServeCo. The restructure is a smart move particularly given the demand / backdrop for infrastructure type assets in a low interest rate environment and the ability for analysts to value these divisions separately will be positive for the group

 -       Telstra is under owned by fund managers: Running an underweight to TLS has been a good play, however that becomes a risker proposition when a planned value accretion event is now on the horizon.

MM remains bullish Telstra (TLS) for income

Telstra (TLS) Chart

4 Best turnaround opportunity

This one will require some patience, however an estimated yield of 8% while we wait is more than palatable. IOOF (IFL) have had a horror 2 years with the royal commission followed by the purchase of MLC that required a huge capital raise, the price dropped below the issue price and the underwriters were lumped with ~85m shares trading at a loss. The purchase and integration of MLC is a complicated one, at a time when wealth management is at a clear crossroads and the broader financial space is under pressure. To complicate matters further, IFL is still bedding down the purchase of ANZ’s wealth management arm which it acquired in 2019.

On the flipside, IFL believe that the acquisition will deliver in excess of 20% earnings accretion based on FY21 forecasts, or in other words, they believe this transaction will increase their earnings in FY21 (on a per share basis) by more than 20% -  clearly an attractive carrot assuming the targeted synergies are met.

They’ve doubled down on wealth management at a low point and if they can pull this off, we will look back at this stock in 1-2 years’ time as a true turnaround story, no longer trading on 12x earnings.

MM is bullish IFL as a turnaround play

IOOF (IFL) Chart

5 Strongest yield (i.e. high & consistent)

Two property stocks are vying for this position. Abacus (ABP) and Charter Hall Long WALE REIT (CLW) which yield 5.78% & 5.85% respectively with a high degree of yield certainty. In an environment of low rates, predicable earnings from diversified property companies (one of which are trading at a discount to its asset base - ABP), is attractive for this income focussed portfolio.

We remain bullish both ABP and CLW for yield

Abacus Property (ABP) Chart

The MM Income Portfolio is a blended portfolio of defensive income positions including bonds, hybrids and other income securities, consistent dividend paying shares, and a few interesting situational opportunities that could provide the x factor for returns over time. We like this sort of approach for our income orientated portfolio.

**New NAB Hybrid**

On Monday, NAB launched an offer for NAB Capital Notes 5 (NABPH), to raise $750 million, with the ability to raise more or less. The offer is accompanied by a Reinvestment Offer for holders of NABPB, which have been called (first call date 17 December 2020). 

The broker bookbuild is being wrapped up today, and from what we hear, demand has been very strong.

Key points:

- $750m with the ability to raise more or less

- 3.50% to 3.70% Floating Rate Margin expected

-  Optional Call Date 17 Dec 2027 ~ 7 years

- New (NABPH) & Re-investment Offer (NABPB)

-  Offer Closes 11th December (although Broker offer closes today)

MM is positive this hybrid

Conclusion

We are positive IGL XARO, TLS, IFL, ABP, CLW

We like the new NAB Hybrid

Have a great day!

James, Harry & the Market Matters Team

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