Income Report / Income Note: Reviewing the MM Income Portfolio against our key macro calls (NABHA, CLW, TCL, SUL)

The ASX is drifting lower this morning although the Energy stocks are a clear standout again up more than 3% while the Materials & Consumer Discretionary sectors are also in the green, all other sectors are trading lower. Solomon Lew’s Premier Investment (PMV) which owns brands like Smiggle, Just Jeans, Jay Jays while also holding nearly 30% of Breville (BRG) provided a 1H trading update today with profit for the half expected to be in the range of $221-$233m, up at least 75% on this time last year and only $10-20m shy of Myers (MYR) total market capitalisation! PMV is trading 14% higher at $25.61

Overall, the ASX 200 is currently trading down -15pts / -0.23% to 6663

ASX 200 Chart

Since our last income note on the 16th December, the portfolio has added 1.05%. Ive Group (IGL) added 11.97%, BHP is up 10.10% & RIO has put on 8%, although this was offset with weakness amongst Sydney Airports (SYD) -7.52%, Abacus (ABP) -6.53% & Transurban (TCL) -5.76%. A bunch of dividends have also been paid.

The portfolio remains well ahead of its benchmark for the current financial year, up 15.27% vs the RBA + 4% target of 2.24%.

NAB Perpetual Hybrid (NABHA) $99.90

NABHA is a perpetual Hybrid Security which was issued back in 1999 – Steve who sits on our income desk and runs our ~$800m Hybrid Portfolio actually listed the thing way back when. In any case, it wasn’t a good security and hasn’t been a great investment for holders over that time however there’s been a lot of debate on what NAB will do with the security – redeem or just let it sit out there. They’ve made the decision to redeem the security and holders will get $100 back plus the final interest payment of approximately $0.3201 per note on 15 February 2021. NAB have made the decision to redeem for one primary reason, from 1 January 2022 they will no longer qualify as Tier 1 regulatory capital so given they can raise capital elsewhere at better rates, and they currently have excess tier 1 capital in any case, the decision makes sense.

The key takeaways for MM are:

  1. This is a $2bn issue, which is large, which means in February there will be $2bn repaid in cash to hybrid holders. A large amount of that should again look for a home in Hybrids and there are no new issues on the horizon, hence we think the currently listed Hybrids will remain firm.
  2. It shows how comfortable NAB (and other banks are) around capital levels and the ability for them to raise cheap debt in the current market

MM’s two preferred securities if buying today are the WBCPJ which has 3.6 years to run with a yield to call of 3.08% and the longer dated NABPH which has 6.9 years to run and a yield to call of 3.84%. Forecast yield to call for longer dated securities have taken a leap up in recent weeks as the yield curve has steepened, highlighting the benefit of holding floating rate notes in this type of environment.

MM remains keen on Hybrids as part of a balanced portfolio

NABHA Chart

Reviewing the MM Income Portfolio against our key macro calls

This time of year we always have a better chance to reflect and that reflection often sees some portfolio tweaks, and the MM Income Portfolio is today getting tweaked to reflect those changes – we’re also planning some tweaks to other portfolios in the coming days.

To recap, we believe inflation expectations are firming and this is putting upward pressure on bond yields, in that environment we want more exposure to commodities and associated service providers, less exposure to long duration assets, we want to hold financials that benefit from a steepening yield curve and we want floating rate fixed income exposure rather than fixed.

The other aspect we haven’t discussed is savings rates and the impact this could have on consumption. In Australia, household savings rates have jumped and that provides a positive read through for consumption which benefits the retailers – more on this below.

Household Savings Rates – Australia

1 Inflation, rising bond yields & a steepening yield curve

The MM Income Portfolio holds BHP & RIO while Wesfarmers through their industrial division has some exposure to the resource sector. We are bullish resources and comfortable with these holdings. We have no real exposure to associated service providers such as engineering & infrastructure development, an area we are also bullish on.

We have strong weightings towards banks from good levels which benefit from the above themes, plus we also expect a positive influence on earnings as overprovisioning is unwound. We hold IOOF (IFL) as a turnaround play in the financial space, exposed to rising asset prices.

In this sort of macro environment, we want to reduce exposure to long duration assets, and at this stage, the MM Income Portfolio holds a number of these stocks that struggle as interest rates rise. Charter Hall Long WALE REIT (CLW) is a holding we’ve flagged a number of times with the intention of selling. We now intend to cut this position for a loss.

MM is bearish CLW

Charter Hall Long WALE REIT (CLW) Chart

The other two obvious long duration assets are toll road operator Transurban (TCL) & Sydney Airports (SYD), both positions are showing around 10% profit, however both are negatively influenced by rising bond yields. They are good assets that have had a difficult period, however we see no near term catalyst for these stocks to meaningfully contribute to the performance of the portfolio given the above macro backdrop.

MM is neutral/bearish both TCL & SYD

Transurban (TCL) Chart

2 Household savings rates

Household savings rates are near 20% which is very high, credit card debt has hit its lowest level in 15 years (obviously influenced to a degree by BNPL), however both of these factors show the consumer is in good shape. Recent updates from key retailers have been positive, this morning it was Premier Investments (PMV) turn to provide a very strong 1H trading update.

All the signs imply to MM that retail is in good shape and the upside here looks better than long duration assets discussed above.

MM holds Wesfarmers (WES) & Metcash (MTS) in the portfolio, clearly this leaves us (purposefully) very exposed to hardware through Bunnings & Mitre 10. Construction is strong and new building approvals are accelerating underpinning our view here.

Yesterday UBS upgraded Super Retail Group (SUL) and this is a stock we’ve owned in the past. In fact, it was this portfolio’s best performing position in FY20 up ~80%. We sold the stock at $10.60 in September and are now revisiting it at a higher price, something MM is never too proud to do.

The retailer has brands such as Super Cheap Auto, Rebel Sports, Macpac and BCF, all of which are enjoying a healthier consumer and greater focus on domestic travel and recreational activities. Earnings in FY21 are expected to grow by 30% after being flat in FY20, which was a solid result under the circumstances. It trades on just 13x with a fully franked yield of 4.64%. UBS upgraded the stocks yesterday, and MM agrees with the call.

MM is bullish SUL

* Watch for Alerts

Super Retail Group (SUL) Chart

Conclusion

MM is now cautious on long duration assets and we intend to reduce our holdings here

We are bullish Super Retail Group (SUL)

Have a great day!

James, Harry & the Market Matters Team

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