Hear from three of Firetrail’s Portfolio Managers on what matters for investors in the year ahead.
Blake Henricks, Portfolio Manager of the Firetrail Australian High Conviction Fund, James Miller, Portfolio Manager of the Firetrail S3 Global Opportunities Fund, and Ramoun Lazar, Portfolio Manager of the Firetrail Absolute Return Fund share their insights with Investment Specialist, Eliza Clarke, on where the market should stay focused in 2023.
Please find a transcript of the video below.
Eliza Clarke: Hello and welcome back to the Firetrail Analyst Series for 2023. My name is Eliza Clarke, Investment Specialist here at Firetrail. Today, we’re going to discuss the one thing that matters for investors looking to navigate the year ahead. Blake Henricks is a Portfolio Manager of the Firetrail Australian High Conviction Fund, a concentrated portfolio of our best Australian equity ideas. Blake, what matters for investors looking to the year ahead?
Blake Henricks: Well, Eliza, for me, I think it’s that nothing happens in a vacuum. And for 2022, the market’s view was really if it’s bad, sell it. But two things can change. The first is that companies’ strategies can adapt to tough markets, and we believe it is going to be tough this year. The second thing that can happen is that share prices can adjust to reflect those expectations. And so while we continue to own companies where we see really good outlooks like Santos and Newcrest, we’ve actually been adding to two stocks and I wanted to share those with you now.
The first one is Domino’s. What matters for Domino’s is selling more pizza because they take a percent of sales. What they rely on is franchisees to be making money and rolling out new stores. And the market’s view, particularly as it evolved in ’22, was that that’s going to be less likely because pizza shops aren’t making much money at the moment. You’ve got high labor costs, high food costs, and high energy costs. What we are seeing out there in the market and what changed our view is that Domino’s is adapting to the market conditions. They’re actually increasing prices, and we believe franchisee profitability is going to improve as we head into ’23. The second thing that changed was the share price. It was $160 at its peak last year. This year, we’re coming into the year around the mid-60s. So it’s come off a long way. And so for that reason, we’ve taken a position in Domino’s.
Another company we’ve been adding too, we already owned it, was SEEK. And SEEK has been in a similar position to Domino’s where it’s come off a long way. It hit highs of $35. Today, it’s around $20, so it’s come off a long, long way. And the market’s view is, well, job ads are going to start falling as we head into a tougher period and we should sell SEEK. We don’t disagree that job volumes are going to fall, but what we do believe is there’s some mitigating circumstances. The first one is that prices can rise, and SEEK has shown its ability over the long term to increase prices. If we look back at the GFC, their price per ad actually rose 15%. So we believe price will start to rise in a tougher environment.
And the second thing, and this is the chart I’m sharing with you now, is on SEEK Asia costs, is that SEEK are an experienced management team, and they’ve loaded a lot of cost into the business through those very boom times of ’21 and ’22. Look at these SEEK Asia costs. They’re running it 80 to 100 mil normally. It’s jumped up a long, long way in ’22. It’s going to be even higher in ’23, and that means there’s a lot of buffer to shield those earnings as conditions get tougher. So we’ve been adding to SEEK as well.
Our view is ’23 should be the year of what’s in the price, looking at companies’ strategies, and making investments on that basis. And on that basis, we are seeing a lot of opportunities out there.
Eliza Clarke: Thanks for sharing your insights, Blake. James Miller is Portfolio Manager of the S3 Global Opportunities Fund, a concentrated portfolio of our best global equity ideas with a sustainable edge. James, where should investors focus in global markets for the year ahead?
James Miller: Well, Eliza, everyone’s looking for indicators for how the world is going right now. We’re in this phase that we haven’t seen for many years. We’ve got higher interest rates, higher inflation. So one thing that we are watching is the soybean price. Now, soybeans, and if you think about all the inputs that go into soybeans, they’re a great economic indicator. And for us at Firetrail in the S3 Global Opportunities Fund, they’re also very important in terms of stock specifics.
Soybeans, if you think about them, they’re a product where there’s 350 million tons produced a year, across 130 million hectares. That’s about five times the size of the UK. They’re turned into soybean meal and soybean oil, protein and carbohydrate. That’s food, that’s feed, that’s fuel. We can think about demand and supply of soybeans. On the demand side for soybeans, we’ve got the food and the feed for livestock. That’s a source of protein which is ever increasing, especially in emerging markets. And compared to other sources of protein, it’s still actually a relatively cheap source of protein. And on the fuel side, it’s very important in terms of decarbonization, especially things like sustainable aviation fuel, which is small right now but rapidly growing. On the supply side, we’ve been constrained in the last year from things like Ukraine and geopolitical disruptions. But more importantly, think about the growers. You’ve got things such as your costs going up, fertilizer, your labor, your diesel, all inputs that go in there.
The price of soybeans is up 25% over one year, and up 75% since pre-COVID. We actually see this price as being sustainable, and that’s great for a few of the stocks in the S3 Global Opportunities Fund. We’ve got Archer-Daniels-Midland. They are a crusher. They are a logistics provider for soybeans. You’ve got Darling Ingredients, and soybeans and soybean oil are great indicator for how biofuels are going there. So soybeans for us in S3 are very important, and my advice for 2023 is ignore the noise, and watch the soys!
Eliza Clarke: Thanks for that advice, James. Ramoun Lazar is Portfolio Manager of the Firetrail Absolute Return Fund. This is a market-neutral fund that invests in Firetrail’s best long and short equity ideas. Ramoun, where should the market be looking in 2023?
Ramoun Lazar: Yeah. Thanks, Eliza. It’s good to be back. Over the last year, the market’s direction has been dictated by inflation and interest rates. Investors have obsessed over the next CPI print and what the Fed’s going to do in terms of interest rates. The reality though for earnings is that we’ve moved from a period of very loose financial conditions, which have been positive for profitability over the last few years, to a period where financial conditions have tightened materially. That’s going to present challenges for corporate profitability going forward. It’s this focus on the earnings outlook that we think will drive the market’s direction in 2023.
To be fair, to date, corporate profits have held up pretty well. Corporate profit margins continue to trade around peak levels. But if you look at the chart of, I’ve put up on the screen today, the financial conditions index, which looks at some leading indicators of economic activities such as consumer spending, employment, and house prices, it’s started to weaken. That’s going to present challenges for corporate profitability in our view over the next 12 months.
We get often asked, “Are we going to see an economic recession over the next year or so?” I don’t know the answer to that. What I do know though is that there’s very little historical precedence for an earnings soft landing when financial conditions tighten so much in such a short period of time. And then if you look at the second line on that chart, you can see that earnings expectations have yet to adjust. So as active investors at Firetrail, we see that as throwing up plenty of opportunities in the year ahead. Fortunately for the Firetrail Absolute Return Fund, we can take advantage of those opportunities on both the long side and the short side.
I’ll start with the short side. It’s pretty simple, our philosophy. We’re looking for earnings risk and the risk of earnings downgrades. Where are we going to see those? We see companies with heightened risk being those companies where demand is reverting from post-pandemic highs, where corporate or profit margins are high and expected to remain high. As that demand starts to revert, the ability for cost to come down as fast as limited, which is going to put pressure on some of those corporate profit margins. That’s how we see it, and we see that broad based opportunity across a number of sectors.
On the long side, we also see opportunities. One area that we particularly like over the next year is gold. I’ve talked about the earnings risks for the market. Typically, a period of earnings risk for the market is positive for gold. That’s a historical precedent. The other thing is that over 2022, gold saw a number of headwinds with rising real interest rates and a high US dollar. Those headwinds are now becoming tail winds. That’s the second factor. And then finally, the China reopening could have a positive impact on consumer demand for gold as well.
How are we playing that thematic? We’re playing that thematic through our holding in Newcrest, which is our preferred player on gold. Commodity price aside, there’s a couple of things that are going on which are positive for Newcrest. The first one is that asset quality continues to improve. Over the next several years, Newcrest is going to add a number of Tier 1 assets to its portfolio. And then the second one is that costs are expected to come down as copper production continues to increase. Why does that matter for a gold company? Copper acts as a cost offset for production costs. We’re cautious around earnings in 2023, but there’s plenty of opportunities both on the long side and the short side for the Firetrail Absolute Return Fund.
Eliza Clarke: Thanks for sharing your insights, Ramoun. Well, we know 2022 was a challenging year in the macro environment, but it sounds like 2023 is going to be an exciting year for equity investors. Thank you for joining us for our discussion on what matters for investors in the year ahead, and we look forward to you joining us on the trail in 2023.
This article is prepared by Firetrail Investments Pty Limited (‘Firetrail’) (ABN 98 622 377 913, AFSL 516821) as the investment manager of the Firetrail Australian High Conviction Fund (ARSN 624 136 045), the Firetrail Absolute Return Fund (ARSN 624 135 879), the Firetrail Australian Small Companies Fund (ARSN 638 792 113) and the Firetrail S3 Global Opportunities Fund (ARSN 653 717 625) (‘the Funds’). Pinnacle Fund Services Limited (‘PFSL’) (ABN 29 082 494 362, AFSL 238371) is the product issuer of the Fund. PFSL is not licensed to provide financial product advice. PFSL is a wholly-owned subsidiary of the Pinnacle Investment Management Group Limited (‘Pinnacle’) (ABN 22 100 325 184). The Product Disclosure Statement (‘PDS’) and Target Market Determination (‘TMD’) of the relevant Fund are available via the links below. Any potential investor should consider the PDS and TMD before deciding whether to acquire, or continue to hold units in, the Fund.
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