News & Media

Travelling around Queensland this week and meeting with clients one of the questions most frequently asked was, “What should I do with my bank shares?” Furthermore today has been one of the worst trading days for the banks since the GFC and with 30 minutes to go before the close the major banks have fallen roughly 3.5% today. Assessing future prospects for the major banks is currently one of the biggest issues facing investors; from the largest institutional equity fund manager at Colonial First State to the smallest retail investor who bought shares in CBA when it was floated in 1991 at $5.40. Over the last 3 months the banking sector’s share prices have declined -14%, significantly worse than the -6.5% total return posted by the ASX200. In this piece we are going to set aside today’s emotional selling and are going to look at the causes of this correction along with some thoughts for the future

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Last week the financial press was full of breathless articles about $100 stock prices, as biopharmaceutical company CSL hit $102 per share and these articles were full of speculation as to whether Commonwealth Bank, Macquarie Bank or Cochlear could also join CSL in having a three figure share price. As a former institutional shareholder of both Incitec Pivot and Rio Tinto during their period of having share prices greater than $100, what we saw was missing in these articles was the subsequent performance of stocks that have enjoyed these lofty per share prices. In this week’s piece we are going to look at the performance of past market darlings that have enjoyed a price greater than $100 per share and over-valuation in general.

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For equity analysts in Australia Christmas comes twice a year,  every February and August when the majority of Australian listed companies reveal their semi-annual profit results. At this time companies also provide guidance as to what growth in profit, revenue, profit margins or dividends that shareholders can expect over the following financial year. This can be a stressful time for a fund manager. When companies reveal unpleasant surprises, the company’s stock price tends to get sold down hard. Alternatively, it can be very pleasant when the company reports a good result, which validates the investment case for originally owning their shares.

In this piece we are going to go through how Aurora approaches each day during reporting season and what goes on during a typical day in an the earnings season.  It’s not all convivial lunches with management teams in the boardroom of an investment bank overlooking Sydney harbor.

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The bitter taste of the GFC, and a strong equities market, have meant Australian investors remain cautious about hedge funds, Malavika Santhebennur reports.

The thought of investing in hedge funds evoked fear in advisers and retail clients after the global financial crisis (GFC) ……..….. Aurora Funds Management managing director, Simon Lindsay, suggested that most investors had an over-exposure to listed equities, especially the big four banks and Telstra.

This was particularly the case for self-directed, self-managed super fund portfolios.

“Ultimately, when everything is going rosy, people don’t tend to worry about the risk to the downside, and I think this is probably the exact time when people should be considering hedge funds in a portfolio,” Lindsay said.

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As the 2015 financial year drew to close last fortnight, casual readers of the financial press may have had the impression that 2015 has seen a large degree of variation in the returns with the falls in oil in October and Greek Financial Crisis V2.0 in June. Contrary to the headlines which have reported the end of the mining boom, European financial crises and a weak domestic economy, the 2015 financial year has been average in terms of the dispersion of returns between the sectors. In this week’s piece we are going to be discussing the performance of the different industry sectors in the market both over the last 12 months and since 2000.

Read more here.

With the close of the 2014-2015 financial year, markets have become focused on the global ramifications of the Greek debt crisis/potential exit of the Euro and more locally the ramifications of a Chinese slow down. While normally it is trite to be permanently pessimistic, the current situation is significant in that the possibility of asset price contagion is relatively high: UBS forecasts a 40% chance of ‘GREXIT’ and if this were to arise then a further 40% chance of ‘severe contagion’.*

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Over past two years investors have faced a barrage of glowing research from the investment banks trumpeting the blue sky potential of new companies seeking to be floated on the ASX. What is also clear is that the overall quality of these new initial public offerings (IPOs) are declining and that investors right now should be more critical of the bright forecasts contained in the prospectuses. Earlier this week we received the IPO offer documents for a company exposed to the buoyant domestic housing sector, valued based on the assumption that the current demand for new homes and apartments remains unchanged.  Indeed one of their competitors that listed just over six months ago and has already fallen 20%.

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Over the last twelve months, listed property has been one of the top performing sectors on the ASX 200. Whilst Australian other sectors in the equity market have faced concerns about a rising and then falling AUD, falling commodity prices, Eurozone issues and bank capital raisings in the wake of Basel III; listed property has seemingly sailed under the radar and the index has posted a total return of +23% over the past 12 months bettering the overall equity market by 17%! In this note we will look at what is going on in listed property together with our positioning in the Aurora Property Buy-Write Income Trust (AUP) in the various property sectors.

Read more here.

This week marked the ASX debut of South32, the third major group of BHP assets (total value $14 billion) to be spun-off to its shareholders in the last 15 years. In its first week of trading, South32 has performed well (outperforming BHP by 11% adjusting for the split).  Whilst this confounded predictions of weakness, we note that most of the gains occurred on Tuesday’s session and pricing may be tested next week on the back of index-related selling from European investors. In this week’s piece we are going to look at the rationale behind spinning out assets to form a new company, together with the other two spin-offs previously completed by BHP.

Read more here.

Written by Hugh Dive

Biotechnology and pharmaceuticals are probably the most seductive and exciting sectors of the market to invest in. Not only can investors have the warm and fuzzy feeling that they are helping humanity (an emotion not readily generated by buying shares in Westpac or BHP), but when drugs or devices are developed and successfully adopted, it can be very profitable. Furthermore healthcare as a sector exhibits little correlation with Chinese growth, the health of the domestic economy or US interest rates and has some powerful demographic tailwinds.

It can be volatile, too. Recently, for example, Sirtex (STX) announced that trials of its eagerly awaited SIRFLOX liver cancer treatment had failed to show a statistically significant increase in survival in patients with liver cancer, though the company noted that liver cancer ultimately has a 90% level of morbidity. The announcement of this news wiped $1 billion off Sirtex’s market cap as the stock fell 55%.

For reference the difference between biotech and pharmaceutical companies is that biotechs like CSL use microorganisms or biologicals to perform a process, whereas pharmaceutical companies such as Pfizer employ a chemical-based synthetic process to develop small-molecule drugs.

Fat profit margins

Most large corporations require substantial and continuing capital investments to maintain the quality of their assets. The major banks are required not only to set aside capital to back their lending, but have consistent expenditure on information technology (IT); for example the Commonwealth Bank spends over $1.2 billion per year on IT services. As the other banks match this expenditure, it does not result in any improvement in profit margins. Similarly, manufacturing companies such as Bluescope produce cardboard boxes and steel from capital equipment that can readily be bought by their competitors. This results in minimal barriers to entry beyond a company’s cost of capital and thus gives low single digit profit margins and growth in line with GDP.

Conversely biotechnology and pharmaceutical companies can enjoy both high growth and high profit margins when a treatment they own and develop is successful and is adopted. For example in 2009 when Sirtex gained traction with their targeted liver cancer treatment SIR-Spheres, the company saw an annual revenue increase of 72% and profits increase from $1.2 million to $18.2 million. Demand for new and potentially life-saving treatments is relatively price inelastic. Furthermore patents and the time and effort required to obtain regulatory approvals for new drugs provide strong barriers to entry for other companies looking to produce competing products.

At the larger end of town in 2014 Pfizer, Hoffmann-La Roche, AbbVie, GlaxoSmithKline (GSK) and CSL all generated profit margins in excess of 20%. Conversely global car makers delivered a profit margin of only 3% and steelmakers -4%. For many drugs, the marginal costs of producing these drugs is small. The best selling drug of all-time is Pfizer’s cholesterol drug Lipitor that generated US$123 billion in sales from 1998 until its patent expired in 2011.

Pitfalls

As the Sirtex announcement showed, the sector can be a challenging place for retail and professional investors alike. Aside from determining whether a company’s drugs will be successful, investors also require that the product be adopted by physicians and often that it be included on a government’s list of approved and subsidised treatments such as Australia’s Pharmaceutical Benefits Scheme (PBS). In 2014, Australian taxpayers spent $9.1 billion on the PBS and listing every medicine on the PBS would quickly make the scheme unsustainable. For example, there is a good chance that an expensive new drug might not be listed on the PBS if it is deemed to only provide a marginal benefit over existing alternatives. Governments globally are looking to curtail healthcare spending that has been consistently growing at a multiple of tax revenue growth.

What to look for before investing

Security of patents. What is the life of the new and existing patents? After Lipitor’s cholesterol patent rolled off, the cost of the treatment dropped from US$500 per month to US$50. The impact of this was an 81% reduction in sales in the US for Pfizer. Investors should be aware whether competitors have similar treatments undergoing approval or if another entity is disputing a company’s patents.

Approval status. Where is a company’s treatments in being registered for clinical use with the US FDA (Food and Drug Administration)? FDA approval is a requirement for sale in the most profitable healthcare market in the world. Companies with at least one product in end-stage trials are safer investments than those just beginning the investigative phases of development. I have seen many companies issue exciting prospectuses and raise capital based on the results of their treatment on mice, with minimal further developments many years later. On average it takes 12 years and over US$350 million to get a new drug from the laboratory onto the pharmacy shelf, with a 3% success rate for drugs to move from pre-clinical trials to full approval.

Financial strength and cash reserves. Whilst this point is germane to investing in all companies, the length and cost of the approval process for a drug is greater and more uncertain than for a new gold miner or retailer. If the company is required to make multiple dilutionary share issues just to keep in the game, its attractiveness as a potential investment declines.

Diversity of the company’s pipeline. The number of investors that have made huge gains in one tiny biotech are dramatically outweighed by those that have seen share prices crater after a company’s only drug failed to win FDA approval. CSL shrugged off the failure of a competitor’s parallel trial of a plasma-derived product used to treat Alzheimer’s, as it had a range of other treatments both in the market and in clinical trials.

Size of the addressable market. Whilst investing in companies treating niche ailments can be profitable, the addressable market is far greater in areas such as HIV/AIDS, cancer, heart disease, diabetes, neurological disorders and immunological diseases. Furthermore companies operating in these areas are more likely to attract a takeover bid from the big pharma companies looking to restock their pipelines.

Complex sector

Looking across the biotech and pharma sectors in the table below, there are 70 companies listed on the ASX, but only six pay a dividend and out of the 70 only 14 are profitable! Furthermore the pharmaceuticals and biotechnology sector encompasses a wide range of companies specialising in very niche areas. Even where an investor possesses a strong understanding of a particular area of medicine such as liver cancer, this knowledge may be of little use in evaluating CSL’s blood plasma treatments. Conversely when investors are analysing the prospects for Boral, insight can be gained from examining competitor CSR’s building products division and speaking with their management team.

Source: IRESS

Hugh Dive is a Senior Fund Manager for Aurora Funds Management Limited.