Q&A with Guy Bunce

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Perpetual

Perpetual Asset Management

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Guy Bunce is a Senior Equities Analyst with extensive experience in equities research who has been with Perpetual for two years. Here he takes us through a few of his favourite stocks, makes the case for Qantas and explains why the city office should not be written off just yet.

Please give us an outline of the sectors that you cover?

I specialise on the industrial side covering transport, infrastructure, telcos, chemicals, packaging, contractors, as well as some of the REITs on the financials side. For the purposes of this discussion, I'll focus more on the names in which we have a holding across one or more of our Australian Equities funds. 

Let's start with Brambles Ltd. What do you like about the company?

Based on our valuation, we see good potential upside to the current share price. One of the reasons we like Brambles is because around 85% of its revenues is linked to fast-moving consumer goods, which has been a key beneficiary of COVID. In addition, it operates in an industry with high barriers to entry, which in turn drives above-average returns. We have looked at Brambles for many years and seen a number of new entrants struggle to develop a profitable position in either local or global pallet pooling markets. Brambles remains the number one pooler globally. In addition, Brambles is in the midst of a number of self-help initiatives in one of its key markets, the US (for example, the company is automating its pallet repair centres). The US probably accounts for around 30% to 35% of group earnings. We believe what they're doing in the US should deliver at least a 1% improvement in their operating margins in the current financial year with further gains likely beyond that. Combined with the expected contribution from other regions, then we’re comfortable that Brambles should be able to grow its group earnings in the order of 5% to 7% in constant currency terms, which we think is a good outcome in the context of the current economic uncertainty globally. And importantly, it has a large on-market buyback of up to US $1.65 billion ongoing, and that should provide near-term support to the share price.  

Real estate investment trust Dexus is another stock you like. Take us through the thinking there?

2020 was a very tough year for the REITs sector generally, but particularly those with material exposure to the office sector. With around 75% of its income coming from office investment properties, Dexus was hit hard. You saw its share price fall from over $13 in February of last year to a low of around $8 a month later and that was driven by concerns about the impact of the pandemic on office occupancy, effective rents and asset valuations. There was a consensus view that COVID would lead to a significant structural decline in the demand for office space, but we took a very different view. 

In our view, the office is going to continue to play a critical role in most people's working lives. It remains a place for collaboration, innovation, culture building, upskilling, career progression and social interaction. We would argue that most of these things are going to be very difficult to achieve through a virtual network, and it certainly would appear that others agree. Up until the recent lockdowns in Melbourne and in Sydney, physical occupancy rates of the CBDs around Australia had been growing strongly once COVID restrictions were removed and, more importantly, we've seen a number of direct property investors agree with us. Since early last year, there's been many direct market transactions either at or above net tangible asset values and that's important in terms of drawing a line in the sand as to what these stocks might be worth. There's also been some good signs in terms of office leasing activity. It's definitely been picking up, particularly in the June half. We believe all of this bodes relatively well for Dexus over the longer-term.

Moving on to Qube Holdings, another one of your preferred stocks, where you argue that a key tenant and investor makes all the difference. 

A key attraction of Qube is its investment in Moorebank, the industrial estate in the southwest of Sydney that stands to revolutionise Sydney’s import-export supply chain. It represents more than half of our valuation. Importantly, Qube has signed an anchor tenant, being Woolworths, and we think what that did was validate the company’s substantial investment in Moorebank. A 20-year agreement is somewhat unusual in the industrial world – and given it was for a large area (some 75,000 square metres), and at an above market industrial rental rate as well – we saw it as a strong endorsement.

Potentially of even more importance was that following that signing, we saw an investment consortium led by a leading global property developer agree to pay $1.67 billion to acquire Moorebank’s warehousing assets. This was critical for a couple of reasons. Firstly, not only does it indicate what the property experts think about Moorebank’s future earnings potential, but also because the transaction significantly de-gears Qube’s balance sheet, it allows the company to more easily fund future organic and acquisitive growth. In the shorter term, Qube is exposed to the impact of COVID on logistics demand. However, the good news is that we estimate it's most exposed in terms of containerised trade, and containerised trade has been much stronger than what analysts were expecting. The latest data we have is for the month of April and across the four major ports in Australia, we saw containerised trade increase some 20%. It's running well ahead of its historic average growth rates and that's obviously a reflection of huge demand for imported goods at the moment. 

With some uncertainty around when current lockdowns are likely to lift, especially in Sydney, how do you evaluate stocks like Qantas, which are more exposed than most?

Qantas is always a popular one to talk about and my current valuation suggests material upside to the current share price. Obviously, it is highly leveraged to the impact of COVID. However, I believe Qantas should emerge from this pandemic in a far stronger competitive position. Both old and new competitors (domestic and foreign) have fared far worse than Qantas. The key attraction of Qantas for us is its domestic franchise, where it holds a 65% to 70% market share. We expect domestic leisure travel to drive the initial recovery in Qantas’ profitability. Prior to the recent lockdowns, we were seeing strong signs of that with the domestic fleet running at about 90% to 95% of pre-COVID levels. Obviously, the recent COVID outbreaks will put a bit of a delay on the recovery, but we take comfort in the fact that Qantas is in a relatively strong financial position. For example, it had roughly $4.0 billion of cash and undrawn facilities, plus another $2.5 billion of unencumbered assets as at 30-April. In addition, we believe management has acted decisively in response to snap lockdowns thus ensuring the long-term viability of the airline.

Find out more about our Australian Equities Funds.


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