Global stock markets delivered strong performances in 2024, fuelled by a resilient American economy and investor optimism about global rate cuts, although the RBA has held steady at 4.35% due to persistent inflation. The ASX 200 rose +9.5% year-to-date as of December 17, 2024, setting record highs earlier in the year but facing slight pullbacks recently. Sector performance varied widely, with financials and tech leading gains, while materials and energy struggled. Market sentiment was buoyed by solid earnings, robust dividends, and optimism about a potential RBA pivot as early as February, although structural challenges persist across key sectors.

Looking ahead to 2025, the RBA’s decisions, alongside geopolitical tensions and global commodity trends, will remain key. Opportunities in sectors like tech, gold mining, and copper are balanced against risks in energy and materials, with expectations of stronger government support for economic growth.

In any case, we made efforts to improve the composition of the portfolio by trimming exposures in some sectors.

In 2024, we published 15 sell or sell-half recommendations (some of which were long-term holdings), with 7 seeing decent to impressive gains and the remainder registering losses in various degrees. Any returns noted below include dividends. Our calls by stock are provided below in chronological order:

Beston Global Food

First on the list is Beston Global which was added to the portfolio back in 2022 largely on its turnaround potential. We noted then that there were strong operational improvements in the cheese, whey powder and lactoferrin offerings while there was notable global growth in dairy and nutraceuticals.

Throughout its tenure in the portfolio, performance was lacking. This was largely due to structural challenges in the dairy sector where the company faced difficulties stemming from uncompetitive Australian farmgate milk prices, global milk oversupply, and mounting inventory levels, which have made it hard to achieve decent margins. As a result, the company had to raise debt levels to maintain operations and eventually we found that long-term risks outweigh rewards and opted to cut our losses with an -87.9% dip in value.

Spark New Zealand

Spark New Zealand was a long-term exposure in the portfolio having been added back in 2014 following its successful transformation (rebranding from Telecom NZ, growth in digital services et al) and improving fundamentals.

This year, we first issued a sell half recommendation to take some profits off the table and to mitigate risks given the market and economic conditions at the time, while awaiting improvements on the fundamentals. We locked in a 148.1% profit (including dividends) with a 9.9% CAGR return.

But, later in the year, with continued economic pressures, management lowered FY25 earnings, capex, and dividend guidance. Concerns over limited growth opportunities, reliance on external funding for capital projects, and a cautious financial outlook have weighed heavily on the stock. We opted to fully exit in light of better opportunities elsewhere. That said, overall returns on Spark amounted to a 96.2% direct bump and a 6.8% CAGR for its entire tenure.

Air New Zealand

Next up was an exposure initially selected in anticipation of a post-COVID surge. In late 2020, the announcement of a highly effective vaccine from Pfizer and BioNTech has sparked optimism across markets, significantly boosting airline stocks like Air New Zealand. The airline was expected to benefit from domestic recovery and potential trans-Tasman travel resumption.

However, the airline faced a challenging recovery despite improving passenger numbers and capacity growth following the reopening of New Zealand’s borders. Operationally, the airline has managed to ramp up capacity across international and short-haul routes but has struggled to translate this into better revenue metrics. We, therefore, opted to exit at a loss of 58.6%.

The Reject Shop

The Reject Shop was first added to the portfolio back in 2020 on the then-potential of its turnaround under new leadership of Andre Reich. His appointment led to the implantation of a three-pronged approach to improve operations and focus on high-demand product as well as expand store footprint.

Despite the solid start, the company continued to face significant challenges despite a slight improvement in sales. While the new merchandise strategy has resonated with customers and driven topline growth, profitability has sharply deteriorated due to rising costs and margin pressures. Leadership instability (CEO Andre Reich ultimately left) compounded the challenges and we called it quits leaving a -44.7% loss.

DroneShield

Next, we’ve covered DroneShield numerous times as a traffic light and only added it in the Fat Prophets portfolio early this year as the war in Ukraine saw massive usage of drones on the battlefield. We also saw a number of contract wins from key military spenders like the US and NATO.

Shortly thereafter, DroneShield skyrocketed as attention on counter-drone technology became mainstream given the surplus of war footage across social media showing drones in heavy use, not to mention media coverage. We saw the opportunity to take profits and locked in a pleasing 143% gain in about 3 months of coverage. Looking forward to the long-term, we continue to view the company favourably, especially towards the long term especially given the fundamental changes in the battlefield (i.e. drones are here to stay).

TPG Telecom

TPG Telecom has been a mainstay in the Fat Prophets portfolio having been covered since 2006, initially as SP Telemedia. As quick recap, SP Telemedia merged with Total Peripherals Group back in 2008 to form TPG. In any case, SP Telemedia was a compelling telecom exposure given the potential to leverage on the then- expansion in IP networks and room for profit growth.

However, over the years, TPG Telecom has struggled to deliver meaningful returns, weighed down by a combination of underwhelming financial results amid operational hurdles which, consequently, led to persistent technical weakness in its share price. The partnership with Optus to extend network coverage is a step in the right direction, but the financial commitments and competitive challenges make it a tough proposition. Ultimately, we opted to make an exit from the group this year.

Nine Entertainment

Nine Entertainment first started its life in the portfolio as Fairfax Media where it was added on the merits of it being undervalued as the market was sceptical on the company’s print media assets despite the substantial growth potential of its digital arm. Then, in 2018, Fairfax merged with Nine to combine their assets and brands across television, radio, print, digital, and real estate.

This year, after failing to recover lost ground in 2021, the straw that broke the camel’s back is the termination of the deal with Meta (read: Facebook). Aside from the immediate loss in revenue, the secular change in the advertising market (Social Media and Search Engines like Facebook and Google are disrupting the market) have affected our confidence in the long-term potential of Nine and we opted to make a full exit.

HUB24

HUB24 was added to the Fat Prophets portfolio back in 2013 on the back of the renewed focus towards its investment platform business and exiting from the stockbroking industry. That also aligned well with the broader industry trends towards the investment platforms and secular shift in wealth management towards independents.

While we remain optimistic with the company over the long term, this year with the strong runup in the share price, we opted to take some profits off the table pocketing a solid return. Members holding the investment since initial coverage would be pleased to now the CAGR is a market-beating 39.5% per annum.

Northern Star

Another long-term exposure, Northern Star, started out in the portfolio as Saracen Minerals. We initiated coverage of the company given its transition from an explorer to a gold producer with the Carosue Dam starting its production. The exposure also aligned well with the bullish strong gold prices (i.e. higher operating margins).

That said, and in more recent times, under its current incarnation as Northern Star we opted to take some profits off the top as gold prices have enjoyed a streak of record highs in 2024, on top of a solid run in operations.

Arcadium Lithium

Next, another mining stock that has had prior incarnations in the Fat Prophets portfolio is Arcadium Lithium. It started out as Orocobre which was released simultaneously with the special report on Lithium (exclusive for our Members). For context, the bullish run on lithium was a direct result of rollout of electric vehicles (among other sources of demand for batteries).

Orocobre eventually turned to Allkem after its merger with Galaxy Resources and, in this year merged with Livent to form its current incarnation as Arcadium Lithium – one of the largest in the space globally. Despite a brutal 2023 for lithium, the long-term case for the mineral is still intact and this has resulted in Rio Tinto eyeing up the company as a possible M&A target. With the shares posting a recovery, we opted to take advantage of the liquidity with a Sell Half recommendation.

Nufarm

Nufarm was a returnee to the portfolio which was reintroduced in 2015 with the company then-making substantial transformation efforts to reduce costs, manage debt and streamline operations for growth.

However, its tenure in the portfolio was lacklustre with the company ultimately failing to live up to the expectations as macro and environmental headwinds buffeted its performance. Heeding Warren Buffet’s wisdom that “when management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact”, we concluded it was better to move on and issued a Sell recommendation.

Incitec Pivot

Incitec Pivot was another long-term exposure having been part of the Fat Prophets portfolio since 2009 where we saw an opportunity with the share price at a cyclical low due to weak fertiliser demand. Long-term growth potential driven by global agricultural needs and diversified earnings made the investment case even more compelling.

Over the longer term, the company did face persistent headwinds with the fertiliser business remaining a liability (impairments, restructuring costs and weak fertiliser performance) and the ambiguity of its divestment (not to mention failed past efforts) casted doubt on execution. We believe there are better investment opportunities elsewhere and issued a Sell recommendation.

Australian Agricultural Company

Another agriculture-related business, the Australian Agricultural Company was another portfolio mainstay having had its tenure start in 2015 on the back of (i) growing demand for beef in Asia and (ii) vertically integrating operations making earnings more stable.

However, over the years, earnings have proven to be far less stable and worse yet is the fact that its premium offerings, like Wagyu beef for instance, have been vulnerable to the inflationary pressures where consumers have been trading down to cheaper options. There are other concerns as well, not to mention beef oversupply, shifting consumer preferences, rising costs, and geopolitical uncertainties. We opted to limit risks and issued a sell report.

Orora

Orora was also another long-term added to the Fat Prophets portfolio way back in 2014 given its appeal as a leading player in the packaging industry with solid earnings growth. At the time of writing, the company was also anticipated to see growth upwards of 20% per year and set to compound with its strategy of acquiring smaller players.

Over the years, Orora performed well through strategic M&A activity and maintained stable earnings through its market leadership position. However, the company now faces significant headwinds including disruptions from the G3 furnace rebuild and soft European demand. While the sale of its North American OPS business commanded a premium, it dampens our forward earnings expectations. Given more compelling opportunities elsewhere, we issued a sell recommendation, capturing a 209% return, equivalent to 10.9% annually during its time in the portfolio.

Qantas

Finally, we turn to Qantas, which is another long-term exposure in the portfolio and was also added back in 2014 on the back of its turnaround efforts. The airline did implement cost-cutting measures, hedging strategies, and operational restructuring which were all intended to address challenges like high fuel costs, competition, and weak margins.

Over the years, Qantas had its share of turbulence (especially COVID-19), but has pulled through and proven to be value creating. With the share price being highly elevated, we recommended members to take some profits to pocket the solid gains year-to-date. For longer term investors, Qantas has provided a market-beating 22.4% annualised return.

Global stock markets have performed solidly overall in 2024 as the American economy continued to run smoothly, and investors began anticipating a global interest rate-cutting cycle, which has begun playing out across many economies, albeit not in Australia just yet due to stubborn inflation. The Australian economy has proved resilient in an aggressive rate-hiking cycle, but headline GDP figures were bolstered by immigration and elevated government spending, masking a GDP per capita recession. Still, stocks have climbed, and the benchmark ASX 200 set new record highs during the year despite having pulled back slightly over the past two weeks.

As of 17 December 2024, the ASX200 was up approximately +9.5% year-to-date, although there have been wide divergences in the performance at the sector level, which we dive into more detail about later.

The key question on every investor’s mind heading into 2025 is when the RBA will begin its pivot. We believe there is a good chance now that the RBA will ease at the next meeting in February, although our overall view will not change if that is pushed down the road for a few more months. However, we will continue to monitor coming data for inflection points that provide opportunities and pose risks.

The RBA left interest rates unchanged at 4.35% at its December meeting as expected but removed a reference to possible further rate hikes, which some viewed as a signal that the central bank could be nearer to a pivot. Governor Michele Bullock stated the central bank did not consider a rate hike at the December meeting, but the more dovish tone acknowledged recent softer data, which points to the first cut potentially arriving in February.

The last rate hike (+25bps) in this cycle was implemented by the RBA in November 2023, and the benchmark cash rate stayed at 4.35% throughout 2024, as shown below in this graphic from Trading Economics (note the other graphics regarding the Australian economy are also sourced from Trading Economics).

Worth Holding

Shopping mall owner Scentre Group (ASX.SCG) shares advanced and continue to trend higher after releasing robust underlying results and upbeat distribution guidance of at least 17.2 cents per stapled security in 2024, above consensus.

Turning to the charts, Scentre Group has confirmed a topside breakout from a multiyear primary downtrend which is encouraging. An advance above $3.20 at the top of the range, would confirm an inflection and raise scope for additional upside to the next resistance level at $3.80.

With that out of the way, we turn our attention to the group’s FY23 trading update:

Trading Update – FY23 Results Review

Scentre Group’s Westfield shopping centres reported record retail sales of $28.4 billion in 2023, marking a $1.7 billion increase compared to the previous year. An interesting result despite a slowdown in consumer spending, perhaps this reflects resilience in the group’s tenant categories.

The surge in sales, up by 6.4%, likely influenced by both organic growth and inflationary effects on goods sold, contributed to a 5.2% rise in funds from operations (FFO) to $1.09 billion for the fiscal year ending December. So far, full year distribution amounted to 16.6¢ per security, up 5.4%.

Increased foot traffic, up by 6.7% across Scentre’s centres, and high demand for retail space drove occupancy rates to 99.2%, up from 98.9% the previous year.  We also note a worthy improvement in leasing spreads, which went from -3.6% 12 months ago to +3.1%. This indicates a notable positive shift in the rental rates achieved on new leases compared to expiring leases within its portfolio of shopping centres and malls.

Throughout the year, Scentre completed 3,273 leasing deals, adding 307 new brands to its portfolio, comprising 42 Westfield retail centres in Australia and New Zealand.

Expansion projects, like the completion of the final stage of Westfield Knox in Melbourne and ongoing developments at Westfield Sydney, aim to enhance retail offerings and customer experiences.

Strategic partnerships with brands like Disney, Live Nation, and Netball Australia, along with initiatives like the Westfield membership program, contributed to increased customer visitation, reaching 512 million for the year, up 6.7% from 2022.

Scentre Group anticipates continued growth, with a focus on creating exceptional retail destinations and experiences, supported by a $4 billion pipeline of retail development opportunities.

The group targets a FFO range of 21.75¢ to 22.25¢ per security for 2024, reflecting a 3 to 5.4% increase over the previous year, and expects distributions of at least 17.2 cents per security for 2024.

Write-Downs

That aside, management brought attention to the fact that there was almost $1.1 billion in write-downs, representing a -1.9% valuation decline. This significant figure indicates a downward adjustment in the value of the company’s assets, primarily its portfolio of shopping centres and malls.

The write-downs were primarily driven by an average 42 basis point softening of capitalization rates. Capitalization rates, also known as cap rates, are used to determine the value of income-producing properties based on their expected income. A softening of these rates were due to a decrease in property values, which necessitated the write-downs.

The substantial write-downs contributed to a decline in Scentre Group’s statutory net profit, which dropped by -41.8% year-on-year to $174.9 million. Though this metric is not as important for SCG as it functions more like a REIT in a portfolio providing income but this development is still worth tracking.

After all, write-downs reflect broader trends in the commercial real estate market, where shifts in economic conditions, investor sentiment, and property market dynamics can lead to fluctuations in asset values. In this case, the softening of capitalization rates may be attributed to factors such as changing market expectations, interest rate movements, or specific challenges within the retail sector.

Summary

Scentre Group’s record-breaking retail sales in 2023 underscore the resilience and adaptability of its shopping centre portfolio, marked by increased foot traffic, high occupancy rates, and strategic leasing initiatives. Despite the challenges posed by the pandemic and inflationary pressures, the company’s focus on creating compelling retail experiences and forging partnerships with leading brands has paid off, driving growth in both sales and funds from operations. Expansion projects and ongoing developments further demonstrate Scentre’s commitment to enhancing its retail offerings and meeting evolving consumer preferences.

Looking ahead, the group’s robust pipeline of retail development opportunities positions it for continued growth, supported by a targeted increase in funds from operations and distributions for 2024.

In the meantime, despite the positive results, we maintain our HOLD rating on Scentre Group (ASX.SCG) for now. We believe that it is crucial for the broader monetary policy to change before we adjust our view on the group.

A catalyst around the corner?

China’s Ministry of Commerce (MOFCOM) has issued an interim draft proposing the removal of tariffs on Australian wine exports. Although not a final determination, we would be very surprised if the removal of tariffs didn’t go through after reaching this advanced stage. Speaking at The Australian Financial Review Business Summit, the Chinese ambassador indicated this would be the likely outcome.

The AFR quoted Xiao Qian as saying, “Currently, Chinese authorities are reviewing and investigating our tariffs on Australian wine and things are moving on the right track, in the right direction.”

After punitive tariffs were imposed in late 2020, devastating Australian wine exports to China, relations between the two countries have been distinctly cool for much of that time. We have seen signs of thawing over the past year and placed a significant probability that a review kicked off in late 2023 would result in a positive outcome for TWE, although we considered this a ‘bonus’ rather than a necessity for our buy recommendation on the stock. We noted a China ‘reopening’ would be a welcome growth opportunity, though the company has already executed well by filling that hole by increasing sales in Southeast Asia, materially strengthening the business.

We continue to see value at current levels, given the solid outlook for luxury wines, the addition of DAOU Vineyards products, and a possible nadir for the Treasury Americas business in 1H24. We are encouraged by the ongoing shift in sales strategy, focusing more on the high-end premium and luxury segments, with the Penfolds brand being a key differentiator and ‘crown jewel’ asset.

Additionally, we foresee more strategic divestments and refined internal investments, as previously indicated. This includes cutting costs in the Treasury Premium Brands segment and minimising the impact of soft demand for lower-tier wines, enhancing the business quality at the group level. As the company integrates DAOU, it is positioning to create a separate sales and marketing focus between luxury and premium product portfolios within the laggard Treasury Americas segment from the beginning of FY25. We rate Treasury Wine Estates a buy.

Treasury Wines has bounced off the primary uptrend and appears technically to be headed towards a retest of the major resistance level at $14. A breakout above $14 would significantly raise the scope for further upside and another run at the record highs. It is encouraging that TWE has held above the primary trendline since the pandemic lows and the introduction of Chinese tariffs.

An imminent outcome. The final determination from MOFCOM is now expected within the coming weeks, and we are firmly optimistic the outcome will be favourable.

Treasury Wine has kept its options open for this possible outcome. The company opted to keep some luxury premium Penfolds volume in reserve in 1H24, which was a headwind for the financials. The Chinese market accounted for roughly 30% of group earnings before the imposition of sky-high tariffs. TWE expects only a minimal incremental EBITS benefit from renewing Australian country of origin exports to China in FY24 should the tariffs soon be removed. We would expect this contribution to lift in FY25, although certainly aren’t expecting a return to the ‘old days’ anytime soon. Positively, TWE was able to successfully pivot to ASEAN sales, which has strengthened the business. Meanwhile, Penfolds’ buyers should brace for global price rises for the high-end Penfolds range if the Chinese tariffs are removed.

In the 1H24 results, group net sales revenue (NSR) of $1,284.3 million was flat on a reported basis and 2.3% lower in constant currency. Positively, luxury NSR increased by 4.3% as the premiumisation strategy continued. Penfolds was the only segment that posted an increase, with sales rising 9.2% to $448.1 million. The Penfolds segment remains the key earnings driver, with EBITS increasing 2.9% to $186.9 million. Group EBITS for the six months came in at $289.8 million, matching market expectations. This marked a 5.8% decrease, hampered by a 17.5% fall in Treasury Americas’ EBITS to $93.1 million. Treasury Premium Brands EBITS was down a more modest 3.2% at $45.8 million.

In summary, Treasury Wine Estates looks poised to benefit from the removal of China tariffs, which we expect to begin benefiting the financials from FY25. TWE delivered to market expectations overall in 1H24 despite a lacklustre performance from the Treasury Americas segment. A strategic shift away from the lower-tier market is ongoing. For investors with a mid-term perspective, Treasury Wine offers an attractive proposition in our view. The company is committed to a premiumisation strategy, eyeing sustainable growth and margin expansion, with a strategic game plan in place should Chinese tariffs ease. TWE has significant scope to expand the distribution of the DAOU luxury range. We retain a buy rating.

The next steps

Sonic Healthcare shares took a hit after the recently reported 1H24 results, interrupting a fledging recovery that began playing out in late 2023, as top-line growth was overshadowed by a sharp fall in earnings. The collapse in pandemic-related revenues made for a stiff headwind in what CEO Colin Goldschmidt calls a “transition” year. Still, some notable cost increases squeezed margins, and net interest expense picked up.

Sonic maintained the FY24 EBITDA guidance range of $1.7 to $1.8 billion provided in August 2023, though it is now expected to lean towards the lower end of this range​. A Belgian fee cut and FX headwinds were drags. Even at the lower end, this implies management is anticipating a material improvement in 2H24, given the $737 million in 1H24 EBITDA only constitutes roughly 43% of the lower bound.

Whether this is achieved remains to be seen; we don’t think it will be easy. However, given the lower bar, we anticipate a material improvement in the second half and beyond. We certainly back the senior management at Sonic, who has grown the business explosively over three decades from humble beginnings. Sonic now command a dominant share in the Australian market, followed by a leading share in Germany, the UK and Switzerland, while achieving a commendable third place standing in the competitive US market.

Despite the waning of the Covid-related business, Sonic remains well-positioned to capitalise on the favourable growth prospects inherent in the healthcare sector. The diagnostic imaging segment typically showcases resilience across economic cycles. The company is advancing sophisticated digital and AI capabilities. These should dramatically improve efficiency in the years ahead, alleviating the recent cost pressure, as should the bedding down of the recent acquisitions. On that note, the windfall from the pandemic left Sonic with a robust balance sheet, providing a platform for a pipeline of bolt-on acquisitions.

While Sonic’s debt levels rose over the past six months due to ~$0.9 billion in acquisition spending, the balance sheet remains healthy, with around $1.5 billion in available headroom.

Source: Sonic Healthcare

Given Sonic’s current market valuation, we perceive these attributes to be overlooked, presenting a robust investment opportunity for those seeking a steady dividend grower. Stocks like Sonic and the broader healthcare sector should attract more interest as the market anticipates looming rate cuts from the RBA. As a defensive sector, healthcare has been vulnerable to elevated bond yields.

Meanwhile, the compression in the valuation and downward revisions from the brokerage community have significantly lowered the bar for future outperformance. Along with some other company-specific elements we view positively, we rate Sonic Healthcare a buy.

Despite the pullback, support from the primary uptrend looks solid for Sonic Healthcare, which should hold and drive a rebound over the coming year. [subscribe_to_unlock_form]Only a breakdown below the primary support level would raise the scope for further corrective downside. The shares have tested and held above the primary uptrend numerous times, as evidenced by the 20-year monthly chart below.

 1H24 headline numbers

Total revenue increased 5.5% year-on-year to $4.3 billion in the six months ended December 2023. A headwind was the plunge in Covid-related revenue to just $37.4 million from $378.6 million a year earlier. This masked the robust 15.2% increase in base revenue to $4.09 billion. This Covid-related headwind is now primarily a spent force and won’t have a (material) drag from FY25. Base organic growth in the half year was 6.2% (with this pace continuing in January), while some $500 million in revenue stemmed from acquisitions and new contract wins. Management noted that they are running the ruler over more acquisition opportunities. Organic revenue growth was strong in the core Australian business (+9%), the UK (+13%), Germany (+8%) and the Radiology division (+11%).

EBITDA fell 20% to $737 million, notably below consensus expectations. The typical weighting towards more robust 2H performance is expected to be enhanced in FY24. Statutory NPAT almost halved (-47%) to $202 million as there were hefty increases in labour (and related costs), consumables, transportation, utilities, borrowing costs expenses and others. Earnings per share fell 47% to 42.6 cents. Still, the interim dividend was given a 2.4% bump to 43 cents per share, reflecting management confidence.

Management has set out cost-reduction programs across the company to tackle elevated costs resulting from the rapid growth seen during the pandemic and recent acquisitions. In addition, there are synergies to flow through from those acquisitions. Combined with digitisation efficiencies to come, we see the scope to fatten up margins materially from the levels seen in 1H24.

In summary, aside from the top-line momentum for base revenue, there wasn’t much to like in Sonic’s 1H24 numbers on the surface. However, there were more favourable underlying elements when digging below the surface, with the EBITDA performance being more heavily weighted to 2H24. Meanwhile, there is significant scope to lift margins from these levels, which, combined with top-line growth, could see a step-up in FY25 earnings growth. The company is well-placed to continue with accretive M&A due to the robust balance sheet, while favourable structural trends support the core business. The valuation is moderate, with catalysts on the horizon that could drive a re-rating. We rate Sonic Healthcare a buy.[/subscribe_to_unlock_form]

What we’ve been waiting for

Suncorp (ASX.SUN) surged to a 5-year high after booking a major win where the Australian Competition Tribunal overruled anti-competition watchdog, the ACCC, after authorising ANZ’s proposed $4.9 billion acquisition of Suncorp Bank. At this point, the takeover will still need approval from the Treasurer, Jim Chalmers, and an official sign-off from the government of Queensland.

Before reviewing the update, a detour to the technicals and Suncorp has inflected above historic resistance after breaking out above the primary downtrend at $15 on the 20yr monthly chart below. This is a bullish technical development and raises scope for additional upside in the coming year. In time Suncorp should challenge the record highs near $20.

Trading Update – Overruled!

Yesterday, the Australian Competition Tribunal has approved ANZ Group’s A$4.9 billion acquisition of Suncorp’s banking business, readily overruling the anti-competition watchdog, Australian Competition and Consumer Commission’s (ACCC), earlier decision that blocked the deal due to concerns about reduced competition in the banking sector. The tribunal’s decision is significant for both ANZ and Suncorp while less relevant to the deal, we expect to see increased discussion on current merger laws.

First, a recap on the journey thus far. The ACCC initially rejected ANZ’s proposed acquisition of Suncorp Bank in August 2023. ANZ had announced its intention to purchase Suncorp Bank in 2022 to enhance its retail presence, specifically its loan book and the larger home lending market, where it has trailed its larger rivals. On the other hand, Suncorp intends to focus on its insurance business after selling its banking unit, aiming to become a dedicated Trans-Tasman insurance company

Originally, the ACCC’s rejection of the deal was based on concerns about the impact on competition within the banking sector in Australia – a view we do not concur with considering that any market share gain for ANZ would not be as material as feared.

ANZ and Suncorp subsequently appealed the ACCC’s decision to the competition tribunal.

Interestingly, we note that despite the positive outcome of the decision for both parties, ANZ shares did not surge higher. Upon closer inspection of other banking analysts, the consensus view is that the acquisition is not likely to significantly increase ANZ’s market share in home lending – hence why we believed that the deal will be pushed through by regulators. Do note that the merger will still be important for ANZ (more on this later when we update coverage of the bank).

Moving on and from this point, the final approval for the acquisition rests with Australian Treasurer Jim Chalmers and the government of Queensland, where Suncorp is headquartered. If the merger is ultimately approved, completion is expected around “mid-2024”.

Commenting on the development, Suncorp Group CEO, Steve Johnston, notes that the sale would now allow Suncorp to dedicate efforts fully to insurance (without distractions from the banking arm) and will transform Suncorp into “a dedicated Trans-Tasman insurance company at a time when the value of insurance and the need for continued investment in a vibrant private insurance sector had never been greater.”

Summary

The approval of ANZ’s acquisition of Suncorp’s banking business represents a significant development for both parties. The decision by the Australian Competition Tribunal to overturn the ACCC’s rejection of the deal is the development we’ve been waiting for. This also confirms our initial view that the deal will ultimately get approval by regulators.

ANZ’s strategic rationale for the acquisition aligns with its long-term growth objectives, aiming to strengthen its market position and capitalize on emerging opportunities. Suncorp’s successful divestment of its banking division underlines the importance of strategic agility and can now focus exclusively on running a Trans-Tasman insurance company (and without the distractions of a banking arm).

Following the results of this, we believe the likelihood of the Suncorp Bank/ANZ deal pushing through has improved dramatically. In light of that development, we have now adjusted our rating on Suncorp (ASX.SUN) back to a BUY for Members without exposure. We will continue to monitor developments here as the merger gets closer to reality.[/subscribe_to_unlock_form]

Solid foundations despite a setback

Even though Evolution Mining faced a challenging December quarter, marked by crimped production at the Red Lake mine in Canada and Mungari in Western Australia, higher gold prices boosted underlying earnings and net mine cash flow metrics. The balance sheet remains rock-solid with an increase in the cash position and lower gearing, while there has been a substantial boost to resources.

The acquisition of the 80% stake in the Northparkes copper-gold mine located northwest of Parkes, in the central west of New South Wales, Australia, looks to be a good one for Evolution. Copper production for Evolution is set to jump, with copper revenues to make up about 30% of Evolution’s total revenue mix going forward. However, this, of course, will be influenced by the pricing of the two metals. Management reported the first two months of Northparkes operation had generated cash and delivered to plan.

The stock tumbled in December and January following the Northparkes announcement and equity raise, followed by the rough December quarter activities report. Gold production was lower than anticipated, and the all-in-sustaining cost (AISC) did not decrease as expected.

We have a bullish outlook on gold and copper. Evolution has high-quality assets in attractive jurisdictions (Australia and Canada), with the scope for existing resources to grow further with more exploration. We view the correction in the shares as an overreaction, with the current valuation appealing to investors seeking gold and copper exposure. We rate Evolution Mining a buy.

Turning to the technical picture, since breaking out of a primary downtrend in the second quarter of 2023, Evolution followed through on the upside. The bullish technical setup has since suffered a setback, with a fair bit of damage on the charts incurred following the disappointing quarterly production update.

However, despite the setback, EVN looks to be finding support at the key $2.90 level, which could drive a recovery in the coming year. It’s important to keep incumbent bearish sentiment around the stock in perspective, with the A$ gold price likely headed for new record highs this year that will continue to drive cash flow.

1H24 headline numbers (in A$ unless otherwise noted)

In the first half of FY24, Evolution Mining produced 319,377 ounces of gold at an all-in sustaining cost of $1,615 per ounce, leading to a 53% surge year-on-year in its underlying net profit after tax to $158.1 million. [subscribe_to_unlock_form]The financial improvement was propelled by a 16% hike in gold prices, reaching $3,000 per ounce.

Source: Evolution Mining

Underlying earnings before interest, taxes, depreciation, and amortisation (EBITDA) climbed by 28% to $572.6 million. Evolution maintained its interim dividend at 2 cents per share, fully franked, which was somewhat disappointing but understandable given the context.

The net mine cash flow increased 136% to $203 million after $231 million of investment in growth projects. Operating mine cash flow increased by a more modest 30% to $618 million, while group cash flow improved by $169.3 million to $52.4 million, swinging from the $116.9 million outflow in the prior corresponding quarter. Decreased capital intensity and improved margins thanks to higher gold prices have driven the cash flow improvement. Evolution Mining concluded the quarter with a cash reserve of $191 million and a reduced gearing ratio, down from 32.8% to 29.7%.

Ongoing exploration at Ernest Henry, Mungari, and Cowal, along with the acquisition of the Northparkes copper-gold mine in New South Wales, has led to an 8% increase in Evolution’s gold mineral resources to 32.7 million ounces and a 134% increase in copper to 4.1 million tonnes. Consequently, gold and copper reserves have climbed by 15% (net of depletion) and 100% year-on-year to 11.4 million ounces and 1.3 million tonnes, respectively. CEO Lawrie Conway noted regarding Northparkes, “The feasibility study for the E22 orebody is progressing and we anticipate the outcomes of that study to be available early in the June 2024 quarter, which will inform future mining options at the asset.”

Despite a substantial production shortfall at its Red Lake mine in Ontario in the December quarter, Evolution maintained its annual production targets of 789,000 ounces of gold and 62,500 tonnes of copper at an AISC of $1,340 per ounce, plus or minus 5% for each of those metrics. In our view, at the current valuation level, the market is pricing an expectation these targets will not be achieved.

In summary, we have a bullish outlook on gold and copper. Evolution has high-quality assets in attractive jurisdictions (Australia and Canada), with the scope for existing resources to grow further with more exploration. We view the correction in the shares as an overreaction, with the current valuation appealing to investors seeking gold and copper exposure. We rate Evolution Mining a buy.

Disclosure: Interests associated with Fat Prophets hold shares in EVN. 

New Directions?

Shares in Alliance Aviation Services dipped lower despite 1H24 results revealing a three-fold jump in statutory profit before tax of $37.7 million. Alliance Aviation is the biggest independent aviation training centre in the United States and Latin America.

Turning to the technicals, listed on the ASX, Alliance Aviation has corrected sideways since 2020 in a primary downtrend. While the stock is holding above support at $2.70, only a breakout above $3.30 and price action follow through would confirm a topside inflection.

Company Overview

Alliance Aviation Services (ASX.AQZ), founded in 2002, is a leading provider of contract, charter, and allied aviation services in Australasia. With a focus on safety, reliability, and customer satisfaction, Alliance has established itself as a trusted partner for clients in the mining, energy, government, and aviation industries.

Alliance offers a diverse range of aviation services, including contract and charter flights tailored to the specific needs of its clientele. Its offerings also extend to wet lease services, providing support to other airlines. The key point here is that Alliance provides essential transportation (personnel, equipment, and cargo) and logistics for miners especially towards remote and challenging locations.

One of Alliance’s distinguishing features is its ownership of the entire fleet, comprising 37 Fokker 70/100 aircraft and 41 Embraer E190 aircraft. Additionally, the company has firm purchase commitments for an additional 26 E190 aircraft until mid-2026. This diverse fleet enables Alliance to cater to various operational requirements efficiently.

We find Alliance appealing largely due to its strategic role in providing contract and charter aviation services to essential industries like mining, energy, and government. With a diversified client base and ownership of its entire fleet, Alliance ensures operational flexibility and efficiency, making it a preferred partner for clients in safety-critical sectors.

Aligned with the positive outlook for the commodity and mining sector, Alliance stands to benefit from the increasing demand for reliable aviation services in remote and challenging locations. As mining activities expand globally, driven by population growth and infrastructure development, Alliance’s market position and growth potential are poised for further enhancement.

That aside, the company also recently appointed a new CEO. Mr. Stewart Tully, who currently serves as the Chief Operating Officer (COO) of the company, will be promoted to the position CEO effective March 1st, 2024. Mr. Tully has been with Alliance since 2015 when he joined as the General Manager – Operations in Brisbane. He brings with him extensive experience in the aviation industry, accumulating 34 years of direct or indirect involvement in the sector.

We like this development as [subscribe_to_unlock_form]Mr. Tully has demonstrated the necessary experience and leadership in running Alliance. With the company leaning heavily on operational excellence, a CEO with background in operations should keep the company in the right direction.

In addition to Mr. Tully’s promotion, Alliance has initiated a search process for two additional Directors as part of its Board renewal strategy. This process aims to ensure Board stability while bringing in fresh perspectives and expertise. The company plans to manage this renewal in an orderly manner.

1H24 Results Review

With that out of the way, a brief review of the 1H24 results. First off, Alliance Aviation reported total revenue from operations of $299.4 million for 1H24, showing an increase of $64.0 million from last year. Growth in revenue was driven by significant expansion in contracted wet lease operations.

While in terms of profitability, the Statutory Profit Before Tax (PBT) for 1H24 was $37.7 million, a significant increase from $9.5 million in the previous corresponding period (1H23). This represents a substantial growth of $28.2 million or 296% year-on-year.

Source: AQZ 1H24 Presentation

The solid growth in Wet Lease operations has resulted in a substantial bump in record flight hours of 50,793 for 1H24, representing an increase from 32,365 flight hours in HY23.

Going forward, Alliance Aviation expects growth in earnings for the 2H24. Management plans to continue deploying capacity to meet increasing demand for wet lease and FIFO (fly-in-fly-out) operations. The delivery of seven E190 aircraft in the 2H24 should also add to the momentum. That aside, management expressed that their focus remains on cost control and maintaining profitability margins in a high inflation economy.

Despite its niche appeal, we do recognise the high-risk nature of this business with it subject not only to fuel prices – typical vulnerability of airline services – but also to commodity prices. Lower prices of minerals can impact demand for services though contractual nature may reduce impact.

That said, at this point, we believe it more prudent to issue a Traffic Light on Alliance Aviation Services (ASX.AQZ). We will track it as part of our watchlist and, when a better buying opportunity presents itself, we will revisit the company as a potential addition to the Fat Prophets portfolio.[/subscribe_to_unlock_form]