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Costa Group

Bennelong Australian Equity Partners’ local equity funds have been shooting the lights out over the past couple of years, topping the Mercer performance tables in 2017 and in the year to June. But things did not go so well in the September quarter.

The Australian Equities Fund lost 2.3 per cent during the quarter, compared with growth of 1.5 per cent of the S&P/ASX 300 Accumulation Index over the same period.

In Bennelong’s September quarter report, the manager says most of the action during the quarter took place during the earnings reporting season in August. In general, the companies in the portfolio reported strong results and gave reasonable guidance.

However, in the case of a number of its larger positions, the market reacted negatively. Their share price falls weighed heavily on the fund’s returns.

One of those companies was Costa Group, Australia’s largest agricultural produce company. The company reported financial results in line with expectations, with profit up 26 per cent. Guidance for the 2019 year was for earnings growth of at least 10 per cent.

The market reacted badly to the guidance and forecasts were downgraded. A sell-off followed.

Bennelong says: “We believe the guidance could well prove conservative. After all, their initial guidance for last year was also for 10 per cent and it ultimately delivered 26 per cent.

“Our more optimistic view of near-term earnings is based on our research into the production growth and price increases, particularly in respect to berries, mushrooms and avocadoes.”

Bennelong has increased its holding in Costa at what it calls “an attractive price”

Another was Flight Centre, which reported 17 per cent earnings growth and was at the top end of earnings guidance.

“It seems the market was expecting even more than what was delivered, and the shares sold off,” Bennelong says.

Flight Centre is currently undertaking a five-year business transformation program, which is focused on more tightly managing costs, cutting out unprofitable businesses and turning around underperforming ones.

“The program comes with ambitious financial targets, which if met would come with very strong earnings growth and material earnings upgrades. Importantly, the company was able to confirm that it was on track in respect of these targets,” Bennelong says.

Flight Centre’s international operations achieved strong growth, while local operations were soft. Bennelong put this down to the distraction of the transformation program. It is confident the Australian business will pick up and surprise the market on the upside.

Bennelong took advantage of the share price fall to increase its holding. It says the company has a lot of cash and could return excess cash via a special dividend or buyback.

Another of the fund’s stocks that lost ground during the quarter was poker machine maker and online game developer Aristocrat Leisure. The company will report its earnings in November.

Bennelong says that, based on its research, the company is on track for “decent growth”. It says Aristocrat has been in an earnings upgrade cycle in recent years, with more of its income derived from recurring revenue.

Bennelong says Aristocrat’s earnings multiple has been largely unchanged, which undervalues its quality and growth prospects.

Bennelong says its approach to portfolio positioning is to have a heavy weighting in relatively lower risk, predictable and defensively positioned stocks.

It has an orientation to growth companies, although it says this is a result of its analysis rather than a style bias. “We are particularly focused on those companies whose earnings growth prospects are underestimated and therefore undervalued.”

The fund has a bias away from large caps. It avoid “pure bond proxies” such as the utilities and infrastructure stocks, as well as less obvious proxies such as blue chips like Telstra that offer little if any growth but generous dividends.

“We remain constructive on the market, being neither outright bearish nor bullish. Australian equities look relatively attractive, although there is the need to remain selective.” It says

“The market trades on less than 16 times consensus earnings, which is only slightly above the historical average of 14 to 15 times. The market yields approximately 4.5 per cent, which after grossing up for franking credits, gives investors a 6 per cent yield.