Investment Objective

CIE is an income-focused listed investment company, with a portfolio of companies largely outside of the ASX top 30. CIE’s stated objective is to distribute 6.5% of pre-tax Net Tangible Assets (NTA) per annum, while maximising franking where possible. We select companies that, in aggregate, generate a sustainable dividend income. The portfolio is characterised by a strong and diverse portfolio of companies that exhibit good cash flows and business models.

Over the past 12 months, CIE has paid a dividend yield of 6.3%, or 8.2% including franking credits. Dividend yield is calculated as the last four dividends paid over the 12 months to 30 June 2019 relative to the closing share price at the beginning of the period.

Performance Summary

CIE’s investment portfolio was positive over the month of June 2019, with a return of +0.5%. The NTA before tax of the portfolio stood at $0.93 per share.

The portfolio continues to edge higher as it has done for most of this calendar year. A suite of earnings downgrades for domestic focussed stocks due to subdued economic activity around the time of the Federal election has held performance back. The benefits of interest rate cuts, tax cuts, relaxed lending standards and better corporate confidence post the election do not appear to have stimulated activity as yet. A recovery in the housing market would be beneficial to the portfolio.

Portfolio Commentary

CIE’s cash position at the end of the month was 6.0%, compared with a target cash weight of 5%. We will continue to be opportunistic with our investing so the cash level may move around this target.

Over the month activity in the fund picked up. We increased CIE’s portfolio weights in stocks that have downgraded earnings and been over-sold. These included Caltex Australia and Viva Energy Group. We also increased our exposure to Bapcor, Brickworks and G.U.D. Holdings, but generally remain cautious of cyclicals going into this results season.

We participated in the GPT Group placement and added APA Group to the portfolio.

On the sell side we exited Coca-Cola Amatil above $10 after entering in the mid $8’s.

Coca-Cola Amatil share price

Source: Bloomberg

The fund also took some profits in GWA Group. The holding in Bendigo and Adelaide Bank was trimmed after a good share price rally.

We also received the final 43c fully franked dividend on our DuluxGroup holding and will now look to exit the position.

Market Commentary

Global equity markets, led by the US, bounced back from May’s weakness to achieve new highs. Positive messages from the Federal Reserve regarding likely interest rate cuts in the months ahead outweighed soft data reads and trade issues.

The Australian market was also higher over the month but lagged world markets. The Reserve Bank of Australia lowered the cash rate which was taken positively as was the relaxing of lending standards by the banks.

A slew of earnings downgrades have justified the RBA cutting interest rates. Most of these earnings downgrades have been due to weak domestic demand.

Australian interest rates 1990 – present

Source: Bloomberg

Australian bond markets continued to rally with the 10 Year bond rate falling below 1.3% during the month before settling around 1.35% by month-end. At the start of this calendar year bond yields were 1% higher.

Local economic activity slowed during the early part of 2019 in the lead up to the Federal election. It is little surprise then that sectoral performance was led higher by sectors exposed to international rather than domestic growth. The best performing sector was Materials (6.2%), followed by Industrials (5.6%) and Healthcare (4.4%). Lagging sectors included Consumer Discretionary (-1.5%), Information Technology (1.1%) and Energy (2.2%).

The best performing stocks in the portfolio were Virtus Health (14%), IPH Ltd (9%), GPT (9%) and ASX (9%).
The laggards were Lendlease Group(-9%), the Star Entertainment Group (-8%) and Stockland Group (-8%).

As can be seen, there were no major negatives in the stock selection. The deviation to market returns has come from CIE’s lack of exposure to the best performing sectors, being Materials (resources) and large healthcare stocks. The reason we are not exposed to these sectors is either the stocks are in the top 30 by size or do not have an attractive yield.

Portfolio Outlook

Over the last several months, 20 of the top 200 stocks have downgraded earnings. The widespread earnings weakness is mainly stemming from weak domestic operating conditions. There appears to have been an appreciable slowing in economic activity heading into the Federal Election in May.

The election outcome was undoubtedly a positive for corporate confidence. Other positives include the proposed tax cuts, interest rate cuts and the relaxing of lending criteria by the banks. The next result season in August will likely show the extent of the weakness in the economy in the first half of the year, but will hopefully be accompanied by more positive outlook commentaries.

The ongoing decline in interest rates should be a positive for yield-focussed strategies, like CIE. Although there may be a bounce higher in yields post any trade resolution, underlying world growth remains modest at best.

CIE remains significantly exposed to those high income generating securities. In our view, these investments will be increasingly valuable in a world of low rates.

Interest rates remain low and economic activity, although slowing, remains positive. While volatility in equity markets is expected to continue, indications of inflation remain largely benign giving confidence that the investment outlook remains favourable over the medium term.