Devon Funds Morning Note - 29 March 2023

Wednesday 29th March 2023

Global

European markets were higher on Tuesday, but the US indices were slightly softer as the yield on the 2-year Treasury note rose back above 4%. Technology names were generally weaker with the notable exception of Alibaba. Shares in the Chinese e-commerce platform surged 14% as it announced a plan to split into six entities. Bank stocks were mostly softer although Citizens Financial, which is buying the rump of SVB, rose to a record high. Lithium stocks leapt after ASX listed Liontown resources rejected a A$5.5b bid from chemical giant Albemarle, the world’s biggest lithium producer.

Sentiment towards the banking sector appears to have stabilised following the decisive actions of officials, and also on plans for stricter supervision to ensure that a case like SVB (which has in any event been positioned as a ‘textbook’ case of mismanagement) doesn’t happen again. Federal Reserve Board Vice Chair for Supervision Michael S. Barr has been testifying at a Senate Banking, Housing and Urban Affairs Committee hearing on “Recent Bank Failures and the Federal Regulatory Response” on Capitol Hill. Mr Barr said that capital and liquidity standards for regional banks over US$100 billion will need to be strengthened.

Barr also revealed that the extent of the run on SVB was bigger than many realised. SVB customers withdrew around US$42 billion from the bank on March 9 on concerns that uninsured deposits were at risk. A further US$100 billion was however scheduled to go out the day before regulators seized control. This would have equated to over 80% of the tech focussed lender’s deposits.

Confidence amongst US consumers also appears to have improved a bit, despite the banking crisis. The Conference Board’s Consumer Confidence Index edged higher to 104.2, from 103.4 in February and ahead of estimates for around 100.7. While the outlook for inflation over the next 12 months remained elevated at 6.3%, the short-term outlook in terms of consumer confidence marched higher to 73, although still below a level (80) which is consistent with recessions.

Some consumer facing companies are still doing fairly well it seems, and particularly those that are defensively positioned. Pharmacy chain Walgreen Boost Alliance posted a better-than-expected rise in quarterly sales, despite declining Covid vaccine volumes. ‘Guilty pleasure’ companies also appear to be doing well, and have a strong outlook it seems. There has been strong investor appetite for chocolate bar maker Hershey and beverage company Monster recently, with both hitting record highs.

In the tech sector, Apple was only slightly lower. The company has announced it is getting into buy-now-pay-later with the launch of “Apple Pay later”. The service will allow users to split purchases into four payments over six weeks.

Also planning a split is Alibaba. The company has announced it will demerge into six business groups, each with the ability to raise external funding and go public. This is the most significant reorganization in the Chinese e-commerce giant’s history, and while positioned as a move “designed to unlock shareholder value and foster market competitiveness,” it is also likely a response to placate Chinese regulators. who have been cracking down on big tech, and in 2021 fined Alibaba for monopolistic behaviour during an antitrust probe. Reports that the company’s outspoken founder Jack Ma has returned to China after several months away suggests that an olive branch may have been extended by authorities.

European indices were higher, with the banking sector up 0.7%, although Deutsche Bank declined 1.3%. The FTSE in the UK rose 0.17% despite data showing the persistence of one key inflationary driver. UK shop price inflation rose to 8.9% in March from 8.4% in February, with food prices jumping a record 15%. Little surprise that industrial action has been elevated in recent months given cost of living pressures. Employers also have their breaking point as well though. The Royal Mail has threatened to put its loss making (around £1m per day) postal service into administration if a compromise deal cannot be reached with the union over pay demands for its 100,000 members

New Zealand

The kiwi market pushed higher on Tuesday, with the NZX50 gaining 1.4% to 11,771. It was the biggest one-day gain in four months, with strong demand for a host of blue-chips. Contact and Mercury both surged between around 4%, as did Ryman Healthcare. Mainfreight drove 4.6% higher, and property stocks were also in demand, with Kiwi Property gaining 3.5%.

Two of the disappointments from the recent reporting season were both weaker again. Synlait’s share price continued to curdle, falling 4% to $2.18. The shares have lost 30% over the past two weeks. The Warehouse fell a further 4% to $1.90, and is down 20% since last week’s half year numbers. The retailers that have produced better results were going the other way. Briscoe Group rallied 4%, while Kathmandu owner KMD Brands added 2%.

Freightways has provided a trading update this morning, also updating on several one-off costs expected to fall in the current financial year (to 30 June 2023). To date the earnings (EBITDA) impact of Cyclone Gabrielle on the Express Package businesses has been in the region of $2m. One-off costs associated with M&A activities (e.g. Allied Express in Australia) and the preparation for a potential dual listing on the ASX will incur additional costs of $1.5m-$2.5m.

The company has also decided to upgrade part of its leased Express Package aircraft fleet, which will have a net annualised impact in costs of $3.5m p.a. This will however deliver significant efficiency benefits, improving reliability and boosting carrying capacity.

Freightways expects the exposure to these costs to be mostly mitigated by price increases being put through from July 1st. Management noted they remained “mindful” of the risk of slower business and consumer activity in the short term, particularly in New Zealand, but encouragingly also noted that since the half year results were announced, Express Package volumes have remained steady.

Australia

It was all about the lithium sector on Tuesday, with Albemarle launching a A$5.5b takeover A$2.50 per share bid for Liontown Resources at a 63% premium to the company’s previous closing price. The bid (as were previous ones) was rebuffed by Liontown, with shares in the target roaring 68% higher, suggesting a higher bid is likely.

Liontown appears to regard the bid as opportunistic, given the de-risking that has occurred at its Kathleen Valley hard rock lithium project in the Northern Territory, which is due to go into production mid-next year. After being on a tear last year, lithium prices have halved since late November, despite a strong long-term demand outlook. Liontown noted that lithium demand is expected to grow five-fold by 2030, with a predicted supply deficit.

With electrification thematic set to only drive higher in the coming years, lithium is clearly a strategic asset. Lithium fires are notoriously difficult to put out, and time will tell if Albemarle’s bid(s) for Liontown lights the fuse on M&A activity in the sector.

Mining heavyweight Rio Tinto has also said it is on the hunt for high-quality lithium assets. Other lithium names pushed higher including Mineral Resources which rallied 6%. Mineral Resources has a 50/50 JV with Albemarle at Wodgina, the largest known hard rock lithium deposit in the world. Shares in Pilbara Minerals, which owns the Pilgangoora lithium project, soared 12%. Mineral Resources and Pilbara are both held in a number of the Devon funds.

The lithium sector wasn’t the only M&A news of the day. Shares in United Malt leapt 30%. Malteries Soufflet, a branch of French agribusiness InVivo, has made an A$1.5 billion takeover offer for the world’s fourth largest maltster.

Overall the ASX200 rose 1.04% to 7,034. Energy and materials led the way, but the banks were also higher. Aussie retail sales came in a touch higher, up 0.2% in February, and following a 1.8% rise in January. The largest increases were in department stores, apparel, and cafes, restaurants and takeaways. Household goods was the only industry to record a fall. The consumer is continuing to wear elevated levels of inflation, but this is moderating. The CPI is due out today, and is expected to have eased to 7% last month from 7.4% in January, and would provide further evidence that inflation peaked late last year.

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