AUDIT OF FINANCIALS FOR JUNE YEAR END HOLDINGS (most)

 STOCK AUDIT 2025 –QUALITY INDICATORS

The audit covers all the June year-end companies, mainly Australian, but also MSFT, some 44.5% of the portfolio, so a decent proportion. The third column is an attempt to weight the results for the stock position in the portfolio. I plan to cover the December and September companies in a similar fashion, after they report.

 

1.      Gross Margin level and stability

The aim is to have a high and stable GM. A high and stable GM may be indicative of positive unit economics and the ability to control the interplay between cogs and price. Ten of the 18 companies report a GM, so the sample is limited. The overall results indicate a quality portfolio. The outliers are BRG with a low GM of 35%, but with very low vol, indicating good control, but in a competitive industry with many pass-through costs, well below the average. Highish volatility is evident in NCK, IEL and JIN. JIN is a surprise, possibly due to changes in the agreement with TLC. IEL is understandable given the industry fluctuations, and NCK, as a retailer, is probably also understandable. LOV has strong and controlled margins for a retailer. MSFT has the lowest vol, great cost/price control.

2.      ROE levels

The ROE levels are well above the market, which I think remains around 10%. Only two companies, LOV and Hub, have significantly increased their current ROE above the 5y average; obviously, the market rewards that outcome. The stocks that remain at low ROEs are PXA, EOL, MIN and SHL. MIN and SHL with current ROE well below 5y averages. PXA continues to fund the UK start-up losses with profits from Australia. Highlighting this is a huge undertaking for the company. The worst outcome would be a prolonged failing venture. SHL continues to struggle post-C19. The result was poor, the guidance was robust, but there may be signs that the game has changed for SHL, and the returns in pathology are no longer attractive.  Min is under pressure from low lithium prices and the burgeoning cost of the iron ore move. EOL ROE is low; the next few years are critical to see ROE move much higher. Now that the base is set for this small company.

 

3.      5Y EPS growth and LT stability

EPS drives SP over the longer term, and we want to see strong EPS growth without resorting to accounting manipulation and excessive debt. Stability is important as it makes extrapolation easier when forecasting growth rates. We want clean, high eps growth and high regression around the trend, not excess volatility.

EPS growth for the portfolio remains very strong; the skill is not overpaying for this growth. The companies with eps growth below double-digit are CSL, NCK and JIN, which are slightly below, and IEL, MIN and SHL, which are negative, with MIN being in losses.

4.      CFO less capex as a % of capital employed

This ratio attempts to measure return on investment in a broader sense than ROE, by adjusting for debt and measuring capital employed, while using cash returns (CFO less internally incurred capital expenditure) as the numerator. A high number is preferred, and a rising trend is more preferred. A declining ratio could indicate falling returns or increased capital deployed yet to generate returns. A high and rising number usually comes with a very high PE, unsurprisingly.

Lowish absolute numbers are evident for CSL 9-10%, as well as 3-4% for PNI and PXA. All these have made large investments, being Vifor for CSL and various fund managers for PNI and the UK entry for PXA. All are large enough to impact numbers and certainly bring focus on the size of the bet involved. BRG is interesting as the cash flows are extremely volatile and in contrast to the stable growing eps numbers. Combining with the stable GM, the conclusion is that this company does require skilled working capital management. There is a disturbing LT downward trend in this number for BRG.

Half of the universe displayed 5% or more decline in returns measured as current over the 5Y average. Many of these are due to expanding assets that are yet to fully generate returns, such as MSFT’s DC expenditure. In fact, my investment philosophy is to identify those companies that can grow their asset base and maintain returns above the cost of capital, so it is not unusual to see this outcome. The declines that stood out, when considering the above, were JIN, which had a large fall due to the volatility in the jackpot rate, when cycling a large number, IEL due to well-understood industry issues, and SHL, which indicates an ongoing issue with pathology profitability. MIN remains very risky with the asset base increasing and returns negative and getting larger.

Three stocks increased their returns above 5%, being RMD, REA and HUB. I would expect higher SP for these, all other things equal.

5.      Cashflow reconciliation with NPAT 3 and 5 years.

This measure reconciles NPAT plus depreciation with the Cashflow from Operations number. The usual difference is working capital, which may grow with sales. The companies I invest in are higher quality, so I do not expect significant deviations in this ratio for them. The 3 and 5-year averages are analysed to allow for smoothing annual fluctuations and show longer-term issues.

The numbers disclose some interesting issues. I choose a 90% cut off as significant, that is, cashflows doing worse than or better than profits by 10%, in aggregate, over a three and five-year span.

Starting with the poor numbers. PNI usually comes up with unusually poor numbers given their business model of being an investor and cash flows coming from their affiliates' dividends, which can be lumpy, so I give them a bit of latitude here. PNI has an 84% coverage over 5 years, so low but understandable.

IEL has a low 82% coverage over 3 years, again understandable given the pressure the industry is under. The number rises to 93% over 5 years. RMD unusually has a ratio of 84% over 5 years, as the working capital fluctuations of C19 progressively fall out of their numbers. RMD 3-year numbers are 98%. One usual finding was CSL, with low numbers for 3 and 5 years being 80% and 87%. Working capital management is a big issue for CSL as plasma is held for 12-18 months on the balance sheet. Adjusting for w/c gives 101% for 5 years and 97% for 3 years, not hugely negative but indicating a deterioration over the last three years, which is unusual given the C19 issues were before that.

The good numbers, defined as cash flow being over 10% above profits, were basically all the software stocks, where depreciation overstates ongoing capex. HUB, WTC, PXA and EOL make up the bulk of this category, and remind us of one reason why software should trade at a premium. The other positives were over 5 years, LOV and NCK (which has some working cap volatility) and over three years MIN (could be impairments as well as working capital).

Overall, I think there are a few lower-order issues here, like CSL, as many companies cycle through the C19 cashflow troubles.

6.      Debt Coverage is defined as ND/ebitda and ND/CFO

I'm no real fan of stock/flow type measures, like ND/EBITDA, as they are open to misinterpretation under different interest rate scenarios, and I would rely on flow/flow numbers, such as interest cover, as being more relevant, but will proceed anyway, given the common coverage of these types of ratios have in the market.

A factor I am consciously trying to avoid in the portfolio is excess debt. Owning stocks with lower debt levels is one of the clear measures we can follow to reduce risk in the portfolio. From this perspective, it is not surprising that the measures on average are low. With ND/ebitda over 2X being regarded as an indication of reasonable risk, only one stock is in this category, MIN. 7/18 are in net cash positions, and another 6 are below 1X, leaving 4 stocks in the 1.5-2X. Even using the much harsher ND/cfo, which is cash flow after all cash charges, there are only 4 stocks above 2X and they are not that much above: CAR, CSL (2.6X highest), SHL and PXA. MIN remains highly levered with negative cash flows, and clearly, the only stock with possible issues from debt in the portfolio.

7.      Revenue and NPAT deviate from expected FY25 results.

I don’t specifically attempt to follow consensus; I do attempt to forecast my own numbers so I can tell if the company is moving in line with my expectations. So this process is not a beat or miss exercise; it’s an assessment of how well I can predict the numbers and understand why the difference occurred, sometimes innocuous, sometimes not. Deviations can occur due to many issues, such as accounting changes, incorporation of M&A timing, one-offs, etc, that I have failed to accurately measure. I am more interested in issues that change my valuation of the company.

Interestingly, the aggregate portfolio numbers show the actual median revenue numbers versus expectations at 0%, so no miss and median NPAT -1% below, so close to in line. However, there were a number of individual numbers well above and below. I use +/-5% a measure of significance here.

Overall, there were 7 outcomes at the revenue line +/-5% and 8 at the NPAT line (out of 18). Firstly, for the revenue numbers, three were above 5% being PNI, HUB and IEL while 4 were below, JIN, SDF, NCK and PXA. For NPAT, three were above 5% being HUB, PNI and RMD, while five were below, IEL, JIN, SHL and NCK.  

For HUB, the conclusion is that it continues to deliver numbers better than my expectations, on the revenue and NPAT line due to operating leverage and FUM gains, market based and organic. The bull market helps here, but the growth story remains strongly intact, and gains are being made that are better than expectations.  PNI numbers are helped by performance fees, which are difficult to predict (for me anyway). Even allowing for this, however, the numbers were better than my expectations. Again, a bull market beneficiary, but the affiliates are showing both FUM gathering ability and operational leverage. Both Hub and PNI are, to some extent, market-related businesses, so there is portfolio market exposure here to be considered.

PXA suffers from the small numbers and low profitability due to funding the UK expansion. However, the process of the UK building in revenues and profits is taking much longer than anticipated and is a case, perhaps in hindsight, of waiting for more evidence of progress before investing. Although the investment is not huge.

The JIN clearly show the issues cycling the strong jackpot numbers and how much of a hangover did occur. Unfortunately, a fair bit of one and the numbers clearly show the cyclicality of the jackpot cycle. That is not the end of the world, but it highlights the lack of real progress in finding other growth drivers, with the jackpot and TLC scenario now being steady rather than great growth.

The IEL result was complex, and both positive and negative indicators. The revenue line showed stability but the NPAT line is still suffering from negative mix, as the higher margin stuff lags. Overall, there were signs of a long bottoming in the rate of decline, although the impact has been devastating over the last few years.

NCK was a very poor result, partly due to excess one-off costs in the UK, which should fall out. In fact, there was strong commentary on the UK. It is just taking longer than expected. The Australian operation result was poor, but there was some positive momentum, the first for some time, going into 2026 with sales. The operating leverage here I found surprising.

The others were a mix, with RMD showing very strong NPAT results as the company outlines cost and GM improvements, highlighting the company's operational excellence. SDF was below expectations on the revenue line but in line at the NPAT line; some of this is mix and acquisition timing. I am not too concerned. Lastly, SHL NPAT was poor and a recurring theme of poor pathology profitability, but 2026 guidance was strong, and will have to be executed. Overall, a disappointment again.

SUMMARY

The takeaways here point to issues for portfolio construction and possible stock changes as the stories start to deviate from the base case.

The negatives are, firstly, MIN is stretched financially, due to the larger-than-expected cost of bringing the iron ore operation on and the low lithium prices. MIN remains the only stock where there is a scenario of substantial balance sheet and operational risk combining to destroy value. Not a position I would ordinarily want to be in, and the story now remains beholden to commodity prices and operational execution.

For JIN, the negatives are the lack of growth in the business. The old story of share gains and gains in electronic over manual lottery participation is no longer large enough to drive attractive returns. JIN is looking at acquisitions, but that remains a less certain path.

SHL's growth outlook remains troubled, with the US being much more problematic than expected, and SHL is not the leader in this market. The other markets are mixed, and Australia continues to be hampered by competition. There are signs the historic levels of profitability are no longer relevant.

PXA now has a new CEO and CFO and appears to be making progress in the UK. The UK expansion has proven much more difficult to execute and has cost more, but the main issue has been getting regulatory approvals and aligning customers to align in a reasonable timeframe. In hindsight, this is an example where the investment could have been much delayed until much more evidence of a positive outcome was evident. The UK remains a large burden on the group.

CSL’s numbers show signs of operational issues, but not to the level of great concern at this stage. There is the large Vifor acquisition that is yet to prove itself and operational issues that have not been to the standard of past achievement by the group. The management is taking action which is a positive and we can wait for this to play out some more IMO.

BRG numbers continue to intrigue me with various positive and negative trends flowing through the numbers. Given the past achievements, I am willing to give management the benefit of the doubt but the business does take a high level of management skill to deliver great returns. If the major shareholder sells out, it would be a very bad sign, IMO.

The rest are either good or good enough, with special mention to HUB, PNI and RMD, which continue to beat my expectations. LOV is also showing continually strong numbers.