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PM CAPITALInvestment insights
June 2013
2
Who is PM CAPITAL?
We are contrarian – equity investors behave poorly
As at 31 May 2013
Fund
Total return
(inception)
Index Total
excess
Absolute Performance Fund
167.4% 19.5% 147.9%
Emerging Asia Fund 139.4% 11.6% 127.8%
Australian Opportunities Fund
301.4% 177.2% 124.2%
Enhanced Yield Fund 111.2% 74.4% 36.8%
3
Absolute Performance Fund
Performance (net of fees) Months Years Since31 May 2013 1 3 6 1 3* 5* 10* Inceptio
n*
Absolute Performance
Fund15.0% 16.7% 34.7% 62.1% 10.3% 4.5% 4.1% 7.0%
MSCI World ($A) 8.3% 12.8% 23.2% 29.3% 8.4% 1.4% 3.6% 1.2%
4
Why the Absolute Performance Fund?
Selective and concentrated long-term investments into undervalued businesses, globally.
A high conviction fund, likely to significantly differ in characteristic from a benchmark focused fund.
A contrarian investment style – investments are purchased on the merits of their risk/reward characteristics.
Investment Performance1
Total Return
Absolute Performance Fund
167.4%
MSCI World ($A) 19.5%
Excess Return 147.9%
Unit holders that have been invested in the APF since inception, have ~148% more capital than if they had invested in the index.
APF Top 10 MSCI World Top 10
Lloyds Banking Group AppleING Groep Exxon MobilJP Morgan Microsoft CorpBank of America General Electric Co
Barclays Plc Chevron CorpWells Fargo GoogleApplied Materials Johnson & JohnsonGoogle Inc IMB CorpBB&T Corp NestleRoyal Bank of Scotland Wells Fargo
GICS SectorAPF
allocation 1 Jan 2012
MSCI World Sector performance
(1 Jan - 31 Dec 2012 - AUD)
Financials 50% 27%Consumer Disc 21% 22%Industrials 3% 15%Materials 0% 10%Consumer Staples 13% 13%Health Care 4% 16%Utilities 0% 15%Information Tech 36% 14%Energy 0% 1%Telco's 0% 7%
5
Selected US and UK banks – recovery of major economies Eg BB&T Corp, ING Groep, Bank of America, Wells Fargo
Technology – semi-conductor, data warehousing Eg Applied Materials, Maxim, Oracle
Services – stock specific opportunities Eg Google, NASDAQ, Comcast, CME Group
Global brewers – global consolidation of industry Eg Heineken Holdings, Anheuser-Busch Inbev
Property – recovery in US housing market Eg MGM Resorts, Howard Hughes Corp
AUD (unhedged) – under pressure
APF – Key investments
23/1/2013
6
Portfolio Guidelines – Absolute Performance Fund
Description Guidelines
Number of stocks 35-45 stock specific ideas
Individual stock positions
Max 7.5% at cost, 10% hard limit
Individual short positions
Max 2% market value, 3% hard limit
Total short positions 30% excluding pairs/spread trades
Sector weighting >2x MSCI WEI weighting or 35%, hard limit 3x MSCI WEI weighting
Target net equity exposure
80% (+/- 10%)
Net equity exposure Max 110% (long equity – short equity)
Gross equity exposure Max 170% (long equity + short equity)
Allocation to debt securities
30% (maturities > 1 year)
Max net invested position
130% (equity + debt securities exposure)
Max cash position 100%
Options/derivatives may be used to minimise risk, enhance yields and replicate underlying positions but may not be used to leverage the portfolio.
7
Case Study: US/UK Banks
Do we understand how the business works?
8
• Borrow – from depositors / wholesale funding
• Depositors – cheap to borrow, stable funding source
• Wholesale funding – expensive to borrow, market volatility can impact liquidity
• Lend – to retail / commercial • Retail – low competition, small loan sizes,
diversity reduces credit risk• Commercial – More competitive, larger loans,
more rigorous credit process
• Trading – for liquidity/ risk management• Liquidity management – low risk trading,
improve interest spread• Risk management – Manage interest rate and
market risk, minimise earnings volatility
• Investment banking – Advisory / Proprietary• Advisory – Fees for advising big clients – high
ROE• Proprietary – Use bank capital to bet on the
market
Borrow Lend Trading Investment Banking
Deposits Wholesale
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Retail Commercial
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Liquidity Risk Mgt
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Advisory Proprietary
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Stock We Own
Wells Fargo
BBT
JP Morgan
B of A
Lloyds
RBS
Barclays
ING
Deposits Wholesale
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Retail Commercial
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Stock We Don’t Own
Goldman Sachs
Morgan Stanley
Citigroup
HSBC
BNP
TRANSPARENT INCREASINGLY COMPLEX
Not all banks are the same
9
Banks Forward P/E
Current P/B
Wells Fargo
9.8x 1.3x
BBT 11.0x 1.2x
JP Morgan
7.8x 0.8x
B of A 10.7x 0.4x
Goldman Sachs
9.6x 0.8x
Morgan Stanley
10.3x 0.5x
Lloyds 12.5x 0.6x
RBS 10.7x 0.2x
Barclays 6.2x 0.5x
BNP 7.1x 0.6x
So what can a well run bank earn when the economies normalise?
Environment Recession Normal Expansionary
Net Interest Spread
High funding costs = 2.50% spread
3.00% spread in normal economy
Higher demand for loans = 3.25% spread
Net Interest Revenue
$2.50 $3.00 $3.25
Fee Income Low fees when people stop using banks = 2%
2.50% of Assets 2.50% of Assets
Non Interest Revenue
$2.00 $2.50 $2.50
Total Revenues $4.50 $5.50 $5.75
Operating costs ($2.75) ($2.75) ($2.75)
Pre Provision Profit
$1.75 $2.75 $3.00
Loan loss rate 1.50% as recession leads to higher consumer losses
1.00% in normal environment
0.75% as consumers are cashed up
Loan loss expense
(1.50) (1.00) (0.75)
Pre tax profit $0.25 $1.75 $2.25
• Assume a simple bank like Wells Fargo , BBT or Lloyds
• For every $100 in loans/Assets what will the bank earn
Significant earnings upside for banks when moving from recession to a normal economic environment…
But valuations imply they are
10
If earnings normalise US banks P/E’s look cheap S&P Banks are currently trading at a
forward P/E of 11.1x, or at 0.2x discount to historical levels. This is:
• Narrower than where the broad market is trading vs. historical levels, and;
• Narrower than 6 out of the 10 S&P Sectors discount to historical
In this rate environment banks are under-earning. Adjusting EPS for a +200bp move in the short end and +100bp on the long end, banks would be trading at a 4.4x discount to historical levels.
We are selective and sticking to banks that not only offer EPS upside in a higher rate environment, but are also rationally valued on current forward P/Es
11
Aust banks (CBA) v US banks (Wells Fargo)Operational metrics comparison
Credit Costs/Loans
Pre GFC Average Current
CBA 0.40% 0.31%
WFC 0.92% 0.92%
Pre Tax Earnings/Credit Costs
1993-2003 Average
Current
CBA 10.5 10.1
WFC 5.9 4.9
Valuation metrics comparison
Price/book
Pre GFC Average Current
CBA 2.1 2.7
WFC 2.9 1.3
WFC is a higher margin business than CBA – 3.75% v 2.20% respectively.
Credit costs (loan loss provisions) are more likely to increase for CBA than WFC.
WFC is more likely to improve its operating performance than CBA (WFC PTE/CC peak was 8x).
WFC is still trading at a significant discounted P/B, but CBA trading at a premium.
Risk is greater for CBA, potential reward is greater for WFC.
WFC has “re-calibrated” for post GFC life, CBA has not…priced for perfection!
12
Banks in summary…
• We believe the current economic environment may provide a unique and rare opportunity to generate returns from some US and UK banking stocks.
• It is vital to understand each bank’s operating model and key inputs to valuation before deciding where to invest.
• Our view is that the banks that are largely focused on retail borrowing and lending will benefit most in a transition from a recessionary to a normal environment.
13
Australia versus Global
SummaryCommodity sweet spot has passed – China’s hard asset investment slowing
Australian banks fully valued – significant premium to global peers
Materials and Financials combined = 60% of index
Narrow subset of opportunities remaining
Currency Overlay+ $A at all time high v most currencies
ConsiderationWould suggest highly correlated ASX 200 funds to be avoided
Would suggest favouring offshore opportunities
14
15
Emerging Asia Fund
Performance (net of fees) Months Years Since
31 May 2013 1 3 6 1 3* 5* 10* Inception*
Emerging Asia Fund 13.2% 12.8% 19.6% 24.5% 7.7% n/a n/a 18.7%
MSCI Asia (Ex Japan) 6.5% 4.5% 11.3% 17.6% 1.5% n/a n/a 2.2%
16
Why the Emerging Asia Fund?
Selective and concentrated long-term investments into undervalued Asian businesses.
A high conviction fund, likely to significantly differ in characteristic from a benchmark focused fund.
A contrarian investment style – investments are purchased on the merits of their risk/reward characteristics.
EAF Top 10 MSCI Asia ex Jap Top 10 MSCI Asia Pac ex Jap Top 10
SJM Holdings Samsung Electronics BHP BillitonWuMart Taiwan Semiconductor Commonwealth BankJobstreet Corp China Mobile Westpac BankingCarlsberg Malaysia China Construction BK H ANZ Banking GroupBaidu ICBC H National Australia BankTurquoise Hill Resources Gazprom OAO AIA Group LimitedBeijing Capital Int'l Airport Tencent Holdings Ltf Woolworths LimitediProperty China Petro & Chem H Wesfarmers LimitedPuregold Price Club ITAU Unibanco CSL LimitedDallan Port Co American Movil Singaport Telecom Limited
17
Infrastructure Eg Dalian Port, Beijing Capital Int’l Airport, China Merchants
Internet Eg iProperty Group, Jobstreet Corp, 104 Corp
Retail Eg Wumart Stores, Puregold Price Club, SunArt Retail Group
Gaming Eg SJM Holdings
Consumer Eg Carlsberg Malaysia, China Resources Enterprise
EAF – Key investments
EAF Portfolio Guidelines
Description Guidelines
Number of stocks 15-35 stock specific ideas
Individual stock positions
Max 7.5% at cost, 10% hard limit
Total short positions N/A – long only portfolio
Net equity exposure 0 – 100%
Max cash position 100%
Options/derivatives may be used to minimise risk, enhance yields and replicate underlying positions but may not be used to leverage the portfolio.
18
19
Case Study: Wumart Stores
Case study: Non discretionary retail (Wumart Stores)
20
Secular change underway
High barriers to entry
Regional strategy/#1 market share in Beijing
Modern retail in infancy
Strong management
Locals with operational expertise
World class margins and
returns
Triggers for mis-pricing: Initial trigger was investigation into founder. Now the challenges with integration of Tianjin operations.
What the market is missing: Long term earnings growth – myopic focus on short term earnings. Expansion opportunities in Hebei not being considered. Will double target market, but leverage existing supply chain. CNY appreciation.
Considerations for valuation: Focus on long term earnings growth potential. Target market is 90 mill people/rev less than 5% of Woolworths. 20x P/E on 2012 estimate.Earnings growth 25%pa for last 5 yrs and forecast to continue for next 5 yrs.
Wumart Stores…the business model
Potential risks: Migration to modern retail stalls. Increase in competition. over the longer term. Significant expansion outside of Beijing. Rapid increase in input costs ie wages, rent.
As at January 2013
21
Australian Opportunities Fund
Performance (net of fees) Months Years Since31 May 2013 1 3 6 1 3* 5* 10* Inceptio
n*
Australian Opportunities
Fund1.4% 8.3% 24.8% 36.5% 13.3% 6.9% 10.3% 10.9%
ASX 200 Accumulation Index -4.5% -2.4% 11.6% 26.5% 8.5% 1.8% 9.8% 7.9%
22
Why the Australian Opportunities Fund?
Selective and concentrated long-term investments into undervalued Australian businesses.
A high conviction fund, likely to significantly differ in characteristic from a benchmark focused fund.
A contrarian investment style – investments are purchased on the merits of their risk/reward characteristics.
AOF Top 10 ASX Top 10
QBE Insurance Group Limited
Commonwealth Bank Australia
Asia Pacific Data Centre Group BHP Billiton LimitedMacquarie Group Limited Westpac Banking CorpEcho Entertainment Group ANZ Banking GroupJB Hi Fi Ltd National Australia BankTranspacific SPS Trust Telstra Corp LimitedWotif.com Wesfarmers LimitedSuncorp Metway Woolworths LimitedRio Tinto Limited CSL LimitedTabcorp Holdings Limited Rio Tinto Limited
Sonic Health Care
Investment Performance Total Return
Australian Opportunities Fund
301.4%
S&P / ASX 200 177.2%
Excess Return 124.2%
Unit holders that have been invested in the AOF since inception, have ~105% more capital than if they had invested in the index.
23
Financials – underweight this sector Eg Macquarie Group, NAB
Property Eg Asia Pacific Data Centre, Lend Lease, 360 Industrial
Corporate debt – taking advantage of favourable spreads
Significantly underweight resources we seek low cost operators at distressed commodity prices (as per 2001).
AOF – Key investments
Source: ASX; Feb 03 – Jan 13
24
Portfolio Guidelines – Australian Opportunities Fund
Description Guidelines
Number of stocks 15-25 stock specific ideas
Individual stock positions
Max 7.5% at cost, 10% hard limit
Individual short positions
Max 2% market value, 3% hard limit
Total short positions 30% (excluding pairs/spread trades)
Sector weighting >2x ASX200 weighting or 35%, hard limit 3x ASX200 weighting
Target net equity exposure
80% (+/- 10%)
Net equity exposure Max 110% (long equity – short equity excl. pairs trades/futures)
Gross equity exposure Max 170% (long equity + short equity excl. pairs trades/futures)
Allocation to debt securities
30% (maturities > 1 year)
Max net invested position
130% (equity + debt securities exposure)
Max cash position 100%
Options/derivatives may be used to minimise risk, enhance yields and replicate underlying positions but may not be used to leverage the portfolio.
25
Case Study: Sonic Healthcare
Case study: Sonic Healthcare
26
High barriers to entry
Clean balance sheet
Growth through acquisition
Dominant local presence
Strong management
CEO in play since IPO
Low cost operator
Triggers for mis-pricing: Govt cuts to regulated pricing. QLD co-pay structure not implemented by key competitor. Profit warning May 2010 – stock down 20% next day. Increased business cost due to deregulation of collection centres.
What the market was missing: Govt regulated pricing would hit smaller players hardest – opening the door for bolt-on acquisition. Increasing volumes would offset margin contraction. 5 year deal with Govt to guarantee 5% rev growth. FX masking underlying offshore earnings. Seen as a “buyer of choice” by potential vendors.
Considerations for valuation: Path volume growth at 6-8% over last 15 years. Valuations were set at $10.10 on 13.4x FY10/11.7x FY11/ 10.6x FY12. Expected return $10.10 › $13.78 = 36% re-rating + 5% div = 41%
Sonic Healthcare…the business model
Considered risks: No tangible assets as a service company with long term relationships/strong industry reputation. Large fixed cost business leveraged to volume.Dilution risk – capital raisings to partly fund future acquisitions.
As at January 2013
Case study: Sonic Healthcare
The price chart demonstrates the dramatic sell-off post the profit warning in 2010.
At $10.10, we forecast 36% growth to fair value of $13.78.
Approaching $13.78, we have been trimming our position.
This is a text-book example of mis-pricing on short-term earnings issues or technical factors. It provided an opportunity to take a core position in a “good business at a good price”.
Ave buy price $10.10
Buying period:
May 21 – Jul 23
Trimmed position $11.67
Trimmed position $13.82
27As at January 2013
28
Enhanced Yield Fund
Performance (net of fees) Months Years Since
31 May 2013 1 3 6 1 3* 5* 10*Inceptio
n*
Enhanced Yield Fund 0.5% 1.6% 3.3% 6.7% 6.3% 6.3% 6.3% 6.9%
RBA Cash Rate 0.2% 0.7% 1.5% 3.3% 4.2% 4.3% 5.7% 5.1%
29
Guiding principles
Always start with “cash”… Capital preservation is our first priority, so depending on investment opportunities in debt securities, our cash position can be anywhere between 20 – 100%.
Focus on the anomalies… A carefully selected portfolio of what we believe to be the best opportunities in global debt markets – typically there are only 40-50 securities in the portfolio.
Broad universe mandate with a strong research focus… This enables broad access to global credit markets, utilising our vigorous research process to identify mis-priced assets.
No surprises… We seek to deliver RBA Cash Rate plus 2%, over the medium term with minimal volatility.
30
Outcomes at a glance…
Income providero The fund has returned 6.9% pa
after fees, since inception (2002).
Low volatility of returnso Annualised standard deviation of
2.3%, since inception.
o 90% positive monthly returns, since inception.
Capital preservationo Delivered positive returns during
the depths of the GFC.
o Sufficient cash to take advantage of significant pricing anomaly's in 2009.
As at 31 May 2013
-60%
-50%
-40%
-30%
-20%
-10%
0%
10%
20%
07/2007 01/2008 07/2008 01/2009 07/2009 01/2010
PM CAPITAL EYF versus Lonsec peers
31
March 09: “a once in a generation opportunity to invest in yield securities.” Quote from our March 2009Quarterly Report.
Cash Allocation: an output of investment opportunitiesJune 11: “This decision to hold a meaningful amount of the fund in cash will also give us ample capital up our sleeve to take advantage of further attractive investment opportunities that materialise over the next 6-12 months.”Quote from our July 2011 Quarterly Report.
Enhanced Yield Fund’s monthly cash position
Please note that his chart is used for internal PM Capital purposes and is indicative only.
32
Recent purchases
Issuer InvestmentDuratio
nCurrent Yield
ALE Property Trust Senior Debt 1.5 years Bills + 275bps
Asciano Senior Debt (USD) 2.5 years Bills + 200bps
Mirvac Senior Debt 3.5 years Bills + 200bps
IAG Subordinated Debt (GBP) 3.5 years Bills + 475bps
Westpac Subordinated Debt (USD) 4.0 years Bills + 425bps
CBA Hybrid (USD) 2.0 years Bills + 350bps
Tabcorp Senior Debt 1.0 years Bills + 185bps
33
EYF Portfolio
As at 31 May 2013
Top 10 Holdings
CFS
Westpac
ANZ
CBA
NAB
Mirvac
ALE
Dexus
Wesfarmers
IAG
Asset allocation
Cash 36.3%
Corporate Bonds 39.9%
Hybrids 22.4%
Buy & Writes 1.4%
Regional allocation
Australia 94%
US 5%
UK 1%
Duration
Interest rate 0.15 years
Avg term to maturity
2.50 years
Summary
Our investment approach is based on:
Selective and concentrated long-term investments into undervalued businesses.
High conviction funds, likely to significantly differ in characteristic from benchmark focused funds.
A contrarian investment style – investments are purchased on the merits of their risk/reward characteristics.
In executing our investment philosophy we would also note that the stock market is far more volatile than the underlying business it represents. Thus, the key to being a successful investor requires both good business judgement and the ability to control your emotions, thereby avoiding the irrational behaviour of crowds or consensus thinking.
34
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Investment Presentation - Disclaimer Statement
PM CAPITAL Limited
ABN 69 083 644 731
Australian Financial Services Licence 230222
Level 24, 400 George Street
Sydney NSW 2000
Ph: 02 8243 0888
www.pmcapital.com.au
This presentation is intended solely for the information of the person to whom it was provided by PM Capital Limited. It is intended to provide information and does not purport to give investment advice.
While the information contained in this presentation has been prepared with all reasonable care, PM Capital Limited accepts no responsibility or liability for any errors or omissions or misstatements however caused. Except insofar as liability under any statute cannot be excluded, PM Capital Limited and its directors, employees and consultants do not accept any liability (whether arising in contract, in tort or negligence or otherwise) for any error or omission in this presentation or for any resulting loss or damage (whether direct, indirect, consequential or otherwise) suffered by the recipient of this presentation or any other person.
Past performance is not necessarily a guide for future performance. Opinions constitute our judgement at the time of issue and are subject to change.