ESG matters for Australia’s upbeat AGM season

Martin Currie: Australia’s quasi ‘third earnings reporting period’ has become a fórum for earnings outlooks and ESG matters

    Reece Birtles

    Reece Birtles,Chief Investment Officer, Martin Currie

    Portfolio Manager

    Will Baylis, Portfolio Manager, Martin Currie

    The Annual General Meeting (AGM) season in Australia has become a quasi ‘third earnings reporting period’, with Chairpersons and CEOs starting to use the forum to update shareholders on the outlook for earnings. Shareholders are also increasingly using the forum to push the ESG agenda.

    “We believe that ESG factors create risks and opportunities for investors… As such, we welcome the increased focus on ESG by both companies and investors at AGMs.”

    This year the AGM season for the top ASX companies started on 15 September, and by 18 December, there will have been 200+ meetings with investors.

    With most AGMs now complete for the season, those that we attended (virtually) contained a good cross-section to help us consider the key themes and issues being looked at by the market. Interestingly, we are seeing a much bigger focus on ESG than ever before.

    This year, given the updated guidance and forecasts provided at the AGMs, we have also repurposed the top-down framework that we typically use for analysis of the bi-annual Reporting Seasons in February and August. We can use this to help judge the overall pulse of the market by its reaction to the guidance provided at the AGMs, and things are looking much more positive than they were in our Australian Reporting Season Wrap for August.

    Improved guidance on economy reopening and ongoing demand

    First and foremost, we have seen a generally positive tone across the outlooks provided at AGMs so far this season.

    Companies that are dependent on their customers being ‘on-premise’ have provided the most upbeat outlooks and guidance. This is particularly prevalent in the housing (Stockland, Mirvac) and construction (Fletcher Building), bricks and mortar distribution retail channels (Super Cheap Retail, Wesfarmers Bunnings and Kmart divisions), while companies in the so called COVID “winner” sectors, such as consumer staples (Coles, Woolworths), and areas of discretionary retail that had done well through the lockdown (JB Hi-Fi, Harvey Norman), have also continued to provide very robust trading outlooks.

    However, companies exposed to the external economy, especially China, have expressed more caution. It remains unclear how the China trade issues will be resolved, and what the duration of trade embargoes for Australian products will be. New lockdowns in Europe and the US are also leading to more pessimistic guidance for exporters.

    Key themes revolve around ESG

    Our team of fundamental analysts and portfolio managers have looked at the proxies, the AGMs themselves, the guidance and commentary provided, and have undertaken pre-AGM engagements with the boards and management of individual stocks. This allows us to do a deeper dive into the key themes coming out of the AGMs, most of which we have found to have an ESG undertone.

    Focus on a ‘reasonable’ remuneration measure

    Leading into the AGMs, boards have in several cases announced performance rights as part of the long-term incentives for the CEO. These have been based on a very low share price, often associated with the trough in earnings due to COVID 19. This does not appear to have resonated well with the market, given many have shown markedly improved earnings and higher share prices as the economy begins to reopen. We note that after pre-AGM engagements with investors some boards have adjusted these incentives to a more appropriate share price which reflects improved trading conditions and outlook.

    An example of this is with Super Retail Group. The company released the following statement to the market. “Following consultation with shareholders, the Board has determined that for the purpose of determining the number of Performance Rights to be granted under item 4, the value attributed to a Performance Right shall be increased to $8.92 (from A$7.19)1.

    This change reflected the pricing period post the financial year end, rather than taking advantage of a low share price immediately after the Government response to COVID-19 was put in place.

    Boards have also caused controversy when declaring executive team bonuses while in receipt of Government support such as JobKeeper.

    Increasing regular Sustainability reporting

    Something we are seeing more of in the Annual Reports prepared in advance of AGMs is information on the risks and actions taken during the year to deal with climate change and waste. Many companies now publish detailed Scope 1,2,3 carbon emissions, and examples of how they are improving their recycling efforts.

    Almost all companies are also now submitting a Sustainability Report as part of their Annual Report. Many companies have dedicated Sustainability teams and are providing detail on issues around waste, climate change, employees health and safety during COVID-19 etc.

    Some companies are now also highlighting plans for their energy transition to carbon neutrality. AGL Energy was targeted this year by impact investors around their transition planning disclosure at last year’s AGM. Aurizon Holdings also launched their first climate strategy and action plan to be net zero by 2050.

    We met with the Chair and Company Secretary of JB Hi-Fi for a discussion following the release of the company’s first Sustainability Report 2020. It is apparent that sustainability forms an integral part of JB Hi-Fi’s company culture. JB Hi-Fi have a major focus on modern slavery, and since February have been working with a supplier on a pilot project focussed on sustainable packaging and they have reported a 73% reduction in plastic bag usage2.

    We also recently attended an ESG briefing with the CEO of ANZ Bank. ANZ has put climate change as a strategic priority, and their focus is on the top 100 clients who will need to show them evidence and a plan to move to a low carbon transition by 2021. We see this as a growing trend for banks and companies to influence the actions of their customers to mitigate the risks of climate change. Similar trends are also occurring in the building construction materials industry where materials are increasingly sourced from suppliers who are lowering carbon emissions.

    Indigenous Heritage

    Following the events with Rio Tinto and the Juukan Gorge, Indigenous relations has become a significant theme for investors. However, we do note that activist resolutions related to cultural heritage at BHP and Insurance Australian Group have subsequently been withdrawn following company engagement.

    We have engaged with both the Board and investor relations at Rio Tinto and summarised our views in a recent piece titled GOVERNANCE ON WATCH FOR RIO TINTO. Our key concerns related to poor communication and a lack of Board accountability for the actions, which has impacted Rio Tinto’s ‘social license to operate’ in the Pilbara.

    We had two recent meetings with the management of BHP on the topic. The company has reviewed their heritage management and processes post the Juukan Gorge destruction and have set up a Heritage Advisory Council in conjunction with Banjima People to provide mine planning input at their South Flank iron ore mine. BHP also have an in-house process for escalation for senior management sign off if BHP discover heritage sites subsequent to Section 18 approval and prior to commencement of mining. BHP has had input into and supports changes to the Aboriginal Heritage Act, currently being reformed, that gives Traditional owners more say in the protection of heritage sites in Western Australia.

    We have also met with Fortescue Metals Group to understand the differences in their approach to Indigenous communities. Fortescue is a relatively new entrant to iron ore mining in Australia and appears to operate with a greater awareness of local Indigenous needs and concerns.

    Focus on Stakeholder rights and Shareholder accountability

    The topic of shareholder rights and responsibility to stakeholders is becoming more heated, and we have also engaged with several companies on the issue.

    Most Chairpersons that we have engaged with on this issue describe that their Board’s responsibility is to the company and its shareholders. That said, all companies are also aware of their broader stakeholder obligations, especially employees, customers, suppliers and regulators.

    We see good governance being aligned with the long-term financial returns to shareholders, which will in part be dependent on the treatment and experience of the broader group of stakeholders.

    Corporate actions, recapitalisations and acquisition decisions made during COVID-19 have been significant. We have looked closely at Directors who have protected shareholder interests in these deals. Badly structured placements/equity issuance, or badly priced incentives have been notable, such as a selective placement by Cochlear at a large discount to share price, and IOOF which made a very large and dilutive capital raising to fund the MLC acquisition; impairing shareholder returns in the short and medium term.

    Trend towards virtual AGMs

    A final evolving theme worth noting is the push by companies for virtual-only AGMs in the future. While we understand that this year it was unavoidable, we recognise that it can limit smaller shareholders’ abilities to engage with corporate officials, raise questions, and hinder the transparent expression of views.

    As a large institutional investor, we have very good access to company management. As such, it is less of a concern for investors like us, but we would advocate for a hybrid model to help avoid anything that results in reduced transparency to the governance process.

    AGM analytics reflect positive tone

    As mentioned, we have repurposed our top-down analytical to also judge what the street is thinking and doing, and have specifically reviewed revisions and price reactions through to 30 November 2020.

    Consensus revisions looking up

    Using our analytical framework to look at how consensus brokers have revised their forecasts post AGMs, we have noticed a positive skew of upgraded revisions for sales, EPS (earnings per share) and DPS (dividends per share) forecasts3. This is a stark contrast to August when the market still had an overwhelming pessimistic outlook and revisions had a downward skew, despite already significantly downgrading companies in April and May.

    Source: Martin Currie Australia, FactSet; as of 30 November 2020. Data shown for the S&P/ASX 200 Index constituents. Calculated using the weighted average of broker consensus forecasts of each holding – because of this, the returns quoted are estimated figures and are therefore not guaranteed. Percentages may not total 100 due to rounding.

    The most positive skew was for Dividends, following on from companies using the AGMs to reissue positive dividend guidance as cash flows begin to re-emerge post lockdown. It also reflects boards and management having some visibility as we move towards the economy reopening in 2021.

    At an industry level, companies exposed to the key earnings drivers of housing (for example, stocks such as Nick Scali), construction (BlueScope Steel, Fletcher Building, Boral), discretionary retail (Harvey Norman, Super Retail Group, JB Hi-Fi) and credit (Bendigo Bank, CBA) exposed stocks have experienced the strongest composite revisions post the AGM updates4. June financial year-end banks have also benefited from the positive delinquent loan stats released and builders benefitted from Government stimulus announcements.

    Source: Martin Currie Australia, FactSet; as of 30 November 2020. Data shown for the S&P/ASX 200 Index constituents. Calculated using the weighted average of broker consensus forecasts of each holding – because of this, the returns quoted are estimated figures and are therefore not guaranteed. Percentages may not total 100 due to rounding.

    On the flip side, China/commodity stocks have been the weakest (Whitehaven Coal, Iluka Resources), and food inflation (Treasury wine Estates). We do note that the falls for gold are unrelated to AGMs, and more linked to the ‘risk on’ tone of the market post the US election result and vaccine news.

    A neutral price reaction to updates

    Let’s now look at how the market has reacted by comparing the share price movement over the two days post each company’s AGM (what we call the ‘price reaction’5). Given AGMs provide less market sensitive information than reporting season, we do expect to see less dispersion in price reactions, but it’s another useful measure to judge the overall tone of the market.

    Source: Martin Currie Australia, FactSet; as of 30 November 2020. Data shown for the S&P/ASX 200 Index constituents. Calculated using the weighted average of broker consensus forecasts of each holding – because of this, the returns quoted are estimated figures and are therefore not guaranteed. Percentages may not total 100 due to rounding.

    Slightly more companies outperformed in the days post their AGM, with market expectations already focused on the economy reopening. Improvements in employment, rising consumer and business confidence, extended Government support for the economy, and also new stimulus announced in the October budget have helped.

    But comparing this also to the magnitude of revisions, it is similar to what we saw during the August reporting season, where there was a clear lack of negative price reaction when there was a downgrade to EPS or DPS. This really suggests that the market understands that we are still looking at bottom of the cycle earnings. The market still isn’t punishing companies for relative EPS revisions, but they are not rewarding them either. We also believe that the noise from the US election, the vaccine news and market volatility also impacted upward stock price movements on positive EPS revisions, especially given the very strong market rally in November.

    Source: Martin Currie Australia, FactSet; as of 30 November 2020. Data shown for the S&P/ASX 200 Index constituents. Calculated using the weighted average of broker consensus forecasts of each holding – because of this, the returns quoted are estimated figures and are therefore not guaranteed. Percentages may not total 100 due to rounding.

    Summary

    To us, what we are seeing in both the AGMs themes and top down analytics is pleasing.

    Ultimately, we believe that ESG factors create risks and opportunities for investors and that it is important to consider these when making an investment in a company, and for the companies themselves to manage these appropriately. As such, we welcome the increased focus on ESG by both companies and investors at AGMs.

    Finally, the more upbeat tone to consensus revisions, the muted price reaction to bottom of cycle earnings data, and the positive outlooks from companies themselves is in keeping with our positive outlook for the Australian market. November performance of the Australian stock market has been strong, and the S&P/ASX 200 Accumulation Index has now wiped out its losses of the year to date.

    The resolution of the US election and a COVID-19 vaccine have also removed two significant risks going into 2021, and we expect the positive global outlook to reflect well on prospects for Australia and Australian equities. Australia is also recovering quickly from the COVID-19 recession, as virus transmission is brought under control and lockdowns have ended.

    We are expecting that the full COVID-19 impacts will have materialised in Australia during 2020, and that a recovery in company earnings and dividends will be seen into 2021 and 2022.

    WHAT ARE THE RISKS?

    Past performance is not a guide to future returns. All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested.

    This information provided should not be considered a recommendation to purchase or sell any particular security. It should not be assumed that any of the security transactions discussed here were, or will prove to be, profitable.

    The information contained in this presentation has been compiled with considerable care to ensure its accuracy. But no representation or warranty, express or implied, is made to its accuracy or completeness. Market and currency movements may cause the capital value of shares, and the income from them, to fall as well as rise and you may get back less than you invested.

    The analysis of Environmental, Social and Governance (ESG) factors form an important part of the investment process and helps inform investment decisions. The strategy does not necessarily target particular sustainability outcomes.

    The opinions contained in this recording are those of the named manager. They may not necessarily represent the views of other Martin Currie managers, strategies or funds. These opinions are not intended to be a forecast of future events, research, a guarantee of future results or investment advice.

    Martin Currie has procured any research or analysis contained in this presentation for its own use. It is provided to you only incidentally, and any opinions expressed are subject to change without notice. The opinions contained in this document are those of the named manager(s). They may not necessarily represent the views of other Martin Currie managers, strategies or funds. Please note the information within this report has been produced internally using unaudited data and has not been independently verified. Whilst every effort has been made to ensure its accuracy, no guarantee can be given.

    This publication is issued for information purposes only and not investment or financial product advice. It expresses no views as to the suitability of the services or other matters described herein to the individual circumstances, objectives, financial situation, or needs of any recipient. You should assess whether the information is appropriate for you and consider obtaining independent taxation, legal, financial or other professional advice before making an investment decision.

    Issued by Legg Mason Asset Management Australia Ltd (ABN 76 004 835 849) (Australian Financial Services Licence Holder No. 240827) Level 47, 120 Collins Street, Melbourne VIC 3000

    ENDNOTES

    1. Source: Super Retail Group company announcement, 22 October 2020: Addendum to Notice of Annual General Meeting

    2. Source: JB Hi-Fi company announcement, 17 August 2020; FY20 results presentation

    3. For revisions, Upgrade is classified as a consensus revision of >2%. Downgrade is classified as a consensus revision of >-2%. No change is a consensus revision within +/- 2%

    4. The composite revision is based on the average of the consensus revisions for sales, EBITDA, earnings, dividends, free cash flow and debt to equity. Earnings driver are determined by Martin Currie Australia

    5. For price reaction, out-performance is classified as a return of >2% greater than the S&P/ASX 200 Index. Under-performance is classified as a return more >2% below the S&P/ASX 200 Index. In-line performance is within +/- 2% of the S&P/ASX 200 Index