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Fund manager warns against politically sensitive sectors

By Rhea Nath
4 minute read

Maple-Brown Abbott has lifted the lid on where it is finding opportunities in the small caps universe as it navigates away from sectors facing the brunt of wage inflation, cost of living, and in some cases, politics.

Maple-Brown Abbott’s Phillip Hudak has outlined smart plays that exist in the small end of the Australian market, including cautioning against exposures to sectors that are “in the firing line of politics”.

Speaking at the Morningstar Investment Conference 2024 in Sydney, he explained that cost of living has become a serious issue in the economy, with its impact continuing to flow into portfolio decisions.

“You’re seeing a huge bifurcation in the older demographics versus the younger demographics. You want to be exposed to those consumers that are linked to that older demographic, so on the travel side, the bricks-and-mortar operators like Flight Centre are a great example,” Hudak said.

However, on the flipside, companies like Baby Bunting that are “deeply in that mortgage belt” are facing a challenging time from a margin and revenue perspective, the co-portfolio manager of Maple-Brown Abbott’s Australian Small Companies Fund said.

Hudak believes the battle to address cost-of-living pressures extends to supermarkets, which have recently come under regulatory scrutiny over price gouging and competition concerns.

In February, the Australian government announced it will direct the Australian Competition and Consumer Commission (ACCC) to conduct an inquiry into this sector, the first of its kind since 2008.

The same month, an inquiry led by former ACCC chair Allan Fels into price gouging and unfair pricing practices in Australia also singled out supermarkets, finding Australia’s food and grocery sector to be among the most concentrated in the world.

Significantly, the average profit margin of the sector has remained remarkably stable despite the enormous volatility in prices throughout the domestic economy in the last few years, the report highlighted.

“Unlike most of the retail sector, supermarkets generally benefited from their position during and after the COVID-19 pandemic,” it said.

“Neither Coles nor Woolworths experienced declines in profit nor revenue over the pandemic as their main businesses were, rightfully, deemed essential services. This position allowed business continuity and retained their position in the market.”

Hudak, too, observed how sectors like Australia’s supermarkets are “in the firing line of politics”.

“You’ve seen most recently the supermarkets have been in the firing line, there is potential that we see the NDIS will start to be on the firing line as well, given the cost blowouts,” he told audience members.

To combat this, he said the fund prefers to focus on sectors where the government is subsidising some of the wage increases coming through, such as aged care and childcare.

He foresees wages being a major concern moving forward and believes markets continue to underestimate the forthcoming impact of wage inflation.

As of March 2024, the seasonally adjusted Wage Price Index at the Australian Bureau of Statistics has grown 4.1 per cent over the year.

“I think the market is underestimating the wage inflation that is expected to come through over the next couple of years,” Hudak remarked.

“It’s quite interesting that we’ve never seen a wider dispersion between the CPI and wages, that means real wages have been going down over the last couple of years.”

In part, he attributed this to the “rigidity” of Australia’s employment regime, with the Fair Work Commission setting the minimum wage every year, while enterprise business agreements are typically made over 3–4-year periods, suggesting a lag.

Hudak cautioned: “We may be in an environment where we’re seeing consumer price inflation going down, but wage inflation is staying relatively high. So, the sectors we’re looking to avoid are those sectors that have a high labour base and minimum pricing power.”

Parts of the healthcare sector, including pathology and radiology, have seen crimped margins “because indexation has either lagged or they haven’t been unable to increase pricing,” he said.

Instead, Hudak said the fund was looking at avenues like IVF, which have been able to increase pricing and maintain strong margins.

“The other area we think will be difficult will be on the retail side. Sales being slow and cost of doing business as a percentage of sales increasing, we’ll see margins being crimped. How are we playing this? We want to be linked to those companies that have automatic price increases coming through,” he said.

These include IT companies, like TechnologyOne and Hansen Technologies, which have CPI+ clauses that come through every year.

“[They’re] keeping up those margins, as well as insurance broker AUB that’s linked to those premium rate increases that are quite significant,” he said.