Tony Boyd, Chanticleer
23 March 2023
Australian Financial Review
Three things stand out in the latest half-year financial results from Washington H. Soul Pattinson – the big bet on Macquarie Group, the $1 billion push into structured credit and the recognition that the capital structure of TPG Telecom is unsustainable.
The results reveal Soul Patts has lifted its investment in Macquarie to about $365 million, or 12.6 per cent of its $2.9 billion large-cap portfolio, and this has come at the expense of a reduction in exposure to the big four banks.
Washington H. Soul Pattinson CEO Todd Barlow says the Milton Corp acquisition has delivered what was promised. David Rowe
This is a relatively large bet given that Macquarie’s weighting in the S&P ASX200 index is 3 per cent.
Chief executive Todd Barlow says the key numbers in the result are evidence of the success of Soul Patts’ decision 18 months ago to take over Milton Corporation for $4 billion.
Barlow highlights the 35 per cent increase in net cash flows from investments to $246.5 million, the 16 per cent increase in net asset value – which was 10 per cent higher than the index return – and the more than twofold increase in cash on hand to $597.3 million.
“I think, from our perspective, we’ve done a great job of being able to prove the benefits of the Milton merger in these results,” Barlow says.
Soul Patts’ chief investment officer, Brendan O’Dea, says the increased exposure to Macquarie in the large caps portfolio is because of the long-term thematic around decarbonisation, particularly through Macquarie’s ownership of the Green Investment Group.
“We think decarbonisation is going to be a very big deal for a very long period of time and Macquarie is uniquely positioned there,” O’Dea says.
“They’ve got a great commodities business, and commodity volatility, we think, is going to continue. Its return on equity is superior to the other retail banks, which we like.
“It obviously trades at a slightly lower yield, but it just has a more convincing growth profile, candidly, than the other retail banks. And a lot of the portfolio rebalancing that we’ve done over the course of the last 12 months has involved moving away from what was an overweight position in those domestic retail banks.”
O’Dea says Soul Patts trimmed its position in Macquarie before the recent decline in the stock, but he is comfortable holding the stock for the long-term.
To fund its position in Macquarie, O’Dea says Soul Patts sold down its holdings in the big four banks. This sell-down was on top of the liquidation of about $436 million in large-cap shares.
O’Dea says the underweight position in the big four banks is because of concerns about the growth in their mortgage books and not because of fears about credit losses.
“Mortgage loan growth has been a real driver for returns for banks in this country for a long, long time,” he says. “And I think it’s probably logical to expect your system growth to slow a little bit with rates going up.”
He does not expect any signs of stress in the big four banks’ mortgage books even though delinquencies will tick up over time. He says defaults will rise from historically low levels.
The $1 billion push into structured credit is a direct outcome of the strategic change in direction following the Milton Corp merger, which took total assets under management to $10.5 billion.
“Over the last four months or so we’ve been increasing our cash on hand and really positioning our equity portfolio to be more defensive, and allocating a lot more of our portfolio towards private market assets, particularly structured credit, which we think offers a better risk-adjusted return right now,” says Barlow.
He says Soul Patts had $483 million in structured credit at the January 31 half-year balance date as well as undrawn and committed facilities of $198.7 million. A further $200 million to $300 million is in the pipeline and ready to be deployed.
“We have basically built $1 billion of this asset class in a relatively short time,” he says. “I would say the need for this type of capital is increasing as the sort of dislocation happens in the banking sector globally.
“But also the pricing is getting better. I mean, not only have bond rates increased materially over the last 12 or 18 months, the credit spread has widened. What we’re seeing is just better assets and more availability of assets”.
Barlow says the credit assessment of a structured credit investment involves a simple question: “We ask ourselves ‘is this a business that we’d be happy to own equity in?’”
He says if you’re happy to own equity in a business, then the debt is actually less risky because equity has to be wiped out before the debt takes a haircut.
The third notable aspect of the result is the recognition by Barlow in an interview with Chanticleer that the value of Soul Patts’ stake in TPG Telecom is being held back by the lack of a free float.
TPG’s share register is Soul Patts and its associate, Brickworks, 12.6 per cent, Vodafone and Hutchison 25 per cent each and David Teoh 17 per cent.
“If you do actually see one of the shareholders exit, then you get a very significant uplift in the free float and potentially get larger index participation – our view is that the stock is materially undervalued,” Barlow says.
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