The Rise of the Asset Owner
The fulcrum of power and influence in Australia’s sophisticated retirement income system has been gradually shifting towards asset owners – particularly industry super funds – from asset management firms that utilise active strategies. The shifting sands reflects four developments.
The poor performance of active equity funds in Australia during the financial crisis has led to scepticism about the ability of these funds to deliver sustainably strong returns to outperform the ASX200, net of fees.
The growing scepticism about the value add offered by high cost active equity funds has come at a time when there has been renewed focus on costs and management expense ratios, which has led to strong investor flows into low cost index, enhanced index and exchange traded funds.
The introduction of My Super has put pressure on pension funds to shift their allocation to these lower cost funds and asset classes, and also bring investment capabilities in-house.
The Superannuation Guarantee – the 9.5% compulsory superannuation contributions made by employers on behalf of employees – has underpinned strong growth of inflows into industry super funds at a time when many firms operating in financial markets have downsized due to lower growth in revenues and profitability.
Against this backdrop, a cottage industry has emerged around Environmental, Social and Governance (ESG) considerations, which has been given an assist by the fact that many institutional investors in Australia have signed up to the United Nations Principles of Responsible Investing. Not-for-profit campaign communities such as Getup! have been successful in raising awareness public and investor awareness around issues relating to economic fairness and environmental sustainability, social justice, including the plight of refugees being held in Australia’s detention centres.
A key implication of the shifting locus of influence towards the asset owners has been renewed interest in ‘activist’ investing. Industry super fund led Divest campaigns have attracted tremendous media attention in Australia over the past year, including decisions of various pension funds to divest fossil fuel companies, coal miners, tobacco manufactures and the old Transfield Services (the new Broadspectrum). Asset owners and institutional investors are more proactive during AGMs and use the proxy process to affect corporate governance policies.
Sharper focus on corporate social responsibility
Australia’s changing investment landscape is having an impact on corporate policies around factors as disclosure, climate footprint, remuneration, board independence, treatment of employees and other key stakeholders, and license to operate. As asset owners and institutional investors continue to flex their muscle, listed companies will increasingly need to balance the goals of maximising profits and shareholder value with reputational risks around managing ESG considerations.
Retailers are particularly exposed to these developments because of the frequent contact that the community have with their stores and the high level of investor recognition they have. This clearly has benefits in terms of promoting their respective brands but it can also be costly for retailers to manage reputational concerns if something goes wrong.
Earlier this year, Evidente noted the Four Corners program (Slaving Away) which went to air on May 5th, which showed damning evidence of exploitation of migrant workers in Australia's fresh food supply chain. The allegations were levelled at stores that sell fresh produce to the public, including Woolworths, Coles, Aldi, IGA and others. Four Corners posted to its website the written responses from each of these businesses, including Woolworths.
Although each of the supermarket chains deals with hundreds, possibly thousands of suppliers, the big supermarket chains need to be careful about managing their reputational risk, particularly as the community and governments have effectively conferred a license to operate to Woolworth, Coles and other supermarkets. The sheer size of Woolworths and Coles suggest that they have more to gain from leading the charge and ensuring that their suppliers do not engage in worker exploitation.
As retailers continue to extract synergies and efficiencies from their supply chain management, they will need to carefully manage ESG considerations that might adversely impact on their suppliers.
More recently, the 730 Report has drawn attention to the practice of ‘sham contracting’ used by Myer. A whistle blower – who was a cleaner at the flagship Myer Melbourne store - who raised his concerns to the media recently about being paid below award rates without superannuation or other benefits, has been fired. Myer contracts out its cleaning services to Spotless which sub-contracts to another firm. According to the 730 Report, this firm then hired cleaners as ‘contractors’ to avoid paying various entitlements under the award system. The sub-contractor has been ordered to reimburse cleaners who were paid below the award rate and denied penalties by the Fair Work Ombudsman.
Retailers – particularly those who invest so much in their brands – will increasingly need to be careful about managing these relationships, particularly in a climate where asset owners and institutional investors are increasingly focussed on corporate social responsibility.
Myer: Unlocking the embedded value in an iconic brand
Myer’s poor market performance since re-listing around five years ago has been underpinned by negative earnings surprises, with the current 12 month forward PE of around 11x comparable to the level that prevailed in 2010 (see chart).
Growth in revenues and profitability has suffered due to structural challenges facing the department store business model including greater competition from e-tailers, a household sector keen on undertaking balance sheet repair in the wake of the financial crisis and up until recently, a strong Australian dollar, which has encouraged foreign entrants into the space. As a result of these developments, department store sales have flat-lined in the past three years while household goods retailing and clothing & soft goods retailing have lifted substantially (see chart).
Evidente has suggested previously that some of these headwinds facing discretionary retailers are gradually transforming into tailwinds. The household saving rate remains high by historical standards (at levels prevailing in the late 1980s) so there is scope for it to fall, particularly in an environment where the change of government leadership in September has given consumer sentiment a fillip. Evidente believes that more monetary stimulus is necessary to support consumption and non-mining business investment. The Australian dollar has depreciated in recent years, which is likely to discourage further foreign entrants into department stores.
Ultimately, new management at Myer will need to address the structural challenges facing the business model. The recent equity raising of over $200 million has helped to shore up the balance sheet.
Against the industrial universe, Myer remains cheap on an ROE adjusted price to book basis, with the stock lying 30% below the trend line, suggesting the much of the pessimism is already priced in (see chart). However, reported earnings (and therefore forecast earnings) are probably overstated to some extent because ongoing expenses associated with restructuring the business in recent years have been treated as non-recurring items. Myer however is not the only company undergoing restructuring to have used their discretion to bring such items below the line. Nonetheless, this practice probably overstates the stock’s valuation support. Much also depends on the transformation of the David Jones business model under the new ownership of Woolworths Holdings.
If the new CEO, Mr Richard Umbers is able to unlock the embedded value in the iconic brand that Myer represents, Evidente expects that patient investors will be rewarded.