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Investor Webinar 21 September 2022: How hawkish will the FED become on interest rates?

October 6, 2022

Fisher & Paykel Healthcare, FPH, Inflation, interest rates, Silk Logistics, SLH

In our Webinar a few weeks ago we talked about how hawkish the Fed might become on interest rates.


We also discussed:

Fisher & Paykel Healthcare (ASX:FPH) is recovering from the post-COVID slump.

Silk Logistics‘ (ASX:SLH) earnings growth is pretty smooth.

See transcription below.


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Marc: Good morning. It’s the 21st of September, time for our weekly investor webinar. Good morning, Stuart.

Stuart: Good morning.

Marc: We’re kicking it off with Fisher & Paykel today. We wrote about that one in “Stocks Down Under” very recently. So, take us through why we like that stock so much.

Stuart: Yeah. So, Marc, I’m a big bull on Fisher & Paykel and ResMed together. What do those companies have in common? They make equipment to treat obstructive sleep apnea. Now, there’s probably a billion people around the planet have obstructive sleep apnea of some kind. The market was pioneered by the folks that created ResMed.

Fisher & Paykel, you might know them. You might even indeed have bought a Fisher & Paykel appliance for your home, like a refrigerator or something. That was the origin of this company, but they had some unique technology in humidification of air, and they realized they could apply that to making a competitive machine to the kinds of stuff that ResMed was doing. That was their origins. That’s since grown into a significant company on both the Australian and New Zealand stock exchanges, headquartered in Auckland.

And they were a big deal during the COVID Pandemic because the respirators they make were useful for keeping people alive who arrived in hospital with serious COVID. So, that’s Fisher & Paykel. The pandemic is more or less behind us now, so it’s a good one to go and revisit.

Two thousand twenty-two, and this company’s a March balance date, they enjoyed 1.7 billion New Zealand dollars in revenue and 400 million in NPAT. Now, that’s actually down for reasons we’ll talk about. But over time, this company’s returned some pretty heavy returns for shareholders, both in a business sense and in terms of share price growth. We evaluated some of the issues the company’s grappling with in “Stocks Down Under” this week, and I wanna talk about them in this webinar for a little while.

There’s the share price chart for the last year or so. As you can see, this stock was north of $30 if you go back about a year or so. It’s now down under 20, and that’s got people wondering, is this a yesterday story? And I’m gonna argue far from that. So, what are the issues? During COVID-19, Fisher & Paykel Healthcare did about 10 years’ worth of sales for its hospital hardware in two. Now, any company that grows that quickly is going to experience what I call corporate indigestion. We saw it, for instance, in online retailing with Kogan, how they just couldn’t cope with the amount of growth they had through the pandemic. Well, I believe Fisher & Paykel Healthcare has not dissimilar problem.

Like every company in the world, they’re dealing with supply chain issues and there’s less demand for the product. So, revenue came down 14% in constant currency during the year March, 2022, impact came down 30%. So, it feels like the growth mojo has gone away from this one. And because COVID is now rapidly becoming ancient history, people have just sold it and walked away. I would encourage people to go back and take a look at this one for reasons different to COVID.

So, what’s the opportunity? There’s about a billion people between the ages of 30 and 70 or thereabouts that have obstructive sleep apnea of some kind. A lot of those people are undiagnosed. The giveaway is, they may snore at night. Now, that may or may not be obstructive sleep apnea, but it’s indicative of an airway that’s not functioning normally. And if your sleeping partner complains about you snoring, it’s worthwhile going and having a sleep test, and you can do these things comfortably in your own home, to at least get an indication whether you are a potentially a patient.

So, that’s been driving the growth for this company is this core business in obstructive sleep apnea. Fisher & Paykel’s demonstrated competitive advantage is they’ve got some knowhow in how to properly humidify air. If you’ve ever been on a plane and suddenly found your mouth getting very dry, that’s because the air isn’t as well humidified as it possibly could be. The more you humidify air, the more comfortable it is. And that’s why Fisher & Paykel has been able to grow a decent size business, and it gets better every year. They spent 9% of their 2022 revenue on R&D. So, there’s new products that come off the hopper all the time both in hospital care, as well as sleep apnea. And so, they’ve been able to stay a pretty strong player in this space.

So, is it worth looking at now? Well, okay, there’s the consensus numbers, expecting another drop in [inaudible 00:04:42] for the year to March, 2023. So, should you stay away? Well, Marc, it’s fair to say FY24 for this company’s not far away. Markets are always looking at the current year, but always looking forward to the next one. So, in the current year, obviously things aren’t so great, but when that year comes to an end, look what happens at the other side of that. We go back to some pretty outstanding growth numbers as this company returns to something like normal. And indeed, normal gets you back to almost COVID kind of conditions with just two or three years’ worth of growth. So, that’s a good reason to take a look. The market will ultimately start looking through this dip and you’ll see the stock price based out at the moment.

Marc: Yeah. Looks, in addition to what you’ve been saying, I think looking at this company and looking at their sales levels through COVID, it’s more than just being struggling with growth. I think it’s also what we’re seeing now is that they sold so much over the past two years that the market is just saturated at the moment. So, you see some sort of negative catch up almost in terms of sales.

And we had a conversation about this stock last week in terms of, you know, valuation and, yeah, as you said, March is the final month of the financial year. So basically, the next financial year, 2024, is only four, five months out, right? So, market will start to look at that, and then looking at that growth versus the valuation. So, 31.6% growth versus 22.5 times EV/EBITDA, that’s a pretty good deal, if you can get it at the moment.

Stuart: Absolutely. So, a lot of good reasons to look at this one. What investors have to keep in mind is there’s the products that help respiration in hospital, and then there’s the sleep apnea opportunity. And I’m saying the sleep apnea opportunity is, the reason I’ve always followed this company is because of that. That comes to the fore again and an environment where that market continues to grow quite strongly, Fisher & Paykel is very well placed.

Marc: Right. And one of their big competitors in the US, which is actually Dutch company, Philips Medical Systems, has got big issues with their sleep apnea product in the US because it turned out that some of the materials, the plastics in the machine, sort of came loose, little, tiny bits of that, and that’s led to a big recall of these machines in the US for Philips. And every time Philips announces its quarterly results, there’s more news on these machines where it’s even worse than they thought prior to that. So, it’s already cost the CEO his job. What, if any, benefits can a company like Fisher & Paykel sort of draw from that? What’s the opportunity for them if one of their big competitors is in trouble?

Stuart: Basically, the opportunity is now to steal a serious march on market share. So, the global leader is ResMed, based right here in Sydney, and number two, as you say, Marc, is Philips. They bought a company called Respironics some time ago. And then as a very strong number three, you’ve got Fisher & Paykel Healthcare. So basically, the end users are gonna be looking at this news about the product recall, and asking who else has got equipment that could work for me? I reckon they’ll be able to steal a march on Philips. Marc, I’m very surprised you’re making negative comments about a Dutch company.

Marc: Well, look, if you look at the history of Philips, you know, 20 years ago, it was, as they call it back then, a big plate of spaghetti and they’ve tried to turn that into a big plate of asperges, you know, being with these nice little divisions sort of all sort of carved out. Philips has come a long way, but in essence, it’s still very much a very bureaucratic company. So, this sort of stuff doesn’t surprise me, even though it emerged from an acquisition they did. But, yeah, not all companies can be as great as ASML, right? That’s just, that’s the life.

Stuart: And it’s interesting. I remember at the time of the Philips/Respironics merger thinking that these [inaudible 00:08:29] are gonna wreck this company. It’ll…

Marc: Sure enough, they did.

Stuart: Anyway, so great Kiwi company. If you’re listening to us from Auckland, go check them out because it’s one of the truly great New Zealand business success stories alongside other great companies like a2 Milk, worth taking a look at.

Marc: All right. Good stuff. When we wake up tomorrow morning in New Zealand and Australia, the Fed will have made its decision on interest rates. So, that’s coming up. It’s, I think it’s 4:00 am Sydney time.

Stuart: Right. Please, Marc, don’t tell me you’re gonna get up at 4:00 am to watch Chairman Powell tell us what interest rates are gonna do.

Marc: Yeah. And then two minutes after, I’ll give you a call, wake you up as well. So, we’ll see this when we wake up in the morning. But I thought just briefly, just look at what’s expected and, you know, there’s an outside chance of a bigger than expected hike and what that would mean. So, right now, the market is expecting a 75 basis point hike. I think that’s sort of priced into the market. So, if that happens, I don’t think we’ll see a major response in terms of markets and equities especially, because sort of, you know, that’s what the market is expecting.

Obviously, the interesting things will be what Powell is going to say after the…in the press conference after the decision, because CPI in August was disappointing, 8.3% inflation versus 8.1% expected. And so, although it was down from 8.5% in the prior month, it was still disappointing.

Stuart: And just on that, Marc, I actually think the market overreacted at the time. It’s like month to month things weren’t so bad, you could make a case that the worst was over. You know, energy prices weren’t going up any higher, for example.

Marc: Yeah. And look, there’s debate on what oil is going to do in the next month or couple of months really, depending on what happens in Ukraine, but also sort of in general terms what happens globally with the economy. So, it could come back, right? Energy prices could spike up further. But that drop in July, in August, sorry, the question is, is that enough to keep the Fed from becoming more hawkish, right? And that’s something that is just not known. And so, we’ll see what happens, but those remarks in the press conference will be really what will be driving the market overnight.

And of course, then there’s a chance, a 20% chance according to, if you look at the bond market that the Fed may actually hike 100 basic points. Now, that is not broadly priced in. So, I think that will trigger a selloff in the market, and especially if Powell comes out with more hawkish statements about, you know, the future of inflation, where it might be going and what might be needed into 2023. So, that is the, it’s a smaller chance obviously, but there’s still a chance that we could see that happen. And of course, in that scenario, you get the high beta stocks like technology, high growth stocks will be under pressure.

But, and I think this is really important, the biggest unknown is yet to come. So, what we haven’t seen so far in this cycle is earnings downgrades, substantial earnings downgrades. We have seen companies like FedEx for instance, but across the board, the earning season has been pretty, relatively good, I’d say. And if we get into a scenario where the economy’s global economy, US as the biggest one, obviously, but if we see those earnings downgrades come through, if we see slow down or even a recession more than what we’ve seen so far, because we have technically been in a recession in the US I think for last two quarters, but it hasn’t been reflected, for instance, in unemployment.

But if we get those earnings downgrades towards the end of the year, early next year, that will be the key sort of question, Marc. So, how much of that is priced in, right? So, it’s priced in to some extent, but if things get really bad, then, yeah, it could become a lot worse. For instance, [inaudible 00:12:18] actually is expecting a depression and now he’s Mr. Doom obviously, but and he hasn’t always been right.

Stuart: Can you just hold for a second, Marc? I’m just gonna open the window here. We’re up on the eighth floor, so should I jump now?

Marc: Well, wait a little bit. And before you do, you sign over your share in Pitt Street Research to me. Oh, all kidding aside, it’s serious business, obviously, but yeah, and depending on who you listen to, the big unknown is still to be answered and that will take about six more months, I think, to play out because that’s really, yeah, we haven’t really seen the worst of a potential downturn just yet.

Stuart: Right. Now, there’s two pieces of good news here, Marc. The first one is we know that the Fed is acting to get inflation under control. Time wise, and you’ve gotta go back a long time where central banks didn’t worry about that stuff too much. And then Jimmy Carter put Paul Volcker into the Fed chairmanship, and then gave him the political cover to say, you know, Paul, go do whatever you need to do, get this inflation problem under control, and we owe a lot of the last 40 years’ worth of prosperity to that decision.

Everyone has been able to read from that playbook, but they’ve never had to been as serious as Volcker was about killing inflation. So, it could be we’re over this sooner rather than later, right?

Marc: I’m not certain about that because the biggest inflation hawks have always been the Germans after the Second World War. And when the ECB took over from, basically from the Bundesbank, in the de facto monetary policy in Northwestern Europe, things have gone downhill, basically. And right now, we’ve got a politician running the European Central Bank.

Stuart: Yeah. That’s not good.

Marc: And that’s really bad news. And they’re behind the curve. The RBA’s behind the curve, the Fed is behind the curve, so they’ve all missed it, really. They’ve all dropped the ball in a big way. And so, you and I, the consumers are paying the price for that at the moment. You know, things like wars like in the Ukraine, you can’t blame that on central banks, obviously, but the problem was before that last year already when everyone was saying, “Yeah, this inflation is transitory.” We wrote something on our website that said, “No, that’s all BS. It’s not transitory. Stop saying that. You need to have interest rate action now.” And that was last year, but they all dropped the ball.

So yes, back then, Stuart, that was a big change for the Fed. But the Fed policy or the charter is still flawed because they’ve got two targets really, and only one instrument. So, they’ve got optimal economic growth and they’ve got an interest rate inflation target, really, and you can’t satisfy both if you only have the interest rate to play around with. So, I’m not very bullish on the prospects of central banks actually properly rectifying this. They could overshoot on the upside when it comes to interest rates. So, we see how this plays out.

Marc: Let’s keep it real. What should investors here in our part of the world be thinking about?

Stuart: Well, we’re not out of the woods in terms of this inflation thing. I think it can go a bit longer depending on what happens. Well, first, for instance, in China, it’s a big driver of, you know, supply chains, which has caused a lot of inflation, but also the war, obviously. Energy prices in Europe are going through the roof still, gas especially. So, we’re not…it’s going to be with us for a while.

The key risk is that the central banks will overshoot on the upside, and sometime next year it will come down, but damage will be done and we have a big fat recession, or, well, I don’t think depression, but, yeah, that’s sort of what you need to keep in mind, and also, in terms of your investments. So, what to play in markets like that, right? So, it’s not easy, but that’s something that you need to keep in mind.

Stuart: Okay. All right. Let me give you something optimistic to think about here, Marc. Let’s talk about Silk Logistics, ASX: SLA. We wrote about that in “Stocks Down Under” on Tuesday. Here’s the download on why you should be paying attention to Silk Logistics. Relatively new company for the ASX, it did its IPO in July of last year at $2 a share. Why do we like this one? Well, a lot of IPOs have gone to hell in a hand basket, but not Silk. It’s held up at around the $2 level since then, and they had a great 2022, revenue up 22%, EBIT up 28%.

This company is sitting on a net cash position at the moment. So, very well placed financially. What do they do? Logistics. And it’s one thing the pandemic taught us we need a lot of, it’s really smart logistics companies to move goods around more easily at a time when people aren’t going to the shop to get those things. So, times have been right for this new company.

What makes Silk so special? Well, the winners in the future of logistics will be those companies that have the best technology to be able to efficiently move their trucks and the boxes they put the goods in, etc., and Silk is quite smart in that respect. They’ve also been clever. They’re focused on industries that are more or less recession proof and it’s served them quite well.

No surprise that their CEO, Brendan Boyd, who’s pictured on the right-hand side of the slide there and his colleague, John Sood, they own about 28% of the company between them. So, they’re very focused on making sure this this thing turns a decent profit. And look at that return on capital employed, 78%. So, with relatively little capital within the company, they’ve been able to build a pretty strong business.

Now, it’s not all them. I imagine Goodman Group with their focus on decent infrastructure to help logistics companies has probably helped. But the times are right for these guys in multiple ways. And the outlook is favorable. Here’s the consensus numbers. Another 10% growth in EBITDA, or 11% is expected in ’23. Slows down to mid-single digits in ’24 and ’25 on prospectus, but you’re paying much less than that on an EBIT to EBITDA multiple.

And what…I love it when companies talk about, and it’s a term I’ve heard more than once, growth in three horizons, an approach that was pioneered by McKinsey’s, the management consulting firm, where there’s the business you’ve got now, there’s the business you’ll have tomorrow, and then there’s the business you’ll have in the medium term. And Silk make sure they take care of business on all three horizons. That’s always great.

You want to short companies that are just focusing on today, and you don’t need to buy companies whose earnings are coming in the medium-term future. This company’s got it cooking on all…firing at all cylinders in that regard. So, expecting some decent growth in 2023 and the balance sheet powder is dry. So, part of that can possibly be by acquisition, fair bit of organic growth from cross-selling as well.

Marc: Yeah, I was gonna say, Stuart, with those numbers for ’24 and ’25, the growth numbers there, they probably be, will be propped up by acquisitions, right? That’s…it’s just a best case.

Stuart: Well, they made one acquisition, but I think this is the, what you’re seeing there is the organic growth numbers. And so, it could get better in multiple respects. Now, keep in mind every acquisition’s got its challenges in terms of integrating it into the core business. But Silk knows what they’re doing in terms of just running a decent logistics infrastructure. So, watch this company carefully.

Marc: All right. Excellent. Thank you, Stu. And with that, we’ll wrap it up and we’ll see you next week. Thank you very much for watching.

Stuart: See you next week.