How to invest defensively

Todd Barlow is the CEO of Washington H. Soul Pattinson — the investment company that has been rumbling along at a decent total shareholder return for years of in excess of 10%, 12-13% per annum, capital growth plus yields, and this year the stock took off. It went from $17 dollars in February to around $27 dollars now. 

It’s come off a bit in the last little while because the full year results fell a little bit short of expectations but it’s had a fantastic run this year, up about 40%. 

The purpose of talking to Todd Barlow is to find out what the hell is going on and why that’s happened. It’s really worthwhile listening to his views on that and also his views on the market as a whole and how to invest defensively. 

ASX code: SOL
Share price: $26.13
Market cap: 6.255 billion
PE Ratio: 23.43
Yield: 2.18%

Here’s Todd Barlow, the CEO of Washington H. Soul Pattinson. 


Todd, up until January, early this year, the shares were trucking along at 13% per annum total return, as you had done for years and years, and all of a sudden the thing took off and you’re up about 40% this year and I’ve been trying to figure out exactly why that is, so you tell me.  Perhaps you could enlighten us as to what happened at the beginning of this year to cause the stock to go from $17 to $27 dollars?  

Well I think that it’s a combination of things across the portfolio but all of our major investments are certainly pulling in the right direction and when I looked at the portfolio about 12 months ago, we could identify that our major stocks, particularly New Hope and TPG were undervalued and there were a range of reasons for that.  New Hope, I think, lacked the sort of free float and liquidity in the market to be attractive to investors and even though we had a very significant rise in the coal price, recovering from the bottom of the cycle, our share price just hadn’t really grown in a way that say, Whitehaven had leading up to the 12 months prior to a year ago.

One of the things that we did to stimulate a bit of a bit of demand was to sell down 10% of our stake.  We went from 60% to 50% and that really triggered a lot of interest in the stock and we saw a very strong recovery in New Hope’s share price, it basically doubled in the last 12 months.  

That was brilliant.  You reckon that was triggered by selling 10% to improve the liquidity of the stock?

I think that was part of it, and now the liquidity is such that a lot of people are suggesting that New Hope might move into the index.  I think that we’ve been able to learn over the last few years that you need to get a bit of interest in the stock and market the stock a little bit better to stimulate that demand and get the valuation on the stock market that the company deserves.  That was certainly a good move and on the TPG front I think the share price had fallen quite dramatically in the face of the threat posed by NBN and then when TPG announced its move into Mobile and their potential significant capex associated with that move, there was a perception that TPG either couldn’t deliver for the amount of money it said it would build out the network or it would require another capital raise, so those shares were held back.

Then, of course, as you know, TPG solved that issue by merging with Vodafone.  They’ve got a very strong balance sheet now.  The capex requirements will be less going forward and there was a material re-rating of that stock.  Both of those events have really increased the value of our portfolio and our share price has followed.   

You’ve been running the business now for what, three years?  Have you made many fundamental changes to it?

I don’t think there’s been any fundamental changes to the way that we approach our investments or our portfolio.  The things that I have tried to change or perhaps implement, that perhaps weren’t focused on in prior years, was a little bit more marketing around who Soul Pattinson is, how to value our portfolio and why we might be an attractive stock to investors.  When I started in the role it was very obvious that we were materially undervalued relative to the value of our portfolio.  So we set about putting out better disclosures to the market and talking to the market about who we are and what we do and why people might want to invest in us. 

That really had a significant impact on the share price, better reflecting the underlying value of the portfolio.  We attracted a whole new range of investors, we went from 11,000 shareholders to 19,000 shareholders.  We also had some institutional interest in the stock which we hadn’t really had in the past.  Some of those initiatives have really paid dividends in terms of the valuation of the share price.  Which, in the past I guess the approach of the company was to really look after the portfolio and focus on investments and if they made money the rest would follow.  But we’ve tried to then match doing that with better communication about what we do and get a better share price as well.

What do you say is the sum of the parts value of the company now?

The market cap today is about $6.5 billion and our portfolio today is about $6.5billion.  The market is well-informed about how to value our portfolio of assets and has been for some time now.

The market’s getting it right now?

Yes.  I think that was really achieved in the first couple of years of my time in the role, and the last 12 months has, as I said, been portfolio driven.  Now it’s a matter of getting on with business and making sure that we perform in an investment sense because I think the task of demonstrating the underlying value of the portfolio has really been achieved. 

I don’t think you’ve made many, if any, changes to the portfolio since you took over, have you?

Some people say that we have a fairly stagnant portfolio, but one of the things we’ve been trying to demonstrate to people recently is, you don’t necessarily need to look at our headstock portfolio to indicate the kinds of things that we do.  In our recent result we put a slide in that demonstrated the M&A activity that had been performed by the group.  When I talk about the group, I talk about not just Soul Pattinson and the head stock, but also TPG, New Hope, Brickworks and API.  If I look at those companies there’s been quite significant M&A activity over the last 10 years. 

Going back 10 years, that was the merger of TPG and our SP Telecommunications business, and in that year we also sold the new Saraji coking coal deposit in Queensland.  Then if I look at what’s happened in the last 6-12 months, there’s the $16 billion dollar merger between TPG and Vodafone, and TPG over the years has had a number of very significant M&A events – it purchased pipe networks, AAPT and iiNet.  Then we had, API bought the Clear Skincare clinics for about $130 million dollars recently and that was a significant event for them and re-rated their stock.  And just in the last couple of months, New Hope acquired a further 40% of the Bengala Coal Mine from Wesfarmers, and that was an $860 million dollar transaction.  If you look across the group there’s been very significant M&A and it’s something that is really important to us to indicate to our investee companies, that smart M&A and smart investment decisions can add a lot of value. 

Do you have any plans to materially change the portfolio, add to it?  Do you have the ability to make any further significant acquisitions?

We do.  A couple of years ago we moved into a new area.  I think that there hadn’t been many new industries or divisions that had been added to the portfolio in a material way, as I was saying before, we really focused on building out the existing investments that we had.  But a couple of years ago, you might recall we moved into financial services by purchasing a stake in Pengana from the NAB.  Then we purchased a stake in Hunter Hall from Peter Hall and we merged those businesses together and we’re continuing to add to our financial services portfolio and that’s been an excellent move for us, we made a lot of money on that transaction and we continue to think that financial services is an area we would continue to look at growing.

Yeah, because financial services is undergoing some revolutions at the moment with the Royal Commission and so on.  What’s your view about how that’s going to unfold?

Yeah, I mean, certainly the areas that we’ve invested in will be beneficiaries of what’s happening in the market at the moment.  We’ve always prided ourselves on targeting companies that act with the highest levels of ethics and honesty, and we think that people will continue to look for good quality advice and good quality investment management performance.  That’s certainly the companies that we’ve been targeting and our view is that some of the very large players in the financial services market were established at a time when the market was different and they haven’t necessarily evolved to keep up with what the consumers are expecting going forward and we’ve always seen that as an opportunity for our businesses to win significant market share and grow our funds under advice.

Do you think you could grow it by acquisition?  The banks are all getting out of wealth management as fast as they can, most of them are anyway.

Yeah, absolutely.  I mean, that would be an opportunity for us, but as I said, you would have to have a business that is suitable to the current environment and many of those businesses are really structured in a way that’s not the modern way of providing advice.  I think organic growth will be significant for us but there will be opportunities to add to the portfolio through M&A for sure. 

One of the things that’s happened this week is just moving onto coal now, the New Hope mine, which as you say, has been an incredibly good performer for you.  We had the United Nations panel on climate change coming out saying the world’s got to get out of coal by 2050.  What do you reckon about that?  Do you think that coal could be a dead-end?

Well, I hope at some point it is.  I think at some point in the future if we can move to an environment – we’re going to need to move to an environment where the world is emitting less carbon dioxide into the atmosphere, that’s something that has to happen over time.  In the meantime, we’re going to have to transition to that arrangement and the best way to do that is through the cleaner coal AGLE plants that are being built.  And particularly in the fast growing Southeast Asian nations.  There was about 1,600 power plants that are coal fired that are currently in the planning stages or under construction.  That’s in 60-odd different countries and most of those countries are in Australia’s backyard in the Southeast Asian countries like Thailand, Vietnam, Philippines and Malaysia.  The growth in the traditional markets, certainly North America, Australia and Europe, we’ve seen coal declining.  But they are not the markets where we sell coal.  Then there’s the North Asia markets like China and Japan and Taiwan and we don’t expect significant growth there, but the Southeast Asian nations that are growing populations, increasing urbanisation of the population and growing wealth, is consuming a lot more power and those power plants that they’re building are going to be long-term assets.  The current forecasts are that there will be about a 45% increase in the demand for seaborne thermal coal in the next decade or so and what those people want is clean coal and Australia produces that clean coal.

That’s very interesting.  You’re basically focusing or pointing New Hope towards Southeast Asia, that’s where the sales are?

Well, that’s where the Australian coal goes, into Asia, and I think there’ll be an evolution of the end user will migrate further to the Southeast Asian markets away from the very big established North Asian markets.  But what’s interesting is this increase in demand is not being matched by any increase in supply.  There’s no real supply response coming out of Australia and the increased focus on environmental issues makes it more difficult to get a new mine off the ground in Australia.  The other major exporters, like South Africa and Indonesia, are starting to focus on providing coal to their domestic markets, so we’re not seeing really any growth in the global supply of coal to meet this rapidly increasing demand.

Perhaps we can just turn to telecommunications – TPG.  You said that the merger with Vodafone solves the problem.  Does it really solve the NBN issue that’s clearly going to stay around?  Obviously it solves short term issues but what about the long term issues for TPG and telecommunications companies like that in general?

Yeah, there’s no doubt that the NBN has really impacted the marketplace for telecommunications.  It’s created a huge competitor in the market and its forced every provider to have to use the NBN, so it’s created this monopolist beast that is very expensive and has to be paid for by the consumer.  It, in the process, reduces the margins that the broadband sellers can make and TPG as an example, used to provide those broadband services on our own network.  Obviously, there’s better margins attached to being able to provide that service off your own network. 

The NBN continues to be a threat to the margins in the broadband business, but longer-term what we’re seeing is a migration of the way that people consume data, and already people are consuming a lot more data on their smartphones and through mobile devices.  In the future when there’s a 5G network in place and the speeds are comparable or better than what the NBN is providing, we’ll see people avoiding fixed broadband consumption and moving to mobile devices in the way that many people today, particularly the younger generation, don’t have fixed telephone lines in their home, they just use their mobile.

I think that the NBN business case is seriously under threat.  I’m not saying that no one will consumer fixed line broadband but the capacity that they were expecting will be impacted by the migration to mobile data.

Right, so the NBN’s business case is the one that’s in trouble really?

Well, it always was.  I don’t think anyone really believed that there was going to be a return on the investment the government was making, but it did force TPG to move into a mobile area.  I mean, I think TPG would have gone there anyway because the modern mobile phone network relies on the fibre optic cable that is the backbone of the cellular network that we have today.  TPG already had that, the logical thing was to go into mobile and they did that very effectively and they were rolling out a network and then Vodafone came along and there was huge synergy benefits in putting those companies together.  Now, we think we think we’ve created with Vodafone and TPG, a very, very strong competitor to Optus and Telstra and we’re hopeful in expecting that they will win significant market share.

Just finally, Todd, can I get your reflections on where the market stands at the moment?  I mean, we’re seeing long term interest rates in the US start to rise, concerns about trade war.  You’ve obviously got a decent sized listed equities portfolio, how are you feeling about that at the moment?

Yeah, there’s lots to be cautious about.  I think in addition to those things that you mentioned, the fact that the market has risen so much and generally these things are cyclical, that Australia’s had 27-28 years of continuous economic growth, property prices are very high, all asset prices are very high.  All of those things would indicate a need to be cautious in the way that people invest and certainly our portfolio is positioned in a very defensive way, but that’s always been the case.  We’ve always had a portfolio of assets that we’re attracted to because they perform no matter what happens, or at least they’re performing in ways that you’re not correlated to each other. 

If I look at our portfolio, I just talked about the supply-demand characteristics of coal and the world needs to turn on the lights every day, so we don’t think that coal is particularly cyclical or tied into the economic cycle.  People’s consumption of broadband and mobile phones is basically recession proof.  Even when we look at brickworks, which is a cyclical business in the sense that the housing market is determined by the underlying economic cycle, the actual investment make up of brickworks is overwhelmingly their investment in us and other investments, and also long-leased property assets.  The exposure to the building product cycle or the housing cycle is actually relatively small.  Certainly our exposure when we look at it in our portfolio, would only be less than a couple of hundred million dollars.

We say that our portfolio is really well-positioned and generally speaking, we would outperform in more difficult markets, so the fact that we’ve been performing and growing so strongly in recent times is really pleasing to us but we think we’re well-positioned for any kind of disruption that might happen in the future.

Someone at the ABC last night came up to me and said, “Should I take all my money out of the market and put it under the bed, do you think?”  So your answer to that would be, “No.”?  That was my answer…

I’ve heard this quote by various people put in different ways, but basically more money has been lost predicting when the crash is going to happen than from the crash itself.  I think there’s been a reasonable case for being cautious for the last 12-18 months and you would have missed out on some really significant returns in that time had you taken that approach.  I wouldn’t suggest selling out entirely, but I certainly would suggest looking for investments that perhaps are not as hard hit by a turn in the economic cycle.

That was Todd Barlow, CEO of Washington H. Soul Pattinson.