Ask a Fund Manager
The Motley Fool chats with fund managers so that you can get an insight into how the professionals think. In part three of this edition, we're rejoined by Romano Sala Tenna, co-founder of Katana Asset Management.
The Motley Fool: 2022 has been a difficult year for many ASX shares. Which sectors are you likely to avoid in the year ahead?
Romano Sala Tenna: At some stage you want to be in a lot of these companies, but I think you don't want to be in most things at the moment.
We need to get through this period, to where we see the impact of some of the tangible consequences of central bank policy. Interest rates have risen significantly to counter inflation, which is also having its own direct impact. For example, we saw 9% food inflation reported in the September quarter. We also have the effect of the energy crisis and the war in Ukraine, and so forth.
All these things are reducing the disposable income of households. But I think it will be post-Christmas before we see the impact on consumer spending really hit. Interest rates are only just starting to bite now.
All the numbers we're seeing now are rear-looking. And consumer spending is about 50% of GDP.
MF: How do you see this all playing out on company balance sheets?
RS: Some companies have really been on a debt splurge. Companies have been rewarded for bad acquisitions for the last five years. And good companies have been penalised for maintaining tidy balance sheets.
NextDC Ltd (ASX: NXT), for example, a recent research note from Macquarie highlighted that a 1% increase in interest rates could increase finance costs by 14% and reduce earnings per share by 34%.
A lot of these corporates are heavily geared. And you can't really pass it on to the consumer, so that hits the bottom line.
We're going to see those two things, the impact on consumer spending and the impact on corporate profitability, flow through the market. And we haven't seen that yet.
Whether or not the markets are forward-looking enough to look through that, only time will tell. But I suspect we've got another leg down to come in the new year.
You also want to try to avoid your high P/E companies or 'long duration growth assets'. If cash flows are 10 years out, when you model it back with the higher discount rate, $10 million 10 years out is worth a lot less in today's dollars.
These are the obvious areas you want to avoid, which really exclude some large chunks of the market.
MF: Some analysts have pointed to ASX bank shares as being able to better weather fast-rising interest rates. What are your thoughts?
RS: Yes, the banking sector gets a lot of margin expansion. But we're going to see a reduction in volumes, strong competition for consumer deposits coming through, so that's going to reduce their margins; strong deposit for tier-one mortgages, rise in bad and doubtful debts. All these things are yet to play out.
I think it's the back half of next year they'll be worried about these things. But it still means today, it makes it hard to get on board.
MF: So, there's quite a field of ASX stocks to likely avoid in the short term. Which sectors and ASX stocks do you believe are likely to outperform over the year ahead?
RST: Clearly lithium, EVs and decarbonisation.
So, try to find ways to play this theme. We think that's got multi-decade timeframes. So if we get it wrong short-term, we'll get it right over the medium to long term.
For example, our largest holdings are still in the lithium space; we've just started to trim a little bit now but we've held our nerve in the lithium space, and that's served us very well.
The two that are currently in our portfolio in size are Mineral Resources Limited (ASX: MIN) and Allkem Ltd (ASX: AKE). We've stuck with the ones that have a long history and we understand well, and that make a lot of sense in terms of the metrics that we see.
MF: Aside from the ASX lithium shares, are there other sectors and stocks that look strong in the decarbonisation trend?
Copper is the other major electrification theme we can play in Australia. It's a bit hard. Despite the importance of copper and despite Australia being the largest resources market, there are really only a handful of copper plays of any quality.
Sandfire Resources Ltd (ASX: SFR) is a highly leveraged play. They've got to get through the next six months. They're not for the faint-hearted. They have to make sure they get their Motheo mine in Botswana up and running. And they've also had some issues with power at their MATSA mine in Spain. It's a company-transforming moment for them. The CEO has left, which always concerns us a little bit, but mind you he's been there 15 years. But if they execute well, Sandfire has very significant upside from here. But not without risk.
The other way to play copper is with OZ Minerals Limited (ASX: OZL) and to a lesser extent BHP Group Ltd (ASX: BHP).
Secondly, we're looking at LNG [liquefied natural gas]. We think there's a structural change underway due to the war in the Ukraine. People aren't buying gas off Russia anymore. And they need to replace that in the short term. On the way to renewables, you need LNG.
There are some nuances around it. For example, what happens in terms of the gas reservation, if governments overstep the mark.
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If you missed part one of our interview with Romano Sala Tenna, click here. For part two, click here.
(You can find out more about the Katana Australia Equity Fund here.)
