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Best and worst allocators of capital

Lex Hall  |  02 Apr 2021Text size  Decrease  Increase  |  
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It’s been a turbulent couple of weeks for Australian company management. First, David Teoh stunned the market by announcing he was stepping away from the telco he co-founded, TPG. Then, after a week of trying to hose down speculation he was leaving, AMP chief Francesco De Ferrari finally announced this week his exit from the embattled wealth manager after joining in 2018.

Assessing company leadership is a key part of Morningstar ratings. Up until December last year, this criterion used to be known as “stewardship”. It was rated either poor, standard, or exemplary. The three levels remain but the term stewardship has been changed to “capital allocation”. The change aims to ensure the focus is on assessing management efficacy. It also avoids confusion with environmental, social, and governance factors to be captured through Sustainalytics company-level ratings for Morningstar coverage.

A capital allocation rating depends on three key items: balance sheet health, investment efficacy, and shareholder distributions. In other words, how do managers use the money/capital they have at their disposal to create value for shareholders—the owners of the company?

“These three drivers are assessed on a forward-looking basis to establish an overall capital allocation rating,” says Morningstar director Mathew Hodge. “We assess capital allocation on a forward-looking basis, over a full economic cycle of about 10 years. History may help inform our expectations, but analysts evaluate balance sheet, investment, and shareholder distributions on what we think is likely to happen in future, rather than the past.”

TPG (ASX: TPG) and AMP (ASX: AMP) both have a standard rating for capital allocation—although that could change. Currently 20 companies under Morningstar coverage carry a rating of exemplary. Woolworths (ASX: WOW) and Ansell (ASX: ANN) stand out because they have a narrow moat—or ten-year competitive advantage—as well as a low uncertainty rating. Over ten years, Woolworths has posted an annualised return of 6.84 per cent; Ansell has posted 12.70 per cent.

“Ansell has demonstrated good capital allocation skills and has successfully integrated 90 per cent of its acquisitions,” says Morningstar analyst Mark Taylor. “The company has balance sheet capacity for acquisitions and share buybacks, both of which can enhance the earnings per share growth forecasts.”

As for Woolworths, the supermarket giant’s first-class management suggests its sector dominance is secure, says Morningstar analyst Johannes Faul. “Its operating leverage could lead to a rebound in operating margins, driving cash generation that funds expansion and acquisitions while allowing capital-management initiatives.”

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At the other end of the capital allocation spectrum, nine companies have a poor rating. Among them are Fletcher Building (ASX: FBU), Brickworks (ASX: BKW), Healius (ASX: HLS), Seven West Media (ASX: SWM) and Qantas (ASX: QAN).

Capital allocation – the top and bottom of the class

Capital allocation – the top and bottom of the class Source: Morningstar Direct; data as of 1 April 2021

In Firstlinks this week, Graham Hand’s summation of the current state of markets is as stark as it is succinct. “Unless there is a remarkable economic recovery or a rapid burst of inflation,” Hand writes, “we will have low interest rates for a very long time. It's doubtful we will see short-term rates above 5 per cent for at least a generation, maybe a lifetime. It's a weird thing to say for someone who spent his first decade in money markets with double-digit rates and a bank bill rate of 17.5 per cent in 1990.”

Hand also explores the dichotomy between the fund managers who look for companies with consistent earnings in predictable ways, and the growth managers who back the disrupters. “Like selecting your hot cross buns,” Hand writes, “there is no single correct answer to which is best, as it depends on what suits your taste and appetite.”

Elsewhere, Lewis Jackson has some investment ideas for the friend who found $10,000 in her cupboard. “The moral of the story,” Jackson writes, “is you can do better than the cupboard.”

Emma Rapaport talks to Mark Taylor about the fortunes of CIMIC, and why the civil engineer is showing signs of recovery as the construction pipeline resumes.

In a two-part feature on sustainability and green energy, we examine why attitudes are changing and why companies and asset managers alike are seeking to help investors feel good about where they invest—and make money while they’re at it. Part two lists some investment ideas.

We chat with Forager's Steve Johnson, who explains why he's bullish on consumer spending, enterprise software companies, and why he has cashed in on big names like Uber.

Lewis Jackson dials in with Morningstar telco analyst Brian Han on the Teoh exit. And why it gives Telstra more room to get its house in order.

Young people are taking too much risk with money they can't afford to lose, with social media and apps fuelling the rise of the thrill-seeking investor. Are you one of them? asks James Gard.

How much should you worry about inflation in retirement? Calculating your own inflation rate is better than using a blunt measure like CPI, writes Christine Benz.

As interest rates fall, Australians have never been wealthier. The rise in house prices has been the main driver of the increase, writes Nicki Bourlioufas.

Susan Dziubinski surveys 10 US stocks worth owning. These names are widely held among some of Morningstar’s favourite US concentrated-fund managers.

And finally, in Your Money Weekly, Peter Warnes explains why the US economy should brace for a shaky ride on the Powell-Yellen rollercoaster.

is senior editor for Morningstar Australia

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