All buybacks are not equal, says Epoch

-- | 19/06/2019

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Glenn Freeman: We're here on the sidelines of Morningstar Investment Conference. I'm joined today by Kera Van Valen from Epoch.

Thanks for your time today.

Kera Van Valen: No problem.

Freeman: Now, the session that you were a part of today was looking at some of the changing paradigm within global equities. Now, can you talk to us a bit about the process that you at Epoch follow in putting together the portfolio?

Valen: We want to find companies that generate sustainable free cash flow and consistently return the cash to shareholders through the combination of dividends, share buybacks and debt reduction. We do start with a screen that helps us identify companies that are capable of generating the sustainable free cash flow but then do the fundamental analysis to really assess what are the drivers of cash flow and how sustainable are those cash returns back to shareholders. So, for example, we recently added Target to the portfolio. We like the fact that not only do they have a roughly 3 per cent dividend yield, they do consistently do share buybacks.

So, roughly another 3 per cent from share buybacks. And we expect mid to high-single-digit growth coming from the organic growth, investments in new store footage and maintaining stable margins.

Freeman: And one of the points that you actually did make during the session also was about that share buybacks aren't all equal that you steer clear of those that are funded by higher leverage. Could you just talk us through that just a bit?

Valen: Sure. We want to find companies that have a consistent capital allocation policy where if you can earn above your cost of capital, by all means, you should be reinvesting for growth or making acquisitions. However, we don't believe there is an unlimited supply of opportunities to do so.

So, you should be consistent about returning the cash to shareholders through either dividends, share buybacks or debt reduction. So, when we think about share buybacks, we want to see that be part of the capital allocation program as opposed to opportunistically trying to take advantage of a short-term disruption in the market. So, not all share buybacks are the same. We want to find out what the motivations are for doing the share repurchase. Not just to meet the EPS targets or simply funding them through debt reduction, because we don't think that's sustainable over the long run.

Freeman: And you mentioned Target as a company that you've added most recently. But are there other sectors, say – obviously, that's a retail stock – do you have any sort of slants or other sectors that sort of stand out, even though I know you say you approach on a bottom-up basis.

Valen: Yeah. We do not want to make a sector call when we are looking for the companies, nor a country call. We really want to find companies that are going to help us deliver the objectives of the portfolio. Diversification is a part of what helps us in minimising the risk of achieving our goals. So, we feel quite good actually right now about the fact that our portfolio is very well diversified.

There's not one single sector that's pushing up against the 20 per cent limit. We do limit our sector exposure to 20 per cent. We don't have any sectors pushing against 20 per cent. So, we feel the portfolio is very well diversified.

Freeman: Sure. Great. Thank you for your time today.

Valen: Thank you.

This report appeared on 2019 Morningstar Australasia Pty Limited

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