Published on Australian Financial Review (Original Interview Here) – Joanne Tran
Romano Sala Tenna is portfolio manager of Katana Asset Management’s Australian equity fund in Perth.
How are you feeling about the upcoming reporting season? Are you cautious because of the lagged impact on earnings from higher inflation and interest rates?
We are most definitely cautious. On the input side, cost inflation and higher borrowing charges are clearly attacking margins. At the recent Macquarie conference, cost escalation was one of the three key themes. On the output side, deteriorating consumer demand is likely to reduce volumes and sales margins. This is a particularly challenging combination that most corporates have not faced for over a decade.
In terms of the upcoming reporting season, we expect to see only the initial effects that these factors have had on corporate profitability. This will be a shock to some investors. But the bigger issue is the impact on future earnings. Due to the laggard effect on demand and input costs, we expect FY24 to be an even more challenging period. Company outlook statements will be pivotal.
What’s your view on investing in Mineral Resources and South32 after they both made significant revisions to their production guidance?
Production downgrades are important, but they are one data point and at a moment in time. If we look at Mineral Resources, we have been trading that company for 16 years, and have one of the most detailed earnings models in Australia. This model is indicating that at least three of the four divisions will double EBITDA over the next two years. This will generate earnings per share in excess of $10 and a resultant price-to-earnings ratio (PER) of less than seven times.
South32 is a steadier performer, but we continue to see value at these levels. The stock is trading on a consensus PER of around seven times FY24 and a fully franked yield of 7.3 per cent. But the real kicker in our view is the pristine balance sheet. This provides the capacity for inorganic growth without diluting the capital structure and hence earnings on a per share basis. We believe that further acquisitions in the copper space make sense and provide diversification and a push deeper into EV metals.
Any junior miners you like that most people (probably) haven’t heard of?
One stock that has enticed us is Tietto Minerals. It has just finished construction and has commenced production at its mine in the safe jurisdiction of Cote d’Ivoire. The recent pullback in its share price values the business at under $600 million. This is simply too cheap for a low-cost, long-life company that will soon be producing at around 200,000 ounces per annum.
Which stock in the fund is most undervalued by the market?
It’s probably a little unusual to describe the most undervalued stock in the portfolio as one that is up 75 per cent in the past 12 months, and over 250 per cent in the past three years. But if Mineral Resources delivers on its growth pipeline, then that is what it will be – the most undervalued stock in the portfolio.
Lendlease is also trading at a historically low price to book value of less than 0.90 times. Pepper Money is trading on a consensus PER (post downgrades) of about five times. Both are very much undervalued for different reasons. However, both face pronounced headwinds in the short term and may stay cheap or fall further.
We have put on small positions with a medium-term lens. We expect to build larger positions over the coming 12 to 18 months as the macro environment normalises.
How are you reading the market in the current climate?
We have been overweight cash for the best part of nine months. This is premised on our view that consumer spending will recalibrate notably lower at the same time as inflation and higher debt servicing impact production costs. This combination will most certainly drive earnings lower. The piece of the puzzle that we are less certain about is the impact on shares. In an ordinary cycle, declining earnings equate to declining share prices. However, this is already the consensus viewpoint, and the herd by definition is rarely positioned correctly.
Having said this, we do not have the luxury to hold cash indefinitely. Our current intention is to hold our course until the end of May. If we do not see signs of the market rolling over by that time, we will pivot and selectively deploy capital.
What characteristics make an attractive investment in the minerals sector?
It’s all about the rocks! Geology is the key ingredient, but it is not as simple as grade.
While grade – or resource per vertical metre to be more precise – is critical, there are a host of factors that will determine whether the resource can be extracted commercially.
Metallurgy is critical, including an understanding of grind size to extract the minerals, ore hardness, processing pathways, impurities and recovery rates. Mine life and to a lesser degree exploration upside are also key determinants of whether the project is viable.
Management, needless to say, is pivotal. We have seen some management teams make big dollars from tough assets, yet others have failed to capitalise on seemingly easier deposits.
Favourite local bar or restaurant? What’s your go-to order?
Prego in Floreat in Western Australia has the best Italian in the state. Our go-to dish is the duo of roast duck and roast lamb.
Any podcasts or TV shows you’d recommend that you’ve enjoyed?
I don’t watch a lot of television, but if I do, it is usually the football (AFL) or news. I also like Chris Judd’s Talk Ya Book as something that throws up some ideas worth exploring.