Lewis Jackson: Hello and welcome to another edition of Morningstar's reporting season wrap. Today I'm joined by Angus Hewitt, who oversees a series of companies ranging from a2 Milk to Qantas.

Angus, thanks for joining us.

Angus Hewitt: Thanks Lewis.

Jackson: So, looking across the coverage universe this reporting season, were there any unexpected surprises, whether to the upside or the downside?

Hewitt: I got a lot of good disclosure this earnings season. So there weren't a lot of surprises from an earnings point of view. But there were a few things that were a little bit interesting when you really started to dig into the results. So on the upside, you've got InvoCare funeral provider, InvoCare, this is one of our best ideas. We really like this company. It's one of few companies in Australia we assign a wide economic moat, and that's underpinned by its series of premium brands in Australia highly respected, well known brands and its cost advantages over a long tail of smaller competitors in what is a highly fragmented funeral market. We already have a pretty good idea of how the pandemic is weighing on InvoCare. That's both on volume and price.

On the volume side deaths in Australia are down. Our handling of the pandemic, lockdowns, restrictions, social distancing, people just washing their hands has led to a virtually non-existent flu season in 2020. And it looks like we're going to have essentially no flu season in 2021 as well. Compounding that you've got on the pricing side when there's restrictions on funeral attendance, InvoCare aren't able to offer their full range of services. So demand for premium services, higher cost, higher margin services, like White Lady have declined in favour of lower cost services with streaming capabilities. So what I sort of found surprising, and to the upside it was good to see how quickly pricing bounced back in periods where restrictions on funeral attendance eased. So that sort of you saw demand for White Lady really bounce back once they were allowed to have funerals with more than 10 people today. And that really indicates the strength of the underlying brands for InvoCare.

Jackson: So, less deaths is good for everyone, but InvoCare.

Hewitt: Something like that.

Jackson: And were there any other names, that surprised in the other direction?

Hewitt: None that come to mind, no.

Jackson: Okay. Now turning to a2 Milk. It's a Morningstar best idea. It's been struggling for little bit and earnings were down 70% when it reported last month. Talk us through why you're still optimistic about it.

Hewitt: Yeah, a2 has been having a rough time, earnings like you said down more than 70%. It wasn't unexpected, we did have a lot of disclosure like I was saying before that this was coming. I will just note, a2 is a – lot of the visibility of a2 in Australia is the fresh milk business. Whereas this is a much smaller part of this company a2 primarily can be viewed as a Chinese infant formula business. The majority the vast majority of its earnings are from sales of infant formula sold directly or indirectly to China. The main concern at the moment is the inventory levels in the English label infant formula, which is being sold through to China. So these high inventory levels has led to lower restocking from the key corporate daigou partners, and also an ageing of the inventory in those channels.

Jackson: And Angus just quickly when you say daigou, you mean?

Hewitt: These are reseller channels selling through to China. So they're buying the English label products here in Australia but they're eventually getting shipped off to China. Yeah. So that's the near-term, the real near-term headwind is these inventory levels. A2 has written off $109 million worth of inventory over the period. And they chose to write this off rather than discount to protect their brand. And this is a good move we assign InvoCare, not InvoCare, we assign a2 a narrow economic moat and this is based on its brand, the strength of its brand in China. A2 is first and foremost a brand business. And we still think it has plenty of brand equity in China. If you look at the Chinese label business, which it sells through what are known as mother and baby stores. The market share in these mother and baby stores at June 2021 is 2.5% versus just 2% a year ago, so they're still growing share. But to get to your question, we're still optimistic on a2. We think this is an opportunity to be greedy when others are fearful. There's a lot of pessimism baked into a2 share price. And we think inventory levels have stabilised and we're expecting continued growth in the China label infant formula business.

Jackson: And with so much importance on the China label side of the business, are you concerned with, the recent tension around China trade tensions and long term the viability of a business so reliant on the Chinese market?

Hewitt: Yeah, it's definitely a concern. A2, I'd like to point out that they are a New Zealand business, not an Australian business. It's definitely something to think of, but foreign owned formula businesses really dominate the premium side of the market in China. So we're not expecting it to weigh on sales in the near term.

Jackson: So, keeping our focus sort of international for a minute. Vaccination rates are increasing, the prospect of international travel is back on the agenda, finally. What does all this mean for Qantas? And is it too late for investors to get in on the action?

Hewitt: Yeah, the situation facing Qantas it probably doesn't need a lot of introduction. So the pandemic has obviously devastated flying across the globe and Australia's decision to close international borders for the last 18 months or so, means that the recovery in Australia significantly trails that of most of the world. This is offset a little bit by the Qantas' highly profitable domestic business when they're allowed to fly. So you've got outbreaks and lockdowns, particularly in Sydney and Melbourne at the moment. And state border restrictions in general is sort of weighing on the near term for Qantas and we're expecting the near term will remain bleak. But and we're expecting fiscal 2022, to be another full year loss as well. But we do expect these to be short term issues. The recovery of air travel will prove highly volatile. We're expecting international travel to return to pre-COVID 2019 levels by 2024.

So there's a fair bit of recovery baked in over the next few years. And Qantas has plenty of financial headroom in the near term to get through a lot of that near term turbulence, and we think it's well positioned to really thrive when the skies reopen. As far as pricing is concerned, shares are trading at around our fair value estimate. There is valuation upside if the vaccination rollout, like you said or pent up demand leads to a quicker than expected recovery in international flying.

Jackson: And was there any optimism in Qantas' guidance when it reported last month?

Hewitt: No, there's a lot of uncertainty, there's a little bit of optimism, that they're expecting, they're tying their expectations for international borders to open with vaccination rollout. So if that's late December, is the current estimate, but I'm not expecting all international borders will suddenly reopen and we'll just go back to where we were, it's going to be more gradual. Maybe it'll just be for certain countries and maybe it'll just be for vaccinated travellers, there's a lot to be seen on how this is going to play out. Obviously, Qantas want international flying to return as soon as possible and they want internal state border restrictions to be a thing of the past. But there's still a bit of headwind to get through at the moment.

Jackson: Don't we all. Angus turning to again, back to the reporting season as a whole you know, you listen to 10s, 10s and 10s of earnings calls last month, was there anything that stood out were there any themes or any interesting questions from analysts, any comments from management that you'd like to draw our attention to?

Hewitt: Yeah. What I guess what surprised me was how much Treasury Wine likes to name drop Snoop Dogg. Snoop is a brand ambassador for one of their premium wines in the U.S. But what really stood out to me was the the Crown earnings call. For an earnings call there wasn't a lot of focus on earnings. Crown are facing two simultaneous Royal Commissions in Victoria and Western Australia. And a long drawn out process to prove suitability to operate in New South Wales and that really overshadowed both the results and the call as well.

Jackson: When it comes to your Crown valuation. Crown is currently undervalued and so it's the buy opportunity.

Hewitt: Yeah, it is. We think all this uncertainty, all this regulatory uncertainty creates buying opportunities. So there's risk. There's risk in investing, of course. But we think Crown will continue to operate in Victoria and Western Australia, and we think will eventually prove suitability in New South Wales and that's underpinned our undervalued rating.

Jackson: Fantastic. Okay. Well Angus, thank you so much for your insights today.

Hewitt: Thanks Lewis.