AFIC’s quality holdings are right for a challenging economic environment

Companies are generally cautious on their outlook for the rest of the calendar year, making it as important as ever for investors, including AFIC, to focus on high-quality companies that are well placed to provide solid returns over the long term. AFIC Portfolio Manager David Grace shares his takeaways from the recent company reporting season.

Companies are bracing for a tougher environment

Company results released over the recent reporting season were largely in line with expectations, reflecting a solid six months to the end of December 2022.

The operating environment however is set to become more challenging, including a weakening in consumer confidence which had previously held up quite well in the face of rising interest rates.

Many companies expressed caution around the outlook for revenue, expecting to see some slowdown. There's clear evidence that consumers are buying fewer or lower-priced items as inflation and rising interest rates force them to rein in their spending habits. Some companies in the housing and retail sectors are particularly exposed.

With revenue growth forecast to slow at a time when wage inflation remains elevated, many companies are expected to experience pressure on their margins over the remainder of the calendar year. A key feature over recent years has been company's ability to pass on cost increases via higher pricing to their customers but, as the consumer environment slows, this is likely to prove more challenging.

On a more positive note, whilst companies are bracing for a tougher environment, improved immigration may alleviate pressures in the labour market to their benefit.

Our approach remains consistent

Our approach, as always, is to stick with companies that are well managed, have strong balance sheets, a market-leading position, and the capacity to produce superior returns over the long term. In a slowing environment, we focus on those companies that have a more defensive earnings profile.

For example, one of AFIC's top holdings, CSL, is in a very good position having produced a strong financial result and with improving business activity as economies move further away from the impact of the pandemic. We believe CSL is well positioned to deliver meaningful earnings growth over the next few years.

Carsales.com, also reported a strong result with a positive earnings outlook. The supply of new and used cars is improving, and the recent acquisition of Trader Interactive is so far performing very well.

Companies such as CSL and Carsales.com both have a strong industry position that gives them a greater ability to lift prices. Those price increases may not be the same quantum as they were last year, but it's a lever that they have at their disposal that many other companies don't.

A focus of the AFIC portfolio always has been to invest in high-quality companies such as CSL and Carsales.com that are well placed to weather the changing economic environment. Given more recent market volatility, we have had the opportunity to add to both these holdings when we felt prices were attractive.

In this context, our approach remains consistent: buy good quality companies when long term value is on offer.

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