Ladies and gentlemen, thank you for standing by, and welcome to the Djerriwarrh Investments full year financial results briefing call. At this time, all participants are just in a listen-only mode. Following the presentation, we'll have some time for a question- and answer session today. To ask a question via the telephones today, you'll just need to press star one on your telephone. Just please be advised that today's call is being recorded. I'll now hand the conference over to your first speaker for today, John Paterson, Chairman of Djerriwarrh Investments. Thank you, and please go ahead.
Thank you. Good afternoon. I'm John Paterson, Chairman of Djerriwarrh Investments Limited. Welcome to this full-year result briefing. I have joining me today on the webinar, Mark Freeman, the Chief Executive and Managing Director; Brett McNeill, a Portfolio Manager from the investment team; Olga Kosciuczyk from the investment team; Andrew Porter, our CFO; Matthew Rowe, our Company Secretary; Geoff Driver, General Manager, Business Development. Before we start the presentation, a bit of housekeeping on the webinar. This briefing is based on the material available on the company's website. If you're using your computer to access the presentation via the webcast, the slides will change automatically. If you're accessing by phone only, the PDF of the slides with page numbers is available on the website. I would like to make a couple of short observations before I pass to our team for the presentation.
This has been a strong year in the market, up 29% including franking credits, which is surprising given where we started in July 2020, early in the COVID-19 pandemic. As we had options written over an average of 35% of our portfolio during the year, one would normally expect us to underperform the ASX 200 by quite a margin. We are very pleased that we've beaten the index by 0.5% when franking credits are included. We are also pleased that alongside the significant capital gains delivered to our shareholders, we've been able to increase the dividends for half year from five and a quarter cents to five and three quarter cents. I'll now hand over to Mark and the team to run through the presentation.
Thanks, John. Talking through the slides, we will start off with slide two, and hopefully everyone has those in front of them, and thank you for everyone attending this briefing today. The first one's a disclaimer. We just talk through that we're here to talk about Djerriwarrh, what we're doing in the company. We're not here to give financial advice. Moving on to slide three, just an agenda for this meeting. I'll give some overview comments. Our CFO, Andrew Porter, will talk about the financial results. Brett and Olga will talk about the results and portfolio. The outlook, my name's against that, but I'll actually get Brett to talk through that. Moving on to slide five. Just some overview on Djerriwarrh. Djerri's one of the largest income-focused LIC in the market, and it began in 1989. Well, that was its listing.
Shareholders get the benefit of a full, transparent LIC, a listed investment company that has high governance standards delivered by an independent board of directors. Djerriwarrh shareholders own the management rights to the company, so there is no fee leakage to third parties, and there's no performance fees. Djerriwarrh is part of the broader group of LICs that we manage, which include AFIC, which is the Australian Foundation Investment Company, AMCIL Limited, and Mirrabooka Investments. Each of these other LICs have a different investment style and profile. Across those four LICs then, including Djerriwarrh, you get a broad research effort from the team, and you get the advantages of the scale of operations that come from that. Moving on to slide 6. The investment objectives of Djerriwarrh.
We're here primarily to provide an enhanced level of fully franked income that is higher than what is available from the market, and we do this at a very low cost to shareholders. We also aim to provide shareholders with an attractive total investment return through access to the fully franked dividends, as well as growth in capital invested. The pleasing part of this result, which we've touched on at previous meetings, is that we did a strategy review around 14 months ago. From that review, we felt that given the pressure we were seeing on option premium, we had been increasing the level of coverage, option coverage on the portfolio. That was constraining our capital growth and therefore our ability to achieve attractive total returns.
From that strategy review, we felt that we could actually have a lower level of coverage and still generate an income that was superior to the market. That would allow us to have more capital growth and achieve better total return outcomes. This slide, particularly on the right, highlights, as John had pointed out, the outcomes of that is that we've achieved very attractive total returns for the market, beating the index. On the slide to the left of that, we can see that we are still achieving a superior yield to the market when we include franking credits. Achieving on our two objectives, but we're getting a better balance now between income and total return. That's been a very pleasing outcome for myself and the board, and I think the efforts of the team have been excellent in achieving that.
At this point, I'll pass over to Andrew Porter, our CFO, to talk through the result.
Thank you, Mark. I'll add my welcome to everybody present on the call. Page eight shows the financial year in summary. Shareholders of long standing will be familiar with how these figures are laid out. The profit for the year at AUD 30.5 million and the net operating result, AUD 31.3 million. The difference is the unrealized position on options. We do that so that we are able to focus on the net operating result, which includes the realized gain from options. I won't go into too much detail on why we do that. Very happy to take questions afterwards should anybody wish. I should add that those figures are before a rather substantial demerger dividend. When I say before, they include a rather substantial demerger dividend, which we had to account for as a result of the Endeavour Group demerging from Woolworths.
The accounting standards say when that happens, we have to account for the transaction as a demerger dividend. Essentially, AUD 6.3 million of income was recorded in our books, which has no franking credits attached to it, is not taxable, and has no cash element. It's one of these quirks of the accounting profession, which is what makes us so popular. That was about, as I said, AUD 6.3 million, and Brett and Olga will go through in more detail later, the results in a more interesting manner later, the results and what that means for the portfolio, how it's structured and essentially how it was built up. 5.75% dividend, as Mark and John have talked about, so for AUD 0.11 dividend total, which means that that yield metric, as Mark has explained, was maintained at 4.7%, substantially higher than the ASX 200, being one of Djerriwarrh's core objectives.
The management expense ratio, AUD 0.0045 at AUD 0.45 for every AUD 100 invested. We believe that still to be a very low NER when we look around and see what else is out there in the market. That will change, of course, depending on how the portfolio in particular changes. That's the real key driver of how that can be impacted year-on-year. The portfolio return, again, Mark's been through that 29.6%, which was an outperformance. With that in summary, as I said, very happy to take questions on any of that later on. Without further ado, I'll hand over to Brett.
Thank you, Andrew. Slide 10 aims to give shareholders a more detailed look at the drivers of the full-year dividend by breaking down the profit and loss statement into its key components. Note that the definition of net operating result, as it is presented on this slide, excludes the Endeavour Group demerger dividend, as it was non-cash and non-taxable, as explained by Andrew. Stepping through the key components of the profit and loss. Dividend and distribution income was AUD 21.7 million for financial year 2021, down 24% on the prior year. Option income was AUD 12.1 million, up 58% on the prior year. These two items are the main drivers of Djerriwarrh's profit and dividend, we will discuss these in more detail on the following three slides. Continuing with the remaining profit and loss items on Slide 10.
Finance and administration costs were AUD 5.1 million, down 19% versus the prior year, largely driven by lower interest expense. Income tax expense was AUD 3.8 million, up 35% on the prior year, due to a greater contribution from option income. This resulted in a net operating result, to be clear, excluding the Endeavour Group demerger dividend, so more of a cash-based net operating result of AUD 25 million, which was down 11% on the prior year. On a per share basis, the result was AUD 0.109, down 13% on the prior year, and this led to a full year dividend being declared by the board of AUD 0.11 per share, down 21% on the prior year.
Turning now to the two main drivers of Djerriwarrh's net operating result and dividend, being the dividend and distribution income received and the option income received. Slide 11 covers the first item, dividend and distribution income.
At AUD 21.7 million for FY 2021, it was down 24% versus the prior year, with the five-year history of this item shown in the chart on the left-hand side. The key driver of this decline in dividend income was the fall in dividend levels across the broader Australian share market. This is shown in the chart on the right-hand side, where we show the dividend yield of the ASX 200 being the orange line, and the dividend yield of the Djerriwarrh portfolio being the blue line. This indicates how Djerriwarrh's dividend income received has effectively tracked the decline in dividends of the broader share market.
Slide 12 drills down some more on this theme, with banks and infrastructure being two of the key sectors responsible for the decline in dividends across the Australian share market. What we've shown here on Slide 12 is the dividends paid by the major banks and infrastructure stocks on a cent per share basis for each of the last three financial years. The major banks are shown in the chart on the left-hand side. As you can see, total dividends per share from the four major banks combined almost halved from FY 2019 to FY 2021, with each of ANZ, shown in blue, CBA in yellow, NAB in black, and Westpac in red, all paying lower dividends in FY 2020 and FY 2021 compared to the pre-pandemic year of FY 2019. The infrastructure stocks are detailed on the right-hand side chart. This chart shows a similar trend in dividends.
Gas pipeline owner APA Group, as shown in gray, has produced a dividend which has held up very well, but the dividends per share from toll road companies Transurban in green and Atlas Arteria, ALX, in orange, declined over FY 2020 and 2021 versus the pre-pandemic year of FY 2019. While Auckland Airport in dark blue and Sydney Airport in light blue scrapped their dividends altogether in FY 2021. Overall, though, the outlook from here for dividends is better. We're expecting a rebound in bank dividends heading into FY 2022, largely as a result of the banks having already made solid bad debt provisions. We think they have strong capital positions, more simplified business models, and have more sustainable dividend payout ratios now. The outlook for the infrastructure stocks is more muted, with dividends unlikely again this year for Auckland Airport and Sydney Airport.
We remain confident in the medium term and the long-term outlook for each of the five infrastructure stocks shown here. Slide 13 looks at the second key contributor to Djerriwarrh's net operating result and dividend, that being our option income. As we mentioned, option income in financial year 2021 was significantly up on the prior year, coming in at AUD 12.1 million, with a five-year history of this item shown in the left-hand side chart. Chart on the right-hand side shows option income but represented as a yield on our portfolio value. Typically, we expect a yield of around 1% on average from option income. The 1.4% option income yield achieved in financial year 2021 was a very pleasing result.
Note that the option income will vary from year to year, depending on a number of key items, including the level of option coverage in the portfolio, but also the level of volatility in the share market interest rates, and market returns in that particular year. In terms of the outlook for option income, volatility levels in the Australian share market are currently low. Our expectations for option income for FY 2022 are currently more subdued versus what we achieved in FY 2021. Hopefully, this discussion has provided some more detail on the key drivers of Djerriwarrh's FY 2021 net operating result and dividends paid. As always, the foundation of our investment performance and our financial performance is our investment portfolio. I'll now pass to Olga, who will give an update on the portfolio.
Thank you, Brett, and good afternoon, everyone. On slide 15, we summarize the main changes we made in the portfolio in the last two years. We have shifted our capital from companies where dividend and capital growth looks challenged to companies on the right side of the slide, which offer both a growing dividend yield and capital growth over the long term. Auckland Airport, ASX, Mirvac, Transurban, Macquarie Group, Wesfarmers, Woolworths, and BWP Trust are high-quality companies with strong market positions, sustainable competitive advantages, and long growth runways. They also have solid balance sheets, and they are run by strong management teams. As such, this shift has increased the overall quality of Djerriwarrh's portfolio. On slide 16, we show how we balance capital growth and dividend income. Some of our biggest portfolio positions are in high-quality companies delivering strong earnings growth, which is underestimated by the market.
CSL, Transurban, Woolworths, and Mainfreight have been all mainstays of Djerriwarrh's portfolio for a long time, as they have a strong track record in delivering shareholder returns and growing their dividend profile. Our portfolio's growth is further underpinned by high-quality smaller companies. These companies, including Equity Trustees, Iress, InvoCare, and Pinnacle, also pay solid dividends, which are often fully franked. Finally, we have modest-sized portfolio positions in the quality companies of the future that have big potential to generate growth for years to come. Netwealth is an owner-driver business and a leading provider of investment software. The company has a strong track record in delivering excellent results and has a long growth runway ahead of it as it continues to take market share from legacy platforms. Its balance sheet is net cash, and its cash generation underpins a small but growing fully franked dividend yield.
Temple & Webster is a pure online furniture retailer. The company has developed an excellent market position in an industry that still offers significant growth potential, and the business is already profitable. FINEOS is an owner-driver technology company providing software for the life, accident, and health insurance sector. The global opportunity for FINEOS is large as the insurance sector shifts from legacy systems to modern cloud-based operating systems, of which FINEOS is a leading provider. The company has a strong balance sheet and continues to invest in their products and technology ahead of their competitors. PEXA is our most recent portfolio addition, having listed on the ASX only this month. PEXA is Australia's leading cloud-based property settlement platform with over 80% market share. Their long growth runway is underpinned by their dominant position in Australia and the potential to replicate that leadership position in the U.K.
With that, I will now pass back to Brett for his outlook commentary.
Thank you, Olga. Turning to slide 18 with our outlook statement. The ongoing strength of the Australian share market has certainly been a feature over the last year, with share prices now at record highs in some instances. We're in a very different position in terms of market levels than we were at this time last year. The outlook for dividends across the Australian share market is mostly positive, that's something that we talked about with particular reference to the banks. The outlook for option income, as we see it, is mostly influenced by market volatility and the level of interest rates. Current conditions would suggest that our expectations for option income are more subdued for the year ahead than what we've just realized.
The short-term outlook for the share market appears to hinge on a number of key factors, including the ongoing global demand for the key commodities that Australia produces, in particular iron ore, and how that will influence dividends in the upcoming profit reporting season for the major miners. The response of central banks to any concerns over inflation is a key factor, in particular to how the bond market prices that response. Thirdly, how society is placed with regard to the ongoing pandemic with the COVID-19 conditions. Clearly, as we're sitting here now, it's a very tricky situation with the current lockdowns in place in many areas. Overall, irrespective of any short-term factors, we believe that the current portfolio settings should enable Djerriwarrh to achieve its long-term objectives. With that, I'll hand back to Geoff to conduct the question- and- answer session. Thank you.
Thanks, Brett. Miles, would you remind us how we in fact undertake questions on the phone? Also, if you want to ask a question via the webinar, you have the ability to do that and I'll coordinate that approach. Thanks, Miles. I think Miles is there. Okay. Well, why don't we go straight to the web questions first? We have one here, Brett, which is probably a smaller company that doesn't really probably sit within Djerriwarrh's remit. The question becomes about Johns Lyng, which I understand is a construction company, what have you. Have we looked at in the context of obviously a lot of disasters that have occurred with storms and floods and those sorts of things, which obviously those sorts of companies, and you might have some minds from other ones that may be busy in the context of those sorts of activities?
Yeah. It might definitely be a short-term opportunity. It's not a priority for us on our investment watchlist at the moment, where we continue to focus on highest quality companies that can deliver growth and income. Yeah, we'll certainly monitor it. The Johns Lyng Group isn't a priority for us at the moment.
Okay. Thanks, Brett. Just a reminder, you can ask a question via the Ask a Question tab in the top right-hand side of the webcast. Just another question on Sydney Airport. Given there's a lot of activity there at the moment in terms of potential acquisition by other interested parties, have you got any sort of comments on Sydney Airport for us?
We're attracted to it, and the reason why we've been a long-term holder in the airport is for the long-term value that's created from Sydney Airport, both growth in dividend income and capital growth, which was clearly halted by the pandemic. We've remained a holder, believing and focusing more on the remaining 76 years left on the airport concession as opposed to the outlook for the next three to four years when passenger growth is unlikely to recover in a meaningful way, or certainly not back to pre-pandemic levels.
Okay
In a sense, we're not surprised to see a bid come through from the airport, particularly from a consortium that has an eye for long-term value. We'd prefer to remain invested in the airport, hence we're a happy holder. Clearly, there's corporate activity there. There's a chance that the stock will be taken over. A good thing from a short-term point of view, but we've always got more of an eye for the long-term value. We'll see how it plays out.
Okay. Thanks, Brett. I've got a couple of questions here, and I think they're sort of combined in some ways. Someone was asking a question about, can we comment on the option strategy given the sharp rebound of the market, obviously, through the year. Did we roll positions or wreck positions as markets rallied? I guess that also feeds back into the ancillary question about what the level of turnover is normally within the portfolio.
Yep. Quickly on, turnover's low in terms of active selling, but with the option exercises, it can really range between 20%-30%, sometimes even above.
It was just under 30%.
Yeah
As a % of the final portfolio this year.
Yeah. We'll definitely swing around depending on the amount of option exercises that are realized from year to year. In terms of the options strategy, broadly speaking, we had higher option coverage at the start of the financial year. We reduced it deliberately to levels of around 25% about six, seven months ago. That was based on a view of where the market was at the time in our bottom-up stock research. Option coverage was extremely low. With the subsequent rally in the market, which was more than 10% from that low level, we were able, thankfully, to capture the capital growth that the market provided. We were then subsequently rewriting a lot of our option coverage towards the end of the financial year, hence it's ended the financial year option coverage at about 38%.
Within that, closing out options early to book profits and leave our potential exposure for capital growth there turned out to be a really good strategy as it meant we booked option income, but also achieved the capital growth, which you can see in the income result, but also the total portfolio return.
I might just add one other thing there.
Yeah, sure.
Brett and Olga have been more tactical in terms of the degree of coverage they've had on specific stocks. If a stock looks cheap, particularly if it's a growth stock, we don't want to have a lot of options over it. We've had more variation in terms of individual stock coverage than we have in the past, and that's paid off very well for us.
Thanks, John. Mark, could I just check back with you? Is there any phone questions at all at this point in time?
Certainly. Sorry, ladies and gentlemen, just another reminder. If you'd like to ask a question, it's just by pressing star 1 on your telephone. At this stage, we've got no telephone questions, sorry.
Okay. Well, I've got a couple more on the web, so I'll go through those. Does the expensive market give the opportunity to write put options on quality companies? I guess you might just run through what our strategy is around using put options.
Yeah
In the portfolio.
We selectively use put options. Our split between, in terms of our option income between calls and puts, tends to be more like 90% call option income and 10% put option income. We do use put options, but very selectively. We tend to write them when share prices are low in our view, and the risk-return trade-off is appealing. We do it based on a view on company valuation, so stock prices, but also our view on the quality of the company, as in, do we want to own more of that company at a certain price? Over the last six months in particular, as the market's rallied subsequently, we had put options written against companies like ASX, Woolworths, Coles, CSL, and they've been very profitable. We've been able to close them out before expiry to book significant profit.
That's been quite an active area, particularly in the last six months. Again, that will change over time depending on market conditions. Where we sit today with the market near record levels, we're not looking to write significant amounts of put options. We'd be patient and wait for stock prices to come back if we were to do that.
I guess the selling of those options versus calls or put options, inverted commas more expensive or less expensive in terms of activity?
No, no clear trend overall. Liquidity is good in both areas of the market, whereas obviously the call option volumes though are a lot higher in most of our activity. Depending on the market conditions at the time, there can be really good opportunities in each, and it's up to us to really respond to those market conditions and how it fits within our portfolio.
Okay. Thanks, Brett. Inflation is obviously a topical question at the moment. The question's come through, how's Djerri's portfolio position in response to inflation growth or is it more structural instead of transitory in terms of inflation, I guess is the other comment?
We don't target a portfolio positioning top-down based on a thematic or a macro component like inflation. I think where it more comes through is if we've invested in what we think are the highest quality companies, typically they'll have pricing power, and that's one of the keys to benefiting in an inflationary environment. I think of some of our highest quality, more small cap companies, for instance, ARB, Reece Limited, we think they've got very good pricing power, and that's a good protection in that environment. Then there's other stocks like.
Toll road company Transurban, and also some of our real estate investment trusts like BWP Trust, Mirvac, and Goodman Group, that within their lease structures, they also have some good inflation protection in there. Overall, I think we're pretty well set. Whether it turns out to be transitory or more sticky long term, we don't have the answer. We clearly expect a spike, but the move in the bond market over the last month has put a bit of a check on that. I guess, one of the areas we take cues from is clearly in meeting with company management teams, and a number have pointed out that, I guess, the long-term drivers of inflation still remain despite a bounce in economies post-COVID-19. Some of those long-term drivers, particularly being demographics and technology.
It'll be, again, it's another thing we'll focus on in the upcoming profit results season where we meet with a lot of company management teams.
Okay. Thanks, Brett. Miles, just checking back with you. Any phone questions at all, or?
No, sorry, no telephone questions at this stage.
Okay. There's a question here about the number of shareholders staying constant. In fact, the shareholder numbers have probably have come down over the last few years. I mean, obviously being a closed-end fund, there's obviously buyers and sellers on both sides of that activity. With the shareholder numbers coming down, what we have seen is obviously an increase in the average size of shareholding. I suspect some of that's been driven by, obviously, the change in dividend over the last few years, where it has come down for some of the reasons we have mentioned previously in terms of the ability to pay our realized gains and obviously fallen interest rates and volatility over the period.
In response to that, yes, the shareholder numbers have come down, but I think, as Mark mentioned earlier on, the adjustment to the strategy is starting to produce some good results, hopefully we'll start to see those numbers increase over time. Also, clearly, we're more on the front foot in terms of marketing back into the market now we've got that position in place. John, you had a few points you wanted to make?
Yeah. Yes. I just wanted to make the point that we're very pleased back in January to have an SPP for our shareholders to subscribe to for probably the first time in about a decade. We've always had a number of our shareholders ask about that. We haven't felt we were in a position to be able to service that in a environment where dividends were under pressure. We thought the time was right in January, and we had a good take-up there. It's something we'll look at from time to time when we feel it's appropriate in the future.
An ancillary question I've got here is about where the share price is trading relative to net asset backing. It was trading at quite a significant premium a few years ago, but as the dividend has been reduced over time, clearly what that has meant is that the premium has actually fallen and we're actually trading at a discount. In fact, getting back to the question of shareholders, it's probably an attractive opportunity for a lot of people thinking about entering back into Djerri as a product. Again, we'll be on the front foot about that and trying to market more aggressively around what Djerri can provide for income-focused investors going forward.
Geoff, I'd just add to that I think what people watching is that, again, that balance between total return and yield, we've made that adjustment now. We're seeing the outcomes come through over this last year. Obviously we're keen to continue on that path. I think if people get more confidence in what we're doing, there'll perhaps be some more interest in the stock.
Yep. Miles, one more time, I'll just check with you. Are there any questions on the phone, or?
No telephone questions at this stage, sorry.
Okay, that's fine. I don't have any further webcast questions, John, so I'll pass back to you to conclude the meeting.
Good. Thanks, Geoff. Look, we've been very pleased to have the opportunity to do a presentation for you just after our results, and we're encouraged by the number of people on the line that it's something worth doing. Our next update obviously will be the AGM. We'll have a little bit more clarity of what's happening to dividends, having gone through the final results season, and we may have even a little bit more clarity about how COVID-19 works when you've got more people inoculated. There may be some uncertainties that are slightly clearer than they are today. Thank you very much for attending. We've been very, very pleased to have you on board for this session. Thank you.
Ladies and gentlemen on the telephones, that does conclude today's conference call. Once again, thank you all for participating, but you may now all disconnect. Thank you.