The 2017 Australian Value Creators Report Sectors in Diverge ANALYSIS OF ASX 200 COMPANY PERFORMANCE The Boston Consulting Group (BCG) is a global management consulting firm and the world’s leading advisor on business strategy. We partner with clients from the private, public, and not-for- profit sectors in all regions to identify their highest-value opportunities, address their most critical challenges, and transform their enterprises. Our customized approach combines deep insight into the dynamics of companies and markets with close collaboration at all levels of the client organization. This ensures that our clients achieve sustainable competitive advantage, build more capable organizations, and secure lasting results. Founded in 1963, BCG is a private company with offices in more than 90 cities in 50 countries. For more information, please visit bcg.com. The 2017 Australian Value Creators Report SECTORS IN AUSTRALIA DIVERGE

ANALYSIS OF ASX 200 COMPANY PERFORMANCE

DAMIEN WODAK

DANIEL SELIKOWITZ

JAMES LITTLE

OCTOBER 2018 | The Boston Consulting Group CONTENTS

4 EXECUTIVE SUMMARY

7 AUSTRALIA WAS OUTPACED BY THE US AND

12 RETURNS BY SECTOR DIVERGE

16 THE TOP PERFORMING COMPANIES AND HOW THEY CREATE VALUE

22 APPENDIX

25 FOR FURTHER READING

2 | SECTORS IN AUSTRALIA DIVERGE PREFACE

HE ASX 200 PERFORMED at the lower end of our global peer Tgroup from 2012 to 2017. The ASX 200 delivered a five-year Total Shareholder Return (TSR) of 10.2%, on par with (10.2%), but behind the US (15.8%) and Japan (17.3%).

Sectors in Australia Diverge TSR differed significantly more by sector in Australia than in the in- ternational peer group, with lower returns in the Banking and Mining sectors playing a large role in the underperformance. Regulation of banks, and a drop in commodity prices during the period lowered re- turns for companies in these two sectors, which together make up al- most a half of the ASX 200 by market capitalisation.

Healthcare companies performed at the top end of the ASX 200, reap- ing high returns due to increased demand from ageing and growing populations, as well as a falling Australian dollar that amplified inter- national earnings.

The Top Performing Value Creators The threshold for top quartile five-year TSR from 2012 to 2017 in the ASX 200 was 23.2%, 8 percentage points above the median of 15.2%. To illustrate how companies with different levels of maturity and from different industries have outperformed the market, at the end of this year’s report we profile six companies from the top quartile: Domino’s Pizza, Fisher & Paykel Healthcare, , , SEEK, and Fairfax Media.

The Boston Consulting Group | 3 EXECUTIVE SUMMARY

ach year our Value Creators Reports analyse company returns Eacross the world to build an understanding of what drives top performance. In Value Creators Report we look at how returns in the Australian market compared to global peers. We then look more closely at how different sectors drove this performance, and what individual companies have done to outperform the market. As the Value Creators Reports focus on long-term, sustained value creation, we predominantly look at returns over a five-year time horizon.

From 2012 to 2017 the Australian market performed at the lower end of our global peer group. The S&P/ASX 200 (ASX 200)1 delivered a five-year Total Shareholder Return (TSR) of 10.2%. This was on par with Europe (10.2%), but behind the United States (US) (15.8%) and Japan (17.3%). The difference between Australia and the US and Ja- pan was even greater at the end of the five years. The ASX 200 deliv- ered a one-year TSR in 2017 of 11.8% while the US and Japan deliv- ered one-year TSRs of 21.8% and 20.1% respectively.

TSR differed significantly more by sector in Australia than in the in- ternational peer group.2 Across the five largest sectors in Australia, the range in TSRs was 13 percentage points, compared to 4 in the US, 3 in Europe, and 9 in Japan. The drivers of TSR performance in Aus- tralia were also different compared with other peers. The ASX 200’s five-year TSR was primarily delivered by profit growth, more so than in the other developed markets where expectation of future growth played a larger role.

•• Healthcare was once again the top performing sector of the five largest sectors in Australia, with a five-year TSR of 18.6%.3 Strong revenue growth was the main driver of returns, in part due to the falling Australian dollar which amplified revenue growth in international markets. Healthcare’s one-year performance in 2017 was particularly strong at 26.3%.

4 | SECTORS IN AUSTRALIA DIVERGE •• Industrials came next with a five-year TSR of 14.9%, and a one-year TSR of 18.2%.

•• Banks, with a five-year TSR of 10.4%, performed closest to the ASX 200 benchmark. Banks produced steady profit growth, but their five-year TSR was lowered by increased capital holding requirements. One-year returns for Banks in 2017 were low, at 2.1%.

•• Consumer Staples came next with a low five-year TSR of 7.2%, despite a stronger one-year TSR of 20.2% in 2017. The low five-year returns were partially driven by intense competition from local and global players during the period.

•• Mining/Materials’ five-year TSR of 5.3% was the lowest of the sectors, held down by a drop in global commodity prices in 2013 and 2014 and resulting negative returns. As prices rebounded over 2016 and 2017 returns were much higher, and in 2017 Mining/ Materials delivered a one-year TSR of 22.9%, the second consecu- tive year of strong one-year returns.

The 2017 threshold for top quartile five-year TSR in the ASX 200 was 23.2%4 which remains relatively consistent with the last two years (25.2% in 2016, 21.5% in 2015). In 2017 three sectors were not repre- sented in the top quartile: Telecommunication Services, Energy and Banks. This is both an increase and a change from last year when only Banks and Insurance missed out on the top quartile.

Maintaining top quartile performance from one five-year period to the next is rare and hard to achieve. To illustrate how companies with different levels of maturity and from different industries have outper- formed the market, at the end of this year’s report we profile six com- panies from the top quartile.

Domino’s Pizza drove average yearly revenue growth of 32% despite intense industry competition, and used its control over end-to-end economics to protect margins. Fisher & Paykel Healthcare lever- aged a leading R&D approach and market leading products to drive double digit profit growth and expectations of similar future growth. SEEK grew profit locally by continuing to innovate and develop its platform, and invested in international growth assets. Xero proved over the period that it could grow steadily in Australia and the UK, and that the business has a pathway to profitability. Qantas drove sig- nificant margin advantage versus competitors, generated modest over- all revenue growth with higher growth outside the legacy business, and returned excess cash to shareholders. Fairfax accelerated growth of Domain in digital, and shrunk costs and capital associated with its legacy business.

The Boston Consulting Group | 5 NOTES The analysis in this report uses a cut-off date of 31 December 2017, unless noted otherwise. Economic indicators are based on calendar years and company financials from public announcements use Australian financial years, unless noted otherwise. Where we refer to a region’s TSR throughout this report, we refer to the performance of the following indices: •• Australia = ASX 200 •• US = S&P 500 •• Japan = S&P TOPIX •• Europe = S&P EUR •• Emerging Markets = S&P Emerging LargeMidCap •• All TSRs are calculated based on Total Gross Return.

1. The S&P/ASX 200 Index is recognised as the investable benchmark for the Australian equity market, as it addresses the needs of investment managers to benchmark against a portfolio characterised by sufficient size and liquidity. It is comprised of 200 stocks selected by the S&P Australian Index Committee. It is a capitalisation index, meaning that it represents the sum of the market capitalisations of the companies making up the index. Changes in the value of the index reflect changes in the aggregate capitalisation of index constituents as their share prices change. The weight assigned to each company in the index is proportional to that company’s capitalisation. It is also an accumulation index, which assumes that dividends are reinvested, and measures both growth and dividend income. 2. In previous versions of the Australian Value Creators Report we published results for the 11 Global Industry Classification Standard (GICS®) sectors. This year we have split out Financials into its three GICS® industry groups – Diversified Financials, Insurance, and Banks – and therefore have 13 sectors in total. Last year we reported that no sector missed out on the top quartile because companies from Diversified Financials were represented. Banks and Insurance were not represented. 3. Sector returns use capitalisation indices. 4. The top quartile is drawn from only those companies in the ASX 200 that have been listed for at least five years. This included 161 companies in 2017.

6 | SECTORS IN AUSTRALIA DIVERGE AUSTRALIA WAS OUTPACED BY THE US AND JAPAN

n the five-year period to 31 December When comparing median company TSRs, I 2017 the ASX 200 delivered returns of which are not affected by market capitalisa- 10.2%; on par with Europe (10.2%), but well tion weights, Australia fared much better. behind the US (15.8%) and Japan (17.3%). ASX 200 median TSR was 15.2%, compared to Australia’s five-year returns are best ex- a median TSR of 19.0% in Japan, 15.8% in the plained through a sector lens. Overall returns US, 13.7% in Europe, and 10.2% in Emerging were uninspiring, but the underperformance Markets. Globally, median TSR in BCG’s inter- was predominantly driven by a few large national company peer set (2,452 companies) sectors that experienced identifiable head- was 15.6%. This means that most of ASX 200 winds. The spread of TSRs across the five companies performed better than the ASX largest sectors in Australia was 13 percentage 200 index, which is heavily weighted by large points, much wider than for international and lower performing sectors. peers. The spread in the US was 4 percentage points, in Europe 3, and in Japan 9.

The Boston Consulting Group | 7 The Australian economy continued to the US, 3 in Europe, and 9 in Japan. grow steadily, but uncertainity re- mains Europe had similar five-year performance to The Australian economy produced consistent Australia (10.2%), but returns were consistent- levels of GDP growth of around 2.5% annual- ly slow across all the major industries. Results ly for the last five years. Results in Q3 of 2017 in Europe were also relatively consistent by saw Australia break the developed world re- geography, with lower results across all the cord for the longest stretch of consecutive major economies other than the Nordics quarters without a technical recession. At the (Sweden, Denmark, Norway and Finland all time of writing, this record stands at 107 had five-year TSRs of 15% or more). quarters, an impressive feat in the face of nu- merous hurdles over the past 26 years. The The US, while strong overall, had a particular- Australian economy has weathered the Asian ly high one-year TSR in 2017 of 21.8%. The financial crisis, the dotcom bubble, the global S&P 500 benefited over the five years from financial crisis, and a dive in commodity pric- exceptional strength in the large technology es. Looking into the near future, GDP growth companies Alphabet, Amazon, Apple, Face- is expected to increase slightly to just over 3% book and Netflix (see The 2018 Value Cre- annually for the next three years. ators Rankings, BCG report, July 2018). Multi- ples also expanded across the board due to a Despite projected growth, uncertainty re- particularly low official cash rate, and the tax mains for the Australian economy, particular- reform passed at the end of 2017 which ly with respect to local and international de- raised the 2018 earnings outlook for many mand. International demand for commodities companies. Beyond this, there is ongoing de- is a major dependency. As an example, recent bate whether recent growth is due to Trump decisions by Chinese authorities to cut steel or owes itself to momentum from Obama. production for environmental reasons could drive increased volatility in the prices for iron Strong returns in Japan over a five-year ore and coking coal. An increase in interna- (17.3%) and one-year (20.1%) time horizon tional trade protectionism also has the poten- were driven by a wider Japanese economic tial to reduce demand. rebound and a subsequent revaluation of Jap- anese stocks, which have previously been Local Australian consumption is similarly dif- looked on less favourably by investors. ficult to forecast. Household debt is high, wage growth and inflation are low, and prop- Emerging Markets had impressive results in erty market growth ground to a halt at the 2017, delivering a one-year TSR of 30.7%. The end of 2017. Household spending has contin- five-year TSR of 9.5% was similar to Australia ued to grow at a faster rate than wages. This due to poor returns from 2013 to 2015. Re- behaviour reflects an expectation that slack turns by sector in Emerging Markets had wage growth will pick up in the future. None- large variations. Information Technology with theless, if low wage growth persists, there is a a five-year TSR of 21.8%, and Consumer Dis- risk consumption growth may fall, particular- cretionary with 14.8%, stood head and shoul- ly if households become concerned about ders above the rest. Energy, Materials and their ability to service growing debt. Telco languished with TSRs ranging between 2.3% and 4.2%. Divergent sector dynamics in Austra- lia underpinned low performance Profit growth was the strongest versus peers driver of ASX 200 TSR In Australia low returns were driven by a BCG’s TSR disaggregation model analyses the number sectors: Banks (10.4%), Consumer drivers of market performance. The model Staples (7.2%), Mining/Materials (5.3%), Tele- disaggregates TSR into: communication Services (3.0%) and Energy (0.6%). The spread of TSRs across the five i. Profit growth largest sectors in Australia was 13 percentage ii. Change in valuation multiple points, compared to 4 percentage points in iii. Cash flow contribution

8 | SECTORS IN AUSTRALIA DIVERGE UNDERSTANDING THE DRIVERS OF TSR

Total shareholder return (TSR) measures •• Cash flow = free cash flow to equity the combination of share price gains and holders, measured as dividend yield and dividend yield for a company’s stock over a change in shares outstanding. given period of time. It is the most compre- hensive metric for measuring a company’s The model uses the combination of shareholder value creation performance. revenue (sales) growth and change in margins as an indicator of a company’s Each year in the Value Creators series, we improvement in fundamental value. It then apply BCG’s TSR disaggregation model to a uses the change in the company’s valua- sample of companies1 from five major tion multiple to determine the impact of indices: the US S&P 500, Japan’s S&P investor expectations on TSR. Together, TOPIX, Europe’s S&P 350, the ASX 200 and these two factors determine the change in the S&P Emerging Markets LargeMidCap. a company’s market capitalisation and the capital gain or loss to investors. Finally, the The model breaks down TSR into: model tracks the distribution of free cash flow to investors and debt holders in the •• Profit growth= growth in EBITDA, form of dividends, share repurchases, and except for Diversified Financials, Banks repayments of debt to determine the and Insurance which use growth in contribution of free cash flow payouts to a after-tax profit. company’s TSR. Management levers for each key element are summarised in the •• Multiple change = change in EV/ diagram below. EBITDA, except for Diversified Finan- NOTE cials and Banks which use change in 1. We excluded companies with non-meaningful P/E, and Insurance which uses change multiple changes, volatile results and less than five in P/B. years of financials.

The Boston Consulting Group | 9 See Understanding the drivers The low change in valuation multiple is best explained at a sector level. Banks and Min- of TSR on page 9 for a more ing/Materials, the two largest sectors in the detailed explanation. ASX 200, both had low contributions to TSR from change in valuation multiple, at –3% and 14% respectively. Multiple change for This disaggregation allows us to understand Banks was negative because investors revised what drove Australia’s TSR performance rela- profit growth expectations downwards in the tive to other markets. face of new capital holding requirements. Negative multiple growth in Mining/Materials Australia’s five-year performance was under- was due to dampened profit growth expecta- pinned by strong profit growth. Profit growth tions driven by lower commodity prices, as was similar in overall contribution to the US well as a shift toward returning value to (contributing around 6 percentage points of shareholders rather than investing for growth. TSR for both countries). Cash flow and valua- Multiple change was also particularly low in tion multiple were both notably small con- Telecommunication Services and Energy. tributors in Australia. More detail on sector TSR break-down fol- lows in the next chapter. Profit growth in Australia was mainly driven by revenue growth rather than change in In Japan and the US, contribution to TSR was profit margin. While this was also the case for more evenly spread across the three drivers. the global peer group, median percentage Companies capitalised on growth opportuni- growth in revenue was higher for the ASX 200 ties in the last five years to produce strong than for any of the global peers. profit growth. Investors showed confidence in the earnings outlook, reflected in strong mul- The low cash flow contribution in Australia is tiple growth, particularly in the US. primarily the result of equity issuance. Divi- dend payments were actually high compared Europe and Emerging Markets had similar to peers, as expected given Australia’s favour- overall TSRs to Australia but markedly differ- able dividend imputation policy. ent contributions from each of the drivers. In

10 | SECTORS IN AUSTRALIA DIVERGE Europe, the three drivers had a similar influ- look for future growth was relatively un- ence on returns. In Emerging Markets, profit changed as reflected in a small change in val- growth dwarfed the other drivers and the out- uation multiple.

The Boston Consulting Group | 11 RETURNS BY SECTOR DIVERGE

o understand Australia’s perfor- applied our TSR disaggregation tool to these Tmance, we split the ASX 200 into 13 sectors and looked at sector-level dynamics. sectors based on the Global Industry Classifi- cation Standard (GICS®).5 In this section, first The performance of the remaining sectors we look at how each sector contributed to (Energy, Telecommunication Services, Con- overall ASX 200 returns, and then we analyse sumer Discretionary, Utilities, Real Estate, Di- the drivers of performance for the five largest versified Financials, Insurance, and IT) is pre- sectors: Healthcare, Industrials, Banks, sented in the Appendix. Consumer Staples and Mining/Materials. We

12 | SECTORS IN AUSTRALIA DIVERGE A small number of sectors lowered growth, which came off the back of market overall ASX 200 performance leading healthcare products, and increased ASX 200 five-year TSR was lowered by weak demand for healthcare from ageing and grow- returns in five sectors: Banks, Consumer Sta- ing populations. ples, Mining/Materials, Telecommunication Services and Energy. As Banks and Mining/ Strong profit growth was amplified by a fall- Materials represent almost 50% of the ASX ing Australian dollar; around half of the sec- 200 by market capitalisation, they have a tor’s income is international, with North strong effect on overall returns. Consumer America, Europe and the UK as the largest Staples, Energy and Telecommunication Ser- international markets. Over the five years, vices are all smaller in size but delivered the Australian dollar devalued on average 6% TSRs well below the ASX 200 TSR of 10.2%. each year against the US dollar, 4% against the Euro and 2% against the Pound.

What drove TSR in the five largest Industrials Australian sectors? Industrials delivered a five-year TSR of 14.9% Our analysis showed that the main drivers of and one-year TSR of 18.2%, outperforming five-year TSR varied significantly by sector, the ASX 200 benchmark over both periods. reflecting the different market dynamics that The majority of outperformance came from affected each sector during that time. change in valuation multiple, followed by cash flow contribution. Healthcare Healthcare continued to lead the other sec- Industrials represents a broad range of com- tors, with a five-year TSR of 18.6% and a one- pany types, including transportation, com- year TSR of 26.3%. The primary contributor mercial and professional services, manufac- to this outperformance was profit growth, turing, and construction. As a result different with change in valuation multiple making up market dynamics have affected results for in- most of the remainder. Strong profit growth dividual companies. was almost entirely driven by revenue

The Boston Consulting Group | 13 Banks In this new context of lower ROEs, banks Banks, the largest sector by market capitalisa- need to focus on capital efficiency and costs. tion in the ASX 200, matched the benchmark Banks have sought capital efficiency through with a five-year TSR of 10.4%. The sector’s divesting non-core, low return assets. Sam one-year TSR was 2.1%, well below the Stewart, head of BCG’s ANZ Financial Institu- benchmark. Five-year TSR was driven mainly tions practice, identifies three ways to reduce by profit growth and cash flow. P/E multiple costs: “Banks need to radically simplify their change was negative. products, services and processes, digitise their operations, and pursue low-cost organic Banks had a turbulent five years. All four of growth.” Australia’s big banks delivered annualised re- turns of around 25% just over two years into Consumer Staples the five-year period. In the latter half of 2015 For Consumer Staples, the five-year TSR of however, P/E multiples and ROE declined sig- 7.2% was below the benchmark while the nificantly as the result of revised capital hold- one-year TSR of 20.2% was much higher. Aus- ing requirements. Despite recovering some- tralia’s Consumer Staples sector is dominated what in 2016 and 2017, share prices suffered by two companies, and again after the mid-2017 announcement of a Woolworths, which make up 75% of the sec- bank levy and additional regulation. tor’s market capitalisation. Grocery accounts for roughly 50% of the combined profit for During the five-year period, average ROE both companies. Grocery revenues and mar- across the big four banks dropped 1.5 per- gins for both companies came under pressure centage points.6 One of the big four banks es- over the five-year period with heated compe- timates that its ROE would be roughly 3 per- tition between the two incumbents and inter- centage points higher today without the national players. Aldi continued to grow its additional regulations introduced during the market share and contribute to price compe- period.7 All else being equal, 3 percentage tition. Aldi’s small stores, simple range and points in ROE is equivalent to roughly 2 per- extensive use of private label minimise its centage points of five-year TSR. costs, and enable it to offer low prices with- out compromising on value for money.

14 | SECTORS IN AUSTRALIA DIVERGE Nonetheless, the Australian retailers bounced Alex Koch, head of BCG’s ANZ Industrial back in the latter half of 2016 and 2017. The Good practice, identifies three key success local companies lowered their prices and fo- factors for the future: “mining companies cused on operational efficiency to partially need to have a relentless focus on digitisation off-set the impact on margin. They drove TSR and technology, a clear sustainability strategy by returning value to shareholders. to deal with increasing community and gov- ernment interest, and continued focus on op- Mining/Materials erating cost and capital allocation discipline.” Mining/Materials’ five-year returns of 5.3% were marked by a dip in commodity prices in 2014 and 2015. Average returns for the sector over that two-year period were -14%. One- year returns in 2017 were much higher at NOTES 22.9%, which was the second consecutive year 5. In previous versions of the Australian Value Creators Report we published results for the 11 Global Industry above 20%. Classification Standard (GICS®) sectors. This year we have split out Financials into its three GICS® industry The two major miners, and BHP, groups – Diversified Financials, Insurance, and Banks – and therefore have 13 sectors in total. make up 67% of Australia’s Mining/Materials 6. ROE as reported on a cash basis from annual reports sector by market capitalisation, and contrib- of the majors. ute significantly to returns. During 2015 reve- 7. 2017 Full Year Result bluenotes interview with ANZ nues for both companies contracted dramati- CEO Shayne Elliott. cally as commodity prices dropped. Costs fell more slowly than revenue, compressing EBIT- DA margins. Both companies delivered nega- tive double-digit returns in 2015 as a result. As prices rebounded in 2016 and 2017, they posted average annual returns above 30% over the two years. The companies drove TSR by returning cash to shareholders, reducing capital expenditure in 2017 to roughly half what it had been in 2014.

The Boston Consulting Group | 15 THE TOP PERFORMING COMPANIES AND HOW THEY CREATE VALUE

o understand how Australia’s holder value over time, we analysed compa- Tleading companies have created share- nies that had been listed on the ASX 200 for

16 | SECTORS IN AUSTRALIA DIVERGE at least five years in 2017. In this section we Top-quartile threshold was relatively focus on ASX 200 median and top quartile unchanged from 2016 returns rather than returns of the ASX 200 The threshold for top quartile five-year TSR index. This is so that we can identify those performance in 2017 was 23.2%. This remains companies that outperformed the majority of relatively consistent with the last two years peers. (25.2% in 2016, 21.5% in 2015), but well be-

The Boston Consulting Group | 17 low the peak of 41.2% in 2007. bank was in 2013 when the of Australia ranked 39th. Energy has The level of outperformance required to only had one representative in the top quar- achieve top quartile TSR has been reasonably tile in the last two years, a symptom of soft constant since 2014, at between 7 and 9 per- oil and coal prices during the past five years. centage points per year above the median TSR. In 2017, the ASX 200 median TSR was Information technology was the most 15.2% per year; top quartile firms outper- over-represented sector in the top quartile, formed by at least 8 percentage points per with 63% of companies in the sector making year. the top quartile. The sector represents an ar- ray of high-growth tech and software compa- A less diversified set of companies nies, and their revenue growth was the domi- made up the ASX 200 top quartile than nant driver of outperformance. last year In 2015 and 2016 all sectors apart from two Range of returns varied by sector financial sectors, Insurance and Banks, had at Consumer Discretionary had the largest least one top quartile performer. This year range of the sectors, with 64 percentage three sectors missed the top quartile: Tele- points between the top and bottom perform- communications, Energy and Banks. ers. Some of the variation is explained by the increasing importance of digital commerce, The performance of individual companies and the different degrees to which companies within sectors varies widely, showing that could capitalise on it successfully. Companies company-level performance does matter such as Dominos, Fairfax (with Domain) and when it comes to TSR. Consumer Staples, made successful digital plays and per- Mining/Materials and Insurance all produced formed well. Other companies struggled as top-quartile performers despite sector medi- customers shifted online. Examples include an returns below the ASX 200 median. None- , Southern Cross Media, theless, for the three sectors that missed the and . top quartile, industry trends proved too strong to overcome. Mining/Materials had the second largest range between top and bottom performers at For Telecommunications, the lack of top per- 59 percentage points. Information technology formers was due to low or negative returns came next, with 54 percentage points be- for most companies in the sector in the latter tween the top and bottom – largely due to half of 2016 and in 2017. As recently as 2015, outperformance at the top end of the sector. every company in the sector made our top quartile list. The volatility in the sector over At the other end of the spectrum, Utilities the last five years was primarily driven by had the smallest range of variation in returns large swings in valuation multiple. EV/EBIT- at 8 percentage points. This reflects the high- DA multiples increased significantly to late ly regulated, mature nature of the sector. 2015, and then took a dive at the end of the Banks had the second lowest range at 10 per- year. The readjustment came as investors re- centage points, unsurprising for an industry considered the effect of industry consolida- heavily affected by external market factors. tion and the rollout of the National Broad- band Network on industry profitability. Low How top performing companies create margins in broadband caused a ripple effect value in mobile with more intense competition Maintaining top-quartile performance for from industry players seeking to gain share of consecutive five-year periods is hard to sus- the mobile profit. tain (see “How Top Value Creators Outpace the Market – for Decades”, a BCG report, July The absence of Banks from the top quartile 2017). Only 26 of the companies from last continues from previous years. In the last 10 year’s top-quartile list of 40 remain in the top years, the only top quartile list to feature a quartile this year. Only four companies have

18 | SECTORS IN AUSTRALIA DIVERGE been in our list for five years in a row: Magel- with high growth expectations; each had an lan Financial Group, Northern Star Resources EV/EBITDA multiple above 12x. Each signifi- Limited, Domino’s Pizza Enterprises Limited cantly outperformed these growth expecta- and REA Group Limited. tions to ‘beat the fade’. Growth in internation- al markets was a common theme across all The likelihood that a company can beat the three, and compounded by a weakening Aus- market by a wide margin year-in and year-out tralian dollar over the five years. is low. For companies in high growth indus- tries, the value creation priority is to ‘beat the Domino’s enjoyed a surge in the home-deliv- fade’. High-growth companies need to signifi- ery market, but not without intense competi- cantly outperform expectations, because capi- tion from aggregators such as Deliveroo, tal markets look forward and continually cap- Menulog and Uber Eats. Domino’s expanded italise expected future earnings into today’s its menu to stay relevant, and used its control stock price. At the other extreme, companies over end-to-end economics to push growth in mature industries often focus on driving and protect margins. Over the past five years value creation by improving efficiency, allo- Domino’s revenue grew at 32% each year on cating capital prudently and returning cash to average. Looking ahead for the company, de- shareholders rather than investing it in bate continues around how heightened com- low-return growth opportunities. These com- petition will affect revenue growth, and how panies may also focus on growth opportuni- the Fair Work’s review of wages and the Aus- ties outside the legacy business. tralian Parliamentary inquiry into franchising may impact margin. To demonstrate different approaches to value creation, we looked more closely at six com- Fisher & Paykel Healthcare not only outper- panies in the top quartile: Domino’s Pizza, formed on profit growth, but also built expec- Fisher & Paykel Healthcare, SEEK, Xero, Qan- tations of significant future growth. The com- tas, and Fairfax Media. pany developed a leading R&D approach, using proven capability to produce differenti- Domino’s Pizza, Fisher & Paykel Healthcare ated, popular products. The company deliv- and SEEK are all companies that began 2013 ered 13% year-on-year revenue growth over

The Boston Consulting Group | 19 the last two years, and the market expects revenue per customer, and profitability. Over this strong growth trend to continue. the period, Xero proved that it could grow steadily in Australia and the UK, and that the Similarly, SEEK grew both profit and multi- business has a pathway to profitability by de- ple. Profit growth was underpinned by solid livering a positive EBITDA for the first time revenue growth in Australia and growth from in the half-year ending September 2017. international expansion. SEEK’s EBITDA margin decreased during the period as man- Qantas sits on the other side of the growth agement prioritised growth over improved maturity spectrum, entering 2013 with an EV/ margins. Internationally, SEEK expanded into EBITDA multiple of 4x. During the five fol- and South America over the five-year lowing years the company launched a bold

period, investing heavily in overseas assets. turnaround effort, driving significant margin In the local Australian market, SEEK experi- advantage versus competitors with a smaller enced organic revenue growth despite strong workforce, simplified fleet, consolidated competition from global players such as In- maintenance centres and reduced operation- deed.com and LinkedIn. SEEK’s domestic al costs. The company returned the addition- growth has been driven by continuing to in- al cash from improved margins to sharehold- novate and develop its platform. ers by increasing dividend payouts and share buy-backs. Qantas generated modest overall Xero began the five-year period still in its revenue growth by growing outside the lega- early stages of revenue growth. Given Xero’s cy business in Qantas Loyalty and Jetstar. For high-growth nature, its share price is depen- more detail see “The Comeback Kids: Lessons dent on expectations that stretch well into from Successful Turnarounds” a BCG report, the future and are highly sensitive to chang- November 2017. ing assumptions for long-run growth and profitability. Xero’s TSR over the five years to Fairfax entered 2013 with its core business of December 2017 was driven by higher investor print media in steady decline and an EV/ confidence in long-term customer numbers, EBITDA multiple of 5x. Facing deteriorating

20 | SECTORS IN AUSTRALIA DIVERGE margins and revenues, Fairfax accelerated •• First, they focus explicitly on the goal of growth of Domain in digital. In 2013 Domain outperforming peers on TSR, normally represented around 30% of Fairfax’s enter- over three-to-five years. prise value. By the end of 2017 it represented around 70% – even after 40% was spun off in •• Second, they make use of all of the TSR late 2017. At the end of 2017 Domain’s EV/ drivers – revenue growth, maintenance or EBITDA multiple was nearly 4 times that of expansions of profit margins, generation the legacy business (Fairfax was at 5x EBIT- and allocation of free cash flow, and the DA and Domain at 18x EBITDA). As well as management-controlled factors affecting growing Domain, Fairfax shrunk property, multiple. They reassess the priority plant and equipment associated with the leg- assigned to each one as the market acy business by 70%, or almost $400m over changes. the five-year period to return cash to share- holders. At the time of writing, Nine Enter- •• Third, they recognise the need to continu- tainment and Fairfax had entered into a ally re-examine and periodically realign Scheme of Arrangement to merge the two their business, financial, and investor companies, with the proposed transaction to strategies and priorities as part of the be implemented by Nine acquiring all Fairfax ongoing corporate strategy process. shares. For coverage of a US media turn- around, see “Gannet: A TSR Turnaround in the Making”, a BCG article, July 2014.

Three steps to superior results These six companies demonstrate a variety of ways to create value. Regardless of the path- way a company takes, the same best-practice approaches apply to achieving superior re- sults. BCG experience shows that value cre- ators typically do three things to consistently deliver superior results.

The Boston Consulting Group | 21 APPENDIX: TSR BY SECTOR

22 | SECTORS IN AUSTRALIA DIVERGE ABOUT THE AUTHORS

The 2017 Australian Value Creators About BCG’s Corporate We support CFOs and the finance Report is produced by BCG’s Corpo- Development Practice Area function across a range of topics, rate Development Practice. BCG’s Corporate Development including CFO on-boarding, digital Practice helps clients with a range & financial transformation, perfor- Damien Wodak of issues on senior management's mance management, and finance is a Partner and Managing Director agenda through our Center for Val- process improvement. in BCG’s office and ue Acceleration, our Transaction leads the firm’s Corporate Develop- Center and our Center for CFO Ex- ment Practice Area in Australia and cellence. . We assist clients with value accel- Daniel Selikowitz eration, on topics including corpo- is a Principal in BCG’s Sydney office rate portfolio and growth strategy, and a core member of the firm’s capital allocation, TSR strategy, Corporate Development Practice shareholder activism, and restruc- Area. turing/TURN & transformation ac- celeration. James Little is a Consultant in BCG’s Melbourne We support clients with corporate office and a core member of the transactions, including mergers firm’s Corporate Development Prac- and acquisitions, post-merger inte- tice Area. grations, carve-outs, initial public offerings, spin-offs, joint ventures and alliances.

The Boston Consulting Group | 23 NOTE TO THE READER

Acknowledgments For Further Contact The authors would like to acknowl- For further information about the edge the contributions of Simon report or about BCG please contact: Murphy, Sam Stewart, Grant Mc- Cabe, Alexander Koch, Simon Pitt, Australia Eliza Spring, Hady Farag, Marissa Damien Wodak Lynch and Rebecca Diepenheim to Partner and Managing Director, the writing and production of this Corporate Development Leader, report. Australia and New Zealand BCG Melbourne +61 3 9656 1000 [email protected]

24 | SECTORS IN AUSTRALIA DIVERGE FOR FURTHER READING

The 2018 Value Creators Persistent Uncertainty Creating Value from Disruption Rankings A report by the Boston Consulting (While Others Disappear) A BCG report, July 2018 Group, March 2017 A report by the Boston Consulting Group, September 2017 How Top Value Creators Outpace The 2018 TMT Value Creators the Market – for Decades Report: Hardwiring Digital The 2017 M&A Report: The A BCG report, July 2017 Transformation Technology Takeover A report by the Boston Consulting A report by the Boston Consulting The Comeback Kids: Lessons Group, February 2018 Group, September 2017 from Successful Turnarounds A BCG report, November 2017 How Top Value Creators Outpace Creating Superior Value Through the Market – for Decades Spin-Offs Gannet: A TSR Turnaround in the A report by the Boston Consulting An article by the Boston Consulting Making Group, July 2017 Group, February 2016 A BCG article, July 2014 Four Ways Banks Can Radically Winning Moves in the Age of The 2018 Value Creators Reduce Costs Shareholder Activism Rankings A report by the Boston Consulting A focus by the Boston Consulting Group, A report by the Boston Consulting Group, June 2018 August 2015 Group, July 2018 Value Creation and Corporate The 2016 Australian Value Reinvention Creators Report: Shareholder A report by the Boston Consulting Value Creation through Group, December 2017

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