Australian Financial Review
10 April 2017
Why DMP's Harry Cator is not
buying the Australian banks
Harry Cator thinks Brexit is boring. Dominic Lorrimer
by Vesna Poljak
"Yeah, I'm bored with Brexit," says Harry Cator. Nor does the DMP Asset
Management boss and apparent history buff try and hide it.
"People go 'Brexit, Brexit!' Well don't forget there's precedent here when Henry XIII
left the Roman Catholic church in 1534 and Poms are good at that, we're an island
state and we don't like people interfering in our business too much."
The real issue for Australian investors, he observes, is a misplaced obsession with the
United States and president Donald Trump "but 73 per cent of everything we do is
with Asia".
It's not dissimilar to the nation's other favourite hobby, cashing those big four bank
dividends. "Everybody can't do without the banks because of the yield but our view is
your major bank share prices in five years' time will be lower than they are today and
therefore you've given up in capital your dividend," Cator says.
He agrees the Reserve Bank is "cornered", but that's another story. "It's an
unproductive asset, housing doesn't create a cracker. Post the build, what do you do?
Wash a few windows?"
The case for or against banks has nothing to do with how they are being run, it's just
for 35 years, he says, "it's been one-way traffic". The exposure of the banks to the
population is also "ridiculously" high since ANZ backed away from Asia and National
Australia Bank the US.
"I own as few of them as I dare allow."
With return on equity elevated, and "the greatest exposure in modern history of the
Australian banking system to the Australian economy," Cator factors in not just an
estimated 65 per cent loan book exposure to residential mortgages but also small
business lending backed off the private residence.
"If you then throw that in as well you're going to be looking north of 80 per cent of
their book is in one spot and never before have the big four banks been so
concentrated in the Australian market," he says. "What you have is a situation where
you have a very, very indebted household, an incredibly concerned APRA to bring up the
equity levels, and when you have 'E' coming up – i.e. more of 'E' required – and top
line slowing and possibly plateauing so no growth, ergo RoE falls.
"And if RoE falls, P/E will follow," referring to the price-to-earnings ratio measure of
value. "The thing about banks with bad and doubtful debts, they don't go from 15
basis points to 16 to 17 to 18 to 19, they go from 15 to 85 and that's a whole year of
earnings written off."
Cator has been with the boutique firm DMP since 2001, after leaving his previous job
as chief investment officer at Axa following its deal with AllianceBernstein. "That's
when I decided that me and politics and big organisations don't mix," he says.
His first investment job was at Mercury Asset Management which he eventually ran
in Australia until it was bought by Merrill Lynch (he resigned from that role too). He
credits his Arabic studies for helping distinguish him among 4500 applicants to get a
foot in the door at Mercury.
The head of HR told him as much afterwards, asking "what idiot does Arabic and
law?" Cator also did a thesis on Islamic banking in 1985 when it was "very untrendy".
In between, Mercury sent him to Japan for three and a half years before he returned
to London. He loves investing because it is an invitation to "stick your nose into
everybody's business", and "this wonderful game when you're trying to outwit a
whole range of other players and the market".
"When you get that right every now and again it feels fantastic. When you get it
wrong it feels like someone's dropped a very large lead weight on your head from a
height and it's a great leveller."
Cator's daughter has converted him into a horse rider, and he does competitive
eventing once a month. He recalls a recent conversation with a fellow rider that left
him in furious agreement. "She says, 'You know what I love about horse riding? It
doesn't matter how rich you are or how great your horse is, when you're picking at
their back feet they all still shit on you'."
DMP takes an interest in hybrids as well as equities, participating in Challenger's latest
capital notes (he also discloses that Challenger and DMP have a non-executive director
in common). "Great company, great offering, amazing dominance in their space," he
says.
"We buy things which we think are going to go up not because they sit at 6 per cent of
the index. Do we make mistakes? You bet we do, everyone does," Cator insists. "In
2012 we took a view on resources and we sold them, goodbye BHP. BHP was 14 per
cent of the index at the time and we went to basically zero."
DMP has not bought any BHP since. "We're still zero. They're in a long-term
structural decline. We sold them mid-30s and today they're $26. BHP is no higher
than it was 10 years ago. So what's the story? Would I have liked to have bought them
at $14? For sure but remember at $14, Samarco was very big, they'd just destroyed huge
chunks of Brazil in the dam disaster, it's still not solved."
His latest investment thinking borrows from a classic fable: "The house of straw to us
is resources, the house of sticks are the banks." Cator wants to invest in the houses of
bricks, which are companies that have an asset or an operating model that is unique,
long-life, or dominant.
"Take Transurban, if you're going to do tollroads in Australia and or in the rest of the
world, they're going to be up there. They dominate the space in this country." CSL and
Carsales also make the cut as does Sydney Airport, even post-Badgerys Creek.
"Another slightly more speculative stock is Syrah Resources, they own the world's
largest new graphite deposit, it's ultra high grade, very long lasting – 45 years of
duration and plus. Electric vehicles, power packs, Tesla, BTR, they need graphite and
they need very high-grade, high-consistency of composition and this is what Syrah
do."
He is "intrigued" by Mayne Pharma which he classes as "contender" for house-ofbricks status. "We know that we need to get the cost of drugs down, we know that
generic drugs are the only way you're going to do it, the trouble about Mayne Pharma
is they're not alone in that space."
Meanwhile, DMP is coming to the end of its investment case for APA Group. "It's one
of those stocks where [chief executive] Mick McCormack's great, it's a fantastic
company, but he's changing his tack.
"APA is one that's on our sell list at the moment in the sense that we hold it.
Because he's gone from gas pipelines into solar into upstage energy delivery, and he's
wandering off target. He's a gas distributor, a very good one, but they're wandering
into solar farms."
Adding to that is a threat the government could "semi re-regulate" and for Cator, it's
time to revalue.
Read more: http://www.afr.com/markets/why-dmps-harry-cator-is-not-buying-the-australian-
banks-20170407-gvfosk#ixzz4dnKvI15k
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