Australian Market Roundup (Issue 458) – July 21st, 2017

21st July 2017, 3pm

Up and down and around we go.

For everything that sounds like news one day, we quickly assimilate it and find it means little 2 days down the track.

The market is down a little on the week, but importantly the economy continues to improve.

Banks were impressive on news from APRA regarding their capital requirements (more on that later), but virtually everything else suffered.

The ASX200 has traded a 3% range for 2 months, and though undeniably economic activity is grinding higher, our share-market remains constrained by its narrowness.

I have a bunch of things to cover this week, which I hope you find relevant and useful.

The Australian Dollar, the RBA & Economic Growth – some green shoots balancing out the grey.

The RBA minutes this week were published and in them the RBA chose to declare their view that a ‘neutral setting’ for local policy rates was 3.5% – well above the currently accommodative 1.5% rate.

It’s a poignant reminder that we are indeed blessed with highly favourable monetary policy at present, and that to expect these conditions to persist interminably would be naïve.

These remarks were then followed up by yet another stunningly positive employment report, that showed a rise in full time jobs of 62,000 last month.

Year-to-date Australia’s full-time employment has grown by 166,000 jobs, and since October last year, the number of new full time jobs added is 273,000.

This is great news, represents annualized growth in full time labour in the order of 3% to 3.5%, and is an absolute requisite for our economic improvement, and explicitly, for a rise in local wage growth from 20 year lows.

I have been rather pessimistic on the scale of underemployment locally (still an issue) for some time, but it is absolutely turning for the better and worth acknowledging to you all.

With all this talk of an improving domestic economic outlook and a reminder that current interest rate settings are low, the Australian Dollar surged to a 2-year high this week just short of 80c.

I have been entirely surprised (and wrong) by the surge in the AUD this year (started the year at 72c).

Though local economic growth is improving, I still think we are some ways away from the first hike in official interest rates.

In fact, the assistant RBA Governor Guy Debelle has just published remarks, as I type, that makes a point of pouring cold water on those insinuating higher interest rates any time soon.

Domestic residential construction looks set to weaken further into 2018 (approvals are down -40% in the apartment space and by -6-7% in new private homes), and it remains to be seen whether the nascent recovery in non-residential construction (definitely on the up, driven in large part by engineering works on Melbourne’s train network and Sydney roads) can plug this pending gap.

We’ll see, but we need to be even-handed, and it would be unfair of me not to acknowledge the improving employment and non-residential construction outlook.

I have added a chart on non-residential construction approvals for good measure.

For those looking to a theme here, we would strongly encourage you to consider ADDING more small-cap portfolio exposure by way of the OC Premium Small Companies fund, or perhaps by way of a small companies ETF such as the Vanguard Small Companies ETF (VSO).

Our recent BUY recommendation in SEEK (SEK) is another terrific play on this theme.

Small companies tend to be more sensitive to the local economy, and have underperformed the ASX200 year-to-date.

Banks – a good week

The big-4 banks took some heart from APRA’s clarification of the term ‘unquestionably strong’ insofar as capital requirements this week.

APRA declared the major banks would need to hold a minimum of 10.5% in equity capital by January 1st 2020, leaving the majors sufficient time to generate the capital from underlying earnings according to most analysts.

ANZ (ANZ) surged the most since it is already largely there following the sales of its Asian holdings and pending life & wealth sale ($4bn+), but each of the CBA, WBC & NAB all pushed higher on relief that the banks would likely close the $3-4bn individual funding gaps without the need for further equity raisings.

We continue to feel that both NAB and WBC stand at risk of modest dividend cuts in light of their very full payout ratios, however we will likely have to wait until full-year results in early November on this topic.

On the banks, our view remains the same – they lack earnings growth, look largely fully valued post the rally (CBA is again 15x) and have leverage to a tapped out domestic consumer.

Hybrids – helped by APRA

Another positive to come from this week’s enunciation of capital requirements from APRA was that it further shielded hybrid investors from the ‘common equity capital trigger level’ of 5.125% by forcing the banks to hold more equity capital.

In really super simple terms, forcing the banks to hold larger sums of equity capital makes issued hybrid capital safer and less ‘equity-like’.

Though hybrids haven’t traded higher on this news this week, the sector has been strong in recent months, and we should all welcome the moves by APRA.

In fact, the news this week rather ironically jibes with the AFR’s front-page article quoting the outgoing ASIC head Greg Medcraft as saying that hybrid securities were inappropriate for retail investors.

I’m not saying there aren’t issues with hybrids in certain situations, but equally they aren’t the devil either.

If anything, this week, hybrids got safer and that’s a good thing.

Metrics Credit Partners – in the press

You may have seen the article in this week’s AFR that announced the pending capital raising from Metrics Credit Partners.

We are super-excited by this raising and really would urge you all to look through our note from May.

Metrics Credit Note

Australian retail superannuation portfolio’s lack true fixed interest exposures, be they via government bonds or corporate debt. Metric’s new offering goes a long way to changing that, by providing investors with a diversified Australian loan portfolio.

We see this offering sitting neatly between low risk and low-returning term deposits, and the higher risk and higher-returning hybrid sector.

Telstra (TLS) – friendless, but worth sticking it out

This week the TLS Chairman John Mullen was interviewed in the AFR and he made a point of drawing comparison between TLS’ high dividend and the low dividend of emerging global tech heavyweight stocks such as Amazon (AMZN) and Facebook (FB) etc.

Personally, I don’t see the connection, but the bigger picture message he seems to be conveying is that ‘yes, TLS is highly likely to cut its dividend in the coming year’.

I don’t think there is any surprise in that, but the market seemed highly offended by the reference, and again took TLS shares lower by -4% on the week.

I have indeed been too patient with TLS in the past 12 months, but feel quite strongly that in the low $4 region the shares are looking oversold and moderately cheap.

Though it is anyone’s guess what the TLS dividend will look like going forward, TLS have forewarned that the impact of the NBN on core cash-flows would be of the order of $2bn (around 20% of the group) between now and the early 2020’s.

Additionally, TLS have announced the potential for a securitization of its NBN royalty stream which would potentially raise a value of $13bn to $18bn

according to brokers, an amount representing between $1 and $1.50 a share.

Putting the potential for a core loss of earnings of 20% over the coming 5 years up against a potential crystallization of as much as $1.50 a share, would leave TLS looking on a low single-digit P/E multiple and with a dividend yield still in excess of 6% on my estimates.

I don’t think TLS is going back to $6 anytime soon, but I do think much of the TLS fear-mongering this week has left the shares looking better value than not.

*** IMPORTANT CLARIFICATION OF FEE STRUCTURE ON THE CONTANGO GLOBAL GROWTH (CQG) ISSUE

For those of you to have taken up the issue in Contango Global Growth last month, you would be encouraged that your $1.10 investment is now worth around $1.18-1.19 as I type today.

However, it is very important we disclose that despite our initial expectations of being remunerated with a 1.5% distribution fee (which we disclosed in our research as we always do), we were in fact remunerated with a 1.7% placement fee.

This is important for us to disclose and was different to our initial expectations and those included in the product offering initially.

Last few things…

Crown Resorts (CWN) were upgraded to BUY this week at JP Morgan.

We still think the company are likely to undertake additional capital repayments in the coming 12 months given the sell-down of the groups significant minority holdings in MELCO.

We think CWN can get to $14 before we think it looks full.

We added to our Regis Healthcare (REG) position this week in both or PRIME’s Equity Separately Managed Accounts (SMA’s).

REG has been far from good to us since our recommendation in 2016, but we do feel like it is now looking particularly good value and worthy of a top-up. The stock is on 17-18x P/E and carries a 5.5% dividend yield here, making it look attractive to us to add.

We actually happen to think both Blackmores (BKL), Mantra Group (MTR) and Oil Search (OSH) all look pretty good value at current levels both in an absolute sense, and relative to a very fully-valued market elsewhere.

In the case of BKL it now trades <18x forward earnings with an excellent balance sheet and still strong prospects of growth into Asia.

In MTR’s case, last month’s international visitor numbers continue to demonstrate a surge in foreign tourism to Australia, particularly from China, and that hotel room rates continue to firm as occupancy rises.

As to OSH, this week the company announced that it was near to confirming plans for expansion of the current PNGLNG infrastructure. This project will be substantially value-accretive to OSH, and provides a truly long-term, steady cash-cow to the business.

We think that OSH remains a very credible takeover target for French oil super-major Total (FP) who are the major holder in the competing Papua LNG project.

Phew.

That’s about it from me.

Regards,

Jono & Guy

Financial Services Guide Update

Our Financial Services Guide has been updated, please click here to download the most recent version.

21st July 2017, 3pm

 IndexChange%
All Ordinaries 5770 -46 -0.8
S&P / ASX 200 5662 -112 -1.9
Property Trust Index 1304 +15 +1.2
Utilities Index 8384 -150 -1.8
Financials Index 6615 +52 +0.8
Materials Index 9815 -325 -3.2
Energy Index 8750 -34 -0.4

Key Dates: Australian Companies

Mon 17th July N/A
Tue 18th July N/A
Wed 19th July N/A
Thu 20th July N/A
Fri 21st July Div Pay-Date – NABHA

Disclaimer: This information has been prepared by Primestock Securities Limited ABN 67 089 676 068, AFSL 239180 (“Prime”). Prime accepts no obligation to correct or update the information or opinions in it. This information does not take into account your objectives, financial situation or needs. Before acting on this information, you should consider whether it is appropriate to your situation. It is recommended that you obtain financial, legal and taxation advice before making any financial investment decision. Prime is bound by the Australian Privacy Principles for the handling of personal information.

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