Australian Market Summary (Issue 351) – 15 May 2015

I feel like I have spent all week writing. First the Budget, then the NAB rights issue, then the Newmark Property offer.

You guys are probably feeling much the same, and keen to see me leave your ‘inbox’ free for a few days at least!

But, when there’s stuff to talk about, we talk. When there isn’t, we don’t.

There are a few items of note this week, that if you didn’t see, you should.

This week I want to focus on opportunities for income.

INCOME OPPORTUNITIES EMERGING – BANK HYBRIDS

The main theme for me this week is YIELD. With cash rates at 2% and record lows, the big issue facing investors is ‘regular, secure income’.

Fortunately, the sell-off in bonds this month is allowing fresh opportunity in yield to emerge.

The lesson in this all is to accept that the market always needs to exhale and inhale, and that when it exhales, patience is rewarded.

So with that said, as bonds have sold off, so too have many of the higher-yielding securities, and as a result opportunities are developing.

The single most notable opportunity set to emerge this week is in BANK HYBRID SECURITIES, most specifically in CAPITAL NOTES.

As of today, you can buy the capital notes of the 4 major banks with maturities out 5 to 7 years with yields knocking on the door of 7%.

That is really good value.

The Commonwealth Bank PERLS VII issue (CBAPD) which listed in October last year at a very tight margin, is now offering a full 1.2% more in yield-to-maturity than it did then. The current yield-to-maturity for CBAPD is 7.1%, which compares EXTREMELY FAVOURABLY to the CBA 2016 grossed up dividend yield of 7.4%.

Simply put, the CBAPD is a higher-quality, more secure instrument than the CBA equity, and yet its yield is only a fraction less than the equity.

Hybrid-securities have been much-maligned in recent years for the way they are structured and priced, and much of this criticism has indeed been fair. At the very least, the market is becoming better informed as to the risks associated with the hybrid securities in the event of a financial or bank balance sheet crisis.

However, this education process has in many ways unduly scared investors away from the sector.

Point blank, the CBAPD on a 7%+ yield is TODAY A BETTER INVESTMENT THAN CBA EQUITY for those investors looking at the next 2 years.

To explain this a little further, consider the following two points.

  • First, investors own shares for growth.

In the case of CBA and the major banks, the next two years will be absent growth due to the impact of increased competition and the burden of higher capital requirements. If there is no growth, then you want to own shares cheap.

CBA has no growth and is still not cheap.

  • Second, in the case of the hybrids, the higher capital requirements demanded of banks actually makes the hybrid space MORE not LESS secure. More capital held, means the chance of these hybrid notes being converted to equity are lessened.

Ergo, CBAPD at 7%+ is a great value opportunity for any of you looking to add in the income-security space.

INCOME OPPORTUNITIES EMERGING – NEWMARK HARDWARE PROPERTY TRUST #1

Secondly, without wanting to re-write yesterday’s client note, we urge you to take a look at the NHPT opportunity.

We have put quite a deal of effort into identifying opportunity for clients in the unlisted property space, and feel like we have not only found a specific property trust for investors, but a manager in whom we can see ourselves doing future business with.

The NHPT will offer investors a 7.5% initial yield over two large, brand-new Bunnings stores in each of Launceston and Maroochydore. The lease expiries on each property are now 11 and 12 years respectively, with a 3% annual rent rise built-in.

Please take a look and then give us a call.

THE MARKET, THE BUDGET & THE AUSTRALIAN DOLLAR

On the market this week, we are a little under 1% higher which is fine.

The best sectors were those impacted by the Budgets generous small-business incentives, so consumer names such as Wesfarmers (WES), Woolworths (WOW), JB Hi-Fi (JBH), Dick Smith (DSH), Myer (MYR) and Harvey Norman (HVN) led all-comers on expectations for an uptick in hard-good sales.

The travel sector kicked again in large part due to the stronger Australian dollar – QANTAS (QAN) rose to a 6-year high after this week disclosing the ongoing benefits of its cost strategy, the savings it was making on fuel charges, and that ultimately the company was carrying excess capital available for return to shareholders.

Flight Centre (FLT) also continued to push on, which is a minor frustration to us since we chose to exit the winning trade in the $43.50-$44.00 range.

It’s hard to time things perfectly (though we try!), and since FLT is up a whopping 35% in 3 months, we felt and still feel it is the appropriate move.

Interestingly, Magellan Financial Group (MFG) which we switched out of into FLT back in January continued to fall this week, dropping 6%.

MFG is now 10% below where we initially recommended selling it, and switching into FLT.

As far as the Budget is concerned, it was a good one, and will help short-term consumer and business sentiment. That’s a good thing.

I’m not convinced it is enough to get me feeling any less cautious than I have felt this last month however, since there are few positive signs out there for banks nor miners.

Moreover, since declaring the diminished prospects for more rate cuts a fortnight ago, the RBA has unwittingly put a floor under the Australian dollar, which is another drag around the stock-market and the prospects for upside.

The longer the Australian dollar lingers at 80c, the less chance our economy has of finding its feet and perversely the greater likelihood of more RBA rate cuts and ultimately a LOWER Australian dollar.

For our favoured AUD-exposed names like Computershare (CPU) and Crown Resorts (CWN) it does hinder their ability to perform in the near term, but in no way diminishes our confidence in each recommendation.

On the positive front, the stronger Australian dollar is making the opportunities to invest beyond our local shores more attractive.

We have various suggestions for clients looking to broaden their geographic exposures, and would have a number of funds run by high-quality names such as Vanguard, Platinum, Magellan and Blackrock that offer clients strong, cost-effective exposure to equity markets in the US and Asia particularly.

On the stock front this week, it is very important I address the fall in RESMED’s (RMD) share price.

RMD fell 18% on Thursday in response to the release of Phase 3 trial data which showed that patients with congestive heart failure and central sleep apnea were in fact MORE likely to die if they used a particular air-ventilation device than not.

The trial result was a complete shock to the market, and though the trial was not conducted on either of RMD’s core APAP or CPAP ventilation machines, the risk of a tainted clinician and patient response to the trial caused the market to sell RMD off heavily.

We are disappointed with the share price fall, and are currently contemplating our next move. RMD has been a largely winning trade for most, since the initial recommendation was made 40% lower. However, those to have bought it recently will be disappointed with the fall, not unlike ourselves.

For now, we will hold pat in belief that the initial selling was perhaps a shade overdone, but a strong bounce will likely see us choose to jettison the holding.

On the positive front, Carsales.com (CAR) took heart from the Federal Budget and bounced soundly alongside other consumer plays. CAR is up 7% on the week and now back at $10.

That’s it from me.

Key Dates: Australian Companies

Mon 18th May 
Earnings: Dulux (DLX)
Div Ex-Date: Macquarie Group (MQG)
Tue 19th May 
Div Ex-Date: RESMED (RMD), Incitec Pivot (IPL)
Wed 20th May 
N/A
Thu 21st May 
Earnings: James Hardie (JHX)
Fri 22nd May  
Earnings: Fisher & Paykel Healthcare (FPH)

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