Australian Market Summary (Issue 361) – 24 July 2015

Maybe I’ve had one coffee too many this morning, but I am excited to share some thoughts with you all today.

OIL-SEARCH (OSH) & AGL ENERGY (AGL)

As you all know, we have been busy this week. The BUY recommendation in Oil Search (OSH) has been really strongly received. Like the vast majority of equity recommendations we try to find for your portfolio’s, OSH is company with excellent assets, management and growth potential, and a share that offers sound valuation support and the prospect of further accretion.

For those of you that had AGL Energy (AGL) in your portfolio, then that was a good news story too, and a nice place to book a profit after the 20% rally.

In truth, AGL didn’t reach every portfolio back in September last year, in the main because our belief in the share was more as ‘plodder’ than a ‘sprinter’. Many clients felt they didn’t need AGL when they were loaded with banks and Telstra (TLS) and IOOF (IFL) – a not unreasonable assertion.

However, rather fortunately, AGL surprised us all and has eclipsed the market by some 20% in the past 10 months.

MINERS & THE PROSPECT OF SOME TOUGH DECISIONS AHEAD…

This is the cool stuff.

The fun parts of my job, and perhaps all jobs, is the bit when you have to knuckle down and make the really difficult, and sometimes controversial decisions.

‘When the going gets tough, the tough get going’, and all that.

But that’s the fun stuff. More professionally, it’s actually the bit that separates your performance from the pack. It’s the real value-add stuff.

In the past 2+ years we have advocated for Telstra (TLS) in particular, some banks (those less than the benchmark) and a broad suite of Australian corporates with sound offshore earnings streams. In large part this strategy has worked, and the performance of our managed accounts, and ideally your individual portfolios too, has been strong.

Exclusively, we have been negative on the miners. BHP has been the sole portfolio position recommended, and it has been recommended as significant underweight at that.

Since the start of 2013 to now, the ASX200 Materials index has underperformed the ASX200 by 35%.

But, I now wonder whether we are coming to the end of that period of underperformance.

It’s a big call.

But if you think about things, it’s not the most controversial remark to make. After all, who doesn’t know that iron ore prices have cratered? Who doesn’t know that Chinese industrial activity has been soft? Who doesn’t know that the iron-ore majors from here to Brazil have flooded the market with cheap capacity expansions?

So the next question should then be ‘but is it in the price?’

And this again, is the fun stuff.

Follow me here.

Both Rio Tinto (RIO) and BHP (BHP) are now back at the levels we thought they might look fair – $50 for RIO and $25 for BHP. But are they cheap enough to buy?

I chose to use RIO as my test-case, and I surprised myself a little with the result.

If I was to assume that iron ore prices find a natural low point in the US$40-50/t range (currently US$47/t), then I feel sound in assuming RIO can earn something like US$2.10-2.50 in earnings-per-share (EPS). Translating this to Australian dollars at the current 0.73 exchange rate suggests RIO trades roughly a 2016 P/E of 14.7-17.5x.

If I then try and get a sense for RIO’s dividend paying potential in that year, it feels right that I can conservatively assume a dividend-per-share (DPS) of ~$US$2.00 – this makes RIO a 5.5% fully-franked yielder at $50 a share currently.

BHP is broadly similar.

I guess what I am starting to hint at, is that the MINERS are now trading CHEAPER and with a HIGHER DIVIDEND YIELD than the likes of the banks and Telstra, yet are closer to their cyclical LOW POINT unlike the banks and Telstra who arguably look nearer a peak.

Its food for thought, and like all our musings, we like to share these thoughts with you early to lay the ground for potential change to portfolios.

Take note guys.

THE MARKET THIS WEEK…

The ASX200 fell a little over 1%, with miners and oil stocks the standout as weakest. In particular SANTOS (STO) and Origin (ORG) continued to fall, down 7% and 4% respectively. Mining services were also lower again, and offer a great demonstration that when the trend turns in a deeply cyclical and leveraged sector, the share price falls can continue for years, not months.

Both Macquarie Bank (MQG) and Sonic Healthcare (SHL) updated the market on trading this week, MQG encouragingly and SHL modestly negatively. Neither stock moved materially however after the news.

We were encouraged with the rebound in IOOF (IFL) this week, having flagged the name as excellent buying again in this update last Friday. The stock rose 5% on the week, and investors seemed heartened by the positive fund flow onto its platforms in the recent quarter.

We still feel very strongly that IFL is a core position in portfolios.

Adelaide Brighton Cement (ABC) was also a sound performer again this week, and is broadly at or around its highs. ABC is a share that has been an excellent performer for many portfolios, but the closer it gets to $5.00 the more inclined we are to be booking a profit in the share – at $5.00 the stock would be up over 40% on our initial recommendation.

For next week, the focus for us will be on RESMED (RMD) and its quarterly profit report on Thursday night.

On the macroeconomic front, the only notable observation to make is that the Australian dollar reached a fresh low of 73c today, following disappointing manufacturing data out of China. The AUD is now at its lowest level since 2009.

Key Dates: Australian Companies

Mon 27th  July 
N/A
Tue 28th July 
N/A
Wed 29th July  
N/A
Thu 30th July 
Quarterly Profit Report: RESMED (RMD)
Fri 31st July  
N/A

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