Australian Market Summary (Issue 363) – 7 August 2015

So much to cover yet again this week. So much.

Firstly, admin.

Can I please thank all of you that clicked through to the new Prime Facebook page and chose to ‘LIKE’ or ‘FOLLOW’ us. We do sincerely hope this new site provides you another avenue to easily see our views and thoughts. As a reminder the site is at –

For those that haven’t been and taken a look, do please go and have a meander through the content. As I said last week, we will be adding more and varied content, both investment-related and then more broadly general knowledge.

This week is a great article on the ’11 Attributes of Successful Investors’ authored by the CEO of Magellan Asset Management, Hamish Douglass.

Do take a look.

THIS WEEK …

Ok, now for markets.

Clearly the focus this week for me will be on the bank sector. Regrettably it’s a negative, and like all negatives it comes in a surge, not a trickle.

Whilst we have flagged our long-standing reservations over bank sector portfolio weights, hindsight shows one can never shout too loud. Even with our overt caution, we too regret not having yelled even louder.

But though the banks take centre stage for discussion today, there are several more points to raise and discuss, namely –

  • Orica (ORI) had a major profit warning.
  • The Reserve Bank of Australia (RBA) spoke
  • Australian economic conditions showed some notable and interesting improvement in the July data
  • Rio Tinto (RIO) reported earnings, and the miners outperformed
  • Corporate earnings season commences in full next week

WHO SHOT THE BANK SECTOR …?

As I write this now, the bank sector is down a further 2.5% and down 4.5% for the week.

The heavy selling has come about following the surprise urgency with which ANZ announced their intended $3bn capital raising.

Early on Thursday morning, ANZ announced plans to raise up to $3bn at a minimum price of $30.95 – a 5% discount to the previous night’s close. The sudden news seems driven by ANZ’s desire to raise capital in advance of the Commonwealth Bank (CBA), who are widely rumoured to be seeking to raise $4-5bn in capital at their Full Year results on Wednesday next week.

The recent decision by Australia’s bank regulator to raise the capital held against mortgage lending seems to have been the trigger for the truncated capital raising schedule by ANZ.

The raising goes a long way to addressing ANZ’s capital shortfall – to reach a minimum 9% equity tier 1 ratio, ANZ were seen to need between $3bn and 4bn. To match this ratio, CBA are seen to need $4bn to $5bn.

But let me make this clear. Whilst the raising by ANZ represents only a small 3% or so of its equity capital base, $3bn is a lot of money. Even more so when you consider CBA are the gorilla behind them looking for another $4bn+

And what about Westpac (WBC)?

A week ago the market seemed indifferent to the prospect of major bank capital raisings. Only the National Australia Bank (NAB) after its $5.5bn rights issue in May was seen to have addressed its capital shortage, but yet the prevailing market wisdom was that each of CBA, WBC and ANZ would in large part raise the necessary capital over the coming 12 months by way of asset sales and internal capital generation.

The decision by ANZ to raise now almost single-handedly forces CBA to follow suit next week, which in turn offers up the real prospect that WBC too will be in the market cross-hairs for a raising of some $2bn or so.

Banks operate and exist on the basis of trust born in large part by the strength of their balance sheet.

Where one goes, in large part, the others follow.

So with the prospect of another potentially $6bn in capital to be raised this year from the bank sector, it’s any wonder that the sector is weak.

With these raisings and this weakness, bank share prices are now back at their lowest levels to the broader ASX200 in nearly 3 years.

ANZ is at its lowest point relative to the market since 2009 today.

And though bank share prices have fallen, I have to say, I still don’t see any real value in the broader sector. NAB and ANZ are fair, but each of WBC and CBA are still 10% too rich.

The sector will increasingly offer up attractive income potential, but nothing more. There will be next to zero earnings growth for the sector in the coming two years.

On ANZ specifically, retail investors will next week be offered the ability to subscribe for up to $15,000 in new shares at a likely price of $30.95 (above todays $30.44). Whilst we don’t know where ANZ’s share price will be in a week or two, at this early juncture it is unlikely we will be recommending clients subscribe. But more on this in the coming week.

To conclude, what happened this week is precisely why we have warned against OVEROWNERSHIP in the bank sector. Portfolio’s need and should be weighted appropriately:

a) to ameliorate damage when events like this occur, and

b) to ensure portfolio’s stand positioned to participate in new investment recommendations that offer the prospect of better returns as and when we make them.

THE RBA, THE ECONOMY & INTEREST RATES …

The RBA sat this week and as expected announced rates would remain unchanged at 2%.

Furthermore, the RBA opined that the Australian unemployment rate was lower than they had expected and in fact that the lower Australian dollar was supporting demand for domestic goods.

The RBA also chose to raise their inflation forecasts UP (that’s right) to 2.5% for the next two years.

These are hardly the remarks of a central bank looking likely to lower interest rates again any time soon (at all).

Confirming the RBA’s remarks, Australian service sector activity jumped to its second-highest level in 6 years in July, and domestic employment also surged more than expected.

The RBA are spot on in their remark that the falling dollar is corralling more activity into the local economy, and believe it or not, it is genuinely being reflected in a pick-up in activity.

Again, to my very strong opinion, AUSTRALIAN INTEREST RATE CUTS ARE OVER.

ORICA (ORI) … profit warning.

ORI today announced a massive 20%+ downgrade to profit expectations for this year and next, causing the share to plummet 16%. Weakness in demand for its mining explosives is the root cause.

In July 2013 after the ORI first profit warning we were chastened and told clients to SELL the share. It was unfortunate and a little embarrassing.

In the interim, the stock has been up, down and around. But the lesson in ORI, even now, 2 years on after its first profit warning, is to take action when appropriate and to jettison stocks that will not perform for you, even if at a loss.

Whilst ORI did rally over 30% in the 6 months after we chose to vacate clients from their positions, the stock is now 10% below where it was in July 2013 but MOST IMPORTANTLY HAS UNDERPERFORMED THE ASX200 BY 28% IN THAT TIME.

Holding onto ORI has proven to be quite the opportunity cost.

It only takes one ORICA, MONADELPHOUS, QBE or COCA-COLA AMATIL in a portfolio to out-stay its welcome, and a lot of the hard-work done in the winning shares can be given back.

We make mistakes. Everyone does. But when it’s time to jettison a position even at a loss, as ORI proves, the first cut is the cheapest.

CORPORATE EARNINGS TO COME NEXT WEEK …

We have a huge week for portfolios next week with Australian reporting season kicking into full-swing.

CBA, Telstra (TLS) and CSL are the big names to feature at an index level, but as important for us and you will be results from each of Carsales.com (CAR), Crown Resorts (CWN) and Computershare (CPU).

We are quite expectant and hopeful of strong profit figures from each of CAR and CWN, but expect CPU earnings to be indifferent.
In the case of CPU, our belief is simply that things will progressively improve in the coming 12 months on all of the corporate activity front,  interest rates and the positive impact of offshore earnings. Either way, we feel on 14x P/E CPU is a superbly valued and well managed company and deserving of our optimistic outlook.

TLS is the other major for us, and of huge significance given our belief in the defensibility of its dividend stream.

We have flagged that we are increasingly nervy as to the fullness of the TLS valuation, but so far have persisted with our optimistic view. Thursday’s results should be sound and carry few surprises.

RIO TINTO & MINERS BOUNCING…

RIO this week published a really decent set of half yearly profits, in spite of fears surrounding the impact of the iron ore price.

Profits were clearly well down on previous periods, but this was entirely to be expected, and RIO fortunately managed to better expectations on net profit, future capital expenditure plans and net debt.

It is a credit to the management of CEO Sam Walsh that RIO have been able to address their cost base in such aggressive fashion, and is one of the reasons why we are increasingly paying attention to the share in and around $50.

We have flagged on several occasions that the major miners were increasingly ‘fair’ value. They are.

We now wait for the shares to become outright cheap, and at that point you will hear from us.

Key Dates: Australian Companies

Mon 10th Aug
Earnings: Ansell (ANN), JB Hi-Fi (JBH)
Tue 11th Aug
Earnings: G8 Education (GEM), Greencross (GXL), Magellan Financial Group (MFG), Transurban (TCL)
Div Ex-Date: Suncorp (SUN)
Wed 12th Aug
Earnings: AGL Energy (AGL), Carsales.com (CAR), Commonwealth Bank (CBA), CSL (CSL), Computershare (CPU), REA Group (REA)
Div Ex-Date: WBCHB, WOWHC, WBCHA
Thu 13th Aug 
Earnings: Crown Resorts (CWN), Fairfax (FXJ), Goodman Group (GMG), TabCorp (TAH), Telstra (TLS)
Fri 14th Aug  
Earnings: James Hardie (JHX)

If you would like to discuss any matters with me:

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