Australian Market Summary (Issue 378) – 20 November 2015

What a difference a few days makes.

The ASX200 is up 5% in 3 days and makes the gains for the week over 4%.

All of this in spite of the Parisian terror attacks, continued commodity weakness and the strongest prompt from the US Federal Reserve yet, that US interest rates will see a rise in mid-December.

Pretty good going on the whole, insofar as Australian equity markets are concerned.

Oil stocks lead the charge locally this week, with that sector up 7%, followed by telecoms (Telstra deservedly jumped nearly 6%).

The jump in oil was surprising in some respects, particularly given that oil prices continued to spiral towards their lows at $40/barrel for WTI.

Oil wasn’t the only commodity to take a beating this week, as copper prices reached a 6 year low and iron ore made fresh lows under $42/t.

It makes for a tough time to be in resources right now, but for BHP (BHP), we think it’s all been priced in and the stock stands a strong chance for a trading bounce.

BHP – AGM & the Dividend

BHP held its AGM in Perth on Thursday, and despite all the headlines, we learned very little about the prospect for a BHP dividend cut.

And nor were we going to.

BHP is a June year end, meaning the soonest they will even discuss dividend policy formally will be after its interim results in early February.

And at that point, short of a miracle, BHP WILL CUT ITS DIVIDEND TO REFLECT THE NEW NORMAL IN GLOBAL COMMODITY MARKETS.

And when they do, we shouldn’t be surprised.

The previous ‘progressive’ dividend policy which saw US$1.24 paid in 2015 was born of a time when BHP was earning supra-normal profits.

In the current environment and with still a significant $40bn in net debt, BHP will first and foremost be committed to its A-grade credit rating (currently A+ with S&P but on negative watch).

It’s my opinion that the balance sheet precedence (rightly) will force a cut in the dividend to something around A$1.00 a share – making for a 5% fully-franked dividend yield at current levels.

Alongside, my back of the envelope figures for BHP earnings, I truly feel that the worst is now being priced into the stock at $20 and the prospect for a trading bounce back to $25 is perfectly plausible.

Beyond $25 would be a struggle simply because end-markets for BHP production remain poor. With that in mind, we really only see BHP as a trade for 20% and little more than that. Let’s see how it plays out.

AGM Season – Commonwealth Bank (CBA) comments & IOOF (IFL) & QUBE (QUB) next week

Beyond the BHP AGM, we also had CBA’s AGM this week. The CBA AGM was pretty anodyne, but of more interest were remarks later in the week from the CBA CFO who was quoted as saying ‘there’s an enormous amount of mortgage prepayment’ going on, and that it ‘it will take a lot to cause hardship in housing’.

These remarks are interesting for many reasons.

In the main they are of note because they support my view that housing is merely transitioning from a period of strong growth, to one of consolidation.

We are so pre-disposed to expecting and talking about the ‘best’ or the ‘worst’ case scenarios in everything, and no less of that occurs in financial markets.

But there’s thing called a normal distribution curve, and in essence it says what we all know – that extremes are called extremes because they are extreme!

I’m being facetious, but the reality is that most of the time the worst won’t happen, and sadly, nor will the best.

It sells papers if we talk about a housing collapse. But it is unlikely to happen given the strong underlying employment picture here and the prospect for a continued low interest rate environment.

House prices might go flat for a few years, but that’s OK isn’t it?

Next week we have the IFL and QUB AGM’s, which will be interesting.

IFL is a share that has been excellent to us, but we are mulling over the idea (and level) at which to book some profits.

QUB is interesting more so because of the potential to learn more about the group’s planned strategy in bidding for Asciano (AIO). Regrettably, we were looking at recommending QUB at $2.00 and, like other things through September, we missed our chance.

Euro Weakness – something to pay attention to

I want to raise this as an important burgeoning issue for corporate earnings in the months to come.

With the prospect for higher US interest rates and the equally increasing chance of more money printing in Europe, it’s perhaps no surprise that the Euro is just off its lows against the USD, and around 10% weaker against the Australian dollar in the last 3 months.

Companies like AMCOR (AMC), Brambles (BXB), Ansell (ANN), RESMED (RMD), Cochlear (COH), Computershare (CPU), Macquarie (MQG) and Hendersons Group (HGG) all earn significant profits from their European operations.

The weakness in the Euro should be increasingly front of mind lest it starts to force the prospect for earnings downgrades here. Within the mix above, CPU and RMD are two favourites of ours, and we are watching this issue with greater focus in the here and now.

Other Bits and Bobs – Crown Resorts (CWN), James Hardie (JHX), Oz-Forex (OFX)

There were concerns this week on CWN in relation to the conservative budget forecast made by the Macanese Government for 2016 casino gaming revenue. The Government in Macau have budgeted for $25bn in revenue, which is below analyst forecasts, and the lowest figure since 2010.

We remain comfortable with CWN as we have discussed time and again and feel much of these issues are in the price.

We would note last week’s decision by James Packer to raise his stake in CWN to 53% by buying a further 3% of the company at $12 as strong vindication for our view.

James Hardie (JHX) disappointed the market this week with a modest lowering of its projections for this years profit.

The stock is down 6% on the week.

Much of the tempering in expectations comes from a more competitive US market, where JHX struggled to take the market-share they had anticipated, and where price pressure was more acute.

OFX was the latest Australian stock to be the subject of offshore takeover interest, with Western Union reported to have offered to pay over $3.50 a share for the online money-changer (a premium of 35% on its last traded price).

I have said it before, and will say it again – with the AUD down at 70c, our market will increasingly be at risk of predatory bids from global multi-nationals.

There is nothing wrong with this, and is a healthy reinforcement that we do have some great quality companies listed locally. The regret is that too few Australian companies used the strong Australian Dollar through the previous 5 years to make similar offshore purchase when the price was right.

Anyways, that’s enough from Guy and I.

We are pleased to see the market catch a bid this last week as we had hoped.

Informative Videos on Investments to Share:

Investment Process: What is it? from Prime Financial Group on Vimeo.

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