Australian Market Summary (Issue 382) – 15 January 2016

Welcome back! Yikes.

Down 7% year-to-date we are, as at noon today.

Hardly an inspiring start to the year.

I’ll endeavour to stick to the market commentary this week, simply because I think I made my feelings clear on the year ahead in the piece you received earlier in the week.

But for those that missed it, I’ll surmise by saying – global growth is now under threat from Chinese devaluation and this means greater doubt is being cast over corporate profitability which in turn creates heightened uncertainty over share-market valuations.

That said, I did remark that mitigating these darker clouds was the fact we had already lost 7% for the year, valuations locally looked defendable, the Australian economy was showing signs of improved service sector activity and that ultimately we didn’t anticipate a Chinese economic collapse.

The year will be a down year for the Australian share-market, after FOUR positive years on the trot.

However, at this stage we feel it’s a market that should prove manageable in spite of the headwinds.

The week that was…

I guess it felt a lot worse this week than the 1% fall we see now.

Oils and miners again underperformed, falling 4% at the sector level.

BHP – ‘the ever diminishing Australian’

BHP (BHP) saw some love emerge later in the week as two large investment banks chose to upgrade the stock to BUY on valuation grounds.

Having made similar representations to you all at $19-20, albeit as a tactical trade, I have to say I lowered my colours there. Fortunately, we advocated a responsibly modest increase in our ‘market-weight’ position for BHP but all the same, it’s been a black mark for the past month or two.

On the news-front for BHP, they today announced a US$4.9bn write-down of their US shale oil assets in light of the oil price collapse. The news itself is not ‘market-moving’ since it is a non-cash move, but it certainly draws attention to the folly that was BHP’s substantial investment in US shale oil in 2011.

As a recap for investors, BHP spent US$20bn in acquiring shale assets in 2 separate transactions in 2011 (when oil was $90/bl) and with todays writedown, have now written off US$10bn in the carrying value of these assets since acquiring them – in other words, the assets are worth perhaps half what was paid for them.

Whilst Rio Tinto’s (RIO) acquisition of Alcan for $38bn in 2007 still rightly rests as the biggest corporate howler I can recall, it does demonstrate that BHP too have been disappointing in their recent allocation of capital and that these acquisitions have proven highly disappointing to share-holders.

For clarity, we will get BHP’s result announcement on the 23rd February and the undeniable focus will be on board policy towards the dividend.

No doubt you have seen our published expectations of a major pending dividend cut – likely a halving of the dividend would be my best guess.

At $16 or under, and with a dividend halved to ~$0.90 a share, BHP sits on a dividend yield of 5.5% fully-franked, and higher than that of Commonwealth Bank (CBA).

It’s this last reason that I would persist with BHP for now and still feel that a rebound in the oil price mid-way through 2016 will provide respite for shareholders and the ability to likely sell for better levels ($20+).

Sonic Healthcare (SHL) – our positive view

The market sell-off means we ought to get some more good opportunities to buy some real quality.

SHL is one such name and we think and expect the share to perform well in the coming 12+ months.

For a market that we think may have a flat-to-downward bias during 2016, we see the very real potential for SHL to push well above $20+ as the outcome of the government amendments to bulk-billing become better understood.

Origin (ORG) & SANTOS (STO) – merger makes good sense.

This week one of the major brokers wrote an excellent research piece identifying strong merit in a tie-up between the two levered oil plays, ORG & STO.

Both companies in spite of recent capital raisings remain overly geared and hence hugely levered to the oil price collapse.

The note speaks of the ability to make huge cost savings at both a corporate & perhaps project level between the two groups substantial Queensland LNG Export projects, neither of which will generate any favourable cash-flows at current oil prices.

Additionally, at a political level a deal would seem well-founded since there would be the net positive effect of freeing up gas slated for export for the domestic electricity market. This in turn would reduce the risk of an electricity price spike later this decade that many expect.

It’s a good thought and one that I am sure long-suffering shareholders of each ought welcome, but by no means a reason to add money to the two shares at current levels.

A quick update on some of PRIME’s preferred shares…

IOOF (IFL) was hit over Christmas after erroneous press reports suggesting the CEO had sold half his stake in the company. I say erroneous since there was in fact no sale, but a transfer of shares based upon a Family Court judgement.

The stock fell over 10% and we think looks well over-sold.

We remain minded to look for the chance to take some profits, but this heavy selling means the stock is now over well 10% away from our target areas.

Crown Resorts (CWN) has been solid around the $12 mark, with little new info about over the holiday period about the prospect for a privatization. We still feel it is a strong chance and are hopeful of being provided with a neat exit in the $14+ range.

Flight Centre (FLT) has been great since we recommended it, outperforming in a down market. Results are due late February and we feel pretty confident that the company will deliver on its profit guidance, providing a strong share price boost given the negative sentiment still directed at the share.

Insurance Australia Group (IAG) and Computershare (CPU) have been sound and if anything look a little cheap here. Both are quite defensive in nature and we hope and expect will weather the market headwinds currently blowing. IAG’s 6% dividend yield and bullet-proof balance sheet post the Berkshire (Warren Buffett) deal only reinforce our belief here in the low $5’s area.

Next Week … important. US earnings season commences.

Next week is actually a pretty crucial week for equity markets given the commencement en-masse of US corporate reporting season.

Given recent concerns surrounding the outlook for global growth and corporate earnings, the results and forward outlook for 2016 will be closely monitored.

Australian earnings result aren’t due until early February, but will be equally eagerly anticipated.

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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