Australian Market Summary (Issue 385) – 5 February 2016

 I’m full of beans this week, so I’ll apologise in advance if I get a little wordy.

There is a heap on, and a heap to discuss.

It’s gonna be a long one.

Being the start of the month, we have had the usual ‘data dump’ of statistics, this time from January activity. Secondly, corporate reporting season commenced locally this week and develops a full head of steam in the fortnight ahead.

So there’s a lot to rabbit on about.

The week just gone… more mean reversion.

The share-market lost 1% during the week, which is neither here nor there. Of note however, was a reversal of the momentum seen in several major trends, notably the US-dollar and commodity markets.

The US-dollar fell back 3% during the week, driven by ongoing cracks in US economic data. Data for US manufacturing activity remains at around 6-year lows, and services activity data in January also took on a slightly softer tone falling back to 2-year lows.

With the US-dollar falling, commodity prices all rallied (why? … because commodities are priced in US dollars), the Australian dollar ended up at 72c and shares in miners like BHP (BHP), Rio Tinto (RIO) & Fortescue (FMG) spent the week rallying.

The respite in mining shares was offset by selling in many of the recent ‘market darlings – SEEK (SEK), Blackmores (BKL, see comment below), Bega Cheese (BGA), Dominos Pizza (DMP), Magellan Financial (MFG, comment below), REA Group (REA, comment below), Ramsay Healthcare (RHC) and Healthscope (HSO) all ended up as under-performers.

Clearly there is some mean reversion at play, and with valuations extreme between winners and losers, it ought to be no surprise.

Furthermore, the early reactions to profit reports from Ansell (ANN), REA Group (REA), Tabcorp (TAH) & Macquarie Group (MQG) point to a market in no mood for disappointment.

Ansell (ANN) – the first shoe to drop.

Ansell (ANN) was the big loser this week, falling 25% after making a disappointing assessment of its sales outlook.

ANN seemed to find a slew of excuses for downgrading profit expectations by around 10%, but in the main it seems entirely due to the groups exposure to industrial and energy customers and to emerging markets such as Brazil and Russia.

ANN has become the latest victim of a falling oil price since much of its high-margin products (gloves in particular) are sold into companies and economies that rely on the oil price.

ANN seems cheap on 11x except that it isn’t.

I expect more earnings downgrades in ANN and the stock to end up somewhere in the $12-13 range before it truly bottoms. Down there it might just prove to be a tempting takeover target for global industrial titans like Honeywell or 3M.

REA Group (REA) – priced for perfection

REA is down 9% for the week, and 6% today as I type. This is in spite of delivering half-yearly profits in-line with market expectations (up 29% on last year incidentally).

REA is simply another share that seems priced for perfection. Even with assumptions for another 15% revenue growth in 2017 (punchy given housing market and sector competition issues emerging), REA trades 25x cash earnings.

I made mention of REA in this light last week.

Price matters. Sometimes it’s the travelling not the arriving.

Macquarie Group (MQG) – weaker financial market trends

MQG fell over 10%, again after reporting only ‘in-line’ forecasts.

From what I can tell, MQG tempered their outlook for the commodity and financial market business and acknowledged that with share-markets down, asset management fees would similarly be constrained.

Nothing new here, and yet the stock fell 10% (over 25% from its highs).

Like REA, this is simply another case of markets pricing in too perhaps a touch too much optimism, and being chastened for it.

MQG is a very good quality company all the same, and to be very honest, I think begins to look pretty good buying in the $55-60 range.

… so if Macquarie (MQG) & REA Group (REA) can fall so much after ‘OK’ figures, what does it say for Commonwealth Bank (CBA) & Wesfarmers (WES)?

Look, I’m being a little inflammatory with this remark, but I still think it bears consideration.

WES & CBA are the bluest of blue-chips, but they are being priced for such perception.

WES is on 18x 2017, but on 25x cash earnings (yes, that’s correct) and pays part of its middling 5% dividend yield out of debt.

It’s a terrific company, but it simply can only go so far.

CBA is entirely the same. 14x P/E when compared to 9-10x for NAB just seems excessive. CBA is clearly the pre-eminent Australian banking franchise (they are the pick of the banks on I.T), but remember when NAB was precisely that 20 years ago?

All I am saying here is that so many portfolios rely far too heavily on CBA and WES, and whilst that strategy has been a successful one for the past 5 years, the valuation on both and the outlook for the coming few years is very different to that of 5 years ago.

Lecture ended.

National Australia Bank (NAB) – Clydesdale de-merged

NAB de-merged the UK banking assets this week into CYB shares.

It’s really neither here nor there for portfolios since CYB (last at $4.18) represented only 3% of the NAB share price and hence well under 0.5% of client equity portfolios.

There has been some conjecture over NAB’s ability to maintain its dividend in light of the earnings lost from the CYB de-merger and the sales of their US and Australian life assets.

We think NAB are in good shape to keep a constant yield in the order of 7% currently ($1.90 DPS), and maintain our confidence in new management and the balance sheet clean up currently underway’

NAVITAS (NVT) … doh!

A mea-culpa this week again that NVT is not yet in our preferred portfolios.

It is increasingly the one that got away.

NVT posted reasonable profit figures for the half, but encouragingly announced a buyback of 7.5% of the company – a demonstration of confidence in the future of the group.

The stock initially burst through $5, but is back in the mid-$4’s.

We love the NVT story, and are keen to participate in the future success of education and NVT as a global leader in its field, but continue to hold out for better levels to be buyers.

The week to come … gets busier.

Firstly, Gong Xi Fa Cai!

Next week is Chinese New Year and ahead the Year of the Monkey.

Next Monday is also the day of the Super Bowl.

Beyond all of this, reporting season kicks off with a bang. CBA, (CAR), Computershare (CPU), Rio Tinto (RIO) and Transurban (TCL) are all notable companies to report.

We expect a continuation of the tricky conditions we have come to get used to this past month. Fingers are crossed we can navigate the earnings minefield, and perhaps find a few opportunities for portfolios along the way.

We retain significant cash in our Australian Equity Separately Managed Accounts (SMA’s) following the sales of RESMED (RMD) and Adelaide Brighton Cement (ABC), and are hopeful of finding some good uses for this cash in the ongoing volatility.

Blackmores (BKL) … a remark and something of a view

I finally managed to do some reading on Blackmores (BKL) over last weekend, and felt it appropriate to share my cursory view.

There is no doubt the group has been enormously successful in cultivating a strong brand-name within the Asian region, and in capitalizing on the high importance the Chinese place on food and dietary provenance.

The company were able to react to the opaque surge in demand during 2015, and more recently have forged substantive distribution links into China particularly.

And that’s all great.

But what longevity should we expect of these business trends, and what edge do Blackmores have as seller of vitamins & supplements locally and into the Asian region?

This is where my reservations heighten.

In the last 12 months, expectations for BKL 2017 profit have risen 3.5x – from $35m to $120m, and the value of BKL has jumped from $800m to north of $3bn.

It now trades on 26x June 2017 earnings, which is a multiple that’s hugely expectant of additional earnings upgrades and ongoing growth.

And that may well be the case, after all, China is a billion people all in a deserved rush to improve their quality of living.

But BKL sell vitamins, and vitamins aren’t a particularly high-margin nor value-added product – think of it like pretty much any other chemical manufacturing business.

It’s a volume game.

No one is getting healthier from a Blackmores fish-oil supplement than they would a Swisse or GNC branded pill.

So Blackmores is a brand. And Swisse too are a brand. Admittedly both good ones, but what else is there?

They operate in a highly commoditized industry, but one that right now by virtue of customer perception, places a markedly higher premium on their product than others.

It doesn’t make for an overly sustainable growth story in my mind.

So at 26x already hugely inflated earnings forecasts, I have to say, I find the risks in the share far too high for us to play or participate in.

BKL is a huge success and deserved of the credit afforded it by the media and the broader market, but it doesn’t mean that as a share its one we will be playing any time soon at current prices.

BKL and the broader China consumption theme has been hugely topical of late, and I just thought many of you would be interested in my brief take on BKL for context.

Geez. I feel like I have been typing all day (I have), and yet I feel like there are million other things we could discuss today.

Let’s leave it here all the same.

The share-market remains edgy.

I’m not convinced we have truly seen the worst of it, but equally as I have said before, I expect the market to find its feet only another 5-7% lower than here if pushed.

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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