Australian Market Summary (Issue 386) – 12 February 2016

 WHERE TO FROM HERE …

Let’s start with some good news.

We’re almost there. By that I mean, I think we are near a level to hold and bounce from.

The simple synopsis from me is that the world surely has its troubles and my concerns remain for the year (and years) ahead, but at this point right now conditions are not so bad as to expect further financial market meltdown in indices that in many cases are already down significantly – Australia is -20% from its highs, Europe -30%, Hong Kong 35%, Japan 26% and the US a respectable 14%.

The Australian market and economy is not without its problems (notably the policy paralysis on tax reform and falling export receipts). The reliance on the bank sector (which is a de-facto housing exposure) is another weight.

But we also have a free-floating currency which in the past 12 months has been hugely supportive to the domestic service sector, we have a significantly better government debt position than the vast majority of developed world countries and, lastly, significant room to further lower interest rates should it be necessary – a point the RBA Governor seemed keen to re-inforce in comments earlier today.

Valuations on many Australian shares now look reasonable given the growth outlook and the relative value against Australian 10-year bond yields at 2.5% is also sound.

When we look to play the bounce, we need to be finding shares that will perform for much longer than any initial snap-back. For this reason we won’t be adding to banks nor miners as we feel the client base continues to have too many bank shares and the miners will likely remain moribund for an undetermined period.

We will be looking for shares with an interesting medium-term growth theme and most likely to go hunting in the domestic services, healthcare or education arena’s for choice.

THE WEEK ON REFLECTION …

It was feeling pretty hairy at about lunchtime on Wednesday, but we seem to have steadied up a little since then to be down 3.5% for the week (2% off the mid-week lows).

In some ways it’s good it got a little hairy because markets don’t tend to bottom until we get a bout of pure fear. There was definitely fear evident here on Wednesday and the 8-10% falls in Japan and Europe this week are also indicative of some major stresses.

Banks …

Banks took the brunt of the selling and led the market lower this week, this in spite of some genuinely reasonable results from Commonwealth Bank (CBA). The driver for this was ongoing offshore banking concerns, with European and US banks heavily hit on concerns relating to the profitability (and ultimately capital viability) of large European banks such as Deutsche Bank, Credit Suisse, UBS & Italian & French majors.

The fall in the banks is simply an extension of the re-pricing of future profitability in light of increased capital requirements and a peaking housing market (and the effect this will have on dividend payouts).

Liquidity issues in foreign banking markets clearly drove the shares this week, but the weakness is simply an extension of the re-pricing of future prospects mentioned above.

However, to my mind it’s largely priced in.

The APRA Chairman Wayne Byres yesterday commented that the Australian financial system was ‘fundamentally sound’ and that recent moves in credit spreads and share prices ‘have been quite manageable’.

The RBA Governor this morning backed these remarks up by saying there was ‘no evidence funding markets for Australian banks are impaired’ and his ‘instinct is that some of the global doom is overdone’.

I have to say, I totally agree.

Australia’s economy and Australia’s banking system is a slave to residential house prices. I have said it a million times.

It is absolutely a risk and house prices are undeniably set to consolidate, but at this stage it is hard to foreshadow anything other than a period of perhaps moderate price falls, which should be well-managed by the banks and their regulatory overseers.

Sector & Stock moves …

Whilst banks were poor, so too continued the malaise of recent market darlings such as Blackmores (BKL, -10% for the week), Challenger (CGF, -9%), QUBE Holdings (QUB, -9%), Mantra (MTR, -9%), SEEK (SEK, -9%) & Magellan Financial (MFG, -9%).

This is encouraging and could well provide a happy hunting ground, in time, for new portfolio holdings.

Computershare (CPU)

A bit of an own goal this week regrettably.

CPU fell 13% after results that led analysts to downgrade future earnings.

Though results were delivered in-line with expectations, CPU management noted a softening outlook and the market didn’t like the ongoing mix shift towards mortgage servicing and the costs associated with this business transition.

The impact of weaker equity markets, lower interest rates and the costs associated with building new revenue streams continues to weigh on CPU and this is something I had not expected to be such a burden.

The debate surrounding ‘blockchain’ and its ultimate impact on CPU’s core registry business is a longer-term issue, but when coupled with the underlying lack of momentum and a shift into more cyclical earnings streams, means investors voted with their feet and sold the stock lower.

I feel CPU is now particularly cheap on 10x future cash earnings, however increasingly I feel the stock has deserved some of this de-rating.

I am on notice here and I’ll report back as and when appropriate, but increasingly I feel this is a stock I have gotten wrong and we will likely look to reduce exposures in time.

Carsales (CAR)

Sound figures and an excellent company, but nothing to change our view that the best buying for this share is lower.

Korean and Brazilian momentum is improving and CAR’s dominance of the local online market is undisputed, but sales momentum on used cars is mixed.

We are comfortable with our recent decision to take profit and think $10 is a level where value again opens up in the name.

Rio Tinto … a precursor for BHP in 2 weeks

RIO actually posted some pretty impressive profit figures relative to analyst expectations and this is something we should be getting used to under Sam Walsh’s stewardship.

The company reduced debt and announced plans for further cost and capital expenditure reductions, but acknowledged this was being done in light of particularly trying industry circumstances.

The main point to note was RIO’s decision to flag a dividend of ‘not less than US$1.10 per share’ in 2016 and a payout ratio targeted at 40-60% of underlying earnings in the future.

This is a near halving of its dividend yield and puts RIO on a yield now of 4%.

Expectations for BHP’s result on the 23rd February are for a similar halving in its dividend, to perhaps A$0.90 a share, which at $15 puts BHP on a yield of 6% fully-franked.

Transurban (TCL), Cochlear (COH), AGL Energy (AGL), Boral (BLD)

Some pretty good results in here amongst this lot.

COH posted some really good implant sales momentum, albeit much of it was into the lower-margin Chinese market.

The real boon for COH has been the AUD weakness and this is where COH were able to raise profit expectations for the current year.

COH however now trades over 30x, which is simply too rich for our blood.

Boral (BLD) has a ripping set of figures and bounced well in spite of weaker markets.

We have had our eye on this one of late, but it hasn’t quite got back to levels we are comfortable paying. We watch this space, as the underlying environment for construction materials remains sound and supported by government policy.

Transurban (TCL) posted some solid numbers and upped their dividend guidance for the year ahead too. Momentum in the business is fine and with bond yields and oil prices low, there is little to expect TCL to do anything other than hold ground here.

However, again we struggle to find merit in the current TCL valuation so are happily sidelined here.

AGL posted sound figures too, though perhaps a little underwhelming given the strong share price performance this past 12 months.

There is no doubt AGL have a stiff breeze at their back, with wholesale electricity prices strong and a new CEO with aspirations for cost-reduction and plans for a ‘greener’ company.

That said, again, we feel the share price is up with events on 15x P/E and a 4% dividend yield.

Next Week …

More of the same! More results and perhaps more volatility, albeit I think the potential is increasing for that volatility to be back on the upside soon.

Telstra (TLS), National Australia Bank (NAB) and ANZ (ANZ), Origin Energy (ORG), CSL (CSL), Challenger (CGF), Magellan (MFG), Woodside (WPL), Sonic Healthcare (SHL) and SANTOS (STO) all report earnings, so it will be undeniably a busy and important week for portfolios.

Conclusion …

It remains tough to generate any outperformance and certainly with markets down 9% YTD portfolios are in an absolute hole.

However, we forewarned of this indifference and feel that we are closer to the end of this squall than the start.

It’s my hope that we will find several opportunities in the coming week or two to make good use of excess cash and in shares that will do well in broadening client portfolio exposure for what will continue to be a difficult year ahead.

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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