Australian Market Summary (Issue 388) – 26 February 2016

I hate having a bad week.

In my job sadly, it’s pretty public.

The market had a pretty rubbish week too and at the moment is trading under some pretty pessimistic skies.

This week and month was proof positive of the need for portfolio diversity, since Banks, Telstra (TLS), Wesfarmers (WES) and BHP (BHP) have all been rubbish.

I never thought I would be an apologist for the Australian share-market, what with all my criticisms of its lack of diversity this past 18 months, but the overt negativity surrounding the Australian bank sector in particular this week seems grossly overdone.

The global economic backdrop in my mind is deteriorating (see the international section on US economic figures) and that makes it very hard to be constructive or optimistic for shares.


More interest rate cuts are coming …

In Australia, we have a boatload of levers to pull to defend the economy, certainly relative to our neighbours overseas.

On this note, I would point out that with the Australian dollar creeping back up above 72c (where are all those people calling for a collapse to 60c now?) the prospect of a renewed set of interest rate cuts is on the cards.

This is a total change of view for me, so it is important to note.

I would think there is increasing potential for the RBA to consider lowering interest rates as early as Q2 and this would be accompanied by continued vigilance on the regulatory front insofar as bank lending volumes and standards.

A cut in interest rates would be a positive and a positive for bank shares and interest rate sensitives such as Telstra (TLS), Transurban (TCL), Sydney Airport (SYD) etc etc.

The RBA won’t say much new next Tuesday, but I’ll bet there is an increasing slant in their remarks towards their ability to further ease as necessary.

‘The Banks’ … the press embarrassed themselves this week.

The Fairfax media and Channel 9 this week demonstrated the shortcomings of current journalism, promoting some hugely self-serving reports on a supposed Australian house price bubble.

It seems you don’t have to have a critical eye in much of the media these days, so perhaps I shouldn’t be surprised by the TV ads and newspaper headlines speaking of Australia’s ‘Big Short’.

Anyways, suffice to say that though Australia’s house prices definitely have room to pull back in the years to come, the suggestions of a house price collapse and that the ‘banks will cease paying dividends’ is a touch embarrassing.

Go and check the CBA half-yearly result to see the underlying credit quality of its housing loan book.

Over 78% of borrowers are ahead of their minimum payment.

The 90+ day ‘arrears’ data for CBA shows virtually no change in the 1H 2016 figures since 2013.

The average Loan-to-Value (LVR) is 50% – and anyone who has a mortgage knows how the banks frustratingly low-ball your properties value!

Again, I see the irony in my defending of the banks given that I have spoken until I’m hoarse of the over-concentration of banks in private portfolios, but these things here are very oversold.

National Australia Bank (NAB) is now at a 5-year low to the ASX200. It trades on 9x P/E and even with a 10% dividend cut would still yield north of 10% gross per annum.

And, will be hugely benefited by interest rate cuts later in the year.

But I can’t tell you all to buy them, because the vast majority of the investor base own too much already – which is part of the reason why the selling has been so harsh.

What I can do, is tell you not to panic and to laugh as hard as I did the next time 60 minutes or ACA wheel out their self-serving experts on the next sensationalist topic (I should make a point of note, that I hold John Hempton’s work in general in very high regard, but the other guy from London… well, he has newsletters to sell).

Woolworths (WOW) … new CEO & results. Impressive performance from new CEO.

Today’s WOW figures were in-line with market forecasts.

Encouragingly for WOW, transaction volumes turned positive during Q2 – the next step and more important, is driving ‘basket’ growth.

Quarterly sales figures for WOW on the core Food & Liquor business improved modestly on the previous period, but are still negative 0.6%.

The initial disappointment today, however, came with the appointment of an internal candidate to the CEO role, disappointment I might add that I think is overdone.

Brad Banducci currently runs the Food business for WOW, but has only been in that role for a year. Previously he ran a hugely successful turnaround in the WOW Liquor business (Dan Murphy & BWS) and is seen to be a very capable head at the helm.

I repeat my view that WOW is a tarnished gem of a business and with the closure of Masters and a new CEO and strategy for the core Food business, a really cheap long-term position.

BHP (BHP)… disappointing

Where to begin?

The decision to re-base the dividend to a 50% payout ratio, not unlike RIO at 40-60% was sensible, but brought about a significantly larger dividend cut than I and the market anticipated.

The dividend forecasts this year and next now point to a US20-40c dividend per share, or a yield of 2-4% at best.


I would stress that if you have one of these portfolios, please give your adviser a call to discuss income alternatives.

Beyond the income cut, the results themselves were broadly in line.

The decision to replace the divisional heads of iron ore and petroleum (BHP’s two largest divisions) doesn’t send an overly warm message to the market.

BHP is a stock that looks around fair value here to me and not a shade cheap the way I thought nearer $19-20.

I got that wrong.

If the stock was to push back nearer $20 we would likely be sellers.

The fast money round… results remarks…

Flight Centre (FLT) – fine, reiterated profit guidance. The Australian & UK businesses were good and the US was poor.

The business is continuing to grow, but with increased capital intensity. It seems to me the market won’t credit the share with the growth angle, but fixates on the negative being margins.

On 14x and with 10% of its market-value sitting in cash on the balance sheet, the stock is still too cheap.

It has outperformed the ASX200 20% since we bought it in early December and I would think we would need to see $45+ before rethinking our position.

IOOF (IFL) – excellent cost performance. Just a really boring, conservative, well-run business that is too cheap in the low $8’s.

Investment market performance will be a drag in the coming 12 months, but with the strong work on acquisition cost synergies, the share looks sound.

Target $9+

Crown Resorts (CWN) – a touch disappointing that higher corporate cost growth (Mr Packer’s follies) overshadowed reasonable domestic Australian casino profits.

We still think there is a better than even money chance CWN gets taken private at $14+ and for that reason remain very comfortable with our core position.

Encouragingly too, the Macau gaming sector is beginning to show some positive momentum for the first time in well over 12 months and this will benefit Crown’s substantial associate income from MPEL.

Blackmores (BKL) – a little on the light side for profit figures and some burgeoning concerns of a near term regulatory change that could impact their distribution channels into China.

But, the stock is still doing great volume growth and having fallen 20% in a month, it gets more interesting the more it falls.

We are watching it, but would think <$150 (another 10%++ to fall) it may be interesting to consider.

Wesfarmers (WES) – typical WES. Excellent Coles and Bunnings figures, but a sloppy set of figures from the resources business.

I shook my head at the share price response after the figures, as it was proof positive to me at least that this market was simply ‘too hard’!

I have had reservations over the value of WES for months and flagged that a move to $45 post results would see us look to take profit.

In my wildest dreams I didn’t expect the market to take WES down 10% in the 2 days post ‘in line’ results.

Urgh. It’s too hard. Anyways, the same view applies – WES is an excellent business and should trade cheaply at $35 and rich at $45.

We prefer Woolworths (WOW).

Adelaide Brighton (ABC) – profit in-line and another special dividend (extra 4c) from ABC.

The outlook continues to be sound for both price and volumes as east-coast engineering and infrastructure work remains solid.

But the stock is on 16-17x, so we feel vindicated with the idea of taking profit on this stock earlier this year.

RESMED (RMD) – announced the US$800m acquisition of healthcare software provider Brightree.

The deal is accretive, but I am pretty happy we have exited our RMD position having looked into this deal since; a) the size of the deal has forced RMD to cease its share buyback and b) the acquisition takes RMD into a different industry segment.

Brightree is not a device player, but instead a supplier of billing and practice management software to Home Medical Equipment Suppliers (RMD’s customers).

Happy to leave this one for now.

It was a busy week and not a week nor month where I feel we covered ourselves in glory.

There were some winners and some disappointments, but I still feel comfortable that with patience the right calls will come to us.

We are retaining a conservative and high cash bias in both the PRIME Australian Equity Growth & Income portfolio’s and continue to expect indifferent markets in the months ahead.

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