Australian Market Summary (Issue 398) – 6 May 2016

Australian Market Summary – 6 May 2016

Well in a busy week, if there was one thing that stood out to be crystal clear, lest anyone is mistaken, was that low inflation, low interest rates and low asset returns are here to stay.

Low inflation, low returns

Firstly, the RBA did the right thing by reducing domestic interest rates to 1.75% on Tuesday, specifically citing Australian Dollar appreciation as a potential complication.

This is the first of two likely rate cuts, the second of which I would anticipate to come on the Tuesday following the Federal Election in July – I suspect the RBA will hold off next month, not wanting to cut mid-election campaign.

Secondly, entwined alongside the interest rate cut, the RBA today cut its core inflation forecast for 2016 from 2-3% to 1-2%.

The RBA are no longer concerned that housing will careen higher.

Recent regulatory efforts to curtail both offshore buyers and investment borrowing appear successful, and with wage growth still mute, the feeling is that even with lower interest rates, house prices are unlikely to take a fresh leg higher.

I agree wholeheartedly.

Australia has now officially joined the rest of the world with inflation figures well under most central bank targets of 2% or more.

Record low Australian Government Bond Yields

Today, after the RBA Monetary Statement in which they cut their inflation forecasts, we have seen Australian government bond yields fall to record lows – 3-year bond yields are now 1.56% and 10-year yields are 2.28%.

Term deposit rates are set to fall.

In fact, returns on most asset classes will similarly fall – property price strength is such that capitalization rates across most commercial property sectors are back to 2007 levels.

Defensive equity streams with high dividend payout ratios should do well – I would note Telstra (TLS) here as a stand-out.

Make no mistake, return on investment is continuing to fall.

Proposed Superannuation Changes

With the promise of lower investment returns already in train, it was far from comforting for most savers to learn this week that a Coalition Government would not only cap tax-free super balances at $1.6m but restrict lifetime non-concessional contributions to $500,000.

A double-whammy if you will.

Looking forward, lower investment returns and reduced tax deductability only makes the need to sweat ones assets all the harder.

Portfolio complacency will be punished infinitely more in the years ahead than it ever has in the recent past.

BHP (BHP) – more negative news

The recent SELL recommendation in BHP seems vindicated with the shares down 12-13% in the past 10 days, in part due to new civil claims against the company relating to the Brazilian dam collapse.

The press reported early in the week that a civil claim had been launched against both BHP and its SAMARCO partner Vale (VALE) for some US$44bn in restitution, a number that at the headline level exceeds the payout made by BP after its Deepwater Horizon oil spill in the Gulf of Mexico several years.

Although it seemed far-fetched, investors took flight.

Adding to the negativity was the 15% fall in Chinese iron ore prices over the past 10 days too, a phenomenon we see as ongoing and fundamental to our pessimistic BHP call.

Telstra capital return pending

At its investor day, this week TLS management confirmed they would return over $1.5bn to shareholders at their full year earnings in August, which is welcome news.

Though the $1.5bn is barely 3% of Telstra’s market value, the news is encouraging and speaks to the strong internal cash generation of the business alongside ongoing asset sales.

TLS is and remains a big, dull, lumbering share and company, but with a defendable 5.8% fully-franked yield against falling local interest rates, we feel the stock is a sound portfolio bet and one that could comfortably see $5.80-6.00 before we would even consider it fully valued.

Woolworths heavily sold, but not sure why

WOW posted its Q3 sales figures on Tuesday, which though still negative in the core food franchise, were no worse than most analysts had expected.

The company committed to additional price investment in the 2H of 2016 to the tune of another $150m, which will definitely positively impact on future footfall and basket sizes and ultimately sales and market share.

Let’s remember WOW is 30% bigger than Coles in super-markets, and has the best sites. So this $150m re-investment should be seen as a serious shot over the bow for competition.

Instead, the market chose to vote with its feet, selling WOW aggressively on the Wednesday, and taking WOW down 10% on the week.

I had to scratch my head. This is indeed a step in the right direction for WOW, and a move that should reap significant benefits in upcoming trading.

The broader General Merchandise business (BIG W namely) was disappointing, and in the same way that the food business is undergoing transformation, so too will GM.

We would reiterate the view that WOW is the single biggest potential turnaround story in big-cap Australian shares, and we feel entirely comfortable in the recent BUY recommendation in spite of share price softness.

Crown Resorts – the takeover jungle drums are beating

James Packer seemingly took another step closer toward plans to take CWN shares private this week, with confirmation that CWN had sold some $1.1bn of shares in its Macanese subsidiary MPEL back to the company.

The sale at market price was instantly earnings accretive to CWN, but far more importantly transfers $1bn+ of debt from CWN’s balance sheet onto MPEL.

The significance of this debt reduction is that it frees up the balance sheet in CWN should Mr Packer choose to want to fund any minority bid through the use of CWN’s own balance sheet.

I feel pretty strongly that a takeover bid for the minority interests in CWN is a certainty, and we will continue to hold on for a bid somewhere in the $14 range.

Bank results – mixed, but a positive reaction

Following a week where Australian bank share price relative performance weakened to a 2-year low, we saw some respite for shareholders in the major banks this week.

All the major banks saw signs of a worsening in credit quality both within the corporate and retail arena, albeit no worse than expected.

Similarly, non-interest income (fees on banking and wealth management etc) was a disappointment across the sector.

Westpac (WBC) and ANZ (ANZ) saw slightly worse net interest margins than expected, though NAB held firm. This last point ensured NAB continued its recent run of outperformance within the sector.

Though ANZ chose to rebase its dividend by perhaps 8% or so (80c for the interim, and the promise of 80c+ in the 2H), the result and the strategic direction senior management plotted in their presentation seemed to be taken well by investors.

I will leave it here for now.

Have a terrific weekend.

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