Australian Market Summary (Issue 412) – 12 August 2016

Reporting season is underway, so there is a lot to remark upon.

The market this week is largely flat, but within it we saw some crazy moves as traders guessed and second-guessed as to what was priced into many expensively priced shares. (CAR) was the pick for mad moves.

Having delivered perfectly in-line and dull figures, the stock fell 7% before then rallying 10% intra-day to close up on the day. On the week, peak to trough, the stock traded almost a 20% range despite delivering profit figures smack bang in-line with expectation.

It’s a good stock and company, but it’s way too rich for our blood here.

Cochlear (COH) and REA Group (REA) were others to demonstrate ‘odd behaviour’ for want of a better description.

REA blamed the election for the 11% fall in July real-estate listings (as did Fairfax) and, after falling 10% in response to this business deterioration, all was forgiven and REA actually closed the week up. Odd.

Again, its 15-20% too rich for me here.

Before we get into the corporate nitty-gritty, on the economic front, the week was notable for the ongoing melt-up in the Australian Dollar to 77c.

Also of note, the NAB Business Conditions index for July saw a bit of a knock and is now at a 6-month low. This bears watching for many reasons, not least of which being employment.

Ok… now let’s jump into the shares.

Telstra (TLS)… rising capital intensity

Telstra (TLS) was a modest disappointment this week, lagging the market after management confirmed a rise in capital intensity.

The operational results were largely in line, but the market seemed to take issue with the upping of annual capital expenditure by $1bn for the next three years.

At a headline level I can understand how the market might view this negatively initially, since greater

capital intensity lowers returns to shareholders by definition. However, in another sense the commitment to network quality should give comfort to investors as to the longer term asset longevity of its mobile and data assets post the full rollout of the NBN.

The stock looks cheap at the margin at $5.40 given its 6% full-franked yield and mid-teen P/E multiple and we will continue to persist with it for a $6.00 target price.

Australian Banks … a changing of the guard?

The banks were interesting this week. ANZ (ANZ) and National Australia Bank (NAB) outperformed, whilst the former market darlings, Commonwealth (CBA) and Westpac (WBC) lagged.

The moves were deserving too.

ANZ were actually OK.

Sure, the trends are against the sector, but since ANZ are desperately keen to shed low-returning and capital intensive lending (Asia & institutional), they managed to deliver a balance sheet de-gearing without negatively impacting net-interest margins.

What was once a negative, is now proving a positive.

It was the opposite at WBC & CBA, both of whom saw fee pressure negatively impact and concerns arising as to mortgage pricing.

Where CBA and WBC have commanded premium multiples given their heavy domestic housing exposure, with that secular trend now turning against them, it’s quite possible we see a continued burst of performance from ANZ and NAB (note NAB release their trading statement early next week).

Commonwealth Bank (CBA) in greater detail

CBA results were as ho-hum as I can remember in the three years I’ve been in this job.

Certainly if you look at the second half trends relative to the December half, pressure on the core business is becoming more apparent.

Most analysts seemed to downgrade EPS by 2-4%, with fee income notably slowing (less lending, capital market activity impacting fees).

CBA’s reliance on mortgage brokers is a concern (lower margin) and its growth in lower-margin institutional lending (the opposite of ANZ), also casts a shadow over future earnings quality.

Costs were good, capital generation was OK, but one can’t help feeling that CBA are now beginning to face the pressures already born out in results from their competition.

On a side note… banks & the economy

The decision by CBA and several other banks to raise deposit interest rates after last week’s RBA rate cut will bring additional funding costs to the banks.

Supposedly the deposit rate rise was spurred by concerns within the banking sector executive that the continued collapse in cash rates could cause significant depositor flight precisely at a time when the banks are being forced to bolster their funding (by way of capital raisings).

Raising deposit rates is a costly means of insuring against the loss of this formerly cheap funding.

Like the economy to which it is a major contributor, the banking sector is increasingly like the frog in the boiling water – the heat is escalating, but thus far it feels manageable.

On a side note, personal loan arrears are rising as they have done for several halves and should be something to watch.

Personal loans tend to be the first debts to sour as household incomes tighten and they are indeed slowly creeping up.

I would also point to statistics I have that demonstrate credit card utilization increasing.

The RBA Governor Glenn Stevens spoke to these various points (for the umpteenth time) in his swan-song address this week.

Household debt is rising and the tailwinds behind our expansion are diminishing.

Fiscal expansion is really the last hope, but like most countries around the world (ex-China), our government remains largely unresponsive. This is as much because WE, the electorate, have been led to believe it’s a bad thing (thank you Kevin Rudd for your fiscal incompetence and thank you Tony Abbott for convincing us that all fiscal spend has to be Rudd-like).

It isn’t. Not all fiscal spending is created equal. I’m poking fun, but I think you get the gist.

As a whole, Australia is slowly but surely eating into credit to sustain its current standard of living. Our trade balance points to expenditure in excess of exports receipts, investment incomes are falling alongside the cash rate and the longer the AUD remains stubbornly high, the less momentum felt in domestic activity and wages.

This is the road we are on and though it might still seem like a long journey to the destination, be sure, we are on this road.

Computershare (CPU) some respite

Computershare (CPU) were a surprisingly bright spot in this week’s reporting, albeit the stock remains at or below where we recommended SELLING positions.

CPU’s core business hung in slightly better than everyone thought in the second half.

Furthermore, guidance for 2017 of ‘slightly up’ earnings-per-share indicated a continuity of the sound second half performance.

The stock is nominally cheap, but I still struggle with the erosion of its core registry cash-cow and the replacement of high-margin/quality earnings with newer earnings streams.

For this reason, I remain pretty comfortable with our decision to take the hit on CPU and to leave this stock for much lower levels.

Fairfax (FXJ) snatching defeat from the jaws of victory

Fairfax (FXJ) disappointed in spite of sound performance from its business.

Analysts have downgraded earnings by around 4-5% after the figures in which the legacy metropolitan media assets fell even faster than the declines expected. is now seen as being worth the entirety of the current FXJ share price, so the media assets are indeed being given a low value.

However, the company followed REA’s guidance from last week that July listing volumes for real estate had been notably weak (election impact they say), which makes me think FXJ have missed the boat in timing best the supposed spin-out of the Domain asset.

We are happy to sit on the sidelines here and would need the stock a good 10-15% lower to feel there was credible upside to play for.

Mantra Group (MTR) … a new BUY.

Hopefully you all saw Thursday’s BUY recommendation on Australian hotels operator Mantra Group (MTR).

This fits the bill for us in that it is a well-managed, under-geared company with a strong suite of assets and operating with a significant industry tailwind.

Year-to-May international passenger growth into the Gold Coast and Cairns airports was +15% and 25% annually, supporting the strong ‘resort’ operation MTR has through Queensland.

Results are due next Friday which we think will be good and we think the stock should again ascend its previous highs near $5.00 over the coming 2 years, providing investors with a 50% return.

AGL Energy (AGL) … disappointing

AGL Energy (AGL) were a mild disappointment.

Rising wholesale electricity prices have given fuel for optimism (our reason for buying the stock in Sep 14), however this failed to translate into reported numbers nor guidance for 2017.

Additionally, the company’s focus on ‘growth’ means the $2bn they see as ‘headroom for growth’ is likely to be re-deployed into the business (our reason for selling in July 15) and unlikely to be returned to shareholders.

We would certainly happily re-consider the stock nearer $18.00 given the strong pricing outlook and good balance sheet, but in the near term, though improved, AGL’s risk/reward is still mixed.

At $18 AGL would look good value on 15x and with a 4%+ dividend yield in 2017, growing further into 2018.

Next Week … more of the same.

See the table below, but notable results for us and the market next week are Sonic Healthcare (SHL), BHP (BHP), National Australia Bank (NAB), Crown Resorts (CWN), CSL (CSL), Insurance Australia Group (IAG) and Mantra Group (MTR)

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