Australian Market Summary (Issue 437) – 24 February 2017

 Another busy week, but fortunately a better one on the whole for most of the names in our share portfolios.

Reporting season done, likely consolidation now

Reporting season has now largely come to an end, and looking forward investors will again re-focus themselves on the macroeconomic outlook in the coming months.

Globally the big focus will be on the March Federal Reserve meeting (March 16th) in the U.S. with an increasingly real prospect for interest rate tightening then.

Locally, the economic data is mixed as I have said numerous times before. This week’s decision to reduce penalty rates for casual workers is another knock to consumer confidence, and could precipitate additional weakness in consumer demand near term.

Equities have rallied significantly since the US election and are +9% higher since November 11th.

Australian equities have outperformed bond indices by +15% in that time, and it would seem fair to expect some consolidation.

Miners and banks have led the market, but in recent days the mining sector has begun to consolidate.

Chinese iron ore and steel inventories are significantly higher than they have been in recent years (iron ore is at a record, Chinese finished steel inventory is at a 3-year high), and now is seasonally the time when end-users in China begin to drawdown on inventory, alleviating end-demand for steel and its inputs.

Banks too are back at their highs. Results from the sector were fine, and credit quality was a notable standout, but revenue growth remains elusive.

Commonwealth Bank (CBA) is now back offering only a <5% dividend yield and on 15x P/E despite the absence of earnings growth in the coming 2-years.

I guess the question again becomes, ‘where’s my upside as an equity investor?’.

It’s a question I regularly pose on Australian shares, and with the market at its highs it’s again pertinent.

The weight around our legs – lack of earnings growth

I am constantly asked why our market hasn’t recouped the highs of 6800 it reached back in 2007, and yet the US market is some 60% or more higher, and there’s a really simple answer – we aren’t innovating and we aren’t growing.

Australia’s market is and remains dominated by banks and miners and a couple of cozy duopolies.

On Macquarie Bank’s estimates, Australian shares excluding the banks and property trusts will demonstrate virtually no earnings growth between 2017 and 2019.

What makes it a potentially dangerous market in the longer term is that it is still incredibly ‘over-owned’ by domestic investors.

Again, this is a well-worn case I have made and will continue to make.

We are the fourth biggest pension market in the world, but our share-market is only the 13th biggest.

Australia’s share-market value comprises only 1.5% of global share-market values.

And yet Australia’s low-growth blue chips dominate domestic superannuation portfolios.

Being ‘over-owned’ tends to make our shares expensive.

In trying to cram all of our pension savings into the domestic share-market and to accumulate cherished franking credits, Australian shares trade expensively in spite of their absent growth.

Many large Australian companies, including some we own, trade well over 20x earnings in spite of tawdry earnings growth.

Yet offshore, you can buy big-pharma companies for 14-15x earnings, consumer brands, banks and technology names all at a discount to Australian multiples.

Facebook (FB) trades on 20x 2018 earnings as an example.

This is precisely why Australia’s Future Fund holds only 7% of its portfolio in Australian shares.

Look, the simple point to note after this reporting season is that earnings growth (excluding the miners bounce) still remains hard to come by locally, and until that changes, Australian shares are going to continue to lag their offshore peers.

This is going to be a long-term and highly relevant theme, and we will continue to bang the drum on this for as long as it remains pertinent.

You’ll note we recently advised for clients to raise their foreign equity exposures to as much as 50% of total equity portfolios.

Corporate Profit results this week

<Crown Resorts (CWN) were a pleasant surprise this week, and some modest respite for long-suffering shareholders like ourselves.

Operationally CWN continue to suffer from a drought of VIP patronage in the wake of staff arrests in China, and the main floor at Crown in Melbourne is also absent growth from regular ‘grind’ gamblers.

However more interesting was the volte-face in corporate strategy, with CWN declaring a focus on its domestic Australian assets and a desire to reap the cash-flows they continue to provide.

Having sold much of their Macau stake late last year, CWN declared an 83c special dividend (60% franking, making the grossed up value $1.04) and an intention to pay 60c annually (60% franked).

It also announced a $500m share buyback, which at last price of $12.40 is worth over 5% of the company.

The shares go ex-dividend on Wednesday next week.

We think shareholders will reward the company with this new change in strategy. CWN will become a domestic casino property play with low gearing and a 5%+ dividend yield going forward.

With the buyback behind it in the coming months, I fully expect CWN to outperform.

SEEK (SEK) reported sound profits this week too.

You’ll note we published a BUY recommendation on SEK late last week that unfortunately coincided with SEK’s announcement of its intention to buyout the minorities in its rapidly-growing Chinese job portal, Zhaopin.

For those of you that followed us on our decision NOT to chase the shares higher on that announcement, and instead to buy in the $15.30-15.50 range, you have been rewarded.

SEK traded $16.00 during the week, and is now 3-4% above our buying levels.

We feel really strongly that this is a stock for portfolios in the coming 12+ months, and we would encourage those of you yet to add it to portfolios to consider placing limits to buy at $15.50 or less.

Regis Healthcare (REG) was another positive result this week, and though the shares are today flat, they are indeed +4% higher on the week.

REG delivered strong and sound profit figures and though 2018 profits will be impacted by tightening government reimbursement thresholds on aged-care services, we see REG continuing to emerge as the gold-standard in aged-care, and with an exceptional pipeline of growth projects (over 20% growth in new beds).

Woolworths (WOW) were also solid and the shares are beginning to really work as an investment.

WOW Food operations are hitting their straps in terms of customer and staff engagement and cost-of-goods efficiencies. Second quarter like-for-like sales growth of +3.1% was well ahead of analyst forecasts.

Cash-flow generation was another constructive feature of the results, and but for the continued disappointment of Big W profits, WOW profits would have been even more impressive.

WOW has outperformed the market by +12% since December and we think there is further upside to $28 before we would look to trim holdings.

Rounding out a week of constructive results, QUBE Holdings (QUB) and Woodside (WPL) delivered in-line figures.

There was little to remark upon with QUB in terms of new information, but we feel convinced of positive news-flow from their Moorebank terminal asset during 2018, and likely tenancy agreements that will underpin confidence in the value of this tremendous long-term asset.

WPL were similarly solid and have done an excellent job at cost reduction as an offset to this past year’s low oil price.

With the oil price now stable in the mid-$50’s after OPEC’s successful production cuts, WPL actually looks set for further upside into the mid-$30’s, so we would advocate for investors to hold on until we see $33-35 for WPL.

Our preference in the sector continues to be Oil Search (OSH), and though its profit figures this week showed an uptick in production costs, everything else on the OSH story continues to develop constructively.

OSH increased its proven reserves by 50% late last week, and this week announced an uptick in drilling to prove up the size of its Muruk gas discovery.

The prospect of a low-cost expansion of the PNGLNG facility is now shaping as a foregone conclusion, which will make OSH one of the largest and lowest cost regional LNG producers for the coming 20 years or more.

And yet, OSH now trades at near enough to a 6-year relative low to the ASX200. OSH is and remains a standout BUY in the low $7’s, and I firmly believe that if the shares don’t start to push higher in 2017, its Papua New Guinean business partners (Exxon & Total) will surely take the company over given its outstanding prospects.

Having had a more fortunate week on results in the most part, I left the one blight on portfolios until the end.

Blackmores (BKL) continue to be confined to the naughty step, and were down -12% on the week.

I concede we have been too early on BKL (not unlike REG) and regret that positions are under-water, however much like the recent rebound in REG, I remain firmly confident that BKL is closer to turning a corner operationally than it has been in 12 months.

In this week’s BKL results profit and sales figures were actually in-line with analyst forecasts, however an extension of its inventory issues from mid-2016 saw cash-flows deteriorate as BKL were forced to pay suppliers for over-ordered stock.

This will ease in due course.

As a result, I feel the sell-off this week was overdone, and we are more likely than not to add to BKL holdings at $100. In fact, the CEO Christine Holgate chose to do much the same, buying over $100,000 worth at $104.

Stay the course.

I think that rounds out my comments on the reporting season.

There are quite a few companies we are looking at with a view to perhaps adding them to portfolio’s, much like what we did with SEEK. Again, price is vital.

We have mentioned James Hardie (JHX), but Tabcorp (TAH) is a fresh one that might be interesting for yield-seeking investors nearer $4.00.

One name that stands head and shoulder above the rest, but regrettably we recommended well above here, is Mantra Group (MTR). If you haven’t bought that yet, you got lucky, but you should take a closer look here.

MTR trades 14x 2018, has a terrific balance sheet and concerns around its CBD hotel portfolio should now start to lift as corporate spending stabilizes.

The resorts business is going gangbusters and ought continue to do so.

Take a look.

Anyways, that’s me done. Have a great weekend.

Jono & Guy.

All Ordinaries5799-56-1.0%
S&P / ASX 2005750-59-1.0%
Property Trust Index1368-5-0.4%
Utilities Index8143-152-1.8%
Financials Index6663-49-0.7%
Materials Index10021-397-3.8%
Energy Index9029-97-1.1%


Key Dates: Australian Companies

Mon 27th February  Div Ex-Date: AGLHA, WBCPD, Coca Cola Amatil (CCL)

Tue 28th February  Earnings: Harvey Norman (HVN) Div Ex-Date: Bega Cheese (BGA), Insurance Australia Group (IAG), NABPB, Navitas (NVT) Div Pay-Date: Ardent Leisure (AAD), Charter Hall (CHC), Dexus (DXS), Scentre Group (SCG), Westfield Group (WFD)

Wed 1st March  Div Ex-Date: Crown Resorts (CWN), Telstra (TLS), NABPA Div Pay-Date: ANZPC, ANZPD

Thu 2nd March  Div Ex-Date: Bendigo Bank (BEN), Bluescope (BSL), Fortescue (FMG), Woodside (WPL), Woolworths (WOW) Div Pay Date: Magellan (MFG)

Fri 3rd March  Div Ex-Date: REA Group (REA), Treasury Wine (TWE), CWNHA, CWNHB

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