Australian Market Summary (Issue 444) – April 13th, 2017

Another busy week with disappointment felt for Telstra (TLS) shareholders, some interesting proposals put to the BHP (BHP) board, a continued collapse in iron ore prices, an explicit recommendation by Chris Richardson from Access Economics to young Australians right now ‘not to buy property’ and lastly a surprising, and perhaps encouraging jump in March full-time employment.

I will walk through most of these issues today before we sign-off for the Easter weekend.

One step forward, two steps back?

Telstra (TLS) – a 4th mobile competitor

Telstra (TLS) proved the cause for consternation this week, falling 8% after it emerged that TPG Telecom (TPM) had acquired some high-profile mobile spectrum that would allow it to build a 4th Australian mobile network.

Such was the aggressive price paid by TPM ($1.26bn for an 11-year license), investors fear that for TPM to stand any chance of recouping the spectrum costs, they will be forced to aggressively chase mobile subscribers.

TLS was forced 6% lower on Thursday when the news emerged, whilst alternative telecoms rival Vocus (VOC) fell 12% after the announcement.

VOC is down 30% in a little over a week.

The whole situation is a fascinating one to watch, albeit a frustrating one in which to be involved from the viewpoint of investment.

TPM’s mobile network is still at least 3-years away, and TPM still have the mammoth task of building out all of the base stations to serve the future customer base.

TPM’s claim that they can set up a network to service 80-85% of the population for as little as $1.9bn seems awfully low, particularly when you consider that TLS and Optus spend $1bn annually in servicing their mobile networks.

But investors have decided to shoot first, ask questions later.

It seems that TPM are in some respect hopeful of a favourable regulatory decision by the ACCC later this year that would see TLS capped on the price it can charge other operators to roam on its mobile network. Given the comprehensive network coverage of TLS, TPM are likely hopeful that a favourable decision here will allow them to get the benefit of full coverage at a fraction of the invested cost.

This is a tricky and speculative move, and TLS have a strong argument to claim that they have indeed invested heavily in their proprietary network and hence deserving of a lighter regulatory touch.

Either way, the endgame is that TLS is now down at $4.20 and offering investors a fully-franked dividend yield of at least 7% for the coming 2 years to our mind.

The TLS balance sheet is in sound condition with only $14bn in net debt and in the coming 6 months we expect a potential capital return associated with the securitization of the government’s NBN access payments to TLS.

Although not entirely comparable, there are similarities between the way TLS shares have been sold down and those of Woolworths (WOW) 18-months ago.

All is not lost, and for choice we are strongly of the view that for those capable of adding to their position in TLS (equity portfolio weight no larger than 10%) they could and should do so at $4.20.

BHP (BHP) – activist shareholder Elliot makes a proposal

Well-known and well-regarded global hedge fund Elliott Advisors this week published an open letter to the BHP board seeking them to consider the collapse of BHP Billiton’s dual-listed-company (DLC) structure and to spin-out the U.S Petroleum business by way of a separate U.S listing.

Elliot claim that by doing this BHP could see almost 50% upside in share price terms over the coming 5-years.

It’s a tricky one. Firstly 50% over 5-years isn’t as impressive as it sounds.

Secondly, it is debatable whether the separate listing of the North American oil assets would elicit any value uplift whatsoever.

And thirdly, and this is the million dollar question, if BHP were to collapse its increasingly outdated DLC structure, would the costs associated with the change outweigh the benefits?

The BHP board seem to think so, and hence they issued a polite but firm rebuttal to Elliot this week, saying that the board have considered and continue to consider all of the proposals made, but at this point consider the suggested benefits to be insufficient enough to warrant pursuit.

The reason for the Elliot letter (which incidentally backs up a 4.1% holding in the company by way of the UK listing – and this is important) is that BHP’s Australian business is accumulating significant franking credits by way of corporate tax paid here, and hence is struggling to disseminate them given the UK-listing shareholders don’t value the credits and would need some form of make-good payment in lieu.

Largely on account of this discrepancy in the franking situation (amongst other items), BHP shares in London trade at near a 20% discount to the Australian shares – remember that Elliot own their holding in BHP via the UK plc share (the one at a 20% discount).

Make sense now?

The endgame is that most investors would like to see the DLC structure collapsed in order to more proportionately distribute the accumulated franking credits, but for tax and political reasons it continues to be far from simple.

BHP have batted this week’s suggestion into the long grass for now, but the proposal is sure to be given further oxygen in the months ahead, and that is a good thing for BHP shares.

However, a much bigger issue for BHP shares this week, and indeed for the other miners too, is the collapse in iron ore prices from nearly $90/t in February to $64/t today.

Had the Elliot proposal not been announced this week, I’m pretty sure BHP’s share price would have been down a lot more than the 1% it currently is.

BHP has further to fall.

House Prices

A good article and discussion from Chris Richardson at Access Economics this week about house prices, and the headline he made Wednesday to young Australians ‘not to buy’.

For those of you interested, it is well-documented in the Australian Financial Review.

Further on house prices this week is the rather quizzical debate on whether the coalition should consider the idea of allowing young Australians to use their superannuation as a means for buying a house.

Let’s see where this one goes, since the PM is on the record as saying this is a ‘dumb idea’, and I have to concur, albeit I would probably argue the point a bit more strongly.

The point on all of this is that the jungle drums are now beating on housing as they rightly should, and you ought expect to see a gradual softening in house price momentum in the months leading into Spring auction season.

Just on a related point, this week we had February housing finance figures out and they slowed rather significantly even before the impact of APRA’s ‘speed limits’ announced 10 days or so ago.

For some context, owner occupied lending rose +1.5% annually, well below the +14% growth on investor lending (down significantly from the previous month in the high 20%+ growth range YoY).

First time buyers as a % of all new loans are just shy of a record low at 8%, and just a fraction of the still 40% of loans that are being written to investors.

Again, mind your eye on negative gearing as the 2019 Federal Election draws closer and if Labor retains its lead in the polls.

Employment surged in March … apparently

March jobs figures were released today and saw a RECORD rise in full-time employed during March.

The number is encouraging, but carries with it some doubts as to its veracity. Let’s see next month since several economist have argued of a seasonal bias to the survey that means we could see negative revisions in the months to come.

But for now, lets treat it as the positive we should.

Certainly it gives us greater confidence in our recent recommendation to BUY SEEK (SEK), which is now up almost 10% since the recommendation, inclusive of its interim dividend.

Some stocks to keep an eye on in the coming weeks

With the market near its highs, you wouldn’t be surprised to hear there are a few companies we are watching with a view to book some profits.

Transurban (TCL) has risen 15% since our BUY in September, and it has paid out 25c in dividend in that time too.

North of $12.00 we are contemplating how much additional upside there is in the share near term, and could be minded to take profits.

Crown Resorts (CWN) is also moving higher and as we stand today, trades at $12.16 ($12.99 inclusive of the 83c capital return). Another 50c or so in CWN and this could be a good level to exit what has been a frustrating position for us over the past 2 years.

Woodside Petroleum (WPL) is now over $33 and benefiting from the rising oil price. A move into the mid-$30’s could be a good time to reduce positions here.

Oil Search (OSH) remains our preferred oil bet.

Lastly, Woolworths (WOW) is only 5% away from our target levels, though we expect its quarterly sales figures on May 2nd to provide us with the share price spur to that level. But again, it is worth being on top of.

On the buy side we continue to advocate for Healthscope (HSO), Mantra Group (MTR), Blackmores (BKL) and this week, we think TLS is also a good level to buying more.

To everybody, a happy long weekend. Speak next week.

Jono & Guy

Financial Services Guide Update

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Thursday 11am Values

All Ordinaries5923+3+0.1%
S&P / ASX 2005886+7+0.1%
Property Trust Index1440+28+2.0%
Utilities Index8914+12+0.1%
Financials Index6857+59+0.9%
Materials Index9888-68-0.7%
Energy Index9505+96+1.0%

Key Dates: Australian Companies

Tue 18th AprilN/A
Wed 19th AprilDiv Pay-Date: SEEK (SEK)
Thu 20th AprilDiv Pay-Date: Vanguard ETF’s (VACF, VAE, VAF, VAP, VAS, VGB, VGE, VGS,)
Fri 21th AprilDiv Pay-Date: Vocus (VOC)

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