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Hidden Barriers – The Sequel

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Always an independent thinker, Rudi has not shied away from making big out-of-consensus predictions that proved accurate later on. When Rio Tinto shares surged above $120 he wrote investors should sell. In mid-2008 he warned investors not to hold on to equities in oil producers. In August 2008 he predicted the largest sell-off in commodities stocks was about to follow. In 2009 he suggested Australian banks were an excellent buy. Between 2011 and 2015 Rudi consistently maintained investors were better off avoiding exposure to commodities and to commodities stocks. Post GFC, he dedicated his research to finding All-Weather Performers. See also "All-Weather Performers" on this website, as well as the Special Reports section.

Rudi's View | Jun 03 2015

This story features MEDIBANK PRIVATE LIMITED, and other companies. For more info SHARE ANALYSIS: MPL

In this week’s Weekly Insights:

– Hidden Barriers – The Sequel
– Hope And Pitfalls For Resources Stocks
– Questions Around BHP Dividends
– Share Buybacks – Who’s Doing It?
– Rudi On TV
– Rudi On Tour

Hidden Barriers – The Sequel

By Rudi Filapek-Vandyck, Editor FNArena

On April 20 this year I published “Hidden Barriers”.

In it I lined up a number of stocks whose share price appeared to be held back because of issues that were not immediately clear from their operational performance or from public statements.

Today’s follow-up adds more stocks to the original list.

Medibank: A Promise That May Not Deliver

Medibank Private ((MPL)) listed in late 2014 amidst a lot of hype, market noise and widely held expectations about cost cutting, growing margins and further sector consolidation.

One of the predicted outcomes post listing is that fund managers were left scrambling for stock, and scramble they did. Add quick index inclusion and the share price went parabolic, at first, reaching $2.55 by February and again in early March, but it’s been one direction south since.

On Monday, while I am writing this, the share price closed at $2.08. Medibank has not paid out a dividend since listing yet, so institutional shareholders whose IPO allotment price was $2.14 are now underwater while retail investors, having received pre-IPO shares at $2.00 are still above water, but only just. This assuming they didn’t buy shares post listing at higher prices.

On FNArena’s observation, analysts have kept their estimates pretty much unchanged since February, so what exactly is going on?

In one word: general scepsis. It’s ok to list with a lot of potential on the back of seeking operational efficiency and further cost reductions, but if changing market dynamics are keeping top line growth under pressure, doubt will creep into the market’s mind at some stage. And doubt has come in spades in past weeks.

Analysts at Morgan Stanley produced the chart below and it immediately makes clear where exactly Medibank’s key problem is situated: market share is declining as competition is getting fiercer. This is exactly the opposite as what investors were expecting at the time of listing. Medibank is doing a Woolworths. Management better turn this trend around, and quickly.


 

The month of June is traditionally an important one for the industry. Medibank generates circa 20% of total annual sales in this one month, driven by “get in before end of financial year” advertising. A good outcome for June should therefore be well-received by the share market, but Morgan Stanley analysts (and others) are rightfully commenting one good June sales report won’t fix the medium to longer term question marks hanging over the business.

One of the problems plaguing Medibank is that discount brand ahm continues growing strongly (at some 20% annualised) but at (much) lower margin and potentially while partially cannabilising the core Medibank brand.

How to stop margin decline, while taking back lost market share and continue promoting ahm? That remains the big question mark and investors will want to hear some solid plans and achievements from management come the August reporting season. Until then, don’t expect a swift reversal in the downward trend for the share price.

Fellow-health insurer NIB Holdings ((NHF)), which had a marvelous experience as a listed entity prior to Medibank’s ASX introduction, has managed to recover from the early share price weakness because of Medibank, but flatlining is the best description as to what has happened to its share price since February. Flatlining is not too bad given the extreme volatility for the share market post March, but will it last?

At present, analysts are visibly taking a more cautious approach towards NIB as well and market consensus does not anticipate much growth in the short to medium term and no growth at all in the dividends for the foreseeable future. August reporting season shall equally be an important event for NIB and its shareholders.

Changing Dynamics For Dental Services

Dental Services group Pacific Smiles ((PSQ)), with a close link to health insurer NIB Holdings, immediately rewarded its shareholders with a hefty gain post late-2014 IPO, but things have become rockier in recent weeks. Its peer, 1300Smiles ((ONT)) has in recent weeks experienced somewhat of a sell-down.

Here, too, the culprit seems to have been a change in market dynamics. Kiwi competitor Abano Healthcare has been making some noise in the local media of late. Abano Healthcare is the largest in the sector on the other side of the Tasman and it wants a piece of the action on this side too.

According to press reports, Abano management is embarking on aggressive expansion in Australia, expressing plans to grow annual sales to $800m in the decade ahead, from circa $124m today. Already the Kiwi “intruder” is buying one or two dental practices a week. One fourth contender which is yet to catch investors’ attention is private equity owned National Dental Care.

Bottom line: competition is heating up in the sector and investors have started to pay attention.

Greencross Has A Cross To Bear

Between January and April the Greencross ((GXL)) share price clearly carved out a head-and-shoulders formation on price charts. The result has been that this stock which had been trading around $9.50 not so long ago is now battling to stay above $6.50 and visibly finding it hard to gather any momentum to the upside. It surely has been a tough year so far for shareholders who have enjoyed significant gains since 2011.

The downward movement in the share price received some extra support from the fundamental side as well with bad weather in greater Sydney, a general reluctance in consumer behaviour, some third party warehouse interruption and the post-mining boom economic slow down in Western Australia all hitting sales and profits for the present fiscal year.

There is noticeably increasing competition too, at least in the marketing and offering of pet insurance services with much larger distribution networks at Woolworths and the NRMA now actively vying for pet owners’ attention. But has it all changed Greencross’ future potential for strong growth?

The market seems to have taken a very cautious/bearish view given the share price where it is. Unless I am missing something crucial to this story, Greencross would be my number one candidate to turn things around when reporting in August.

Crown Remains Macau-Derivative

Forget about Barangaroo, Vegas or the casino battle for Queensland, Crown Resorts ((CWN)) is all about Macau and Chinese visiting Macau to spend part of their fortune around roulette tables. Analysts the world around have been amazed, flabbergasted and dismayed by how much growth in Macau has deflated over the months past. It has led to continuous downgrades to forecasts.

What used to be a stock primed for $20 (early in 2015) has become a share market laggard that is wallowing around $12-$13.

The causes of the Macau slowdown have been attributed to the lack of additional hotel rooms, the slowing in the Chinese economy, the property market in particular, as well as the corruption clamp-down from the top in Beijing down across the Chinese communist party. One thing’s for sure, many analysts have given up predicting a swift turnaround in trend and they are awaiting concrete indications instead.

Shareholders hopeful of a reversal in the months ahead are keeping their fingers crossed the tide shall turn in Macau.

Nine’s Capital Return Not Enough?

The sorry state of free-to-air TV operators around the world is well-known and well-documented. In Australia, share prices have fallen a whole lot further since the start of calendar year 2015 amidst a general view this sector is going through what print media went through a few years earlier. Sure enough, international research suggests the sector is commanding a greater piece of the advertising pie than seems warranted, so more bad news is definitely an option.

One clear stand-out has been the re-listed Nine Entertainment ((NEC)), slim and ambitious post private equity ownership, and debt free too. While Nine Entertainment shares have avoided the dreadful down, down, down trend movement of its peers in Australia, volatility in general has picked up this year with the share price falling as low as near $1.60 and peaking above $2.30.

This seems odd given the company has agreed to sell its non-TV assets with the intention of handing out a lot of cash to shareholders. Buying back its own shares is already happening and consensus estimates put the prospective dividend yield next year at no less than 7.3%.

There is also the prospect of M&A potential in case the government in Canberra finally decides to change local media laws. What then is holding back the share price? Must the market be reminded about the 7% yield which, according to Nine itself, will be largely franked? Or is fear lingering that the entry of Netflix into Australia will cause more disruption than is now visible in forecasts and valuation?

Nine Entertainment is in JV with Fairfax Media ((FXJ)) to counter Netflix through “Stan”, whose advertisements you would have spotted by now. Cannot help but think the Nine share price is poised to reset at a higher price level from the moment investors are being reminded about next year’s increased dividends.

Hope And Pitfalls For Resources Stocks

A well-constructed graphic is an investor’s ultimate eye candy, which is why I think many among you will appreciate the Mining Investment Clock above.

Analysts at the Lion Selection Group, specialising in investments in mining and exploration companies, first got a few investors excited in early 2014 when their clock reached 4 o’clock, but boy, what a wild ride it has been since. Quite amazing to realise that after all the time that has passed since, Lion’s clock has now moved up to 4.30 o’clock. It’s still early days.

Lion Selection Group is ASX-listed under the code ((LSX)) and, as one would expect, the share price of the fund has trended south and further southwards. Given their specialisation, one would expect them to retain a positive bias, even with all the carnage that has taken place, or maybe because of the carnage.

To their credit, there is growing support for the view that overall (and only gradually so) the climate seems to be improving for all those small and smaller mining and energy stocks, and their derivatives among industrials, if only because things have become so bad for so long.

Lion Selection notes, for example, the index weighting for metals and mining stocks has now fallen to circa 10%. Compare this number to the peak of 27% in June 2008 and the average 14% during the bear market of 2000-2004. Even in March 2011 the number was still 24%.

A rough comparison with the four previous “corrections” for mining stocks over the past fifty years suggests the present correction, starting in 2011, is by far the longest in duration; officially 48 months now, and still counting.

Commodity analysts at Deutsche Bank also have a few things to say about commodities and resources stocks. Relative to global equities in general, on Deutsche Bank’s calculation commodities are now trading at their lowest valuations since the early 1970s. Making matters worse, last week Deutsche Bank hosted its flagship investor conference in Asia and a survey among the attendees showed commodities are now the least preferred asset to seek protection against inflation, if and when it arrives on the horizon.

History suggests that when bearish views are ubiquitous, a big turnaround can feed off and take off from what later on proves to be fertile ground for contrarians. History also shows bearish views tell you nothing about the exact timing. Certainly Lion Selection’s clock moving to 4 o’clock and then to 4.30 while the share price of Atlas Iron moved from $1-plus to 12c (in a trading halt and destined to re-open at much lower price) just goes to show what the implications can be of being a fraction too early in this sector.

For what it’s worth, the aforementioned Deutsche Bank conference revealed market participants continue to see a stronger US dollar ahead, so no surprise they foresee continuing headwinds. Precious metals are their least preferred exposure for the year ahead, followed by energy (as in: oil and gas). History also suggests industrial metals can see somewhat of a revival when the USD strengthens, but investors should note this is because in the past this tended to occur alongside stronger global growth.

Regardless, industrial metals seem to be the best way to play the emerging improving environment for commodities and I observe, for example, rising anticipation for reversals in fortune for both nickel and copper. Investors should realise bulk commodities remain in a long term bear market; all of them, including iron ore.

I can only sympathise with Deutsche Bank’s survey. I too believe financial markets are too sanguine about a price recovery for crude oil by year end.

How do I put this politely? Only to be considered if you have the appropriate skills, experience and risk appetite. Note: short term rallies/sell-offs tell you nothing about the longer term prospects.

Cash-less mergers and acquisitions do feed into the idea that what we are experiencing is the very early stage of better times ahead.

Questions Around BHP Dividends

It wasn’t that long ago that I was writing stories about BHP Billiton ((BHP)) being one of the most reliable dividend payers in the Australian share market. Indeed, back in 2008 and 2009 when cash flows ran dry and debt and gearing had become ugly words, many industrials had to reign in payments to their shareholders, and so did the banks, but not BHP.

Such an enviable track record deserves a reward and investors gave it to the Big Australian through solid and reliable support at the (forward looking) 4% yield level.

Quick forwarding to today and, post the spin-off of South32, BHP shares are trading close to the $29 mark, 5.1% yield at AUDUSD 0.78 (average for past twelve months) or 5.7% yield at AUDUSD 0.76 (present value) depending which AUDUSD input we use to translate payments to shareholders in Australia. Whichever number we take as our guide, there’s no sight of 4% anywhere nearby.

BHP has given no indication whatsoever it is considering cutting next year’s dividend. So what is going on?

The problem BHP (and most of its peers with large exposure to bulk commodities) is facing is one of a long extended period of price weakness, and it appears this story of weakening prices still has a lot further to go, regardless of short term relief. As analysts are putting further updates through their modeling, it is becoming increasingly clear BHP won’t generate enough cash next year to pay a progressive dividend.

The company does have options at hand, including further cost reductions, asset sales, reductions in capex and, maybe, a positive surprise in product prices, for once. But one gets the feeling the market is increasingly becoming aware that the battle for BHP’s cash is getting tougher and tougher and how much future growth exactly is the board prepared to sacrifice to satisfy shareholders hunger for returns in the short term?

In other words, BHP may not have given any indication it might reconsider its dividend policy, investors have decided it is but a logical thing to do in the face of continuous fierce price resistance. At some point, one would assume, it becomes but “prudent policy” to put a limit on the payout. This is why 4% no longer does the trick.

On the same basis I can only express my surprise that Woodside Petroleum ((WPL)) shares are making a dash for the high $30s again. Current market consensus has the yield for this year at no more than 3.7%. How big of a shock is the interim report going to be in August when those who are on board for the dividends are to receive a harsh lesson about backward looking and investing?

Only time will tell.

Share Buybacks – Who’s Doing It?

Below is an incomplete overview of companies buying in their own shares this year. We very much appreciate all contributions and suggestions at info@fnarena.com

– Amcor ((AMC))
– Aurora Buy-Write Property Income Trust ((AUP))
– Australian Governance Masters Index Fund ((AQF))
– Boral ((BLD))
– Centuria Capital ((CNI))
– CSL ((CSL))
– DWS Ltd ((DWS))
– Fairfax Media ((FXJ))
– Fiducian ((FID))
– Finbar Group ((FRI))
– GDI Property Group ((GDI))
– GWA Group ((GWA))
– Industria REIT ((IDR))
– Intrepid Mines ((IAU))
– Lemur Resources ((LMR))
– Logicamms ((LCM))
– Matrix Composites & Engineering ((MCE))
– Money3 Corp ((MNY))
– Nine Entertainment ((NEC))
– Ochre Group (OGH))
– Orica ((ORI))
– Pro Medicus ((PME))
– ResMed ((RMD))
– Rio Tinto ((RIO))
– Seven Group ((SVW))
– Sigma Pharmaceuticals ((SIP))

Rudi On TV

– on Wednesday, Sky Business, 5.30-6pm, Market Moves
– on Thursday, Sky Business, noon-12.45pm, Lunch Money
– on Thursday, Sky Business, between 7-8pm, Switzer TV

Rudi On Tour

I have accepted invitations to present:

– August 2-5, AIA National Conference, Surfers Paradise Marriott Resort and Spa, Queensland – for more information about this event:

http://www.investors.asn.au/events/events-schedule/aia-national-investors-conference/

Note: FNArena subscribers can attend at similar discount as AIA members

(This story was written on Monday, 1 June 2015. It was published on the day in the form of an email to paying subscribers at FNArena).

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena’s – see disclaimer on the website.

In addition, since FNArena runs a Model Portfolio based upon my research on All-Weather Performers it is more than likely that stocks mentioned are included in this Model Portfolio. For all questions about this: info@fnarena.com or via Editor Direct on the website).

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THE AUD AND THE AUSTRALIAN SHARE MARKET

This eBooklet published in July 2013 forms part of FNArena’s bonus package for a paid subscription (excluding one month subscriptions).

My previous eBooklet (see below) is also still included.

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MAKE RISK YOUR FRIEND – ALL-WEATHER PERFORMERS

Odd as it may seem, but today’s share market is NOT only about dividend yield. Post-2008, less risky, reliable performers among industrials have significantly outperformed and my market research over the past six years has been focused on identifying which stocks, and why, are part of the chosen few; the All-Weather Performers.

The original eBooklet was released in early 2013, followed by a more recent general update in December 2014.

Making Risk Your Friend. Finding All-Weather Performers, in both eBooklet versions, is included in FNArena’s free bonus package for a paid subscription (excluding one month subscription).

If you haven’t received your copy as yet, send an email to info@fnarena.com

For paying subscribers only: we have an excel sheet overview with share price as at the end of May available. Just send an email to the address above if you are interested.

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CHARTS

AMC BHP BLD CNI CSL CWN DWS FID FRI GDI GWA LCM LSX MCE MNY MPL NEC NHF ONT ORI PME PSQ RIO RMD SVW WPL

For more info SHARE ANALYSIS: AMC - AMCOR PLC

For more info SHARE ANALYSIS: BHP - BHP GROUP LIMITED

For more info SHARE ANALYSIS: BLD - BORAL LIMITED

For more info SHARE ANALYSIS: CNI - CENTURIA CAPITAL GROUP

For more info SHARE ANALYSIS: CSL - CSL LIMITED

For more info SHARE ANALYSIS: CWN - CROWN RESORTS LIMITED

For more info SHARE ANALYSIS: DWS - DWS LIMITED

For more info SHARE ANALYSIS: FID - FIDUCIAN GROUP LIMITED

For more info SHARE ANALYSIS: FRI - FINBAR GROUP LIMITED

For more info SHARE ANALYSIS: GDI - GDI PROPERTY GROUP

For more info SHARE ANALYSIS: GWA - GWA GROUP LIMITED

For more info SHARE ANALYSIS: LCM - LOGICAMMS LIMITED

For more info SHARE ANALYSIS: LSX - LION SELECTION GROUP LIMITED

For more info SHARE ANALYSIS: MCE - MATRIX COMPOSITES & ENGINEERING LIMITED

For more info SHARE ANALYSIS: MNY - MONEY3 CORPORATION LIMITED

For more info SHARE ANALYSIS: MPL - MEDIBANK PRIVATE LIMITED

For more info SHARE ANALYSIS: NEC - NINE ENTERTAINMENT CO. HOLDINGS LIMITED

For more info SHARE ANALYSIS: NHF - NIB HOLDINGS LIMITED

For more info SHARE ANALYSIS: ONT - 1300 SMILES LIMITED

For more info SHARE ANALYSIS: ORI - ORICA LIMITED

For more info SHARE ANALYSIS: PME - PRO MEDICUS LIMITED

For more info SHARE ANALYSIS: PSQ - PACIFIC SMILES GROUP LIMITED

For more info SHARE ANALYSIS: RIO - RIO TINTO LIMITED

For more info SHARE ANALYSIS: RMD - RESMED INC

For more info SHARE ANALYSIS: SVW - SEVEN GROUP HOLDINGS LIMITED

For more info SHARE ANALYSIS: WPL - WOODSIDE PETROLEUM LIMITED