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Five Market Observations

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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 | Oct 28 2015

This story features TELSTRA CORPORATION LIMITED, and other companies. For more info SHARE ANALYSIS: TLS

In This Week's Weekly Insights:

– Telstra Falling Out Of favour
– Childcare Centres Beyond G8
– It Was Kevin, Not Julia
– Smaller Lenders In Retreat
– Risk Appetite: The CS Version
– Rudi On Tour
– Rudi On TV

Five Market Observations

By Rudi Filapek-Vandyck, Editor FNArena

Telstra Falling Out Of Favour

What is happening with Telstra ((TLS))? The question arises more often these days. On everyone's observation, the share price no longer starts with a 6 but now with a 5 instead. While daily trading volumes are still robust, it is clear overall appetite for adding more Telstra shares has dimmed, and quite a lot.

In FNArena terms, the share price used to consistently trade above consensus price target, indicating strong demand and support from yield + safety craving investors. But in past few weeks the share price hardly manages to reach near consensus price target, and then is incapable of holding on.

So what exactly is happening?

Last year, I labeled Telstra the default Go-To destination for yield seeking investors. That made a lot of sense. Telstra is on every metric a giant. Its business is a household name. Its yield is as safe as yield can be in a share market. And there's no direct exposure to the Australian housing market.

The result has been a stellar performance, even when banks were experiencing one of the heaviest sector de-ratings seen in the last three decades. All that changed in August.

So what exactly has changed for Telstra? For starters: perception. Telstra board members and management have indicated competition is heating up and Telstra is not afraid to sacrifice short term profits in order to hold its ground. Nice. Except such suggestions do impact on overall perception, especially when various analysts are becoming a little less comfortable with how competition is achieving greater impact on Telstra's business.

It doesn't get any better with Telstra also signalling it might become a major investor in the Philippines. No doubt, many an investor still has bad memories about Telstra's earlier ventures into Asia. Or about Australian companies moving offshore in general. Remember what happened at Insurance Australia Group ((IAG))?

Also, analysts have been paring back their profit expectations recently and while this is by no means a BHP/RIO experience, history nevertheless shows a close correlation between analysts' forecasts and share price performances. Stock Analysis indicates consensus is now anticipating a negative growth year this year, followed by a relatively robust high single digit growth year in 2017. The latter will become important for the share price performance from here onwards, I reckon.

None of these issues is going to die off soon, so Telstra shares are likely to experience an extended period of lukewarm investor support. On the other hand, if market expectations about its dividend prove accurate, the yield (100% franked) has now risen to 5.8% this year and to 6.0% next. Depending on how troubled the growth outlook for Australian large caps turns out to be, one would expect there's a natural limit to the downside.

For now, the banks are outperforming and that shouldn't surprise. Three of the Big Four are about to report their financials, plus an updates from Macquarie Group ((MQG)) is scheduled for the coming week.

Time to dust of dividend-centred strategies again.

Childcare Centres Beyond G8

Somehow, somewhere the investment story of G8 Education ((GEM)) fell apart and no matter what management says or does, or so it appears, investors simply have no appetite to help to rejuvenate the share price of this once market darling.

It wasn't that long ago, the third quarter of 2014 to be precise, when the share price was seen trading solidly above $5. It has seen a relentless slide south since. A little over a year later and the share price is languishing around the $3 mark, having been to $2.90 but otherwise showing little intention to revisit much higher price levels.

The market's scepticism is probably best illustrated by the fact that robust growth numbers of 26.0%, 43.2% and 61.6% for the years FY13, FY14 and FY15 are about to be replaced with a rather "normal" 6% next year (G8 runs a calendar year till December financial record). Needless to say, the market is sceptical about the medium term outlook for this industry consolidator.

And yet, G8 operates in a market that is primed for long term growth strategies. It was proven by Eddy Groves, Mr Flamboyant of the fraudulously failed ABC Learning. It was again highlighted in a recent sector analysis by stockbroker Moelis.

As Moelis' research confirmed, childcare enjoys strong government support, and is likely to continue to enjoy strong government support, while demographic projections suggest many more childcare centres need to be built to satisfy demand in the decades ahead. There is a possibility though those favourable longer term prospects might have to deal with a certain degree of indigestion in the shorter-to-medium term as the industry is seen adding some 400 new centres over the next twelve months. This is double the average from the past ten years, notes Moelis.

The analysts do point out childcare centres operate in micro-markets and some indigestion in some of these markets does not impact on the market as a whole. Equally important, highlights the Moelis report, the combination of ongoing population growth and increased labour market participation suggests Australia needs an additional 4000 centres over the next twenty years.

Once built, such centres require low capex while providing reliable and predictable income. This is the stuff the likes of Woodside Petroleum, BHP Billiton and Atlas Iron can only dream about.

Then consider the strong support from the federal Government. Effective from July 2017, an enhanced childcare funding regime will be implemented as part of the 2015 budget measures. The new regime will result in the Government committing to a $3.5bn increase in funding over the next four years.

Changes will include a simplified and new single means-tested childcare subsidy, paid directly to the operators. Low income families will receive funding for 85% of the childcare cost per child up to designated benchmark price, which will reduce to 50% for families with income of $170,000 and above.

The removal of the existing subsidy cap of $7,500 per child pa for all families with an income below $185,000 will allow an increase in financial assistance beyond the existing cap, determined by usage. Families with earnings over $185,000 will see the cap increased to $10,000 per child pa.

Overall, concludes Moelis, the 2017 package should provide childcare operators with the potential to increase occupancy levels through increased demand, due to greater accessibility and by limiting pressure on fees for the vast majority of parents.

Investors looking to expose their portfolio at least in part to this growth outlook, but with no appetite to take on board G8 Education shares, might consider Folkestone Education Trust ((FET)) or ARENA REIT ((ARF)) instead.

Moelis has updated its valuations for both. Folkestone's new price target sits at $2.40, well above today's share price, while ARENA REIT's was lifted to $1.84. None of these two stocks is currently covered by any of the regular eight stockbrokerages in the FNArena database, so I'll add some key data from Moelis.

Folkestone's earnings per share is projected to grow by double digit percentages in the years ahead. The yield on offer is projected to lift from 6.7% this financial year to 7.0% in FY17 and to 7.2% in FY08.

For ARENA REIT, growth is expected to come in single digit percentages and the yield on offer is projected to increase from 6.5% in the current financial year to 7.1% in FY17 and to 7.3% in FY18.

Both are rated Buy (of course).

[Note: ARENA REIT has no connection to FNArena]

It Was Kevin, Not Julia

Last week, see "Investor Illogicality: Auto Leasing", I wrote about how the Labor government in mid-2011 ruined the success story of car leasing and salary packaging market leader McMillan Shakespeare ((MMS)). The error I made was to embed a reference to the Gillard government when it was, in fact, the returning messiah Kevin Rudd who is to blame.

One reader corrected me after publication and I am thankful for it. So here it is, setting the record straight: Kevin destroyed the investment story of McMillan Shakespeare, not Julia. This, however, still doesn't solve the enigma as to why McMillan Shakespeare has been left high and dry since, while its peers who listed on the ASX since are enjoying above-market Price-Earnings multiples.

Smaller Lenders In Retreat

Pointing at the illogicality surrounding McMillan Shakespeare triggered a question about smaller providers of consumer credit in Australia. Share prices for the likes of Credit Corp ((CCP)), Collection House ((CLH)), Cash Converters ((CCV)), Thorn Group ((TGA)) and even FlexiGroup ((FXL)) have not genuinely been participating in the recent market recovery and that's even apart from the observation some of these stocks fell out of bed in August-September.

Some of this underperformance can be traced back to company specific matters such as a sudden management change at FlexiGroup, but a lot would be related to ASIC's clamp down on providers of so-called small amount credit contracts (SACC). According to legislation, this market niche is defined by loans under $2000 for up to 12 months. It wasn't that long ago companies including Credit Corp and Thorn Group thought they'd discovered a new avenue for growth. Now these companies are abandoning this market, leaving full reign to embattled Cash Converters and a few smaller, private operators.

The intense scrutiny from the corporate watchdog, the negative media attention and the resulting brand damage has made it a very disappointing experience for most.

Then there is the recent acquisition of a majority interest of Baycorp Holdings by Encore Capital. Analysts at JP Morgan/Ord Minnett see Encore Capital's market entry as a potential turning point whereby more capital is likely to be injected into the purchased debt ledger (PDL) sector. Given the price-led nature of the industry, the analysts suggest this opens up significant risk that Return on Equity (ROEs) for all participants will decline in the medium term. Plus Collection House effectively issued a profit warning last week.

Risk Appetite: The CS Version

Last week's Weekly Insights included Citi's Panic-Euphoria indicator of market sentiment, including Citi's comments the dip into "panic" was likely setting the stage for a healthy return for investors who keep their heads cool through short term volatility. Citi is far from the only one with a proprietary measurement for global risk appetite.

Credit Suisse has one too and CS's indicator also dipped into "panic" mode this month. And back out of it too.

Does this mean we have now seen the worst of 2015? Credit Suisse analysts who are operating on a shorter-term horizon than Citi, are awaiting confirmation from the MACD indicator, as spelled out on the graphic above.

Rudi On Tour

– I have accepted to present to members of Australian Shareholders' Association (ASA) in Canberra, on Tuesday, 8th December 2015

Rudi On TV

– on Wednesday, Sky Business, Your Money, Your Call – Equities (host), 8-9.30pm
– on Thursday, Sky Business, Lunch Money, noon-1pm
– on Friday, Sky Business, Your Money, Your Call, Equities versus Bonds, 7-8pm

(This story was written on Monday, 26 October 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 September available. Just send an email to the address above.

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CHARTS

ARF CCP CCV CLH FXL GEM IAG MMS MQG TGA TLS

For more info SHARE ANALYSIS: ARF - ARENA REIT

For more info SHARE ANALYSIS: CCP - CREDIT CORP GROUP LIMITED

For more info SHARE ANALYSIS: CCV - CASH CONVERTERS INTERNATIONAL LIMITED

For more info SHARE ANALYSIS: CLH - COLLECTION HOUSE LIMITED

For more info SHARE ANALYSIS: FXL - Flexigroup

For more info SHARE ANALYSIS: GEM - G8 EDUCATION LIMITED

For more info SHARE ANALYSIS: IAG - INSURANCE AUSTRALIA GROUP LIMITED

For more info SHARE ANALYSIS: MMS - MCMILLAN SHAKESPEARE LIMITED

For more info SHARE ANALYSIS: MQG - MACQUARIE GROUP LIMITED

For more info SHARE ANALYSIS: TGA - THORN GROUP LIMITED

For more info SHARE ANALYSIS: TLS - TELSTRA CORPORATION LIMITED