Rudi's View | Apr 26 2017
In this week's Weekly Insights:
-Telstra Is Not BHP
-Conviction Calls: Citi, UBS, Canaccord Genuity
-New Website: FNArena Price Charts
-2016 – L'Année Extraordinaire
-All-Weather Model Portfolio
-Rudi On TV
-Rudi On Tour
Telstra Is Not BHP
By Rudi Filapek-Vandyck, Editor FNArena
It may be hard to imagine today but it wasn't that long ago, the first half of 2015, when Telstra's ((TLS)) share price was consistently trading above $6 and the boldest forecasters in the local sharemarket were targeting a share price starting with 7.
One year ago the share price was still at $5.60. Last week it was threatening to break below $4. How times have changed.
First the bad news: for all those who followed their stockbroker's advice and bought the shares from the moment it dropped below $5; that was, simply, bad advice. The share price is highly unlikely to trade at that level again. Times and context have changed. Better reset those expectations and re-assess.
I haven't been a strong advocate for owning/buying shares in Telstra since 2015, and that is putting it mildly. Judging by the relentless downtrend that is now apparent on backward looking price charts, the heavy dose of Telstra-scepsis has been more than justified. But now the share price has fallen a further -20% since January, the question has to be asked whether the share market, as per usual, is not getting overly bearish, pushing the share price too low?
The answer, I believe, lies not with whether the current bad news cycle has further to run (it probably has), but with Telstra's ability, and determination, to maintain its dividend for shareholders.
Straight up: I don't believe Telstra is going to reduce its 31c payout per year anytime soon. But there won't be any further rises either. It is true the odds have moved into favour of dividend cuts sometime into the future, maybe four or five years from now, and this is what the share market is currently focusing on.
Set aside the global search for yield that once dominated the local share market, this shift in operational dynamics is essentially the driver behind Telstra's share price de-rating over the past two years. Previously, stockbroking analysts were projecting ongoing dividend increases to 32c, 33c, even 34c in the years ahead. That downshifted to 31c for as far as the eye can see.
In more recent times ongoing reductions to earnings per share (EPS) forecasts are suggesting Telstra's profits this year will be lower than 31c per share (see Stock Analysis on the FNArena website), further exacerbating investor angst that juicy yield from the former telco monopolist won't be on offer for much longer.
All this ignores the fact the company remains a cash cow and there will be ongoing NBN payments from the Australian government. Telstra has paid out higher dividends than its reported EPS on multiple occasions in the past.
Nevertheless, it does make sense for investors to focus on what can go wrong and what scenarios are likely, given most would own Telstra today for its annual payouts.
It wasn't that long ago many were holding on to their shares in BHP Billiton ((BHP)) as they believed the board's promise of sustaining a through-the-cycle, steadily rising annual dividend. But then things went from bad to worse and they got so bad, nobody believed the board could possibly stick to its promise. By the time the inevitable was announced publicly, BHP paid out less than one quarter in dividends from the previous year (i.e. they cut by nearly 75%). By then, the share price had already been slaughtered and started recovering.
Prior to the board's admission the progressive dividend policy was no longer sustainable, BHP shares too had been in a drawn out downtrend. For much of the post-2011 years the shares found support at the 4% prospective yield level, until market confidence shifted to the negative. After that, things moved quickly, and relentlessly.
There are more than a few lessons in here for investors investing for yield in the share market.
Some investors might still be traumatised by the BHP experience, but there is another recent reference point. Up until mid last year, Australian banks were also in a persistent downtrend amidst widespread belief they might have to cut their dividends, if not raise extra capital on top of the capital raisings of 2015. As it turned out, only ANZ Bank reduced its dividend, once, and it proved more of a haircut than another BHP/Rio Tinto experience. Bank shares have significantly outperformed the broader market since.
Telstra today is not the BHP Billiton of tomorrow. If, in coming year(s), the Telstra board proves me wrong and does decide to disappoint the circa 50% of retail investors on its shareholder register by reducing the annual dividend, it will be more of an ANZ Bank repeat experience rather than another BHP Billiton copycat. Of that I am even more convinced.
One of the more interesting research reports on Telstra was released at the end of last month, by analysts at UBS. In it, the analysts argue a prudent Telstra should reduce its dividend to 29c per annum (from 31c now). They also stated the Telstra board, very aware of the company's dividend status in the local market, was more likely to ignore their advice, until they no longer can.
This further reinforces my point: Telstra shareholders should not fear a dividend cut this year or next. It is too early for that. In the low odds outcome of a negative surprise, it'll be a small reduction a la ANZ Bank, not another sledgehammer experience a la BHP or -heaven forbid – Origin Energy.
Another intriguing report was released last week by Deutsche Bank, who believes Telstra's 31c dividend is safe until 2019. After that, a relatively benign reduction should be on the cards. The latter should be interpreted as 28c-29c instead of the 31c for the next three years (including current FY17).
What this means, point out analysts at Deutsche Bank, is that Telstra's share price at around $4.20 already is reflecting a 6.6% sustainable yield. Plus franking. No surprise thus, Deutsche Bank has upgraded the stock to Buy with a price target of $4.51. On the analysts calculations, Telstra shares are now trading at a -39% discount vis-a-vis the broader market.
According to FNArena's Sentiment Indicator (see website), only four stocks out of 400+ in our database now offer a higher yield than Telstra does. Those four are: Crown Resorts, Fortescue Metals, Alumina Ltd and Harvey Norman. But even if we assume the current 7.38% is not 100% representative and we concentrate on the underlying, sustainable yield of 6.6% instead, only two more stocks jump above Telstra with a superior yield; Aventus Retail Property Fund and Rio Tinto.
While I don't think Telstra is ever going to be a fantastic investment, I do think it is but a matter of time before the gap between its current, beaten down share price and the rest of the yield offering stocks narrows. The average yield in today's market is closer to 4%. Major banks are offering between 4.9% and 5.8%. In comparison, Telstra's 6.6% underlying, if not the at face value 7.38% (short term secure) looks too attractive to ignore indefinitely.
Having said all of the above, there remains potential for ongoing bad news for the sector and for Telstra in particular, starting with a pending ACCC decision on whether to declare Telstra's mobile roaming service, which would give competitors access to Telstra's network without having to make substantial investments.
I recently spotted a technical view on the shares which suggested the new trading range could reach as low as $3.75. While nothing is impossible in the face of edgy traders and nervous investors, and it would be a brave man to declare the bad news cycle is over, but I'd be hugely surprised if the share price falls as low as suggested by that particular technical view. I'd be even more surprised if the share price won't be higher in 2018.
It appears the Chinese steel market has once again done what the Chinese steel market does best: expect too much demand for its products. A correction is taking place as I write this very sentence.
The price of iron ore has tumbled in excess of -30% in only a few weeks time but falling steel prices in China (only just beginning), coinciding with a sharp deterioration in Macquarie's survey among Chinese steel producers suggest a sharp recovery seems unlikely. Moreover, it may well be that the price bottom lies lower, still.
Last month quant analysts at Macquarie released an interesting piece of research, drawing a relatively reliable correlation between data from the stockbroker's China steel survey and share prices for leveraged companies such as Fortescue Metals ((FMG)), BlueScope Steel ((BSL)) and Whitehaven Coal ((WHC)), among many others. That piece of research now looks particularly interesting since share prices have retreated significantly on the back of a tumbling iron ore price. Fortescue Metals, for example, has fallen from above $7 to below $5.50 with the share price now below the 200 days moving average.
From the results from the Macquarie steel survey we can possibly make the following assumption: Chinese steel producers, and commodities market traders, have been bullishly riding the wave of optimism throughout the first three months of the new calendar year, possibly expecting order intake this year might catch up on the record year that was 2016. Alas, after three months hoping for such an ultra-optimistic outcome, the opposite has proved true.
A quick reversal has since taken place. One noteworthy observation is this implies order intake seems to have peaked sooner than is usually the case. A second one is the deterioration in sentiment has been swift and violent. In terms of the Macquarie survey, sector sentiment reached an all-time high in February and has now fallen to its lowest reading for any April month in the history of the survey (since 2011).
Both the Orders Index and the Sentiment Index are now below 50. In Macquarie's lingo both indices trigger a Sell (or Short) signal.
Equally noteworthy, the latest NBS production data show Chinese crude steel output hitting a record high in March of 72mt, nearly 1mt above the previous peak level seen in May 2014.
This is where things get interesting. Because of the sharp fall in iron ore prices, most steel producers are still enjoying healthy profit margins, as also indicated by the survey, and this likely means they'll happily continue producing. This cannot go on indefinitely, of course, and overproduction will eventually come home to roost, triggering a destocking cycle, and more downside pressure on input prices such as iron ore.
Better not think this correction is the end of it, or that it'll be resolved tomorrow. Not if Macquarie's survey has the last say.
Conviction Calls: Citi, UBS, Canaccord Genuity
The world of equity investors is, broadly viewed, currently split in two opposing camps. One part sees higher growth ahead, globally, with rising corporate profits and inflation, plus US tax cuts, taking care of higher bond yields and less accommodation from the US Federal Reserve. The other part sees elevated asset valuations being supported by, still, exceptionally low bond yields, and thus a rather moderate outlook for returns.
Take your pick.
Citi's North American equity strategist Tobias M Levkovich sits solidly in the first camp. Citi just released its mid-2018 target for the S&P500 in the US and set at 2560 this implies circa 7.8% upside from current level plus some 2% in dividends. Still very attractive in a low bond yield environment, adds a bullish Levkovich. Plus potential tax cuts from the Trump administration are not included.
By the way, Citi's S&P500 target for year-end is 2,425, implying more gains are to be made in the first half of next year than in the remaining eight months of 2017.
On the opposing side sits the local team of strategists at UBS who see solid growth prospects, but predominantly for resources stocks, and elevated valuations for just about every other sector in the Australian share market. Valuations above historic multiples can be justified through exceptionally low bond yields, finds UBS, but expectations are best kept in check.
UBS just raised its year-end target for the local ASX200 to 5875 (from 5700 prior) and this implies most returns are to be made from dividend payouts and from volatility in share prices, assuming we all get in and out at the right times.
Valuation modeling at stockbroker Morgans indicates the S&P500 is trading well ahead of fundamentals (the model indicates more than one year ahead based upon prospective operational profits) and the same seems to apply to Australian equities with Morgans' modeling setting fair value at 6070 for the ASX200, at year end 2017.
Canaccord Genuity's equity research in Australia specialises in small and medium cap stocks so its Top Australian Focus List might provide some insights about potential value and opportunities outside the ASX Top-100. Stocks that have been added since the last update are:
Remaining Focus List inclusions are:
-Blue Sky Alternative Investments ((BLA))
-BSA Group ((BSA))
-Cooper Energy ((COE))
-Credit Corp Group ((CCP))
-Galaxy Resources ((GXY))
-Infigen Energy ((IFN))
-QMS Media ((QMS))
-SpeedCast International ((SDA))
For a total of 11 High Conviction stocks.
Citi's Focus List Australia/NZ has seen the removal of AGL Energy ((AGL)). This is because Citi analysts have come to the conclusion that politicians and others involved will manage to find a solution to the current electricity crisis, and by then it won't be pretty for shareholders that have been enjoying the upside over the past few months.
Remaining stocks on the Citi Focus List Australia/NZ:
New Website: FNArena Price Charts
One of many changes we introduced on the new website is the extended usage of FNArena price charts. Apart from Stock Analysis, where price charts are an integral part of the suite in data, news and experts views facilitating research into ASX-listed stocks, FNArena news stories now display the same charts at the bottom of news stories for every ASX-listed company mentioned.
This is generating a number of questions from investors who, perhaps, are not as yet familiar with the data available through Stock Analysis.
FNArena distinguishes itself from most other financial data and analysis providers in that we collate and generate our own proprietary data. The consensus price targets, the consensus forecasts and the consensus views that are available through the FNArena website are all unique to our service.
The same applies to the price charts in which we incorporate some of the key data to assess the status/outlook for a given stock. As such, every FNArena price chart also shows position and evolution of consensus price target, in addition to the 60 and 200 days moving averages. The consensus price target is shown through a grey-ish background, while a blue and red line show the two mathematical price trends.
Equally important, and sometimes triggering questions, is that the top bar of the price chart also displays the most recent values for each. In other words: the number behind SMA (60) indicate where the blue trend line currently sits. The number behind SMA (200) shows the positioning of the red trend line. The number behind Cons Target shows the exact calculation for FNArena's consensus target.
Underneath each price chart sits a second window, usually showing two horizontal trending lines, one yellow and one red, interrupted by one vertical bar stating "New Financial Year". These are FNArena's consensus forecasts for earnings per share (EPS) for Year-1 and Year-2. Note that as companies release their actual financial results, these forecasts move up by one year respectively.
In other words: the Year-1 forecast to the left of the "New Financial Year" expires upon release of financial results, but Year-2 then becomes Year-1 into the new financial year.
There are many observations that can be made from these price charts that can assist investors with their research and their assessment. Is the trend in consensus price targets up or down? Does the red line for "EPS2" remain above the yellow line for Year-1 EPS? Is divergence occurring between share price and consensus forecasts?
While these are all potentially interesting, if not important inputs, investors should at all times keep in mind that sometimes the market leads and stockbroking analysts might have to catch up, while in other times the market simply ignores and then finds it needs to catch up with what no longer can be ignored.
There are no silver bullets when it comes to investing in the share market, but day-to-day observations, accumulated experience and in-depth analysis and research can make a huge difference.
2016 – L'Année Extraordinaire
It was quite the exceptional year, 2016, and I did grab the opportunity to write down my observations and offer investors today the opportunity to look back, relive the moments and draw some hard conclusions about investing in the world today.
If you are a paid subscriber to FNArena, and you still haven't downloaded your copy, all you have to do is visit the website, look up "Special Reports" and download your very own copy of "Who's Afraid Of The Big Bad Bear. Chronicles of 2016, A Veritable Year Extraordinaire" (in PDF).
For all others who still haven't been convinced, eBook copies are for sale on Amazon and many other online channels. You'll have to visit a foreign Amazon website to also find the print book version.
All-Weather Model Portfolio
In partnership with Queensland based Vested Equities, FNArena manages an All-Weather Model Portfolio based upon my post-GFC research. The idea is to offer diversification away from banks and resources stocks which are so dominant in Australia, while also providing ongoing real time evidence into the validity of my research into All-Weather Performers.
This All-Weather Model Portfolio is available through Self-Managed Accounts (SMAs) on the Praemium platform. For more info: email@example.com
Rudi On TV
This week my appearances on the Sky Business channel are scheduled as follows:
-Thursday, 12.00-2.00pm, co-host in the studio
-Friday, 11.15am Skype-link to discuss broker calls
Rudi On Tour
Your Editor has been invited to present at the Australian Shareholders Association's (ASA) 2017 Securing Your Investing Future Conference to be held at the Grand Hyatt Melbourne from 15-16 May.
The conference details – www.australianshareholders.com.au/conference-2017
Speaker information – www.australianshareholders.com.au/speakers
Program information – www.australianshareholders.com.au/program
Telephone: 1300 368 448
(This story was written on Monday 25th April, 2016. 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: firstname.lastname@example.org or via the direct messaging system on the website).
BONUS PUBLICATIONS FOR FNARENA SUBSCRIBERS
Paid subscribers to FNArena (6 and 12 mnths) receive several bonus publications, at no extra cost, including:
– The AUD and the Australian Share Market (which stocks benefit from a weaker AUD, and which ones don't?)
– Make Risk Your Friend. Finding All-Weather Performers, January 2013 (The rationale behind investing in stocks that perform irrespective of the overall investment climate)
– Make Risk Your Friend. Finding All-Weather Performers, December 2014 (The follow-up that accounts for an ever changing world and updated stock selection)
– Change. Investing in a Low Growth World. eBook that sells through Amazon and other channels. Tackles the main issues impacting on investment strategies today and the world of tomorrow.
– Who's Afraid Of The Big Bad Bear? eBook and Book (print) available through Amazon and other channels. Your chance to relive 2016, and become a wiser investor along the way.
Subscriptions cost $380 for twelve months or $210 for six and can be purchased here (depending on your status, a subscription to FNArena might be tax deductible): https://www.fnarena.com/index2.cfm?type=dsp_signup