Rudi's View | May 31 2017
In this week's Weekly Insights:
-Don't Be Fooled By Appearances
-No Weekly Insights Until June 19th
-A Dentist's Smile In Your Portfolio
-Conviction Calls: Citi, MS, CS, UBS, DB And Macquarie
-2016 – L'Année Extraordinaire
-All-Weather Model Portfolio
-Rudi On TV
-Rudi On Tour
Don't Be Fooled By Appearances
By Rudi Filapek-Vandyck, Editor FNArena
May 2017 has pushed equity indices in Australia back to levels last seen in March and February, erasing in full the April advance, but as has been the case on so many occasions in years past, face value index movements are not telling the full story of what is happening inside the local share market.
What is clear is that Australian equities have found the going tougher than most international peers, with indices poised for a negative performance for the month, even including dividends. Traditionally, June is often weaker than May, so there could be more downside in store.
Look more closely though and you'll discover the Big Four Banks in Australia are having an absolute horrid time since peaking at the end of April-early May. Since then, and in only four weeks, ANZ Bank ((ANZ)) shares are off -16%, Westpac ((WBC)) lost -14.5%, National Australia Bank ((NAB)) a smidgen over -14% and CommBank ((CBA)) a little over -10%.
Even considering three out of these Big Four paid out half-yearly dividends over the period, it is clear banks in Australia are doing it tough. With a combined ASX200 index weight of circa 27%, a lot of the index's sluggishness in May can be traced back to the Big Four Banks.
This month's rapid decline from what looked like elevated bank valuations in April rekindles memories of a similar turning point almost exactly two years ago. Back in 2015, banks remained in strife, and their share prices in a downtrend for much longer.
Not that past experiences can simply be copied and pasted into today's situation and extrapolated into the months ahead, but it appears a fresh bad news cycle has opened up for the Big Four, and investors don't want a bar of it.
The big falls certainly make the banks share prices look attractive again, with implied yields rising to between 5.5% (CBA) and 6.5% (NAB) on FY18 estimates, ex-franking. Share prices cannot fall forever, and they won't, so a bounce surely must be on the cards soon. This does not automatically translate into sustainably higher share prices in the weeks or even months ahead.
Recent research conducted by Shaw and Partners suggests historically, there is a close relationship between the direction in domestic property prices and banks share prices.
With investors attention firmly focused on expected weakness in the domestic housing cycle, it is likely banks might be facing much stronger headwinds for longer.
Whether investors should fret about the banks and their share price performance comes ultimately down to the composition of their investment portfolio. Most professional fund managers who track the index, and there are many of those around, own plenty of shares in the banks, and so too the overwhelming majority in SMSF portfolios.
Most importantly, there is an argument to be made the banks' resurgence in late 2016 was predominantly macro-driven (the "reflation trade"), while their fall from grace this month is almost entirely domestic sector-specific. Banks are operating in a low credit growth environment and the risk is that, soon, important tailwinds such as the repricing of mortgages and extremely low bad and doubtful debts might turn.
This opens up a much broader question: are we back to sluggish to no growth for Australia's large cap stocks?
Macquarie strategists, for one, recently asked the question and their response was a resounding: yes, we think we are. Think bad news cycle for the banks. Idem dito for the telecom sector. Growing headwinds for consumer spending is surely going to make life tougher for Wesfarmers ((WES)) and Woolworths ((WOW)), and their second derivatives in the form of Westfield ((WFD)), Scentre Group ((SCG)) and Vicinity Centres ((VCX)).
Bricks and mortar retailers are out of favour. So too are health insurers, autodealers and property cycle exposures. Energy stocks remain captive to OPEC intentions and shale gas production in the USA. Mining stocks rely on China not tigthening too much, and providing extra liquidity when and where necessary.
It is not too difficult to paint a picture whereby investors start chasing unquestionable, robust growth stories – again. However, with a few rare exceptions, like CSL ((CSL)), Transurban ((TCL)) and Aristocrat Leisure ((ALL)), such profiles are rather rare in the top segment of the ASX.
Does this mean investors will go back where they left off prior to mid-2016 when the global reflation trade started to kick in?
Macquarie certainly thinks so. In a recent strategy update, titled "Back To The Future", Macquarie strategists state:
"We think the market is at an inflection point that will drive a more sustained period of growth stock outperformance and in turn begin to arrest the underperformance of small and mid-cap stocks vis-à-vis large caps. We think a replay of 2015 is beginning to unfold — buy growth.
"Conditions are falling into place that will make expensive stocks even more expensive, in our view. We see 'growth at any price' making an even stronger comeback as the quantum of stocks that will outperform narrows on the back of the ripple effects from a slowing consumer."
Certainly, price action in April and May supports the Macquarie prognosis. As bank share prices peaked, and subsequently tumbled, medium size growth stocks jumped back to life. Think Altium ((ALU)), NextDC ((NXT)), REA Group ((REA)), Webjet ((WEB)), and numerous others.
Meanwhile, those High PE growth stocks everybody wants to own, but rarely does because valuations are deemed (too) expensive, simply have kept on rising. Cue Corporate Travel ((CTD)), Treasury Wine Estates ((TWE)), Aristocrat Leisure, WiseTech Global ((WTC)), etc.
The FNArena & Vested Equities All-Weather Model Portfolio has been a beneficiary of this below-the-surface dynamic too, enjoying solid gains over the past three months, including in May, as market momentum shifted away from banks and consumer oriented stocks.
The gap in performance between miners and banks and the high quality, cycle agnostic industrials that populate the All-Weather Model Portfolio has narrowed significantly post February from the late 2016 slaughterfest that was inspired by the election of Trump and the Global Reflation Trade that has since come to naught.
As such, we are very sympathetic to the Macquarie view, believing there remains plenty of upside for the likes of CSL, Amcor ((AMC)), Link Administration ((LNK)), NextDC and Technology One ((TNE)), irrespective of premium valuations and share price gains already achieved.
The Portfolio's performance in recent weeks is even more impressive if one considers seasonal and macro-risks have kept our cash component close to 30%, at times even higher. In hindsight, our cautious approach has somewhat limited the portfolio's performance, but such is our wont. We're in this quest for the marathon experience, while protecting the capital of our investors, not for the short term glory.
We have used the opportunity to exploit a few share market anomalies, including adding Viva Energy ((VVR)) to the Model Portfolio following the company's positive market update in May. We consider Viva Energy a robust, inflation resistant, sustainable dividend payer whose share price is only now trading up to fairer value.
While our initial stake is relatively small, we'll be looking to buy more shares on future weakness, as we do for most stocks that are currently held in the Model Portfolio.
In line with my personal market research and analysis, the All-Weather Model Portfolio invests with a medium to long term view in high quality, durable growth stories among industrial companies, accompanied by multi-year growth stories presented by emerging smaller cap stocks. Examples of the first group include CSL, Amcor and Technology One. Paid subscribers can read up on my research, and follow these stocks via a dedicated section on the FNArena website.
Examples of the latter group include Altium, NextDC and WiseTech Global. The high and robust multi-year growth outlook for these companies comes with High Conviction attached.
For more info: see further below.
No Weekly Insights Until June 19th
Next week Monday I shall be traveling to Melbourne to present the following day on invitation of the local chapter of the Australian Investors Association (AIA). One week later, parts of Australia, including New South Wales, will celebrate Queen's Birthday.
These two factors combined means the next edition of my Weekly Insights will be written and published in the week starting Monday, 19th June.
A Dentist's Smile In Your Portfolio
Conceptually, dentist practices and services providers should fit in well with my research into All-Weather Performers. Think less regulatory interruptions, no price competition and loyal customers who will be very eager to have fixed what need to be fixed when that hurtful moment arrives. We all know from personal experience there ain't much that can match the hurt from a wounded tooth.
This is why stocks like 1300Smiles ((ONT)) and Pacific Smiles ((PSQ)) have been part of my research for many years, and why they are included as "potential All-Weather Performers" on the FNArena website.
Of course, nothing is ever as easy and straightforward as it seems in the wild and open Australian share market. Offsetting those positive key characteristics are the fact we are talking about small cap stocks, and daily trading volumes at times can be extremely thin, leading to all kinds of shenanigans typical for the smaller end of the market.
One additional complicating matter is there's hardly any research around for the stocks involved. This is why last week's sector update by analysts at Wilsons caught my attention.
Wilsons very much likes Pacific Smiles in the sector, arguing industry feedback is pointing towards (potential for) a market beating result in August, plus Wilsons' confidence in ongoing robust outlook for FY18 is on the rise. The company is seen as a winner in Australian dental, where a multi-year consolidation process is taking place, with many more years of high growth on the horizon virtually guaranteeing a premium valuation should remain in place for a long while yet.
Wilsons' price target of $2.43 is still well, well above today's share price. So no surprise, the recommendation to investors is to Buy.
The view turns sour when looking at peer 1300Smiles, which trades at a similar valuation, give or take, but does not have the same robust growth prospects under its belt, argues Wilsons. Hence a Sell rating and $6 price target, below today's share price, remain in place.
There's a third party involved, New Zealand born and listed Abano Healthcare ((ABA.NZ)) which is building a growing presence in Australia. Abano is currently trading on the cheapest multiples of the three, but Wilsons suspects investors might have to wait until FY19 before a growth spurt kicks in. Hence the Hold rating and NZ$8.50 price target.
Stockbroker Morgans, the only broker out of eight monitored daily by FNArena who also covers 1300Smiles, is not as negative as is Wilsons, rating the stock Add (equivalent of "Buy") with a price target of $7.94, some +22% above the current share price. 1300Smiles shares have been kind to shareholders over the past five years or so, but ever since the calendar moved to 2017 a downtrend has materialised.
As said, daily volumes can be extremely thin.
The only broker in the FNArena database that covers Pacific Smiles, Morgan Stanley, is even more enthusiastic than Wilsons. According to Morgan Stanley, this company offers exposure to THE superior sector roll-up story in the Australian share market. High returns in a defensive industry with costs of operations well below the competition, what more can one ask for?
Morgan Stanley cannot understand why the shares are not trading at a much higher valuation. There seems little doubt the results in August are going to surprise to the upside while the years ahead seem poised for uninterrupted high growth. Morgan Stanley considers Pacific Smiles as the stand-out exception in consumer exposed industries in the local share market.
Morgan Stanley rates Pacific Smiles Overweight, sector In-Line with a price target of $2.60; well above today's share price.
Paid subscribers can look up the above information via Stock Analysis on the FNArena website. Visit the dedicated All-Weather Performers section for more info on my research.
Last Minute Note on Wednesday morning: Pacific Smiles joined the unexpected profit warning club one day after the above was written and published. Morgan Stanley analysts have been quick to express their surprise, while also arguing this doesn't change their longer term view. Paid subscribers can read the broker's update in Wednesday's Australian Broker Call Report on the website.
Conviction Calls: Citi, MS, CS, DB And Macquarie
Probably one of the most difficult challenges for investors is to stay the course when companies enjoy a structural growth story. Share price gains to date, Price-Earnings (PE) ratios, increasing volatility, the urge to secure profits; it all distracts from the fact such companies create a lot more value than investors and commentators on the sidelines instinctively are giving them credit for.
In short: share prices for stocks like Corporate Travel ((CTD)), Transurban ((TCL)), Treasury Wine Estates ((TWE)) and NextDC ((NXT)) are poised to appreciate a lot further in the years ahead, irrespective of how much these shares have gained already, or any other shorter term considerations.
Another one of such stocks is Aristocrat Leisure ((ALL)). Of course, we all detest the many addicts populating the gaming room at one's local RSL, and I have personally witnessed the buses filled with pensioners arriving at the Las Vegas strip, while no U2 video clip was being recorded, but the key observation still stands; Aristocrat Leisure is killing it, operationally; grabbing market share left, right and centre while making a successful transformation into online.
Aristocrat shares have gained some 62% over the past twelve months -they have gone up almost tenfold since January 2012- and yet Citi analysts still retain the stock as a Conviction Buy, recently lifting their price target to $25.45 after yet another market-beating performance by the company.
Two observations are worth highlighting: Deutsche Bank's price target is set even higher, at $26.85, plus Aristocrat's recent interim report has forced just about every stockbroker target well above today's share price.
Another stock that has received firm stockbroking analysts' support is car parts reseller Bapcor ((BAP)), without much resolve as the share price continues to weaken, I must add.
Bapcor can do no good these days because it is being lumped in with The Reject Shop, Super Retail, JB Hi-Fi and many others in the "retailer" basket and that means "Amazon is coming", meaning: everyone get out!
This despite only a small part of its operations can truly be described as "retail". Some 80% of sales stems from trade sales to mechanics which is what makes this company one of the most resilient, recession proof businesses on the local share market. Let's not beat around the bush: FNArena's All-Weather Model Portfolio is a proud owner of the shares, and we have been buying more.
Morgan Stanley has now elevated the stock to "Small-Mid Cap Top Pick", indicating this high quality, high growth business is being derated on unwarranted concerns, creating a strong buying opportunity for investors who can see through the share market madness.
The team of four analysts responsible for last week's 34 page research report, "Bapcor Limited – Clear road to re-rating", shows no doubt there will be no interruption in the company's high growth trajectory in the next 3-4 years, at least.
Portfolio strategists at Credit Suisse have decided to secure their profits, and cast overboard, all shares in Fortescue Metals ((FMG)). Instead, they have bought shares in AMP ((AMP)). Here the idea is that a struggling AMP has now disappointed so many investors for such a long time, that most will be late to the party when the benefits from a successful restructuring start trickling through.
But they will come as more evidence of an operational turnaround presents itself, Credit Suisse believes. The fact there is a gross dividend yield of 7.8% attached to the shares only further adds to the investment opportunity at hand, suggests Credit Suisse.
Do resources stocks need a commodity bull market to outperform, strategists at UBS asked recently? They think not. Resources stocks are still cheap, relative to broader equities and global growth is expected to remain healthy.
UBS remains Overweight resources, both for mining and energy. Its favourite exposures are copper, oil and mineral sands, but iron ore is equally seen as attractive around current price level.
Portfolio strategists at Deutsche Bank made a series of adjustments, moving Overweight the oil sector, adding exposure to gold on "lingering political risk", while sticking with the banks as a contrarian position.
The portfolio has added Woodside Petroleum ((WPL)), Evolution Mining ((EVN)), James Hardie ((JHX)) and Link Administration ((LNK)) while selling Santos ((STO)), Orora ((ORA)), Fletcher Building ((FBU)) and Macquarie Group ((MQG)).
Should investors own gold?
Analysts at Deutsche Bank published a 59 page report on the matter and their conclusion is: yes, as protection against increasing geopolitical risks. The analysts observe the global gold sector is trading on 7.6x EV/EBITDA, which is well below the 10-year average (10x). Free cash flow is strong and balance sheets are improving, but upside is stock-specific, warn the analysts.
Coincidentally, analysts at Macquarie also updated their preferences for exposure to gold stocks. Macquarie's top picks are Evolution Mining and OceanaGold ((OGC)) among international players, St Barbara in the junior space and Dacian Gold and Gold Road ((GOR)) among developers and explorers.
Portfolio managers at Macquarie have reduced exposure to yield stocks such as Macquarie Atlas ((MQA)) and Sydney Airport ((SYD)), while selling out of AGL Energy ((AGL)) and Suncorp ((SUN)). They have added Henderson Group ((HGG)), QBE Insurance ((QBE)), Computershare ((CPU)) and Corporate Travel ((CTD)) instead.
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:
-Tuesday, 11.15am Skype-link to discuss broker calls
-Wednesday, 8-9pm, hosting of Your Money, Your Call
-Thursday, 12.00-2.00pm, co-host in the studio
-Thursday, between 7-8pm, interview on Switzer TV
-Friday, 11.15am Skype-link to discuss broker calls
Rudi On Tour
Your Editor has been invited to present before members and non-members of the Melbourne chapter of the Australian Investors Association's (AIA) on June 6th, 12.30-2pm. Location: Telstra Centre, in Room 1, First Floor at 242 Exhibition St, Melbourne CBD.
(This story was written on Monday 29th May, 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