Rudi's View | Apr 27 2018
In this week's Weekly Insights (this is Part Two):
–Outlook 2018: A Complex Equities De-Rating
-Slowing Growth, Rising Yields, High PEs
-Australian Banks: Cheap, But Value?
-Rudi On TV
-Rudi On Tour
[Note the non-highlighted items appeared in part one on the website on Wednesday]
By Rudi Filapek-Vandyck, Editor
In Part One, this week published on the website on Thursday due to public holiday on Wednesday, I pointed out the global economy is losing momentum and investors are increasingly paying attention.
Also add rising bond yields, ongoing positive momentum for corporate earnings and numerous macro uncertainties and what looks like a year of de-rating for global equities has, only four months into the process, turned into an increasingly complex development.
The first segment below, "Slowing Growth, Rising Yields, High PEs" should be read in conjunction with "Outlook 2018: A Complex Equities De-Rating" which is the core segment of the first part of Weekly Insights for the week starting on Monday, 23rd April 2018..
Slowing Growth, Rising Yields, High PEs
Slowing growth will separate the true achievers from the pretenders, but more attention goes out to rising bond yields – they weigh upon share price valuations, in particular for stocks trading on high Price-Earnings (PE) multiples, or so goes the general narrative. Not so, of course, because not every stock on a high PE multiple is equal.
Cue the latest research into this matter presented by the equity strategy team at Credit Suisse. In line with my own research, Credit Suisse strategists have made a distinction between the right kind of high PE/long duration stocks versus the wrong kind. As one can gather from the chart below, the difference between the two groups has led to very different experiences over the past two years.
As Credit Suisse explains, those High PE stocks that still outperformed in the local share market even with bond yields rising were not particularly leveraged, and they continued to enjoy EPS increases with both rising margins and revenues contributing. These companies, including a2 Milk ((A2M)), Aristocrat Leisure ((ALL)), Cochlear ((COH)) and Orora ((ORA)), also invested twice as much as their peers in the "wrong kind" group, while return on equity (ROE) was also higher.
In contrast, the wrong kind of high PE/long duration stock would have come with higher financial leverage, higher dividend payout ratios, weaker revenue growth and margin contraction. Think Bega Cheese ((BGA)), Domino's Pizza ((DMP)), Healthscope ((HSO)), Qube Holdings ((QUB)), Trade Me ((TME)), TPG Telecom ((TPM)), and numerous others.
So which High PE stocks are still looking good in the face of higher bond yields?
Credit Suisse research suggests Altium ((ALU)), ARB Corp ((ARB)), Cochlear, Fisher & Paykel Healthcare ((FPH)), REA Group ((REA)), ResMed ((RMD)), a2 Milk, Webjet ((WEB)), and WiseTech Global ((WTC)).
Names to avoid, however, include APA Group ((APA)), Ardent Leisure ((AAD)), AusNet Services ((AST)), Chorus (NZ listed), Crown Resorts ((CWN)), Domino's Pizza, Graincorp ((GNC)), Qube Holdings, Sonic Healthcare ((SHL)), and Tabcorp ((TAH)).
Readers who have been following my research into All-Weather Performers (available for paying subscribers on the FNArena website) will have noticed the overlap between my research and stock selections, and the updated lists from Credit Suisse.
Certainly, the experience from the past post-GFC years has shown portfolio return is not just about how much sits in cash at the right time, but more so which stocks are well-represented in the portfolio, most of the time.
The Australian equities research team at Canaccord Genuity has updated its short list of conviction Calls, labeled Australia Focus List. The team has carved out its own niche in the local market by concentrating on the smaller end of the share market, hence why some names on the list might trigger a blank response from investors taking notice.
Codan is a mining services provider, including gold miners in Africa; while Clean Teq is developing its Sunrise mine project, offering exposure to cobalt; Comet Ridge is Queensland CSG under development; while Cooper Energy operates in the particular basin mostly located in Queensland; whereas Credit Corp is still chasing up overdue consumer debt; and Echo Resources could potentially become the newest ASX-addition of gold producers, with prospective tenements located in WA's Eastern Goldfields.
The other remaining eight stocks on the selective list are: Experience Co ((EXP)), formerly known as Skydive The Beach Group; Galaxy Resources ((GXY)), producer of lithium; Metals X ((MLX)), for tin and gold; aerial imagery provider Nearmap ((NEA)); Orocobre ((ORE)) for more lithium exposure; Perseus Mining ((PRU)), troubled gold producer with potentially improving dynamics; online marketplace Redbubble ((RBL)); and provider of global satellite communication, Speedcast International ((SDA)).
Equity strategists at Credit Suisse have added ResMed to their Long Portfolio while going "short" (negative outlook) Sonic Healthcare. They both replaced Domain Holdings ((DHG)) and Charter Hall ((CHC)) respectively.
Australian Banks: Cheap, But Value?
One Citi analyst comment stood out post Bank of Queensland ((BOQ)) interim market update recently: the share price is down -17%, but the results showed this was fully justified.
As a matter of fact, the shares have lost circa -22% since failing to cross the $13 level in late October last year. On consensus forecasts, the stock now yields 7.3% fully franked, but when bad news hit, the share price needs to go down, and so it has. Bank of Queensland's interim report revealed downward pressure on loan volumes, thus on group sales, with headwinds building for the net interest margin (NIM).
Luckily, for shareholders, management still has a tight grip on operational costs while loan defaults remain low. There was no special dividend but analysts believe excess cash remains, and thus more specials lay on the horizon. But pressures are building and the regional lender should be thinking about re-pricing mortgages.
What are the chances of the latter happening with national scrutiny intensifying on the back of damaging revelations from the ongoing Royal Commission?
Plus, aren't banks digging their own downfall by continuously repricing mortgages to keep earnings from going backwards while household budgets already are under pressure? Surely, that tipping point when defaults jump higher is drawing nearer with every added burden for mortgage holders?
Investors wondering as to why banking shares in Australia have done nothing but weaken since the start of the new calendar year need not look any further than the recent results release by Bank of Queensland: yes, bank shares look cheap compared to the rest of the market, and even compared to their own history, but expectations are for disappointing, if not negative announcements when H1 financial reports are released in the weeks ahead, and risk appetite in general isn't exactly booming.
Analysts at Morgan Stanley, who have held a negative view on the sector for a while, last week summarised the sector's outlook as followes: [a] fundamental change in the mortgage market, modest growth prospects, downward pressure on returns, and increased political and regulatory scrutiny.
"Accordingly, we expect structural and cyclical headwinds to ROE and growth to drive a further de-rating."
All shall be revealed in the coming weeks. ANZ Bank ((ANZ)) shall kick off the sector heavyweights' reporting on Tuesday, May 1st.
Last week's audio interview about joining this year's upward momentum in oil&gas stocks:
The prior week's audio interview about seasonality in the share market, and whether this year might be different:
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
-Friday, 11am, Skype-link to discuss broker calls
Rudi On Tour
-Presentations to ASA members and guests Gold Coast and Brisbane (2x), on 12 & 13 June
-ATAA members presentation Newcastle, 14 July
-AIA National Conference, Gold Coast QLD, June 29-August 1
-Presentation to ASA members and guests Wollongong, on September 11
-Presentation to AIA members and guests Chatswood, on October 10
(This story was written on Monday 23rd April and the first part was published on the day in the form of an email to paying subscribers at FNArena, and again on Thursday as a story on the website. Part two will be published on the website on Friday).
(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: email@example.com or via the direct messaging system on the website).
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