Rudi's View | May 31 2018
In this week's Weekly Insights (this is Part Two):
–Value Versus Growth – The Uncomfortable Truth
–Conviction Calls (1)
–Compare The Pair: REA vs DHG
-Conviction Calls (2)
-Pressure-Points In Aussie Staff Costs
-Rudi On TV
-Rudi On Tour
-At The AIA Conference
[Note the non-highlighted items appeared in part one on the website on Wednesday]
Compare The Pair: REA vs DHG
By Rudi Filapek-Vandyck, Editor FNArena
The more I research the share market, the more I come to similar conclusions.
One of my recent pet observations is that certain stocks are trading on a higher valuation than others, simply because they are "better quality" companies. Cue Aristocrat Leisure ((ALL)) versus Ainsworth Gaming ((AGI)); Xero ((XRO)) versus MYOB ((MYO)); Ramsay Health Care ((RHC)) versus Healthscope ((HSO)), et cetera.
Under different circumstances I would also have included any of the banks versus CommBank ((CBA)), but maybe when CBA is involved in so many more scandals and mistreatments of its customers, while the share price is shedding its usual sector premium, maybe in this particular case the standard rule no longer applies?
Otherwise, and I have done the historical analysis to back this up, any relative outperformance by either ANZ Bank ((ANZ)), National Australia Bank ((NAB)), or Westpac ((WBC)), to stick with the major four, was always but a temporary phenomenon and investors have been best served by sticking with CBA over the past two decades.
In similar fashion, while short term momentum changes might well favour the lesser quality alternatives of Ainsworth, MYOB and Healthscope, to stick with the examples mentioned earlier, long term investors are most likely best off by ignoring the short term and keeping faith in the fact that time always works in favour of the better quality companies.
Take a look at long term price charts, if you don't believe me, and discover it for yourself.
The "better quality" theme featured prominently in a recent research update on online property platforms by Citi. In the local context this means REA Group ((REA)), still partially owned by News Corp ((NWS)), and Domain Holdings ((DHG)), partially spun off by Fairfax Media ((FXJ)) in mid-November last year.
At face value, REA Group shares seem quite "expensive" trading on 40x FY18 multiple and 33x FY19 consensus EPS forecast. In contrast, Domain Holdings trades on 36x FY18 estimates and on 28x FY19 consensus EPS forecast. The usual conclusion is thus that Domain Holdings is "cheaper" than REA Group, with the underlying suggestion it thus makes for a better investment option between the two.
I've said this before, and I will keep repeating it, backed up by hours of historical data research, this is not how it works.
Detailed analysis, as reported by Citi, has revealed REA Group is increasing its dominance over Domain Holdings in property sector ad displays in just about every region in Australia, leaving but a few small pockets where the number two in this sector can genuinely flex its muscles and beat its chest.
In simple terms, this means REA Group's current growth is much broader based. No surprise thus, Citi analysts anticipate its residential growth numbers will look strongest when both companies will be reporting financials in August.
But here is not where this story ends. Domain Holdings must act if it wants to stay relevant in the long run. In practice this translates into higher marketing spend, which means less profits for shareholders, and probably lower margins too. Citi has identified "price" as the key growth engine for Domain, while REA Group's top line growth is supported by both higher volume increase and a better product mix, plus market share gains.
Citi analysts are worried about rising costs for Domain, which, surely, is not what is priced in or anticipated at present elevated multiples? (Note: Citi is one of two brokers that has a Sell rating for the shares in the FNArena universe).
On the other hand, Macquarie just downgraded REA Group to Underperform with a price target of $86 and the main motivation behind the move is that the share price/valuation might be a tad high, or as they say in the sector: the stock looks priced for perfection.
REA Group shares might have to consolidate for a while after yet another strong rally since early April, but this doesn't change one iota from the analysis you have just been exposed to.
Readers who follow my research into All-Weather Performers know REA Group is a solid member and it goes without saying its shares are being held inside the FNArena Vested Equities All-Weather Model Portfolio with the aim of still owning it when the shares cross the $100 mark in (hopefully) the not too far off future.
Conviction Calls (2)
When it comes to investing in miners and energy stocks, there is no greater bull in Australia than Shaw and Partners senior commodity analyst, Peter O'Connor. His Conviction dates all the way back to 2016, and it definitely has won him a large number of fans across the country.
Imagine the smiling faces of the stockbrokers working at the firm who put their clients' money into the likes of BHP ((BHP)), Woodside Petroleum ((WPL)), and Rio Tinto ((RIO)) over the past two years. O'Connor still thinks the current cycle won't be over until the BHP share price reaches $40. He also believes Fortescue Metals ((FMG)) is an absolute steal, but that call carries a whole lot less enthusiasm from the mere mortals with the share price refusing to decisively rally past $5 since last year.
While it appears the sector is ripe for a retreat in the short term, O'Connor maintains it won't be anything else but a short term dip in an ongoing uptrend. His advise is therefore: don't lose your nerve, instead use any weakness from here onwards to add to your positions. The miners have added some 150% since bottoming in late January 2016 and the Shaw superstar analyst observes there have been six upswings of 18-20% over that period, followed by so-called "higher lows" during consolidation periods.
This time won't be any different, he predicts – with ongoing Conviction.
Talking about ongoing Conviction… a little while ago I saw an email from one fund manager in Australia questioning: what does UBS know that we don't? This was in response to banking analyst Jonathan Mott and his team releasing their negative stance on Australian banks, when most investors elsewhere are salivating at the prospect of acquiring exposure to the sector at (seemingly) below fair value share prices.
The answer is Mott & Co have grown convinced a much more rigorous interpretation of Responsible Lending, thanks to a number of scandals and revelations at the Royal Commission, is translating into a domestic credit crunch. In UBS's mind, the only question that remains unanswered is whether the inevitable housing market slow down will be orderly or disorderly.
As the team of banking analysts continues to update their views and thoughts, it appears Conviction is only growing stronger. UBS's latest update is best summarised with the following sentence: "We expect credit growth to slow sharply and believe the risk of a Credit Crunch is rising".
The UBS view received some extra back up from the team of economists at Westpac this week. It shouldn't surprise the House of Bill Evans whose prediction that lower-than-forecast inflation and economic growth will keep the RBA on hold for much longer, shares a few key common views with the team at UBS.
Try "another year of below trend consumer spending". As the official cash rate in the US continues rising while the RBA won't do a thing, Westpac is predicting that by end 2018 the Australian cash rate is set to be -63 basis points below the Federal Funds Rate; by end 2019 the gap could well be -112 basis points below the Federal Funds Rate.
If that isn't eye-catching enough, the team at Westpac also throws in the forecast that Australia has entered "an extended period of falling house prices", explained as "up to 10% over the course of the next two years". Needless to add, the expectation is this rather dramatic change in the housing market dynamics is expected to add further downward pressure on consumer spending.
In Westpac's words: "While the wealth effect was modest in the period of rising house prices it is reasonable that there will be a more marked effect through the downswing".
It goes without saying that if these forecasts prove correct, UBS's negative view on the outlook for banking shares will likely be justified as well. In addition, UBS analysts already published the prediction that falling house prices will be followed by a drop in new car sales.
As if the above is not enough to worry about, UBS strategist David Cassidy and his side-kick Jim Xu wonder whether High PE, High Growth stocks are now priced for perfection?
Key risks have been identified as potentially a sharp increase in government bonds (not happening right now, but it remains a risk), much weaker economic growth which unexpectedly could also impact on operations that are not directly leveraged, and then there is always the risk that somehow expectations cannot be met; the good old profit warning from left field.
With Price Earnings (PE) ratios at historically high levels, market response to any of these risks materialising could be quite savage, one assumes. Look at Domino's Pizza ((DMP)) post August 2016, or Blackmores ((BKL)) over the past two years.
What the UBS research does not point out is that companies like CSL ((CSL)) and Aristocrat Leisure ((ALL)) have only just updated investors about strong momentum in their operations and this, all else remaining equal, should reduce the risk for a negative surprise from the company itself in the short to medium term.
One most interesting piece in the UBS analysis, is that ten large cap stocks in Australia have dominated the local share market in significant fashion, and for an extended period of time. There has been a large degree of consistency as well. On UBS' assessment, the Top Ten of Growth Companies in Australia from three years ago is almost identical to the Top Ten today, considering eight members of the ten have remained the same.
The current ten names are: Aristocrat Leisure, Treasury Wine ((TWE)), CSL, a2 Milk ((A2M)), ResMed ((RMD)), Carsales ((CAR)), REA Group, Cochlear ((COH)), Seek ((SEK)), and James Hardie ((JHX)). Have been de-rated from three years ago are Ramsay Health Care ((RHC)) and TPG Telecom ((TPM)), while the analysts also include Domino's Pizza, Blackmores, and Vocus Group ((VOC)) as growth companies that have been de-rated.
Further analysis of the strong gains these ten stocks have booked over the past three years suggests investors in local indices should worship their inclusion because UBS' calculations suggest industrials as a group, and without these ten stocks, would have only returned 3% in capital gains and 14.9% in dividends over the past three years for a total return of 18.4%, i.e. some 6% per annum.
Put simply: these ten major growth achievers are the FAANG stocks of Australia. Their total return has been 123.9%, of which only 5.4% stems from dividends. This also easily explains why CSL is now larger in market capitalisation than either ANZ Bank or National Australia Bank.
The UBS strategists cannot genuinely pin down any reasons as to why investors should now adopt a more cautious approach, other than pointing out potential risks and the fact that each of these ten stocks has experienced a period of being out of market favour in the past.
Then there is the second half of 2016, when a rapid change in bond markets and portfolio rotation in equity markets meant these share prices went down quickly. But as I have highlighted myself on numerous occasions, that period of share price weakness only lasted so long, and here we are, less than two years later and share prices involved in many cases have rallied to new all-time highs.
For what it is worth, drawing conclusions from current valuations and forecasts put forward by UBS analysts, the strategists suggest it appears accumulating positions in Aristocrat Leisure and Treasury Wines still seems to make sense, while investors are cautioned that negative returns might lay ahead when buying into today's share prices of Cochlear and REA Group.
Over at stockbroker Morgans, portfolio strategists recently added Rio Tinto ((RIO)) to increase exposure to the resources sector, while watching share prices in Link Administration ((LNK)), Australian Finance Group ((AFG)) and Aristocrat Leisure for any weakness in order to buy.
Morgans' Growth Model Portfolio has increased the weighting of Macquarie Atlas Roads, now continuing corporate life as Atlas Arteria ((ALX)). The Cross Asset Income Model Portfolio has added new positions in Westpac ((WBC)) and Aventus Retail Property ((AVN)) while trimming its exposure to Sydney Airport ((SYD)).
Finally, and adding some bullish optimism in this week's collection of Conviction views, equity strategists at Ord Minnett (erm, JP Morgan) expressed their general optimism that better corporate growth prospects, helped by an improving economic back drop, have been responsible for a recovery in share prices after early-year weakness.
Apart from a weakening Aussie dollar and stronger-for-longer commodity prices, JP Morgan strategists (erm, Ord Minnett's) also believe there are currently positive currents flowing through the corporate sector in Australia. Obviously, it has to be said, their forecast for the local economy is not in-line with either UBS, or Westpac, or my own forecasts.
But as they say (again, and again, and again): different views are what maketh the market.
Pressure-Points In Aussie Staff Costs
Analysts at Credit Suisse have taken another deep dive into why wage increases in Australia are currently below levels that historically marked economic recessions, with no real prospect for improvement.
They have identified four key factors:
-De-unionisation of the labour pool
-Rising female participation (with the RBA suggesting this is caused by household's high indebtedness)
-Casualisation and increased flexibility for labour
The analysts also believe the current situation (persistent low wages growth, at or below annual inflation) is leading to a strong rise in Protection Action Ballots, i.e. the precursor to carrying out strikes. According to the Fair Work Commission, such Protection Action Ballots are now running at decade highs. Is Australia about to experience an outbreak of major industrial actions? Or will this pressure cooker situation show up through other avenues?
Below are the sectorial pressure points as identified by Credit Suisse:
Audio interview about falling share prices and when do we, investors, get rid of disappointing underperformers in portfolio:
Rudi On TV
This week my appearances on the Sky Business channel are scheduled as follows:
-Monday, Money Talks with Peter Switzer, 7.30-8pm
-Tuesday, 11.15am Skype-link to discuss broker calls
-Thursday, from midday until 2pm
-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
-ASA Presentation Canberra, 3 August
-Presentation to ASA members and guests Wollongong, on September 11
-Presentation to AIA members and guests Chatswood, on October 10
At the AIA Conference
As stated in the overview above, I will be presenting at the AIA National Annual Conference at the Marriott Resort and Spa Surfers Paradise, from 29th July til 1st August 2018.
This year's theme is SYNCHRONICITY, Identifying opportunities in a world growing in sync…
For the first time in over a decade, the world’s major economies are growing in sync.
What does a world that is structurally awash in capital look like?
What will it mean for investors?
(This story was written on Monday 28th May 2018 and on Wednesday the 30th. Part One was published on the day in the form of an email to paying subscribers at FNArena, and again on Wednesday as a story on the website. This is Part Two).
(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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(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.)
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