Rudi's View | Sep 20 2018
In this week's Weekly Insights (this is Part Two):
-It's Different This Time, Not A Bubble
–August Reporting Season: The Final Act
-Shame, Shame On You, IOOF
-Rudi On TV
-Rudi On Tour
[Non-highlighted parts appeared in Part One on Wednesday]
August Reporting Season: The Final Act
By Rudi Filapek-Vandyck, Editor
August Reporting Season: The Final Snippets I wrote last week. That was until I discovered there was a little bit of additional insight left that still deserved to be pointed out, hence why this week contains one final addition to the final set of observations published last week.
At the end of the day, I very much feel I am now writing for future scholars of the recent reporting season, also because financial markets are very much in the grip of international tensions between the Trump administration and Xi Jinping's China.
And that doesn't seem to disappear anytime soon.
Beauty, as they say, is always in the eye of the beholder and nowhere is this more visible than in Citi's assessment post August. Strategists Tony Brennan and James Wang have held on to their targets for the ASX200 to reach 6500 by year-end and 6650 by mid-2019 (note the small gain post December) and on their assessment the local reporting season provided enough evidence these targets look reasonable and will be met.
As a matter of fact, the Citi strategists report overall their confidence in the share market's outlook has grown, irrespective of macro-economic, and other, risks.
Further observations can be derived from the table below, which shows how profit growth expectations have shifted throughout August. There are mostly positives in there, one would have to conclude.
Industrials analysts at Morgan Stanley have used post-August updates to reiterate their view that operational dynamics are improving for Amcor ((AMC)), as well as their support for the proposed acquisition of Bemis in the US. The latter deal, while not meeting Amcor's future return hurdles, is seen as strategically sound, while also both EPS accretive and value-accretive.
Adelaide Brighton ((ABC)) remains on Underweight. The analysts feel the stock was priced for higher growth that was always tough for the company to meet. Even though the share price has weakened post the result, the analysts are still not jumping on board.
August showed the housing construction market remains pretty resilient, point out the analysts, though their preference is with companies that have more leverage towards new infrastructure. Apart from Boral, the preference lies with Lend Lease ((LLC)) which, the analysts note, has won new engineering contracts for Westconnex and the above-station development at Martin Place in Sydney and seems poised to increase market share.
Strategists at Macquarie are more inclined to highlight the flipside to Citi's encouraging observations. They note Industrials ex-resources, AREITs and banks in FY18 recorded the second weakest year of growth since FY11, suggesting conditions overall remain challenging. Macquarie suggests this is likely why a larger proportion than usual reported in-line in August.
On Macquarie's calculations, Industrials' EPS growth for the year did not exceed 1.4%. And while downgrades across the board have occurred for FY19 forecasts, Macquarie strategists don't believe the reductions have as yet gone far enough. This view is shared with the likes of JP Morgan, but not with Brennan and Wang at Citi who see rather little risk for further downgrades to growth forecasts.
Macquarie singles out specific sectors where market consensus is likely to be proven too optimistic, including banks, retail, insurance, telcos, and real estate with a specific reference to structural and/or cyclical headwinds.
Macquarie's key take-aways from the August reporting season are:
1) cost pressures are increasing and cost out stories continue;
2) capital management continues with buybacks, special dividends and capital returns (indicating limited growth options for some companies);
3) the benign fall in national dwelling prices since peaking in 2017 is already being felt in some corners;
4) retail banking conditions continue to deteriorate;
5) some results were impacted by the weather;
6) changes to accounting standards
Lastly, stockbroker Morgans, worried about the current risks while equity valuations are not cheap, to put it mildly, warns its clientele not to be complacent. Better to re-shuffle portfolios before the proverbial hits the fan. Start thinking about protecting capital in an abnormal market situation, suggest the strategists.
They have created three baskets to assist with recalibrating portfolios post August. The first basket are stocks that are probably best divested; Morgans continues to see further potential for negative news and that's best to be avoided. Stocks selected are Vocus Group ((VOC)), Speedcast International ((SDA)), Michael Hill ((MHJ)), Monash IVF ((MVF)), Bega Cheese ((BGA)) and Graincorp ((GNC)).
The second basket of stocks is seen as "expensive". Here investors are advised to either trim exposure or switch to a cheaper alternative. Stocks selected include CSL ((CSL)), Cochlear ((COH)), ASX ((ASX)), Domain Holdings Australia ((DHG)), Blackmores ((BKL)), Freedom Foods ((FNP)), Accent Group ((AX1)), and Domino's Pizza ((DMP)).
With exception of Accent Group, and to a lesser extent Domain Holdings, nominated share prices have already come off noticeably over the past week or so.
The third basket consists of stocks the stockbroker doesn't want you to own; better to switch to alternatives elsewhere. Selected stocks include ANZ Bank ((ANZ)), Pendal Group ((PDL)), Insurance Australia Group ((IAG)), Coca-Cola Amatil ((CCL)), Brambles, Aurizon Holdings ((AZJ)), Automotive Holdings ((AHG)), Pact Group ((PGH)), Santos ((STO)), Newcrest Mining ((NCM)), South32 ((S32)), New Hope Corp ((NHC)), Elders ((ELD)), and Ansell ((ANN)).
Shame, Shame On You, IOOF
"Helping Australians achieve financial independence since 1846" it states proudly on the website of IOOF Holdings ((IFL)), one of the pure play financial services providers listed on the ASX, with half a million customers and $126bn of funds under management.
As a steady and reliable dividend payer, I imagine shares in IOOF which, among many other things, owns half of the equity in stockbroker Ord Minnett, has been popular among many retirees and SMSF operators in search for regular income from the share market. The shares more than doubled since 2010 before carnage kicked in on the back of a Royal Commission that not only cut deeply into the banking sector, but did its best to equally dig up many a smelly corpse inside the land of superannuation service providers.
Here, few would doubt, a most despicable testimony in the witness box was delivered by IOOF Holdings chief executive Chris Kelaher. As soon became clear to all and sundry, IOOF is the type of operator that commands a strong and enforcing financial sector regulator. In the absence of such regulatory regime, multiple kinds of bad behaviour are allowed to occur. APRA has a lot to answer for, but so too the federal government.
Investigative journalism by Fairfax newspapers had already laid bare a culture where rules can be broken (allegedly), and are subsequently covered up (allegedly), with whistleblowers being treated like Chelsea Manning requesting a visitor visa to Australia. All that was before the IOOF culture was spread out for everyone to see at the Royal Commission.
This was also the observation made by the RC which, in its closing submission, concluded not only that IOOF "had preferred its own interests to the interests of the members of the superannuation fund" but also that CEO Kelaher appeared incapable to understand the difference between the two, including "the fundamental obligations of a trustee and the directors of a trustee".
You'd think such damning declarations would be enough for Kelaher & Co to seek shelter under a big rock, maybe issue a public apology or two, but no. IOOF's stoic defiance was subsequently confirmed in its official response to findings of the RC. I know of a certain President who lives in his own bubble, but clearly he is far from the only one.
One of the (many) reasons as to why investors should pay attention to the culture of a corporate once again rose to the surface this week, and quickly too. A few years ago I suggested the fledgling local industry of aged care centres and retiree villages operators looked very promising on the back of demographic shifts taking place, but that was before I gained more insights into how this sector operates.
Similar to IOOF, the signs were plenty and everywhere this sector carried a lot of potential for damaging scandals and regulatory backlash. The announcement of the next Royal Commission on Sunday to help clean up the aged care sector might have been a complete surprise, the low quality of the operators and their modus operandi should not be.
I now believe stocks like Japara Healthcare ((JHC)), Aveo Group ((AOG)), Estia Health ((EHE)) and Regis Healthcare ((REG)) have become the new Telstra. All the experts appearing on TV and in print media telling investors this is good news, an opportunity for the sector to come clean, to separate good operators from the bad, et cetera are simply talking their own book. Either their own portfolio owns shares in affected companies, or their customers do.
On Wednesday, Macquarie analysts said it best when they concluded risk for these operators has jumped up a few notches, both from an operational and financial point of view, which, as a follow-through effect, should raise questions about dividends in FY19.
There are no such questions about IOOF dividends, at least I have seen none to date, but wealth management businesses from the banks are now under significant pressure, and IOOF is buying the underperforming funds from ANZ Bank.
That's still not the point I am trying to make here. For decades investors, and I include institutions and professionals of all kinds and colours, have mostly ignored elements like corporate culture, compliance, the overall quality of the business, et cetera. In the world of value investors all that matters is a low share price and the potential for it to revert back to the mean.
I believe this is changing. Increasingly investors in the US and in Europe are paying attention to immeasurable factors such as does a company treat its customers well, are staff happy campers and is the corporate culture top notch quality, because they have come to understand corporate quality is what separates, say, CSL from Telstra, and WiseTech Global from AMP. Increasingly, research supports the notion that high quality companies are best for shareholders in the long run.
Dare I say it, IOOF also sits firmly with the low quality equivalents, as does the aged care sector.
All of the above aside, if anyone happens to have some superannuation with either IOOF or ANZ Bank I strongly suggest time has arrived to seriously ask the question: is this the operator you trust with your super?
Audio interview about share market in September and the August reporting season:
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
Rudi On Tour
-Presentation to AIA members and guests Chatswood, on October 10
-Presentation to ATAA members and guests Sydney, on 18 October
-AIA Celebrity Lunch, Brisbane, on November 3
(This story was written on Monday 17th September 2018. It was published on the Monday 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, written on Wednesday).
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