Rudi's View | Feb 07 2019
In this week's Weekly Insights:
–February Reporting Season Preview
-Between A Graphite Rock And A Hard Place
-Rudi On TV
-Rudi On Tour
It's 2019, and we're back..!
February Reporting Season Preview
By Rudi Filapek-Vandyck, Editor FNArena
The public debate as to whether the US, and by extension the global economy, is heading for a recession has quickly fallen flat in early 2019. Very little works as reassuringly as rising share prices, and as the dire and gloomy final quarter of calendar 2018 has been followed up by one of the strongest January performances on record, investors worldwide seem to accept that maybe there still is a valid alternative in between raging bull and relentless bear.
One might be inclined to draw a parallel with early 2016. Things seemed similarly doomy and gloomy at that time, but the Federal Reserve, then chaired by Janet Yellen, got the message and pressed the pause button. By year's end the outcome for global equity markets turned out a lot better than many would have dared to predict at the start of the year.
I doubt whether 2019 will carbon copy the year 2016, though we do share Brexit on the calendar, and the RBA is patiently sitting on its hands. Global growth appears to be decelerating rapidly, with growing concerns about Europe and China, while indicators and data in Australia further highlight all is not well with construction of apartments and consumer spending.
For the local share market specifically this implies earnings forecasts and short-term valuations will need to reset at a lower level; a process that has already started ahead of the February reporting season. Analysts at stockbrokerages have been busy cutting estimates and price targets for a number of weeks. But many a share price is by now trading at a level well below last year's peak in August.
The Big Question for investors then becomes whether forecasts still need to be reduced further or whether share prices are already reflecting an outlook too dire for what likely awaits next?
The proof of the pudding, as the old saying goes, is in the eating. Corporate results, and in particular forward guidance provided over the following 3-4 weeks, will be submitted to extreme scrutiny, if only because many investment portfolios got dented, battered and bruised throughout the late 2018 turmoil, and investors will be anxious to avoid further disappointment.
Properly assessing this "earnings recession" is now on every investor's mind. Is it really as bad as (some) share prices are suggesting? Where are the likely surprises? How much risk is there still out there? Is it really worth trying to go contrarian?
Corporate reporting seasons overseas are only half-way through at the most, but observations to date suggest the US looks reasonably OK, while Europe has been rather disappointing. And Australia? Locally we don't have much to work with yet, apart from a few dozen negative profit warnings, mostly from small cap companies, plus a handful of early corporate result releases.
The February reporting season is still only warming up. The calendar gets busier next week, but in particular in the final two weeks of the month. Meanwhile, local investors have enjoyed higher share prices in response to a much more relaxed Federal Reserve, and on expectations of no escalation in tensions between the Trump administration and China; OK corporate results in the US have further supported general sentiment, as did the final Hayne report following the Royal Commission into banks and financial service providers.
Post its February Board meeting on Tuesday, the RBA's assessment included a downgrade of the economic outlook while highlighting additional downside risks, while still maintaining a positive outlook overall.
In terms of concrete signals from the corporate coal face, more than twenty profit warnings issued by small cap companies throughout December have been followed up in January with similar warnings from the likes of Investsmart Group ((INV)), Yowie ltd ((YOW)), Wagners Holding Co ((WGN)), McPhersons ((MCP)), Oliver's Real Foods ((OLI)), and Navigator Global Investments ((NGI)) in further evidence operational momentum late last year has run into a serious slow-down headwind for a number of Australian companies, in line with economic data and indicators.
The impact from the global slow-down is not restricted to small caps, as shown by recent profit warnings issued by Sims Metal Management ((SGM)), Boral ((BLD)), Costa Group ((CGC)), Platinum Asset Management ((PTM)), Kathmandu ((KMD)), and several others.
As far as actual corporate results are concerned, ResMed ((RMD)) and GUD Holdings ((GUD)) both missed market expectations and their share prices were sold down in response, quite savagely too with ResMed's US-listed shares losing in excess of -20% immediately after the quarterly update. Both are quality, resilient performers with a positive track record, and a longer-term growth path intact, which is probably why their share prices have somewhat recovered since.
The treatment of both "misses" however will have put experienced investors on notice: things can get quite brutal if corporate results somehow miss the mark. Fund managers will have responded by taking some share market exposure off the table, with the aim of slightly reducing risk and having the ability to respond to outbursts in short-term volatility.
Credit Corp ((CCP)) did perform better than expected, but forecasts and broker price targets didn't move that much higher, so the initial jubilation was quickly met by traders selling. That is the other kind of risk this month: maybe most of the good news is already in the share price?
The other scenario is, of course, a share price that is simply too low for whatever seems to be happening operationally. Here, investors can take heart from the market's response following an update by perennial disappointer James Hardie ((JHX)). While the quarterly performance continues to look subdued, management has announced a new cost reduction program and narrowed guidance for the full financial year. The share price jumped by 6%-plus on Tuesday.
Admittedly, the stock lost a big chunk of its value since August last year -some -37% on the back of two consecutive disappointing market updates- but the underlying message is nevertheless that some share prices at least have fallen too deeply.
Combine all of the above, and the February reporting season will inevitably become the first major litmus test for how corporate Australia is coping with the many headwinds and challenges. We can all believe, suspect, speculate and predict, but ultimately the financial numbers and their impact on market forecasts and sentiment will do the main talking.
Every reporting season has investors and analysts worried about at least one segment of the market and this time around the widespread concern is about the general deterioration in consumer spending, which is expected to weigh upon financial performances of discretionary retailers and automobile-related business models. But not all of them, of course, and not all of them to the same degree.
Carsales' ((CAR)) share price has fallen quite dramatically since September last year, but many a sector analyst thinks the resilience of its core business, which revolves around selling and buying of second hand cars, should shine through this month. Automotive Holdings ((AHG)), on the other hand, is often mentioned as more likely to issue yet another disappointment, as is Motorcycle Holdings ((MTO)).
A similar divergence could open up between bricks and mortar retailers with some analysts speculating share prices for the likes of Super Retail ((SUL)), JB Hi-Fi ((JBH)), and Harvey Norman ((HNV)) could actually rally in the absence of any further negatives. But given they also think this theme is going to stick around for longer, questions are being asked about realistic prospects and sustainability of any share price gains further out.
On the flipside, Baby Bunting ((BBN)) and Accent Group ((AX1)) are expected to come out with strong results, possibly even better than what is expected. Opinions remain divided about what to expect from cheap bling jeweller Lovisa Holdings ((LOV)), as well as from ARB Corp ((ARB)) and Bapcor ((BAP)) with some analysts suggesting the latter company might surprise with a better-than-expected guidance. Either way, all analysts remain convinced Bapcor remains a solid longer term growth story.
But more so than on the retailers, investors' attention is increasingly directed towards listed landlords for those retailers in the form of shopping mall owners, in particular those who own and operate sub-regional and neighbourhood malls (as opposed to prestigious inner-city towers). One team of sector analysts at Deutsche Bank has gone as far as to declare 2019 to be the turning point for retail assets, in a negative way.
Retail assets in recent months have been bought and sold at small discounts to book value (between -2-5%) and Vicinity Centres ((VCX)) already incorporated a minor write down for the value of its assets. These signals are minor in itself, but nothing in this sector moves rapidly and it is hard to argue that if this is now the new trend, share prices will find it hard to move much higher irrespective of present Net Tangible Value (NTA) calculations.
Irrespective, some analysts still argue the market is being too harsh on Stockland ((SGP)) and Mirvac ((MGR)), while Viva Energy REIT ((VVR)) is also mentioned for possibly releasing a strong report. The same applies for Goodman Group ((GMG)) and Charter Hall ((CHC)), as industry dynamics for industrial property remain strong, but here lofty valuations are oft mentioned as a major impediment to get more excited.
The downturn for housing construction is expected to linger for longer, and this, obviously, is weighing upon prospects and valuations for building materials stocks. BlueScope Steel ((BSL)) too might be starting to feel the pinch. James Hardie ((JHX)) was widely predicted to release yet another disappointing quarterly performance. These expectations proved accurate but management's promise to reduce costs by a further $100m had investors excited, and thus the share price responded positively.
Resources in a broad sense seem cum upgrades because commodity prices are mostly higher than forecasts, but, as per always, divergences are wide and widespread, and many doubt whether it can last. Miners are the only sector that has enjoyed upgrades to forecasts pre-February reporting season.
In a general, broad market sense, earnings estimates have fallen from a forecast of 6%-plus on average in late 2018 to now circa 4%, which is below the two prior years as well as below historical trend in Australia. However, most analysts and strategists remain of the belief this average will be even lower by the beginning of March. Ex-resources and ex-banks the average forecast EPS growth now sits at 1% only, suggesting this number is about to fall into negative territory.
No guessing why most analysts are expecting February will see more surprises to the downside than to the upside.
Financials will not be the sector to turn this trend around. At least not in the short term. Commonwealth Bank ((CBA)) had been predicted by many an analyst to likely fall short of already subdued expectations, and CBA's report did exactly that on Wednesday. Overall enthusiasm for Bendigo and Adelaide Bank ((BEN)) is even lower.
Diversified financials, predominantly asset managers and insurers, might have a negative skew because of last year's heavy turmoil across financial markets globally. Funds managers are battling underperformance, downward pressure on fees and funds outflows, while insurers are expected to release quite messy results, including weather-related claims, restructurings and asset sales. Analysts weren't quite sure what to expect from Insurance Australia Group ((IAG)) either, but the jump in share price following the release of H1 results suggests investors are willing to look through minor negatives and instead concentrate on the positives.
Here one observation stands out: while uncertainty still reigns about what exactly will the February result release look like for Link Administration ((LNK)), given local superannuation industry changes and Brexit in the UK, virtually every sector analyst has this company as the top favourite, if only because the share price is deemed too cheap.
Elsewhere the team at Citi is worried growth in dividends for infrastructure stocks Sydney Airport ((SYD)), Transurban ((TCL)) and Auckland International Airport ((AIA)) might be cum de-rating. The analysts will be extra attentive, looking for further evidence this reporting season. In media, Nine Entertainment ((NEC)) is considered a prime candidate for releasing a solid performance, while Domain Holdings' ((DHG)) share price has already come under pressure in anticipation of a rather weak financial report.
As far as individual companies are concerned, UBS sees dark clouds approaching for A2B Australia ((A2B)) (formerly Cabcharge), Automotive Holdings, Netwealth ((NWL)) and Servcorp ((SRV)) but potentially better results and better guidance from companies including Adairs ((ADH)), Appen ((APX)), Corporate Travel ((CTD)), Cleanaway Waste Management ((CWY)), G8 Education ((GEM)), Infomedia ((IFM)), Imdex ((IMD)) and Webjet ((WEB)).
Out of this selection, both G8 Education and Webjet are currently dividing opinions with analysts elsewhere either agreeing or disagreeing.
UBS also believes companies including AMA Group ((AMA)), Bapcor, Costa Group, Freelancer ((FLN)), Kogan ((KGN)), Megaport ((MP1)) and NRW Holdings ((NWH)) are likely to surprise through positive guidance.
Morgan Stanley continues to like offshore earners with IDP Education ((IEL)), Nearmap ((NEA)) and MNF Group ((MNF)) upheld as "compelling structural growth" stories, alongside Baby Bunting and McMillan Shakespeare ((MMS)). Stocks to avoid, according to Morgan Stanley, include Webjet (!), InvoCare ((IVC)), Lovisa (!), 3P Learning ((3PL)), SG Fleet ((SGF)) and Automotive Holdings.
Stockbroker Morgans is counting on Treasury Wine Estates ((TWE)), Jumbo Interactive ((JIN)), Acrow ((ACF)), Corporate Travel, Medibank Private ((MPL)), and Baby Bunting to deliver positive surprises. Capital management initiatives could be forthcoming from the likes of Woolworths ((WOW)), Wesfarmers ((WES)), ERM Power ((EPW)), Flight Centre ((FLT)), and Whitehaven Coal ((WHC)).
Morgans also lists a number of candidates it believes only have to meet market expectations to see their share prices rally: Reliance Worldwide ((RWC)), Kina Securities ((KSL)), Origin Energy ((ORG)), Emeco Holdings ((EHL)), Coronado Global ((CRN)), Apollo Tourism ((ATL)), Monash IVF ((MVF)), and Adairs.
Companies poised for a "miss", according to Morgans, include Sydney Airport, Superloop ((SLC)), Pact Group ((PGH)), InvoCare, Ansell ((ANN)), Ramsay Health Care ((RHC)), JB Hi-Fi, National Tyre & Wheel ((NTD)), Motorcycle Holdings, Bapcor (!), and Automotive Holdings.
Analysts at Wilsons see positive surprises coming from Austin Engineering ((ANG)), Ausdrill ((ASL)), Alliance Aviation ((AQZ)), Bravura Solutions ((BVS)), Countplus ((CUP)), EML Payments ((EML)), EQT Holdings ((EQT)), Nick Scali ((NCK)), Noni B ((NBL)), National Veterinary Care ((NVL)), and NRW Holdings.
Candidates for downside surprises not yet anticipated or priced in are Ainsworth Gaming ((AGI)), ARB Corp, Class ((CL1)), G8 Education, Mayne Pharma ((MYX)), Motorcycle Holdings, and Silver Chef ((SIV)).
Last but not least, some analysts are speculating resurrected (sort of) Telstra ((TLS)) might deliver yet another bombshell in flagging another reduction in shareholders' dividend. Local superstar CSL ((CSL)) is expected to put in yet another solid financial performance, without an upgrade to guidance. The question then remains: is the short term money possibly expecting more?
For investors it is good to keep in mind all of the above are best guesses and forecasts, and investor responses don't always seem straightforward and logical, at least not in the short term when speculation, market positioning and macro-considerations can have their say as well. Short term disappointment does not by default translate into long term underperformance, though impacts can linger for three months and longer. All shall be revealed over the next three weeks, hopefully.
As per previous reporting seasons, FNArena is keeping a daily watch on local companies reporting and what it means for estimates, ratings and valuations:
Analysts at Wilsons updated their Conviction Recommendations; all positive. The selection counts 14 names with prospective returns for the year ahead (if everything goes according to plan) of between 10% and 280% for Bravura Solutions ((BVS)) and ImpediMed ((IPD)) respectively.
The other twelve names on the list are ARQ Group ((ARQ)), Collins Foods ((CKF)), Ruralco ((RHL)), Ridley Corp ((RIC)), Nanosonics ((NAN)), Pinnacle Investment ((PIN)), EQT Holdings ((EQT)), Noni B ((NBL)), GWA Group ((GWA)), Ausdrill ((ASL)), Mastermyne ((MYE)) and NRW Holdings ((NWH)).
Elsewhere, Wilsons' technology analysts expressed their preference for Bravura Solutions and EML Payments ((EML)) in the sector, while also recommending investors stay clear off Integrated Research ((IRI)), Ainsworth Gaming ((AGI)), Class ((CL1)), and Elmo Software ((ELO)) ahead of the February reporting season.
Shaw and Partner's Large Cap Portfolio had an excellent January experience, fully enjoying the sharp bounce back from heavily sold down levels, but CIO Martin Crabb is worried share prices might have moved too sharply, too soon, while forecasts globally appear too high, in particular with momentum indicators continuing to flash amber lights; the global economy continues to decelerate.
Time to shift into a more conservative modus, argues Crabb.
The Large Cap Portfolio has trimmed some of the outperformers in Materials and Energy, BHP ((BHP)) and Fortescue Metals ((FMG)), while staying overweight both sectors overall. Northern Star ((NST)) has been added to inject some gold exposure. Caltex ((CTX)) has been sold, further reducing the portfolio's exposure to Australian consumers.
ANZ Bank ((ANZ)) shares have been added (ahead of the release of the Hayne report) to make sure the sector's bounce won't go completely unnoticed. Further enhancing the defensive switch, exposure to Macquarie Group ((MQG)) has been trimmed, while Wesfarmers ((WES)) has been replaced by Coles ((COL)) and Dexus ((DXS)) has become the newest addition, plus Lendlease ((LLC)).
Crabb's final statement underpins the move towards more defensive exposures: "We still think there is money to be made from the Australian share market, but it will mostly be in the form of dividend yield and secular growth rather than a continued expansion of sales and operating margin. Stocks exposed to a continued deceleration of world growth seem most vulnerable and not all share prices have this risk factored in."
Other names on the selective list are Cleanaway Waste Management ((CWY)), OZ Minerals ((OZL)), ResMed ((RMD)), Westpac ((WBC)), Reliance Worldwide ((RWC)), Lovisa Holdings ((LOV)), PWR Holdings ((PWH)), Volpara Health Technologies ((VHT)), Kina Securities ((KSL)), and Australian Finance Group ((AFG)).
The latter share price tanked in excess of -29% on the day after the release of the Hayne report. Not sure whether this was an oversight, or whether Morgans is now even more convinced about AFG's future potential? (I tend to think it's the first, but happy to await the next update).
Stockbroker Morgans also still has Corporate Travel ((CTD)) listed as an active shorter term trading suggestion.
Also, back in December, when share prices seemed to be falling with no end in sight, Morningstar (once upon a time known as Huntley's) updated its Best Stock Ideas for the year ahead. In the meantime, equity markets have bounced off their lows, and hard too, but it's nevertheless never a bad thing to stay on top of Conviction Ideas put forward.
As such, Morningstar's Best Stock Ideas are a2 Milk ((A2M)), Aveo Group ((AOG)), G8 Education ((GEM)), InvoCare ((IVC)), James Hardie ((JHX)), Link Administration ((LNK)), Macquarie Group ((MQG)), Pendal Group ((PDL)), Telstra ((TLS)), Westpac ((WBC)), and Woodside Petroleum ((WPL)).
Between A Graphite Rock And A Hard Place
Outspoken mining analyst Christopher Ecclestone (Hallgarten & Co) has a strong view on why investing in specialty metals is fraught with danger: every once in a while a megalomaniac entrepreneur with an unhealthy dose of grandeur enters the window of opportunity, and then spoils it for everyone, including for their own financial supporters and shareholders.
I am paraphrasing, but you can read that prior sentence as a near perfect summation of Ecclestone's view. His latest warning to investors includes local graphite newby Syrah Resources ((SYR)), at times popular with parts of the readership here at FNArena. Which is why I think Ecclestone's warning might hit a soft spot, here and there.
So here it goes…
"Let's start with the reality that the flake graphite market, at least for the moment, is 750,000 tpa. Syrah Resources has built and is currently commissioning a mine in Mozambique with a nameplate production capacity of 350,000tpa.
This was a dumb idea from the start and it is not going well. Capital costs are more than double original estimates, the project is well behind schedule and after a more than a year of commissioning, it has only achieved 50% of throughput and up to 70% of recoveries. Syrah would have gone bust in September, 2017 and again in 2018 but was bailed out both times by equity financings in Australia. So far it has raised over US$400 million.
The project is cash flow negative and has to increase production (if that is even technically feasible) to lower unit costs but higher production will depress prices and it is unlikely the market can absorb the volume. It is a no-win situation for them.
In the interim, Syrah's production has further depressed prices and uncertainty over its future has put a chill on the financing and development of other projects. Anyone thinking of investing in graphite has to have an opinion on Syrah."
But wait, there is more…
"Gargantuanism has been the curse of the mining industry this century. Something relatively simple like graphite should have escaped the curse but in the case of the two companies cited [Syrah and Zen Graphene Solutions], they embraced the philosophy with both hands and made it their strategy. The results have not been pretty. If Syrah “succeeds” it will screw up pricing in the graphite space for the short to medium term (i.e. up until 2025).
Failure will be a blessing not in disguise."
Rudi On TV
My weekly appearance on Your Money is now on Mondays, midday-2pm.
Rudi On Tour In 2019
-ASA Inner West chapter, Concord, Sydney, March 12
-ASA Sydney Investor Hour, March 21
-ASA Toowoomba, Qld, May 20
-U3A Investor Group Toowoomba, Qld, May 22
-AIA Adelaide, SA, June 11
-AIA National Conference, Gold Coast, Qld, 28-31 July
-AIA and ASA, Perth, WA, October 1
(This story was written on Tuesday 5th and Wednesday 6th January 2019. It was published on the Tuesday (part 1) in the form of an email to paying subscribers at FNArena, and again on Thursday as a story on the website. By then the preview on the February reporting season will have been extended as communicated in today's email).
(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
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– 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)
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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.)