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Rudi’s View: Banks, Cimic, Coles, And PWR Group

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Always an independent thinker, Rudi has not shied away from making big out-of-consensus predictions that proved accurate later on. When Rio Tinto shares surged above $120 he wrote investors should sell. In mid-2008 he warned investors not to hold on to equities in oil producers. In August 2008 he predicted the largest sell-off in commodities stocks was about to follow. In 2009 he suggested Australian banks were an excellent buy. Between 2011 and 2015 Rudi consistently maintained investors were better off avoiding exposure to commodities and to commodities stocks. Post GFC, he dedicated his research to finding All-Weather Performers. See also "All-Weather Performers" on this website, as well as the Special Reports section.

Rudi's View | Mar 22 2019

In this week's Weekly Insights (this is Part Two):

-Central Banks Keep The Worries Away
BC *Extra* Puts Small Caps In Focus
-Changing Climate Has RBA's Attention
Conviction Calls
-February Reporting Season: Final Observations
-Rudi On TV
-Rudi On Tour

[Non-highlighted parts appeared in Part One on Thursday]

By Rudi Filapek-Vandyck, Editor FNArena

BC *Extra* Puts Small Caps In Focus

FNArena's daily Australian Broker Call Report focuses solely on eight stockbrokerages, and so does the permanent Corporate Results Monitor we are running all-year around on the website. This can have the disadvantage that sometimes smaller cap stocks, albeit promising and/or interesting, fall through the cracks, in particular when the team of journalists is extremely busy.

This year we have tried to compensate for this through two updates of the Australian Broker Call *Extra* Report; two editions published last week that are chock-a-block filled with lesser-known ASX-listed names such as Bigtincan Holdings ((BTH)), Elanor Investors Group ((ENN)), Fluence Corp ((FLC)), and Macquarie Telecom ((MAQ)), as covered by a wider group of brokers.

The added value is now that investors can also search for these companies on the website, with share price information and price charts included. Above all, for all that are specifically interested in finding the next small cap opportunities, there's a whole new bunch to read about, consider and add to your watch list.

We are awaiting for the tech development team to introduce an easy-to-locate archive for these *Extra* editions next to the archive for daily Broker Call Reports on the website. In the meantime, I have to admit it's not easy to find where exactly are these two special editions in between all the stories we publish and update every day.

Hence why I have included two direct links:

https://www.fnarena.com/index.php/2019/03/11/australian-broker-call-extra-edition-mar-11-2019/

https://www.fnarena.com/index.php/2019/03/13/australian-broker-call-extra-edition-mar-13-2019/

One of the obvious observations to make from these two *Extra* February reporting season-inspired updates is that small cap engineers and specialist services providers to miners and energy companies are back on analyst radars. Whereas many would argue the share price for a sector stalwart such as Monadelphous ((MND)) already reflects a lot of future optimism about both sectors ramping up spending in the years ahead, judging from a whole lot of comparable companies mentioned, this doesn't seem to be the case for everyone in that sector.


That idea is further fuelled by analysis such as the one published by UBS on 11 March recently, in that infrastructure construction spending across Australia is still looking healthy, offering engineers and contractors visible growth potential at least out to 2021 from public infrastructure spending on top of the resources sector.

UBS's favourites to play the theme are Seven Group ((SVW)), Downer EDI ((DOW)), and Cimic Group ((CIM)).

The main caveat here is that this theme is by no means new, and recent years have also exposed many disappointments for investors who jumped on board the wrong stocks, believing they could benefit from what, from the outside at least, looks like a cannot-lose situation for contractors. Wagners Holding ((WGN)) comes to mind, as well as RCR Tomlinson (no longer in existence), while Adelaide Brighton ((ABC)) has been nothing but a disappointment as well.

Conviction Calls

Stockbroker Morgans has released what is possibly best described as a negative conviction list; stocks that are either too expensive, or unattractive for other reasons, with investors advised to trim holdings, or sell out completely, and seek better rewards elsewhere.

Note that Morgans is, and has been, worried about how quickly the local share market recovered from its December low, with a rather mixed and lukewarm reporting season to support current share price levels.

Stocks listed to sell include ASX ((ASX)), TechnologyOne ((TNE)), Fortescue Metals ((FMG)), Newcrest Mining ((NCM)), and AGL Energy ((AGL)).

Stocks that are better avoided, with better opportunities seen elsewhere, include Coles Group ((COL)), Pendal Group ((PDL)), JB Hi-Fi ((JBH)), Accent Group ((AX1)), Coca-Cola Amatil ((CCL)), Vocus Group ((VOC)), Freedom Foods Group ((FNP)), and Sandfire Resources ((SFR)).

Stocks for which investors are advised to trim their current ownership include Brambles ((BXB)), Medibank Private ((MPL)), Insurance Australia Group ((IAG)), APA Group ((APA)), Aurizon Holdings ((AZJ)), Atlas Arteria ((ALX)), Transurban ((TCL)), Cleanaway Waste Management ((CWY)), Centuria Industrial REIT ((CIP)), Ramsay Health Care ((RHC)), Ansell ((ANN)), and New Hope Corp ((NHC)).

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Stockbroker Morgans has also updated on its model portfolios, revealing its Balanced Model Portfolio has sold out of Link Administration ((LNK)) -disappointed with the interim result and believing the future offers headwinds- while adding Woolworths ((WOW)) in a move to strengthen the portfolio's defensive characteristics, while also trimming positions in Cleanaway Waste Management, Corporate Travel ((CTD)), and Transurban.

It should be noted, the Growth Model Portfolio has kept its shares in Link Administration, sold out of Atlas Arteria and Apollo Tourism & Leisure ((ATL)), trimmed its exposure to Corporate Travel, and bought additional shares in both Motorcycle Holdings ((MTO)) and ResMed ((RMD)).

Preferred yield plays remain, in order of preference, Viva Energy REIT ((VVR)), Centuria Metropolitan REIT ((CMA)), Centuria Industrial REIT ((CIP)), and Aventus Group ((AVN)).

Might be useful to also take into account A-REIT preferences at Ord Minnett with all of Aventus Group, Viva Energy REIT, Centuria Metropolitan REIT and APN Convenience Retail REIT ((AQR)) enjoying the broker's highest rating.

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Bell Potter's tech analysts Chris Savage and TS Lim have had to stretch the principle of what makes a tech company to compensate for TechnologyOne's strong share price performance. TechnologyOne is no longer a Key Pick at Bell Potter, not quite joining WiseTech Global ((WTC)) as yet as a Sell-rated stock, but it was decided the Top Three of Key Picks for the local technology sector needed a revamp.

Apart from Citadel Group ((CGL)) -most preferred- and Integrated Research ((IRI)), number three is now PWR Group ((PWH)). If anyone's just a little confused, I can fully understand it, as I was too upon reading the latest update. PWR Group designs and produces cooling systems for fast driving cars. Bell Potter justifies its selection by stating there is a lot of technology involved.

I have visions of queues of market commentators, and the occasional punter, to address Domino's Pizza ((DMP)) as a tech company when the share price was rallying towards $75.80 in August 2016. Remarkably, to say the least, since then the label "technology company" has seldom been used in relationship with Domino's Pizza, with its share price now in the mid-$40s.

I can sympathise somewhat. For years I have been pointing out both ResMed and Cochlear are technology stocks, and some very good ones too. They just happen to operate inside the healthcare sector and therefore carry that specific label, but they are, in essence, technology driven with all the typical characteristics that come with it.

I cannot sympathise with Domino's Pizza, though, and fail to connect with PWR Group. Maybe the true message here is that Savage and Lim have decided not to nominate either of Adacel Technologies ((ADA)), Catapult Group International ((CAT)), Empired ((EPD)) or Over The Wire Holdings ((OTW)) as their third most preferred technology sector choice, despite rating all as a Buy?

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Model portfolio operators at UBS retain an Overweight preference for Metals and Mining, Defensives and Energy, while sticking to an underweight exposure to Banks, Other Financials, and REITs.

At a stock level, report the analysts, Premier Investments ((PMV)), Brambles, Woolworths, CSL ((CSL)) and BHP Group ((BHP)) all continue to screen well, while quantitative analysis suggests an unfavourable outlook short term for stocks including Seek ((SEK)), DuluxGroup ((DLX)), TPG Telecom ((TPM)), Vocus Group, and Sims Metal Management ((SGM)).

Looking at the finer details, UBS's Model Portfolio remains heavily underweight banks at close to -30%.

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Macquarie's Model Portfolio, on the other hand, continues to see downside pressure on domestic bond yields, and thus ongoing support for yield names. Taking guidance from past research, Macquarie analysts believe healthcare and yield stocks tend to outperform in the lead-in to RBA rate cuts.

The Macquarie Model Portfolio has further reduced exposure to local banks to make room for the addition of Fortescue Metals, alongside Amcor ((AMC)). The latter replaces Orora ((ORA)), while OZ Minerals ((OZL)) is also out.

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The team of analysts covering consumer related stocks in Australia at Morgan Stanley has equally communicated their Top Favourites and Best To Avoid picks post February reporting season.

Top Picks are JB Hi-Fi ((JBH)) and Flight Centre ((FLT)). For the former, the analysts agree sales momentum is likely to continue slowing throughout the rest of the year, but this is already reflected in the share price, in their view.

For Flight Centre, the composition of sales is changing towards more corporate (rather than leisure) in the US and as investors start to acknowledge this, a higher valuation should ensue.

Two stocks to avoid are, on their assessment, Wesfarmers ((WES)) and Blackmores ((BKL)). The latter is facing a more difficult environment for longer, is the analysts' view, something that has yet to be priced into the share price.

As far as Wesfarmers goes, Morgan Stanley's deeper dive research into big box retailing (see also further below) is showing sales per square meter at Bunnings is now slowing noticeably, with negative consequences for the outlook.

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Earlier in the month, analysts at stockbroker Morgans had updated their selection of High Conviction Stocks which resulted in the removal of Cleanaway Waste Management, OZ Minerals and Lovisa Holdings ((LOV)) alongside the inclusion of Sonic Healthcare ((SHL)).

Apart from Sonic Healthcare, the selection also still includes ResMed, Reliance Worldwide ((RWC)), Westpac ((WBC)), Oil Search ((OSH)), PWR Holdings, Volpara Health Technologies ((VHT)), Kina Securities ((KSL)), Australian Finance Group ((AFG)), and Senex Energy ((SXY)).

February Reporting Season: Final Observations

If there is one conclusion for investors to draw from the recent February reporting season in Australia, suggest analysts at Morgan Stanley, it is that big box retailing is slowly dying in Australia.

Analysis by the analysts has revealed on current trends sales per square meter only grew faster than 2.5% for just three retailers in the February reporting season. This is a red alarm signal given rental costs are growing by 2.5% and labour costs are increasing at 3.5% on a like-for-like basis.

On Morgan Stanley's calculations, labour costs represent between 70%-90% of all costs for Australian retailers.

Even a child can put one and one together and conclude the squeeze is on.

Morgan Stanley's research also suggests consumers are preferring smaller box retailers, while online competition is increasingly taking market share (together with retailers' own online channel). "Should retailers cut back on staffing, opening hours or marketing we think that this likely accelerates the slowdown in sales per sqm growth", state the analysts and with that statement the sector's dilemma has been captured.

The stand-out slowing down story for Morgan Stanley is Dan Murphy's (owned by Woolworths) with the analysts noting the beer, liquor and wine chain has for a long time been the group's growth engine, but now three years in succession have disappointed. On the latest analysis, sales per sqm growth for Dan Murphy's is negative. Foot traffic, point out the analysts, fell -4% to -5% in H1.

The analysts are predicting the next 12-18 months will see stores being closed. Not helping matters, industry data presented by Nielsen suggest high rates of online growth are representative of in-store cannibalisation, with only minimal growth still occurring in in-store sales, point out the analysts.

What makes this latest piece of analysis so painful for both supermarket operators Woolworths and Coles ((COL)) is that, contrary to the trend, both have been closing down smaller locations and opening up larger sized stores in recent years.

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Staying with the local consumer stocks, UBS analysts have made the effort to trying to establish where the market over-reacted post February results, with their analysis suggesting positive share price responses may likely have been out-of-line enthusiastic for Myer ((MYR)), a2 Milk ((A2M)), Flight Centre ((FLT)), Viva Energy ((VEA)), JB Hi-Fi ((JBH)) and Wesfarmers ((WES)); the latter was downgraded to Sell post interim report.

Where investors might have over-reacted to the downside (i.e. these stocks might be worth revisiting), according to UBS, is after results released by Coles Group ((COL)), Treasury Wine Estates ((TWE)), Super Retail ((SUL)), Costa Group ((CGC)), Woolworths, and Kogan ((KGN)).

To set the sector record straight: UBS's three sector favourites are Flight Centre ((FLT)), Treasury Wine ((TWE)), and Metcash ((MTS)). Least preferred are Wesfarmers, Coca-Cola Amatil  and Inghams Group ((ING)).

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Strategists at Morgan Stanley have observed a sharp discrepancy between the local share market performance in February (which was by anyone's account excellent, generating close to 6% return all-in) and the reporting season itself which, on Morgan Stanley's assessment highlighted the intensification of growth and earnings headwinds.

Meanwhile, macro data in Australia continue to weaken and there are suggestions households are deleveraging, thus creating an automatic headwind for companies dependent on consumer spending. The logical observation to add here is that investors, clearly, are drawing confidence from the prospect for one or more rate cuts by the RBA later in the year, or in 2020.

Morgan Stanley strategists are not so sure, and they would "fade such optimism". Their warning to investors: "The downturn underway could be harder to stimulate out of". Apart from a more cautious stance on the local share market in general, Morgan Stanley's Model Portfolio is not inclined to change the underweight exposure to both banks and housing-linked stocks.

If anything, Morgan Stanley thinks the divergence between housing-linked stocks and the broader share market is likely to widen further, not shrink in the months ahead.

Earlier in the month, quant analysis by UBS indicated that, not only have "value" stocks uncharacteristically outperformed during the February reporting season (usually momentum and growth are outperforming), but macro influences have been of larger impact than the actual results. Think the Hayne report and banks, for example, and production loss at Vale.

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While healthcare stocks have been prominently absent from the month's table of best performers, analysts at Morgan Stanley see further downside for shorter-term forecasts. They also point out, the main ASX healthcare names still offer circa 10% 3 year CAGR EPS growth (on market cap weighted average) compared to no more than 4% for the ASX200.

In layman's language these numbers translate into: yes, healthcare stocks failed to shoot out the lights in February, but over the next three years the key sector performers (which includes all of CSL ((CSL)), ResMed ((RMD)) and Cochlear ((COH)) should still outgrow the large majority of ASX200 constituents, so there doesn't appear to be any reason for panic or despair for investors owning these stocks.

In line with comments and views expressed elsewhere, Morgan Stanley preaches caution when it comes to owning private hospital operators.

Rudi On TV

My weekly appearance on Your Money is now on Mondays, midday-2pm.

Rudi On Tour In 2019

-ASA Sydney Investor Hour, March 21
-ASA Melbourne, May 1
-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 19th March 2019. Part One was published on the Tuesday 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 as a story 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: info@fnarena.com or via the direct messaging system on the website).

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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?)
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– 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.
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Subscriptions cost $420 (incl GST) for twelve months or $235 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

(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.) 

(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.)  

P.S. I – All paying members at FNArena are being reminded they can set an email alert for my Rudi's View stories. Go to My Alerts (top bar of the website) and tick the box in front of 'Rudi's View'. You will receive an email alert every time a new Rudi's View story has been published on the website. 

P.S. II – If you are reading this story through a third party distribution channel and you cannot see charts included, we apologise, but technical limitations are to blame.

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