ASX Weekly Wrap 28/11 - 02/12

Welcome to the ASX Weekly Wrap. A weekly email that will be sent out to clients, and also made available on my website, with a brief description of the events that moved the local markets during the week and also what I am watching on an individual stock level. Feel free to provide feedback and alert me to any topics that you may want covered.

Busy, Busy week and lots to get to, so will get cracking straight away. As predicted the XJO lost a bit of steam this week and corrected -63.80 points or -1.16%. The high was 5,504.10 on Monday and the low was 5,423.20 on Wednesday. Much of the weakness comes down to a bit of profit taking after the ‘Trump Rally’ we have had over the last couple of weeks.

The first drop of major data came from the US on Tuesday night with the US third Quarter GDP figures. The figure beat most forecasts convincingly coming at +3.2% year on year growth. This is higher than the +3.0% most were expecting and higher than the +2.9% last quarter. The beat has been mainly attributed to consumer spending which was up +2.8% from +2.1% last quarter. This is really encouraging as it should consumers are willing to put their hand in their pockets again and spend, which obviously is great for the economy. It is also the final nail in the coffin for the Fed, you would suspect, as rates will get increased 25bps when they meet on the 14th of this month.

The next lot of news came from OPEC, from their monthly meeting in Vienna, on Wednesday night. To everyone’s surprise OPEC nations agreed to cut production by 1.2mill barrels of oil per day. There was much pessimism leading up to the meetings as the last rumored cut didn’t eventuate and talk before the meeting from involved nations were far from positive. This surprise cut sent Oil up +9% for the night as it gained more traction last night as well up another +3%. Crude now sits at $51 a barrel. Understandably there is a lot of bullishness around the price of oil now as it’s the first cut we have seen in 8 years. The finer details of the cut are Iran doesn’t have to cut but just freeze production and Saudi Arabia has a larger cut than the rest. It’s highly unlikely that the full 1.2mill will be cut as stats show from 1979 only 60% of proposed cuts have been implemented. However it’s still a cut and a large and unexpected one at that.

As you can see from the chart above oil still has a bit of work to do to break above that long term trend line (green) again, but my money is it eventuating as we start seeing some of the cuts being implemented.

This is Bullish news for global economic growth moving forward. A higher oil price is inflationary as it’s pretty much involved in every industry known at some point or another. It causes prices to move higher as higher costs are passed on down the line and then eventually infiltrating into spending. This obviously increases consumption and GDP growth. It’s also very Bullish for the US in particular. The US has a very large energy sector and if the Oil price continues to increase it will give cause for more spending in the sector once again, as opposed to the constant cuts, which will lead to more jobs.

I feel it will also have a positive diplomatic effect as well. Trump was very outspoken on his want to tear up the Iran nuclear deal which would have seen the US put restrictions on them again, cutting their production. I feel OPEC is anticipating this and prepared to get some cuts down now to get the price up and keep Trump from their door. Plus also the fact a lot of OPEC nations are running large account deficits they can’t keep up with due to the lower price. It’s all about OPEC keeping control of the price rather have it run away from them like it does during times of conflict.

In more Bullish news this week China released its price manufacturers index (PMI) for November and it again beat forecast. The number dropped at 51.7 after a forecast of a drop to 51.0 from October’s 51.2 read. It’s the highest figure since July 2014 and again reiterates the fact that China is starting to get its engines going again. The trend since July this year has been one about stablisation and recovery and it’s evident in the PMI, Trade Balance, and GDP figures China has been releasing. This also helped get the AUD off its lows during the week and is also a big reason behind the commodity price surges of late. I will speak more about this later.

The final piece of economic data that was released this week was Australia’s retail figures for October. Once again this figure beat forecasts coming in at +0.5% vs +0.3% forecasts. This is below the +0.6% posted in September but the annual pace is sitting at just +3.5%. If you look at just the last three months, however, annual growth is trending at +6.8%. Obviously its good news that shoppers are willing to put their hands in their pockets again of late, but we really need this to continue.

Company news this week was scarce, but still had big impact for a select few stocks. Metcash (MTS) released its half yearly results and they were not pretty. Revenue grew by +0.3% ($6.629bill) and if you did a little deeper you will see food and grocery sales actually were -1.2% and it was Liquor and hardware that offset that. Profit was down 38.6% to $74.9mill and there was no dividend declared. The company stated it was still in the middle of a cost cutting program and that dividends would resume in 2018.

It’s not a stock I believe any of my clients own nor is it one I would look to jump into. Like WOW and Coles, MTS is suffering from increased competition from Aldi which is eating into their sales and squeezing their margins. This is only going to get worse as Aldi expands and on top of that US giant Amazon, who has a fresh food service, will be setting up base in Australia. This is a huge disruption to the retail sector as a whole and not only will it impact WOW, Coles & MTS but also JBH, HVN, SUL, BBN etc. Due to this I have an AVOID on the Australian retail sector as most will struggle to increase earnings, have their margins squeezed and market share stolen. You only have to look at the impact Amazon has had on the retail space in the US to understand what we are in store for here.

A company you are all aware of and had been a favourite of mine in Vocus Communications (VOC) have an earnings update at their AGM during the week. They expected EBITDA to come in at between $430 - $450mill and Net profit after tax at $205 - $215mill. They also noted revenue was to come in around $1.9bill for 16/17 financial year. The profit results in particular were below what most analysts were expecting as most had figures of $225-$240mill. VOC was hammered on the back of this news dropping 25%+ on Tuesday. The stock price got as low as $4 yesterday before recovering slightly to sit around the $4.25 mark today.

The last 6 months haven’t been kind to VOC as it has been impacted by TPG’s guidance cut, its founder & CFO leaving the board and finally the AGM this week. I have marked these events on the chart above you all to see. I believe the market has been too savage on VOC and has over corrected to the downside. As it stands now earnings for 16/17 are expected to double. After this they are expecting earnings to grow at 15% per annum which is a very healthy rate in anyone’s books. At this point VOC are trading at 12.2x 16/17 forecast earnings and 11.0x 17/18. This is great value for a stock growing earnings at 15% per annum. It’s also expected dividends will also grow to roughly 5% (yield) by 17/18. I want to wait for the stock to settle and selling to subside first but I do see great benefit in topping up on VOC down here. As the market gain confidence in the sector again and VOC consistently meet guidance I see it being pushed back up again. For those who already own it. Whilst earnings are lower than expected it’s still a solid business for the long term and I see no point in exiting down here.

Sticking with the Telco theme another company I have been fond of for a little while is Amaysim (AYS). They had an investor day yesterday and gave a small update to earnings during the presentation. It was very brief and they said that subscriber numbers were in-line with forecasts and that revenue would rise in the low teens for 16/17. As soon as I read that I knew the market would punish it sold the last few clients out. They gave no guidance on profit or EBITDA which the market didn’t like and due to the negative sentiment in the telco sector at the moment I thought it best to be on the sideline with this. This turned out to be a good move as the stock has fallen from $2.29 the day before the update to a low of $1.75 today. That is a disturbing -23.5%. You may ask why I decided to exit AYS and not VOC? My reasons are simple. In the whole scheme of things AYS is a small player in the telco sector and running on tight margins. If anyone is going to feel the pinch of tighter margins from increased competition it will be them as they don’t have the economies of scale to combat it. They don’t have the pricing power to compete with the larger guys in the tough times. This being said everything has its price. I will keep a keen eye on them and wait for them to settle. It quite possible one of the larger telcos could come in and try and pick them up whilst they are beaten down.

Final piece of company news comes from the infant formula company in Bellamys (BAL). Today they came out and updated guidance for 16/17 and like others I have spoken about today were savaged by the market. BAL stated it expected revenue for the first half of the 16/17 year to be $120mill and $240mill for the full year. This was $130mill below consensus forecast and the stock was punished 43.5% because of it. BAL states that it’s due to a disruption in the Chinese market and new regulation surrounding the sale of its formula in the country. This news also caused A2 Milk’s (A2M) share price to be sold off 10% as well despite A2M making no mention of China troubles only two weeks ago at its AGM. I will make a passing comment here. Being a new Dad I have noticed that BAL is often on sale at Woolies a lot more often of late than A2M. I feel in the last 2 months BAL has been discounted every second week whereas the A2M formula has only been discounted once. This could suggest they do have excess stock out there and are trying to offload it quickly. It’s just an observation but it does line up with what has happened today.

I think VOC, TPM (TPG Telecom), BAL etc. all show the risk of owning these high growth companies that trade on such high multiples. If they fail to meet expectations of the market the reaction can be quite brutal.

Before I move onto the stock in focus I will make a quick mention on commodity movements during the last week. Iron has been up and down like a yo-yo trading as low as $70/t and as high as $80. Many speculate this is due to Chinese investor trading it like a casino which could soon be stopped as China increase regulations surrounding commodity trading. Copper has traded fairly flat around that $2.60/lb price and Gold has come under more selling pressure at around the $1,170/ounce mark. Remember if Gold cannot hold $1,150-$1,160 it could see $900 as soon as next year. Oil I spoke of at great length earlier.

As expected the XJO rejected that downward trend line and pulled back off it. Would expect us to pull back to the 5,250-5,300 region before our next leg up and ultimate break of that downward trend.

We are almost at the end here so bear with me. My stock in focus this week is one I have spoken to most of my clients about and entered already. To me it’s a simple and logical investment that doesn’t come without its risks.

Name: QBE Insurance Group Ltd

ASX Code: QBE

Sector: Insurance

Last Price: $11.74

Market Cap: $16.102bill

Share on Issue: 1.372bill

Risk: Low

Timeframe: 3 – 5 years

QBE is Australia’s largest Insurer with operations around the globe. During the early to mid-2000’s it was a darling of the market and often one of the first picked in share portfolios. Since the GFC QBE has struggled to perform operating in a tough insurance environment with increase competition and higher than normal environmental events. It also comes to pass that during that time US Treasury yields fell dramatically. You may ask what that has got to do with QBE and company performance. Well when premiums are paid to insurance companies they are put into what they call a ‘float’. This is a pool of money used to draw down on when claims need to be paid. Of course this pool is very large as the claims being paid are well below those premiums that are being brought in. Usually this float is invested into other low risk assets to provide an extra return for the insurance company.

Now it just so happens that QBE’s float is 90% invested in US Treasuries. Hence in times of low yields, such as since the GFC, this performs poorly, but in times of higher or rising yields it performs very well. You only need to look back on the period 2003-07 when rates and treasury yields rose to see QBE’s share price performance. The stock went from $10 to $35 during that time. Due to this investment QBE’s share price has a very high correlation with US Treasury yields.

Due to this high correlation it is estimated that if the fed were to increase rates by just 0.50% this would add $300mill to QBE’s bottom line. Now if you are like me and believe over the next 5 years we will get a period sustained rate increases, although gradual, this bodes well for QBE’s earnings. Of course there has to be a solid underlying insurance business there, which there is. It is well managed and turned a profit of $401mill in the first half of 2016. Current EPS is expected to come in at $0.485 per share which means you are paying roughly 19x earnings for the company with a yield of around 4.0%. Next year EPS is expected to be $0.75 per share meaning 15x earnings and a yield of 6%+. For me the market is still underestimating have far the fed will have to increase rates and thus how high US Treasury yields will go in the next two years. I feel QBE gives you the best exposure to the rising rates in the US outside of buying treasuries themselves. On top of this QBE gives you exposure to a rising USD and lower AUD play helping their earnings grow.

QBE does comes with risks of course. The major risk is higher than normal, and multiple, environmental events such as floods, fires, earthquakes, and storms etc. that are unpredictable and could hurt earnings. Also there is a risk the US economy doesn’t perform as well and rates do not rise as much as expected hence keeping US Treasury yields lower.

Overall I feel QBE is in a position to outperform the market, and forecasts, and is a solid 3-5 year investment for those seeking growth and income.

Well there is literally no scheduled major company events next week so we will have to rely on economic date for now. The US jobs figures for November are released tonight. I’d expect them to underwhelm as the US approaches full employment. Next week we have Aussie services PMI, Job Ads, RBA meeting, Q3 GDP (of much importance) and trade balance. It’s expected the GDP figures to be soft with most forecasting +0.2% for the September quarter. If it beats then we could see the market run. China releases its CPI and PPI next Friday and Japan its Q3 GDP next Thursday. Another busy economic week, but as they say there is no rest for the wicked.

Personally we have just had our backyard landscaped and it’s nice to have some greenery out there rather than dead plants and weeds ha ha. Might go and enjoy a beer or two out on my new lawn as the weather is said to be glorious. We went for the real stuff instead of artificial. Not a fan of the fake lawn. Just looks too plastic to me. Hope you all enjoy your weekend and stay safe as we are starting the festive season. Until next week take care. Go Crows!

heath@hlminvestments.com.au

0413 799 315

PO Box 6014

BURTON SA 5110

Important Notice

Any advice in this article should be considered General Advice only and does not take into account your personal needs and objectives or your financial circumstances. You should therefore consider these matters yourself before deciding whether the advice is appropriate to you and whether you should act upon it. I am happy to assist you in this process. To do so, I will need to collect personal and financial details from you before providing my recommendations. Please note the author may own shares in the companies mentioned in the above blog.