ASX Weekly Wrap 20/03 - 24/03

Whilst there wasn’t much news of the company or economic variety this week the markets weren’t short of action. The market ended the week down 46.10 points or 0.79%. Our high was 5,796.60 on Monday and our low was 5,681.0 on Wednesday.

The week started flat, as per the norm, with little movement on Monday. It wasn’t until Monday night where things got interesting. Fears started emerging that Trump would not be able to get his new healthcare plan, or the repeal of Obamacare, through congress. This put doubts into the minds of investors of his ability to get any of his policies through such as his Infrastructure, tax cuts, defense cuts etc. This caused the S&P 500 to fall 1.5% and we followed the next day with a 1.5%+ decline ourselves. It was our worst day since November 9th 2016. As it turns out the vote on Trump’s healthcare plan has now been delayed until Friday. Obviously he will try and drum up more support and it will become a watered down version. Regardless I feel Trump needs this win to get some confidence back from the markets.

The only piece of economic news to be released this week that I feel is of any importance is UK CPI, which came out Tuesday evening and was swept under the rug somewhat due to the Trump focus. The figure came in at +2.3%. This was above the +2.1% forecast and the first time it has been over 2.0% since 2012. Its important as it further enhances the credentials that inflation is surging and will eventually flow to Australia. Once again this means no more rate cuts here with the next move up. Now I doubt there will be an increase this year now as the banks have started increasing their variable rates outside of the RBA. NAB was the first to move last week and I dare say the others will eventually follow. They are doing the work for the RBA. However there will be an increase by the RBA by Q2 2018 I feel.

Before I get to a couple of earnings reports there were more concerns over our retail sector this week in regards to Amazon entering the Australian market. Credit Suisse put out a analyst note on Monday showing the impact Amazon is forecast to have on our retailers and in particular Harvey Norman (HVN), Super Retail Group (SUL), Myer (MYR) and JB Hi-Fi (JBH). The table below illustrates once Amazon reaches 5% market share here by 2022 that most of the for mentioned retailers EBIT will fall by 30% or more. HVN was off as much 8% on the news during the day and the other retailers also fell hard.

The above figures are exactly why I put the whole retail sector on an AVOID some months ago and it is proving to be a beneficial move. Not only will this impact retailers but also property trusts, such as Westfield (WFD), who have exposure to retail bricks and mortar stores. We will see some companies go belly up and we will see store closures from those who survive. This means lower rents and more vacancies in the property trust sector. It’s a trend the US is now seeing. Some of the larger chains are shutting 400-1000 stores nation wide during 2017. Having said that the impact in the US will be far greater than here I believe. In the US they have 23.5 square feet of retail floor space per person. In Australia that is only 11.1 square feet. Obviously the US market was already over saturated, but none the less we will still see a significant impact here.

Keeping with the retail theme Premier Investments (PMV) released their earnings this week with a very impressive report. PMV are run by the highly respected business man in Solomon Lew and own such stores as Smiggle, Peter Alexander, Just Jeans and Portmans. PMV’s first half profit was $71.9mill up 0.5% on a year before. Overall sales increased 7.1% to $588.6mill and like for like sales increased 2.1%. Their first half dividend was increased 13% to 26cps on the same time last year. The big story to come out of these results were the Smiggle store figures. Sales increased 26.4% for the the store that is becoming very popular with young females. This came from 33 new store openings world wide and 60% of sales now are accounted for outside of Australia for Smiggles. Who would have thought stationary could ever become the trendy item to have?

Despite PMV’s impressive numbers, all things considered, it is not a stock I am looking to enter any time soon. Again it falls into the retail sector category and earnings will soon come under pressure from the Amazon giant. I wonder if Solomon Lew may consider spinning off ‘Smiggle’ to help realise better value? It certainly is an outperformer and one chain that might be able to outlast the dominance of Amazon due to its brand popularity.

TPG Telecom (TPM) was the other major to release earnings this week and they too put out some impressive numbers. NPAT rose 11% to $224mill, revenue increased 8% to $1.24bill and their half year dividend rose to 8cps up from 7cps at the same time last year. The group also maintained their full year EBITDA guidance of $820-$830mill. The main concern with TPM was falling margins and if they were able to arrest the slide. Thus far it seems they have with EBITDA margins coming in at 33.8% and well above the median forecast of 32.5%. With an EPS of 24.5cps for the half, we use that to forecast the full year, we get TPM trading on a PE of 13.7x at current prices. This would suggest TPM does have value in it, especially for a company growing earnings at 11%. Its all about gaining market confidence again for TPM and the telecommunications sector and only continued earnings performances, like we had this week, will do that.

Just quickly want to touch on a possible technical trade opportunity that may arise in the next week or so. It’s been revealed that Dar Group, out of Dubai, have taken a 13.35% stake in WOR during February. In their media release they state that is with the intention of a ‘long term strategic perspective’. To me this spells out that they may intend to takeover WOR at some point. By taking a 10%+ position in WOR they have a blocking stake in the company and can thwart any other company from potentially taking them over. Now why would you do that unless you intend to take over the company yourself eventually. They of course could be in it due to them seeing value in WOR in the longer term, but being an engineering company themselves they shouldn’t be in the business of investing. WOR has many operations in the middle east and would make a nice fit for them. Its also interesting they don’t rule out a takeover in the release, which some company would do if it was just an investment case. It will be interesting to see if they increase their stake any further. You can grab up to 19.99% before having to declare your hand as a potential takeover threat or not.

The buying opportunity may come from the technical side of things for WOR. Their chart is shaping up nicely in an ascending triangle formation. If it were to close above $10.78 (green line) it would officially be in break out territory and a trade I would be happy to take knowing what we know now. Remember the stock price will most of the time move before any news is released as larger money takes their positions and is more informed. There could be a chance at a 20-40% gain here if WOR do indeed break out and Dar group take them over. Will just depend on the premium they wish to pay. I will be in contact with you should the opportunity present itself.

Fortescue (FMG) made a bullish announcement today that they planned on paying back $US1bill due in 2019. It would leave them with a mere $976mill in 2019 owing and the next lot not until 2022, as you can see from the chart above. Its great to see FMG continue to take advantage of higher Iron Ore prices and stick to their strategy of paying down their debt and increasing returns to shareholders. To me this just further derisks FMG and makes them an even more attractive investment. We know that their operating cash flows are huge and will make them a cash cow moving forward.

Lets look at some basic back of the napkin calculations for FMG and the first quarter this year. Lets say they produced 40mill ton of Iron Ore until the end of march at an average contracted price of $70t. Remember the spot price for iron ore has sat above $80 for all this year so I am being conservative. Production for the first half of 16/17 was also 83mill ton so one could safely assume they will produce roughly 40mill in a quarter. This means during the quarter they would have received $US2.8bill in revenue. That’s also in USD so convert that to AUD at 77c that’s $3.6bill AUD in revenue. Operating costs are sub $30t but for round figures lets keep it at that. That means operating costs are $US1.2bill, which then means they have $US1.6bill in free operating cash flow…. For a quarter! As you can see it leaves a hell of a lot of cash to pay down debt and give back to shareholders. Even if the majority of that goes to paying down debt then that leave $US600mill to do as they please, or roughly $800mill AUD. This is on top of the $1.2bill in cash they already have.

FMG now have a problem of what to do with all their excess cash flow. Do they continue to pay down debt? Increase shareholder returns via dividends or capital management (capital returns or buy-backs)? Do they invest in other commodities to diversify themselves? Who knows what they will do. I feel it will be a combination of continued debt repayments and capital management. We could see FMG declare an on market buy-back during their full year results + increased dividends. Remember if they match their 20cps half year div with their full year results it will give them a yield of 6.3% fully franked. Add to this they are only trading on a multiple of 7.5x earnings it makes FMG a very attractive investment for mine.

Taking a step back and looking at the XJO from a technical perspective we still see ourselves in a bullish pattern. We were unable to hold above 5,800 and hence now have formed a wedge pattern. As long as we stay above the blue line we will be breaking 5,800 and moving towards 6,000 within the next few weeks. If we break down then 5,350 – 5,400 is possible. If we were to get down there it would be time to really be aggressive with your buying. The XJO looks excellent value down there. It’s a tough one to call this. Will sit on the fence for now.

Another week done and dusted. At least it was more entertaining than the last few. Will be interesting to see how Trump’s healthcare bill vote turns out. Next week sees the all important US Q4 GDP released on Thursday night plus Chinese manufacturing and services PMI for March. We also have the first of the banks reporting in Bank of Queensland on Thursday.

I have a very busy weekend ahead of me. Spending time with some friends on Saturday and then its off to the footy on Sunday afternoon to see the Crows v GWS. It’s so good having footy back. Even though it was just Richmond v Carlton last night, it just felt right. Hoping my Crows can get over the top of GWS in what will surely be a very close match. GWS are favourites for the flag. Have a lovely weekend and stay safe. I will speak to you all next week. Go Crows!

heath@hlminvestments.com.au

0413 799 315

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.