ASX Weekly Wrap 08/05 - 12/05

In a subdued week the index really went nowhere with the XJO up a mere 0.30 points or 0.01%. The high was 5,922.50 on Thursday and the low was 5,815.60 on Friday.

As we covered some of the major talking points for Monday in last week’s wrap there isn’t all that much more to touch upon this week, hence it should be a shorter than usual newsletter this week.

The main point of focus stems from the Budget and the new Bank Levy being imposed upon CBA, WBC, NAB, ANZ and MQG. The levy is set to raise $6.2bill over 4 years via 6 basis point charge on bank liabilities over $100bill. This is all aimed at increasing competition within the banking sector. It is thought the banks affected will increase mortgage rates or decrease deposit rates to combat the levy. This means other banks in the sector such as BEN, BOQ and SUN will then be able to step up and offer people a better deal with better rates.

However for shareholders of the banks effected by the levy it is obviously negative on earnings. We can expect anywhere from a 2.5% to 6% drop in earnings over the coming four years due to it. The below table summarizing it for you all.

This is all of course if the banks don’t increase their rates to combat it. It is estimated that interest rates would have to be increased by 14 basis points to get them back to where they were pre-levy. Obviously these concerns surround earnings and possible dividend cuts have smashed the banks concerned. CBA -6.9%, ANZ -11.32%, WBC -7.73%, NAB -5.16% and MQG -3.88% are how far the banks are off the recent highs set earlier this month. Rumors of a banking levy started roughly a week before the budget so a lot of the falls happened before the confirmation.

Whilst initially negative for the sector I believe the market has now adjusted and factored these new measures in. If the banks then go on to increase rates to offset it we could see an initial bounce, but in the longer term we will have to wait and see how it affects earnings growth. Will the banks opt for tighter margins and maintain current rates to keep attracting customers or will they opts to increase rates at the risk of losing customers to competitors? Only time will tell, but I still feel it has been factored in and the fore mentioned banks are good long term value here all trading at around 13x forward earnings.

The other major event over the last week, isn’t really market related but could have ramifications if a larger scale event were to occur. This was in relation to the ‘Wannacry’ virus that has infected more than 200,000 institutions across 150 countries. Luckily Australia has been spared by the looks of it, but it is a cautionary tale. Basically the crux of the story is a lot of computers within organisations, such as the UK hospital system, were infected with a ransomware worm. Ransomware is a virus that will seize control of your computer and lock it up until you pay a ransom fee to the distributor. Fortunately a fix has been found, all be it by accident, and systems are being restored, however it did shut down the UK hospital system for 24 hours and people were being turned away.

So how did this attack occur and infiltrate such important systems? Well basically there was a security flaw within windows that had been patched and fixed in modern versions of windows. The computers that were infected were all running Windows XP, a 16 year old operating system that Microsoft stopped supporting in 2014. This means the security flaw was not fixed and patch not rolled out for that version. Thus lessons to be learned from all this is keep an up to date anti-virus program on your PC, always back it up (I do mine once a week) and maybe, just maybe make sure your operating system is still being supported by its distributor.

Retail sales are under pressure and it seems to be more than just within Australia. The US released its retail sales figures for April on Friday night and they came in at +0.4%. This was below the expected +0.6%. This follows the Australian figures released last week that came in at -0.1% for March, seasonally adjusted, and well below the +0.3% expected. This has been blamed on Cyclone Debbie which slowed sales in QLD. Also low wage growth has contributed. I have been doing some investigation, without luck, as to whether these figures include online sales from the ABS. I haven’t been able to find confirmation either way, but retail sales have been very soft in Australia for the better part of 18 months. I can imagine if it doesn’t include online sales, or capture all of them, then it explains the soft figures as we continue to increase our online shopping at the expense of bricks and mortar. If I do eventually find out I will let you all know.

The only notable and relevant company news to be released within the last week comes from accounting software group Xero (XRO). Some of you hold this stock with me and have done so since it broke out above $18. To summarise the company saw revenue up 43% on 2016, losses down to $69mill from $83mill and subscribers pass the 1mill mark, +300k on 2016. In even more important news for the first time XRO was cash flow positive in 2H of 2017 and cash outflows overall were down to $4.4mill from $38mill. XRO held $113mill in cash.

XRO are now the largest cloud accounting software outside the US and are quickly gaining traction. This is bad news for the like of MYOB and Quick Books where XRO is continuing to steal market share. XRO offers a far superior product to the fore mentioned as it continues to gain size and others play catchup. Obviously with XRO it’s all about economies of scale. The more subscribers they gain the more profitable they become as costs largely stay flat. XRO’s gross margin sits at 77% and they are expected to become cash flow breakeven in 2018. I really like XRO’s business. It’s the type of company that is somewhat future proofed and will become a staple in future share portfolios over the next decade as earnings improve. They can easily adapt to a changing landscape as they have done with their new R&D investment into machine learning and AI. Most of XRO’s costs come from marketing and R&D now as the core product is set and CMR churn is just at 1.15%. It’s a lot of work to switch to a new accounting software so once you do it’s not anything you want to do again in the near future. This provides for a very sticky customer.

XRO’s biggest challenge is the US market. They currently have 92,000 subscribers there and plan to gain traction by infiltrating major accounting firms in the US. This then helps spill over to their accounting clients as the XRO software becomes the software of choice as it makes doing business with your accountant easier if you are on the same system. Outside of the US there is new expansion to come from south-east Asia and South Africa.

XRO is capped at $3bill here thus is not a cheap stock, especially with no profits to speak of. However recent subscription and cash flow numbers suggest this is to dramatically change over the next 5-10 years. I feel XRO is a bit toppy at current prices and we could see a re-test of the breakout at $20 before its next leg up. This is where I would be looking for entry and further adding to portfolios.

It was the same old story for commodities this week. Most were weaker with Gold and Oil being the exception. Oil regained some of its losses as it finished the week above the $47 level. Gold continues to trade between 1220 and 1230 an ounce. There could be a short term bounce on gold before its next leg down. Remember 1180 is our target on gold. Iron Ore was soft again as supply build ups and softer steel production weighed on the price. We have to remember this is a seasonally soft period for manufacturing in China. I still expect a rebound in prices in the second half of the year.

The XJO continues to grind along the top of that band we have spoken of for so many weeks now. 5,800 is still the first downside target which I feel we could hit this week. A bounce off of that and another move towards 6,000 could see us bust through that level in the next couple of months. Failure to maintain the 5,800 mark will see us fall to approx. 5,450/5,5500.

On a longer term weekly view we seem to be grinding our way up to the top of that long term trend, established in early 2009, of approx. 6,400. When I say weekly I mean each one of those bars/candles represents a week. Whereas on the chart above they represent a day. Sometimes in tougher markets it helps to take a step back and look at the bigger picture, which that weekly chart does. You can see why I remain so bullish regarding the XJO. This is also why if we do fall to 5,400-5,500 and hold it I will be very aggressive with my buying. Catalysts for a move upwards could be a resumption of commodity price gains, reflation, trump tax & infrastructure plans, local earnings and overall global stability from a geopolitical point of view.

A very quiet week to come, especially in the back end. We have Chinese retail sales, industrial production and fixed asset investment numbers out later today. MQG & NAB go ex-dividend tomorrow and CYB release their earnings. Unemployment data for April is out Thursday, whilst WBC goes ex-dividend then as well. There is nothing to speak of on Friday.

I hope you have all enjoyed this revised timeslot for the ASX Weekly Wrap. As always feel free to shoot me though suggestions or topics you would like covered in future editions. Hope you all enjoy your 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.