ASX Weekly Wrap 15/05 - 19/05

A disappointing week for the XJO as once again geopolitical problems dominated the headlines. By the end of the week the XJO had lost 109.50 points or 1.88%, which was our biggest loss for a week in some time. The high for the week was 5,871.60 on Monday and the low was 5,697.50 on Thursday.

As stated above it was mainly geopolitical concerns that dominated headlines, specifically surround the US president Mr. Donald Trump. It all started when a much respected former FBI director was named head of the investigation into Trump and his campaign’s links to Russia. However the real sell-off occurred when the FBI director Trump had just fired revealed that Trump had tried to persuade him into ending an investigation into one of his party members. Now of course these are very serious allegations as it would suggest the President has tried to interfere/impede with a federal investigation. The market did not like this at all as it could lay the way for Trump to be impeached, however it’s mainly the uncertainty the market doesn’t like. If Trump does have to stand down then Mike Pence is next in line and he is even better and more bullish for the markets as his policies are even more growth orientated. My view is this will all blow over and Trump will be still sitting in the white house when it all concludes.

On a quick side note, and keeping with the geopolitical theme, we had the Brazilian leader get caught up in some problems himself last week as well. He has been accused of accepting bribes for political favors. This caused the Brazilian stock market to crash 10% in one day.

Due to all this uncertainty the VIX index (above), a measure of volatility in US share markets, shot up to the highest we have seen in over a month. Generally we see spikes in this index when there are troubles for markets ahead. It has now settled down again, but people were very concerned beforehand at how subdued it had been. Prior to April the index hadn’t seen a reading above 15 since October last year. Historically this was one of the longest periods without a reading above 15. The fear is with such low volatility it means investors have become too complacent and confident which could be a sign we are leading towards something much worse. Just as a point of reference the index got to a level above 90 during the height of the GFC.

The low volatility could be caused by other factors as well. In recent months there has been a movement of funds away from actively managed funds into passively managed funds. In April alone there was $US500bill that moved from active to passive funds. Why is this a factor? Well active funds are consistently trading and trying to beat the market. Passive funds are usually index/sector weighted hence only trade to match the weighting of certain stocks within the index. This mean less buying and selling has been occurring, causing less volatility. When you have such large funds making those moves it can have an effect on the volatility of the markets.

China released a heap of data to the markets on Monday in form of retail sales, industrial production and fixed asset investment for April. On the whole the numbers were softer than expected, not unusual for this time of the year. Retail sales remained solid with 10.7% growth v 10.6% expected. Industrial production 6.5% v 7.1% and fixed asset investment 8.9% v 9.1% both came in lower than expected. As I stated before this period of the year is generally softer for the Chinese economy as business have finished restocking and economy hits a lull. I’d expect to see better numbers again, although these are not bad, in the second half of the year. The China recovery story still looks on track.

We had the Australian unemployment figures for April released on Thursday in what were some impressive numbers once again. We added 37,400 jobs for April vs the 5,000 expected. Of that we lost 11,600 full time jobs but added 49,000 part time jobs. The official unemployment rate dropped to 5.7%, from 5.9%, and the participation rate stayed steady at 64.8%. We now have 12.099mill people working, which is a record, and we have added 192,000 jobs in the last twelve months. These figures backed up the 60,000 jobs we added in March and is the seventh month in a row of jobs added. As I have spoken about for some time it does seem as if the Australian economy is gaining pace and these jobs figures are a sign of this. Wages are still only growing at 1.9%, as per figures released on Wednesday, but this will start to pick as well once we start getting closer to full employment.

Many economists are pointing to, in a negative way, how it’s being led by part time jobs growth. I would expect that to continue as employers look for more flexibility with employee contracts that they can’t get with full-time employment. We are also in a world where employees need more flexibility themselves surrounding families as both parents usual work now. I read a stat last week, damned if I can find the article again, but the figure showed that 30 years ago only 10% of the workforce was part time. In today’s workforce 30% are now employed on a part time basis. I think this just shows our changing lifestyle and culture of today’s workforce and how we have moved away from that rigid 9-5 work day. Employers are more understanding and flexible when it comes to home life and this benefits everyone.

As there is absolutely no company news of note to touch upon I will move straight into resources. Mainly due to a weaker USD most commodities had a solid week. We saw gold bounce to approx. $1260oz due to the safety factor surround the Trump risk. We saw Iron Ore hold that $60t level and move to two week highs of around $63t. The big story was oil as it has recovered off its lows of $43 to sit above $50 again. This is due to a couple of things. OPEC nations and Russia have already agreed to extend current cuts in production for another 9 months. There is also talk that in their next meeting, which is this week, that they will deepen those cuts. Its forecast the extension could wipe the current glut of oil off the market. This is if US producers don’t increase production, which I dare say they are likely to do. As I have spoken about for some months OPEC will need to cut again if they want to keep that oil price above $50. A softer USD will help somewhat, but it won’t last as there are more than likely two more rate increases to come out of the US.

Technically the XJO broke that upward trend (blue line) we had established back in December. It now looks set to test 5,600 as the next line of support. It also coincides with the 200 day moving average (red line) which historically is an important technical indicator for the XJO. Usually if we break this and cannot reclaim it we are headed for lower lows. The last time we broke it and could not recover was in August 2015. In that instance we continued to lose a further 875 points, or 15.5%, from the index over a period of 6 months. Good news is the last three times we have tested it we have bounced off it and continued on with the uptrend. I feel we should bounce off it again, or if we don’t, see lows of 5,300-5,400 before reclaiming it. Overall we still remain in a bullish longer term uptrend.

It’s time for another ‘Stock in Focus’. It’s been a while, but the stock below has great potential in my eyes. I don’t bombard you with stocks every week as I feel I only want to give you the best of the best. Stocks I am happy to invest in personally. I could talk about the banks, BHP, CSL and all the other usual suspects on a weekly basis but those stories are known. We know what we get from them and are usually the basis of solid portfolios. The stocks I like to cover are a not being looked at by the market as of yet and have the potential to offer greater than usual returns, hence the stock below. Enjoy!

Company: Ellex Medical Lasers Ltd (ASX: ELX)

Last price: $1.09

Share on Issue: 121,146,987

Market Cap: $132,050,117

Industry: Healthcare Equipment & Services

Debt: $8.1mill

Cash: $14.2mill

Risk: High

Investment Timeframe: 2-3 years

The Story: ELX is a small medical device manufacturer based in Adelaide. They specialise in medical lasers and ultrasounds. Their products treat the 4 major causes of blindness: glaucoma, retinal disease from diabetes, cataract and macular degeneration. Annual global spend on medical treatment and devices in this area is over $US10bill. They supply their lasers to Australia, New Zealand, USA, Europe and South East Asia.

They divide their company up into three core parts:

Laser & Ultrasound: This is their core revenue earner and supplied $30mill of their $34mill in the first half of 16/17.

iTrack MIGS Device: Fairly new product and one they are pushing their business more towards. It only produced $3.6mill in sales but is growing at 37%.

2RT: Even newer product and only available for early adopters. Has to pass Phase 3 clinical trials in 2018 to get approval. Only $250k in sales in first half of 2017.

Overall revenue for the first half in 2017 were lower by 1.4%, but up 1% on a constant currency basis. The reason for the lower sales were due to bottlenecks in production capacity. Simply put they had outgrown their current facilities and had more demand than they could supply. They have combated this by setting up, and moving to, a new facility in Mawson lakes. Here they will be able to increase production and meet demand. They will also be able to fill all the back logs in the second half of 16/17. The new facilities will offer better workflow and improved efficiency. This will help bring costs down for the company.

They have stated they will beat last years $7.9mill full year EBITDA comfortably. This means they should also match their $3mill profit they made in 15/16. This gives them a current EPS of 2.5cps and a 43x PE. Operating cash flow was -$0.4mill compared with $3.1mill in the first half of 15/16. This is mainly due to building up inventory on purpose to help with the move and also associated new costs with the new production facility. This is expected to return to positive in the second half and further into 17/18.

Production is expected to increase by 30% over the next 3-6 months and then 100% thereafter. They also expect their iTrack device to eventually match the revenue of their core laser & ultrasound business, thus hit $30mill in the future. Costs remain largly in control and down if you exclude marketing and sales. They have been ramping up the marketing for the iTrack device hence EBITDA/NPAT could be impacted by that in full year 16/17 if they decide to increase it. They are expecting a big retun on this via increased sales in 17/18.

Investment Case: To me ELX stands poised to enter a period of high growth in sales and earnings. It seems in a similar position to what ITD did 24 months ago, which many of you benefited from. They had new products and moved to a new production facility. This lead to lower costs and an rapid expansion in sales/earnings. Sub sequentially the share price rose from 20c to a high of 65c recently. I’m am drawing very similar parallels here with ELX.

It seems their new product in iTrack should be the catalyst to increase sales at a faster rate whilst their core laser and ultrasound will perform solidly. They have stated that Laser & Ultrasound sales for 2H 17 will beat 1H 17 and 2H 16 and be overall being higher than full year 15/16. They also state that iTrack sales should see an acceleration in the growth of 37% they saw in the first half of 16/17 in the second half. This means in total sales should beat full year 15/16 of $72mill.

Expansion into Asia, particularly China, should keep earnings growing at a rapid rate with US and Europe also providing a catalyst. Gross margins continue to expand growing from 54% in 2014 to 59% in the current year.

On a technical basis ELX look poised to break out and head towards old highs of $1.30 and $1.60. Due to the illiquid nature of the stock I am happy to try and take positions now.

ELX should see modest growth in sales and NPAT for 16/17, depending on their marketing spend. I would expect the real growth and benefit of new facilities to come into effect in 17/18 and for earnings growth of 10-20%pa for that year and thereafter.

Hope you all enjoyed this week’s wrap. Wasn’t that much to cover this week and it looks as if next week is going to be just as quiet. Its my son’s first birthday today. Time has absolutely flown by! He is such a happy little man and has brought much joy and love to our lives. Becoming a father has been one of the best things to ever happen to me and really puts things in perspective. Can’t wait for what the years ahead have in store for us. Have a great week everyone. Try and stay dry as it looks we are in for a bit of wet weather. Stay safe and I’ll speak with 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.