ASX Weekly Wrap 14/08 - 18/08

Despite a sell off again on Friday the XJO was able to post strong gains for the week as earnings news really hit its peak. We ended up 54 points or 0.95%. The high was 5,806.30 on Wednesday and the low was 5,707.60 on Friday. The signs were bullish on Friday even though we ended the day down, the index was a lot further down after the S&P 500 sold off 1.5% on Thursday night. We were able to fight back and only end up off half a percent ourselves after some positives earnings news flowed through the market.

As we have so many earnings results to touch upon I will breeze through some of the economic news that was released last week. China released a host of data as per their monthly routine with retail sales, fixed asset investment and industrial production figures released. They were +10.4%, +8.3% & +6.4% respectively, which were slightly below consensus. Still, it is showing solid improvement in the Chinese economy. We also had Australian jobs numbers for July which again beat market consensus. The figures came in at +28k jobs added for July when the market expected +20k. The unemployment rate remained steady at 5.6% as participation ticked up to 65.1%. Breaking it down we saw +48k part time jobs added and -20k full time jobs lost. This composition was half expected given how strong full time job additions have been for the previous three months. Finally the Australian wage price index was released which showed +0.5% growth in wages for the quarter and +1.9% growth year on year. Again a soft figure, as expected, but it does seem to have bottomed and beginning to inch its way back up. I will note if you are to remove WA from the figures the growth is 2.0%+.

I will move into the earnings section of the wrap now and I will try and do it a little differently this time around. I will post a screenshot of what earnings were from the company’s presentation, rather then regurgitating them. This will allow me to discuss them in more detail and add better commentary. The stocks covered below are also relevant to you, my clients, as all are stocks that a majority of you will hold currently in your portfolios.

First up is Mineral Resources (MIN), which I added to a lot of portfolios over the last three months, as our large cap exposure to lithium. MIN also are in the game of mining services and Iron Ore. As you can see, from the summary above, MIN had a stellar year which has been reflected in the share price since we entered. Most of you will be up 30-40%+ on entry as the stock has moved from $9.50 to now sit at $14.50. It seems the market was expected the strong result, as were we.

Iron ore production remained fairly steady at 12.3mt and their price obtained was a healthy $AUD75.1/t. Remember MIN do receive a discounted price for their Iron Ore as it is of a lower quality. They did note that the discount for 58% Fe did widen in the second half of FY17 hence why the price obtained wasn’t as high as originally expected. However this didn’t have a huge impact on earnings as they were able to reduce costs and produce Iron Ore at a healthy $AUD39/t. Their aim is to become the lowest cost producer of Iron Ore in Australia.

The real story here is in the lithium which has much to play out. In FY18 we will get a full year of production from their 100% owned Wodgina Lithium mine. At this mine they ship the Lithium as DSO until 2019. Hence they literally rip it out the ground and sell it as is at 4-5mtpa with no further processing. This obviously nets them a lower price. As of Q3 of 2018 a 500ktpa 6% spodumene plant will be commissioned and they will get roughly $US841/t for that ore at newly negotiated prices. This is a value add and helps increase their margins as DSO only nets them approx $120/t. Once again though they have renegotiated those DSO prices and now will receive $US170/t moving forward until the new processing plant is up and running.

At their Mt Marion lithium mine the value add story is similar. Currently they are producing 200ktpa of 6% spodumene and 200ktpa 4%. Obviously the 4% nets them a lower price. They will be upgrading those processing facilities to make 400ktpa 6% spodumene as well. This will add $US364/t more for 200ktpa of 6% spodumene in 2018. MIN currently owns 43.1% of the Mt Marion mine.

Currently lithium only makes up 10% of MIN earnings with the rest coming from iron ore and mining services. In 2018 they expect their EBITDA to rise to ‘at least’ $500mill, +8% on their 2017 result. I would expect them to comfortably beat that as long as iron ore remains steady, the AUD falls and lithium continues to increase in price as it has done. Their plans for the future is for a further sell down of their share in Mt Marion and a possible 50% sale of their interest in Wodgina mines. This will obviously hand them a load of cash whilst also maintaining the mining services contracts for the life of the mines, and retaining that exposure to lithium’s upside. What MIN do very well is develop a project then sell off the majority of it off once its 100% up and running. From there it nets them a large sum of cash, plus they also retain the mining services license for the project for the entirety of its life. They then move onto the next project, rinse and repeat. After the lithium projects they do have new coking coal asset they are looking to do the same for.

You will note the 54cps dividend MIN have paid throughout 2017. At current prices this is a healthy 3.7% yield (Fully Franked). At the prices most of you paid it will net you a 5%+ yield. This is also only at a 50% payout ratio, hence if MIN do sell down a heap more of their exposure to their lithium mines there is a chance at special dividends or a capital return as they are flush with $378mill in cash already and only $275mill in debt.

I am extremely bullish lithium and MIN moving forward and very happy with their set of numbers. I would expect a cooling in their share price sometime in the near future and will be looking to add on any pull backs in the price. You have to be happy with a 30-40% return on your capital along with a 5% yield any day of the week.

Next up is Sonic Healthcare (SHL), which had another solid result. Their statutory profit was down due to a higher than expected AUD, but if you look at constant currency terms its more of what we expect from SHL. Both their laboratory and imaging divisions saw 7-8% EBITDA growth with a fair portion of that being organic. They increased their final divdend from 44cps to 46cps with a 20% franking rate, which saw a total payout of 77c for the year. SHL saw margins continue to increase 25-30bp as costs are relatively flat.

Not much else to say here as its what we reliably have expected from SHL. SHL trades at a 22x PE, but this is what you pay for consistent and reliable earnings growth. SHL have stated they expect more of the same in FY18 with ‘strong’ growth in EBITDA expected across all divisions. The only negative you take on with SHL is the currency exposure as more than 50% of earnings come from overseas. This is ok when the AUD weakens but as it has been stronger than expected this year. To me this is a minor set back as the AUD historically sits well below where it is now. SHL is a staple of many portfolios under my administration and will continue to be for some time to come. I am a buyer on any substaintial pull backs.

QBE Insurance (QBE) put in a solid set of half year results, but the market has found reason to sell the stock off 15% from its highs. Profit seemed strong with 30% growth along with their gross written premium, which saw a 3% increase. FY2017 outlook also remains bullish and they actually upgraded their stance on growth from stable to modest growth with better than expected performance from Australia, NZ and the USA when it comes to premiums. It sets a fairly positive picture when we can see a recovery in premiums, after years of decline in that area.

So why has the stock been sold off so hard? Well I put it down to two factors. The first being that the interest rate environment in the US has changed from what it was six months ago. It was expected that there would be at least one more rate rise by the end of this year and another 3-4 in 2018. This changed a few months ago and now there is only a 40% chance of another rate increase this year and only 1-2 expected next year. Remember as QBE invests its float into corporate/government bonds this makes a big difference to their bottom line. A 0.5-0.75% lower cash rate in the US equates to potentially $US125-$190mill less earnings for QBE that was being factored into the stock at the start of the year. They have even factored in a lower investment return themselves citing a 3% expected return as opposed to 3.6% for the half just gone. Secondly I feel the dividend came in lower than expected at 22cps, only up from 21cps last year. This equates to a payout ratio of 61% compared to 74% last time around. Hence it seems QBE are being more conservative with their cash.

Thus in the end when there is so much uncertainty from the stock in regards to interest rates in the US, combined with a lower than expected dividend investors lost a major reason to hold. Now most of you bought in higher than at current levels ($10.60 approx). I feel there is no reason to panic as the underlying business is performing strongly with headwinds coming from a stronger AUD and lower than expected rates. The fed is waiting for CPI to nudge higher before making substantial moves in the cash rate, eventually this will happen. We jumped into QBE with a 5+ year horizon and this still remains the strategy and with a 5.2% yield and only 14x PE there is no cause for alarm. I believe that by the full year report we will have more clarity on US rates and QBE earnings moving forward. Now might be the time to actually top up holdings if you are a believer.

Invocare (IVC) put in a much better than expected bottom line with reported profit rising 50% from this time last year. Main drivers of this increase were better operating margins (+1.80%), a higher death rate (+2.8%) and prepaid funerals (+15%). The later is where the real crux of the story is. At this point in time pre-paid funerals are growing at faster rates than what is having to be paid out by 24%. It is also what IVC are doing with these pre-paid funds under management that is providing the extra kick to the bottom line. Their investment portfolio for the FUM is fairly conservative with 17% in equities, 30% property and 53% in fixed interest. Its that property portfolio that has provided the kick with re-evaluations adding a $16mill increase to FUM. Obviously this is not sustainable and not why we hold the stock. The underlying business remains strong with earnings growing 6% in Australia, 20% in NZ and an 8% increase in Singapore.

One cause for concern for IVC is the loss of market share, after it fell 1.3% in the half. This was expected by the IVC board and plans are already in place to address this. The board is using $200mill in funds to secure earnings from 2020 and beyond. This includes increasing market share again. They expect further falls in 2017, a stabilisation in 2018 and for it to start rising again in 2019. Time will only tell if it will be successful but management are very prudent and have grown this business very well since list in the early 2000s.

IVC expects high single digit earnings growth to round out 2017, which double digit growth the target in the longer term. IVC increased its interim dividend by 8.8% to 18.5cps representing an 83.3% payout ratio. I have liked the IVC business and management for a long time. They understand the funeral business well and can be relied upon for consistent earnings growth. This is a case of paying high multiples for a premium company who can consistently grow EPS, much like SHL.

For Treasury Wine Estates (TWE) a 55% increase in full year profit is the result of taking some bold, yet very intelligent, risks a few years ago to sure up and grow their business. These are the reasons we entered the stock some time ago and continue to hold today. As we now know TWE made the bold decisions to literally pour thousands of litres of wine down the drain in order to start re-branding and reshaping their business. This allowed them to concentrate on more premium wines, which would give it a more attractive appeal in China. They also stripped down their business and set out to save $100mill by 2020. A strategy they are well ahead on. This allowed them widen margins so much so that EBIT margins in China now stand at 38% and 18% in the USA. Their push into these regions with increased sales people on the ground and marketing have also helped grow EBITS in the USA 44% and China by 47%. Wine prices have also been rising such is the demand for their product. They will continue to expand into China by increasing warehousing and via offering a wider range of the portfolio to their Chinese customers. TWE wines are the number one wine imported into China via value and TWE are targeting to be the number one imported wines by volume as well.

We entered into TWE due to the China & USA growth story and I plan on seeing that through to the very end. Management have done extremely well to re-brand TWE and strip out poorer products and vineyards. Its very important to have a strong and highly regarded brand in China as their middle and higher class are very fickle. This is something Bellamys have found out the hard way. TWE see strong growth in both EBITS and margin in FY17/18 and an acceleration into FY18/19. They are targeting a group margin of 25%. It currently sits at just below 20%, thus there seems a lot left to extract for TWE. At a PE of 33x and a yield of just 2% (3% for those who bought lower with me), TWE is a company reinvesting in itself and growing its earnings at a very strong rate. They should be able to take advantage of a growing Chinese middle class for many years to come.

Well that does it for the earnings section of the wrap. I will touch on Telstra (TLS) briefly as its been the subject of much discussion. I have been trying to get most clients out of TLS for the better part of the last 18 months. For me the writing was on the wall in regards to their latest profit report. The biggest shocker for most, not me, was the savage cut in dividends. TLS cut its dividend to 22cps FY17/18, down from 31cps in FY16/17. TLS is no longer the reliable cash cow it once was, basically imitating a utility company with assurity of earnings coming from their copper telephone network. TLS will now reinvest more of its earnings back into itself as it will have to make major changes in the way it will do business. I could see this from a mile away hence my constant recommendations to sell the stock. TLS is now down 28% in the last 12 months and lot more since its highs a couple of year ago. I am avoid on TLS until their earnings future is more clear as after 2019 $2bill+ comes out of its EBITDA as NBN payments stop hitting the balance sheet. We have saved a lot of capital by getting out of TLS.

As expected a lot of green last week as the market was up solidly across the board. Telecommunications the only main drag with TLS down a good 10% after reporting poor earnings. Health care was a leader after the AUD fell from its highs and retail also made gains on the back of renewed optimism following Kogan’s results. Property trusts were also strong after many companies in the sector reported solid earnings.

As we enter week 4 of earnings season we have our busiest week ahead of us. Companies such as BSL, BXB, FMG, SYD, BHP, CCL, WOW, WOR, OZL, STO, QAN and FLT all tell us how the last 6-12 months has gone. A very quiet week here and abroad when it comes to economic data. This means market will focus purely on earnings reports. Hope you have all enjoyed the wrap this week. I do apologise for its length but there was a lot of ground to cover. I tried to keep it relevant to what most of you, as client’s, hold within your portfolios. Have a great week and stay safe. I’ll speak to you all soon. 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.