ASX Weekly Wrap 21/08 - 25/08

The XJO’s range continued to tighten last week as mixed earnings reports couldn’t move the market much either way. We ended up the week down 3.20 points or 0.06%. Our high was 5,781.40 on Wednesday and our low was 5,699.0 on Monday.

With little economic data out during the week the markets focus heavily on three things 1.) The meeting of central bankers at Jackson Hole 2.) The US debt ceiling and 3.) Company earnings.

The highly anticipated meeting of central bankers at Jackson Hole was a major let down for most. It was expected to have a hawkish tone with the talk of rate rises to be the main theme, this wasn’t to be the case. Yellen didn’t even really mention rates and Drahgi didn’t talk of tapering ECB QE as expected either. Instead the tone was quite dovish which sent the US 10yr Treasuries yield back down to 2.17%. This suggests that Yellen is comfortable where things are at, and won’t be looking to increase rates again until they see signs of inflation picking up. This is positive for world economic growth because it means debt remains cheap, the USD to remain low and gives commodity prices the best chance of further gains. Eventually this will lead to increased inflation but it seems like we will have a extended period of rates on hold.

The US debt ceiling is again up for debate in a few months. Again they will have to increase it and allow the US government to borrow more if they wish to remain open. Trump threw a spanner in the works though as he threatened to not support increasing it unless it included a provision to build his wall between Mexico and the US. I can’t see it being held up because of a $20bill wall when you have $18trill+ in debt. Seems like it will be a bit of a nonevent and the ceiling will be increased.

Finally company earnings were again the focus of the XJO this week as we had our busiest week yet. Most of the reporting is done with 119 of the 139 due to report have done so. It’s been a solid season thus far without being great. Probably a good reflection of the Australian economy, good but not great. I have a few stats to share with you below in regards to earnings and will give you a full summary when reporting is finished in a week or so.

- 90% of companies have reported a profit. This is above the long term average of 87% but below February’s 94%.

- 91% of companies have elected to pay a dividend

- Cash levels are up sharply by 23.5% to $108bill.

- Around 60% of companies have increased profits which is slightly lower than the average of 62%.

- Excluding BHP profits are up 36%

- In aggregate terms revenues are +6.4%, expense +1%, profits +66.7%, dividends +10.6% and cash +27.4%.

As I did last week I will focus on a select few companies we hold to discuss their earnings during this week’s wrap. It simplifies things and cuts out the noise. Fist cab off the ranks is Fortescue (FMG), who came through with a very strong report. NPAT was up 112% to $US2.1bill, which was a slight miss on the $US2.14 expected. Once again the theme was cash generation which they did plenty of. Free cash flows came in at $US3.5bill which was a result of healthier iron ore prices but also lower costs. Cash costs per wmt came in at $12.82 which was 17% lower than last year.

Debt continues to be repaid with a further $US2.7bill wiped off the sheets with just $US4bill in gross debt on the books. This translates to a net gearing ratio of 21% with also $US1.8bill cash on hand. The first lot of debt due for repayment isn’t until 2022 as well, as the company restructured its debt during the year. The market seemed to focus on the new dividend strategy, which may attract new shareholders onto the books. FMG decided to increase its final dividend to 25cps which brings full year dividends to 45cps (fully franked). At current prices this represents a yield of 7.6%, plus franking. Now I never buy a resource company based off of yield, simply because earnings are so volatile, but it’s great to see FMG reward shareholders by giving so much back. Responsible capital management is rare in a resources company. Often we see a lot of profits retained and used to buy some ‘trending’ asset at the peak of the market. BHP with its shale oil and potash investments are great examples of this and RIO’s takeover of Alcan is another. However for FMG to say to holders we feel that we can’t do anything responsible with this excess cash at this point in time, so we will return it to you is a solid move. The market also liked their increase in payout ratio. Last year it sat at 40%, whilst this year they have declared they will increase it to 50-80% of profits. Current dividends are running at 53% of profits which suggest that there is scope to increase them further down the track should things continue in the same manner.

Looking forward FMG again plans to ship 170mt of iron ore for an again lower price of $11-$12wmt. Debt reduction and returns to shareholders will again be a continued focus. They are also exploring copper and gold tenements in SA and NSW to look to diversify the company in the future. I am a big fan of FMG, as you all know. Trading at just a little under 7x PE and with a yield of 7.6% it looks great value to me down here. If things were to remain the same and iron ore were to continue to trade around $US70t FMG should be able to provide strong returns for holders for many years to come.

Oz Minerals (OZL) like many resource companies also reported strong earnings last week. During the first half we have seen both copper and gold to make gains and as these are OZL core minerals they have helped improve their bottom line. NPAT for the first half came in at $81mill, an improvement of $26mill on last year’s result. They also maintained a strong balance sheet with $625mill in cash and no debt. The board also announced that a new mine at Carrapateena will go ahead as expected and start production of copper and gold in Q4 2019. They plan to fund this operation, which costs close to $1bill, via current cash flows and existing cash.

Not much else to say about OZL as they are on track to meet full year guidance in terms of production and costs. I am very bullish on copper moving forward given the world’s growing manufacturing sector, lower USD and increased demand from China and electric vehicles. Gold I can never get a proper gauge on so any increase here is a bonus in my view. OZL I feel gives you the best pure exposure to copper on the XJO with lots of upside from Carrapateena plus multiple promising exploration projects. Not to mention stronger copper prices moving forward. Much like FMG management are very astute and are looking to make OZL one of the lowest cost copper/gold producers in the world. Dividends are much more timid with a yield of only 2.4% here, but that is mainly due to capital costs with Carrapateena. I am keen on OZL at current prices and feel partial profits will need to be taken close to old highs at $10.00.

BHP Billiton (BHP) again was a mining company that impressed the markets with full year 2017 earnings. Profit rose substantially to $US5.9bill from a year earlier. This also saw a 177% increase in its total dividend to US83c for the year or $1.07 AUD and a yield of 4% here. A theme much like FMG and RIO, BHP has decided to pay out more returns to shareholders and pay down debt rather than investing substantially more in large projects or asset purchases. This is a theme that has been common amongst all of Australia’s large miners this earnings season. BHP currently has a payout ratio of 50%, which it plans to maintain moving forward.

As per usual we saw iron ore drive much of these earnings, accounting for 44% of EBITDA this year. Petroleum made up 20%, Coal 19% and Copper 17% of overall EBITDA. It must be noted that copper production was lower due to power outages in South Australia and that they plan on increasing copper production in 17/18 by 7%+. This gives you a solid idea of what makes up BHP’s earnings. Iron ore is the biggest driver as per usual, but I would expect copper to be more of influence as production ramps up again and prices rise. It must also be noted BHP has recently indicated it wants to get back into the nickel game again, more specifically Nickel Sulphate, as this material will be much sought after for electric vehicles within lithium batteries. BHP also noted there may be a case for it to exit its US onshore petroleum assets and Potash moving forward. These assets are currently loss makers and have been written down by many billions of dollars. It would help simplify BHP’s portfolio and increase overall margins.

Looking at BHP for 17/18 and beyond they remain bullish on China and general commodity prices. BHP is approaching the top of its price range with $28-$30 looking like a solid exit point so I prefer FMG or RIO at current prices for commodity exposure. If you are already in BHP then they are worth holding until they hit that target price. The 4% yield and extra capital appreciation is worth hanging around for. I am a buyer below $25 on BHP unless iron ore decides to go on a rampage then things can change. Extra value can be extracted via further costs cutting, debt reduction, asset sales and, of course, increased commodity prices. Happy to be holding BHP with its continued strong performance.

Commodities remained fairly subdued last week as Gold continued to grind higher to try and test that $1300oz mark. Iron Ore & Oil really showed nothing too impressive but Copper was the star of the show. It punched through resistance at $3lb only to keep going and now sits at $3.05lb. Most expected for it to slow up at $3 and consolidate there before its next move, but as of yet it hasn’t stopped. The next line of resistance is at $3.12lb. Copper’s price increase is being driven by a growing manufacturing sector, low USD, dwindling supply and an increased demand for it via electric vehicles. With no real new supply coming online in the near future prices could realistically go higher. I would expect a cooling at some stage soon though before it can move higher.

Although Oil hasn’t moved much in the last week this Hurricane Harvey, that is currently drifting over Houston, could provide a catalyst for oil to move higher. As it stands now 11.2% of the US oil refining capacity has been shut down and a quarter of all production in the Gulf of Mexico has also. It is expected that these will be offline for about a month. What might happen is the glut of oil supply could be substantially eaten into during this time, hence relieving the selling pressure on oil. It’s something to look for.

As expected it was a mixed bag for most sectors this week. CBA continued to drag down the financials as this money laundering scandal wears on. There was also a shareholder class action set up seeking compensation from CBA. The energy sector provided some gains on the back of upbeat reports from STO, ORG, OSH & WPL in recent weeks. Resources again helped keep markets stable as BHP, FMG, OZL etc. all reported strong earnings.

Not much in terms of economic news again this week except for US jobs numbers on Friday night. We have some housing and building approvals data locally but nothing too dramatic. The earnings season winds down this week with LLC, CTX, DOW, RHC & BKL the only majors left to report. I dare say most of our moves will be dictated by overseas markets once again.

Hope you all have a wonderful week ahead. Stay safe and I will 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.