ASX Weekly Wrap 18/06 - 22/06

The XJO had its best week since November 2016 as it surged 131.20 points or 2.15%. It also finished at ten and a half year highs. Levels we haven’t seen since early in 2008. The lower AUD again proving the catalyst for our market as international investors can obtain cheaper entry into the XJO. We also have reporting, and hence dividend season, around the corner which is attractive to most international funds. The XJO is the highest yielding index in the developed world. I would also expect our earnings season to be better than average as a lower AUD helps with overseas earnings and corporate conditions here in Australia remain close to record highs.

Very quiet week macro news wise around the globe, but we did have the US and EU release their manufacturing PMIs. The US figure came in at 54.6, below the 56.5 expected and the 56.4 read last month. These figures are the lowest we have seen since September 2017. The EU figures came in at 55.0, which was in-line, but also below last month’s read of 55.5. It seems trade war fears are setting in as manufacturers wind back production in case their goods become subject to tariffs. Although these figures are softer they are still well above the 50 point mark which indicates a very healthy, above trend, expansion in these PMIs.

OPEC also met late last week and on the weekend in Vienna to discuss oil output. They were able to come to an agreement to increase output by 1mb/d. However due to production constraints this will more than likely come to 600kb/d with most to come from Saudi Arabia. This agreement came together basically to fill in the supply deficit coming from Venezuela and also is equal to the cut they announced last year. Oil rose by 5% on the back of this knocking on $69/b as markets were relieved the production increase was not higher. In the short term the Oil chart looks very bullish as increased global demand, a removal of the supply glut, and production being kept in check keeps the outlook for Oil positive. However the higher the price goes the more profitable it makes it for shale oil producers to increase production in the US. Eventually this will come to a tipping point again where supply will outpace demand again and prices will fall. OPEC did comment that they see $65/b as the sweet spot for the oil price longer term. I prefer LNG plays over oil for portfolios in the longer term mainly due to the increased demand out of Asia.

Ramsey Health Care (RHC) released an earnings downgrade during the week on the back of some poorer than expected admission numbers in its UK owned hospitals. RHC noted May was a poor month and June was not improving either, hence core EPS growth was now expected to be around 7% for 17/18 rather than the 8-10% previously expected. RHC also noted there would be a $125mill write down of some of its UK assets to come in the 2018 financial year. This is a non-cash write down and thus won’t affect their NPAT, their debt covenants or ability to pay its final dividend.

We had previously been in RHC at higher levels, but exited the stock after it failed to break out and broke down below some critical levels. The private hospital game is a tough gig and with RHC trading at such high earnings multiples any earnings drop off will be savagely dealt with by the market. In RHC’s case the stock has been sold off 12% since the announcement. It has been a terrible last 12 months for RHC’s stock price which peaked around $75 to now sit at $55, a 26% loss. At its peak RHC was trading at 31x earnings, but now sits at around 20x earnings. I have to reassess RHC here as it may offer some value. Management are solid and know the hospital game well. Regardless I would wait for some sort of base in the stock price before entering thus it remains a watch for me at this stage.

Now to cover one of the most maligned and talked about stocks on the ASX at the moment in Telstra (TLS). During the week TLS conducted its investor day where immediate term earnings and the direction of the company were to be revealed. It did indeed lay it all on the table with a plan to see it out until 2022. The highlights include:

· FY 18/19 EBITDA $8.7-$9.4bill

· Income FY18/19 $26.6-$28.5bill

· FY 18/19 Capex $3.9-$4.4bill

· Cut 8,000 jobs or 25% of its work force. Many from middle management to be moved on

· Streamline plan offerings from 1,800 to 20

· Increase costs savings by $1bill to $2.5bill

· Sell off $2bill in assets by 2020

· Create internal fully operational infrastructure company (InfraCo) by June 2019

· Lead industry in network performance surveys

· FY 17/18 final dividend to be maintained at 11cps (100% franked)

· FY 18/19 dividend to be revealed later in financial year

· 5G rollout to begin in H1 19 and available in all capital cities by 2020

· Eliminate two thirds of all servicing calls by 2022. One third by 2020.

· Costs to remain flat

· Capex to sales to be 14% over medium term

Overall there was a lot to be consumed by the market and in the end the market decided it wasn’t good enough and has sold TLS off 7%+ since the announcement. I believe it was mainly the FY18/19 earnings guidance and possible dividend cut within that financial year the market was mostly unhappy about. Most analysts had EBITDA at $10bill+ for next financial year hence it was a bigger cut than most analysts had expected. I do believe TLS are being conservative with earnings numbers now to put it in a position to under promise and over deliver, which works so well for many listed companies and helps support their share price.

The question is how do I feel about the new TLS? As most of you know I have been vocal of my support of TLS around these prices on social media or directly when we have spoken. I have even started dribbling some of you into the stock around current levels. I do believe there is value in TLS at current prices in both the short and longer term and believe much of the positive side is not factored into the price. Market wish to see proof TLS can hit targets first, which is fair enough I suppose. I have split my bull case up for TLS in some dot points below and why I feel it’s definitely worth considering.

· The new 5G network: I have done some solid research on the 5G technology and what benefits it may bring. The obvious point to make are speeds are significantly faster on 5G than 4G. 5G is up to 20x faster than 4G offering up to 20 GB/s speeds vs 1 GB/s on 4G. It is also a directional in nature sending its frequency to those devices requesting it. Whereas 4G is more of a blast service, beaming its frequency to a surrounding area even if no devices are using it. This means 5G uses less power and energy to broadcast itself. It also uses a higher range of frequency that’s currently not being used, thus will suffer less interference/latency compared to 4G. Finally it can handle 1,000 more devices per metre than 4G. Meaning the network will offer a significant boost to bandwidth and capacity for TLS.

· The Premier Network: In conjunction with the new 5G technology TLS will once again be the premier telco network in Australia. In the last 12-18 months data plans have almost tripled in size putting immense pressure on current 4G networks for all telcos. We have even seen the introduction of unlimited data plans for mobiles. This extra data has caused congestion in the network causing speeds to slow and even for the network to fail at times. With the introduction of 5G it eliminates these problems due to the fact it will be able to accept 1,000 more devices per metre than 4G. This means a more reliable connection, less congestion and higher speeds with a lot less strain on the network. This network will be far superior to any other offering in Australia and whilst other networks struggle with older tech TLS will move forward with a much better service.

· The First Mover Advantage: Many forget that TLS is the largest telco in Australia, by a big margin, and that means it also has much more capital available to spend and improve its infrastructure over other telcos. It is due to this available capital and free cash flow that it will be able to roll out the 5G network and sure up its infrastructure quicker than any other network. Thus when other networks are struggling with capacity issues customers will be able to turn to TLS. It has made it its focus to be the highest rated network in Australia by 2022. This is a massive advantage over the competition.

· A Premium Product: It’s not secret TLS margins are the highest in Australia (42%) and possibly in the world. It’s expected these margins are to be squeezed with more competition and lower pricing. This is possibly the case but if TLS can offer a superior product to the competition it can also keep higher prices and wider margins. It has also created the telco brand ‘Belong’ to compete with lower priced plans thus keeping the Telstra brand a premium service.

· InfraCo: There was a theory that TLS would eventually split itself up into two companies on the ASX. One focused on its infrastructure with defensive and reliable earnings and a high yield. The other focused on the telco business and its offering to customers. TLS has taken the first steps to doing this by shifting all infrastructure asserts into InfraCo and having a fully operational company by June 2019. This means as early as the 2H of 2019 it can think about demerging TLS into two separate companies. Based on current valuations InfraCo would have $11bill in assets, $5.5bill in revenue and a $3bill EBITDA. Being able to separate this from the TLS service business should add significant value for shareholders, which is currently not being realized.

· Earnings turnaround: We know about all the costs savings TLS are implementing and thus creating a much more stream lined and efficient version of itself. We also know that 5G is a cost saving technology due to the fact it will use less power, add more capacity/bandwidth and cause much less network problems. We also know that with each new network generation it has lifted TLS ARPU. Thus I see a turnaround in earnings by 2020/21 for TLS and for profits to start growing again. It’s just a matter of when these will be factored in by the market.

· The dividend: The TLS dividend will have to be cut again soon. Some are saying by FY18/19 others are saying not until FY19/20. Even if it is cut this financial year coming, estimated to be cut to 18cps, TLS will still offer a 6.8% fully franked yield at current prices. If you get on TLS now you will be able to get an estimated 29cps dividend in the next 14 months, or 11% yield, even if they do cut the FY18/19 dividend to 18c. The timing of the cut will come down to TLS preference. At the moment with current cash flows, NBN payments, costs savings and proposed asset sales they could easily maintain the 22cps dividend. TLS have stated that they plan on paying back 75% of all NBN payments back to shareholders. They didn’t say this had to be 75% every year hence could pay more one year and less the next. I doubt we will find out about a proposed dividend cut until we are closer to first half earnings for FY 18/19, thus in Jan-Feb 2019. There is even a case for TLS to conduct some sort of capital management in the near future via capital returns or special dividends. TLS has too many franking credits on its books and this can hurt/constrain their ROE figures. Many companies like to dump these via these methods and with TLS to conduct asset sales they may use these to fund a return to shareholders.

· New Income Streams: TLS being in the tech industry has the advantage as it is always changing, and usually very quickly, and TLS has the ability to acquire or develop new income streams to further support its business. They have a large focus on ‘The Internet of Things’ (IoT) where they could gain extra revenue from these services and become a leader of the industry here in Australia. It is one of the fastest growing industries in the US and many telcos there are going down this path. There is no reason TLS couldn’t expand investment into this and diversify itself away from just the traditional mobile/internet services.

· Further NBN Writedowns: It is thought the Australian Government will, in the near term, write down more of the NBN asset, as it did in late 2017. This will lower the average income per user required by the NBN to turn a profit. This in turn will then allow the NBN to offer lower wholesale prices to ISPs. TLS, and other telcos, can then offer lower prices for faster speeds and widen margins at the same time. Fixed line broadband only makes up 10% of TLS EBITDA so this is not a huge difference but if it can then bundle that service with other offerings it starts to add value to the service.

· Most unloved stock on the ASX: One could argue that TLS is the most unloved stock on the ASX and every man and his dog will kick it when it’s down. Usually these unloved stocks are where the best value is found as they are discounted too far and become oversold. I feel TLS fits into this category perfectly and one only has to cast their mind back to when TLS were last at this level in 2011 when all and sundry were calling TLS doom. Back then it was the death of its copper/landline network that would be its ultimate demise. The market also then didn’t factor in what 4G technology would do for TLS, just as they are not factoring in what 5G will do for it now.

As you can see from the above I feel there many reasons to be bullish TLS in the future. I feel in five years’ time, when we look back at current prices, we will feel what a great opportunity it was. I know I haven’t gone over the bear case for TLS, but believe this is very well covered everywhere you look. There are a dozens of analysts out there telling you why you shouldn’t be buying TLS. I feel it is always great to have both sides of the story and that it’s not all doom and gloom for Australia’s largest telco. For me entry is key. I have started to dribble clients into TLS and believe we are close to a bottom. At worst I see TLS falling to old lows around $2.55 and bouncing. My bull case scenario is potential capital upside of 10-20% from current prices plus dividends on top. Remember everything I have said about TLS is general in nature and does not take your personal financial situation, goals or objectives into consideration. Please consult with a professional before making any investment decision.

Mostly green again this week on the XJO as banks lead the way with a 5%+ bounce. Health care was also strong as we saw broker upgrades come in for the likes of CSL. Resources were the main drag on lower commodity prices, a higher USD and trade war fears. Obviously telecommunications was hit hard on the back of the TLS sell off.

Last week I spoke about the possibility of a breakout above 6,150 on the XJO, well it just so happened this is what occurred and we had a very aggressive breakout and move towards the top of our current uptrend band. I our high was approx. 6,249, so very close to the 6,250 target I spoke about last week. We have since pulled back from there and look set to pull back a little further and test that 6,150 breakout level. From there I’d expect us to bounce and test the top of the band again before breaking out altogether and testing 6,600 by the end of the year. Once again the lower AUD providing the catalyst for this latest move, which I feel will then be backed up by a better than average earnings season in August/September.

Another quiet week ahead for earnings and macro news. Metcash will release earnings results this week and a host of REITs will go ex-dividend before the end of the financial year. China releases industrial profits + manufacturing and services PMI. Personally I had a really relaxing but enjoyable weekend. Friday night my wife and I went and saw the new Jurassic Park movie. Highly recommend if you are a fan of the series. On Saturday my wife took our eldest son to Disney on Ice. By all reports he thoroughly enjoyed it and I might just have to tag along to the next one. Unfortunately my two boys and my wife have colds to start the week. Kids are just amazing, no matter how rotten they feel they will still give you the biggest smiles when you walk into a room or pick them up for a cuddle. Hope you all have a wonderful week and stay safe. 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.