ASX Weekly Wrap 20/08 - 24/08

The XJO suffered heavy losses last week as our political leaders squabbled over who should lead our nation. Of course this all resulted in a new PM in Scott Morrison. This sent our markets into turmoil as, going by polls, this has handed Labor a big chance at winning the next election. Normally this wouldn’t be a problem, but Labor have signaled their intentions to shake up negative gearing on property and franking credits on stocks. This of course meant the market was worried about the housing market further decelerating and possibly pushing us into recession. The XJO movements were in stark contrast to global equity movements as most areas saw gains for the week.

In the end the XJO finished down 91.90 points or 1.45% with a high of 6,358.00 on Monday and a low of 6,238.00 on Friday. There was no real economic data to report on from last week. There were some European manufacturing and services PMIs released which were higher for larger nations such as France and Germany but lower for the rest. These were weighed down by the fiasco still unfolding in Turkey. Outside of these there is nothing much to talk about, but there are a heap of earnings reports to cover as we had our busiest week yet on that front.

The world’s largest miner, BHP, released their full year results last week in a report that largely hit consensus forecasts. Much like RIO it was all about free cash flow, cost minimization, debt reduction and returning capital to shareholders. Below is a summary of BHP’s performance:

After all is said and done BHP produced a NPAT of $US9.62bill, which is a wonderful result for the company and 33% higher than 2017. Revenue, EPS and EBITDA whilst all substantially higher all came in slightly below forecasts whilst the dividend and NPAT were slightly higher. Free cash flow of $US12.5bill allowed BHP to pay a $US0.63 (69% payout ratio) final dividend and $US1.18 for the year. In AUD terms that’s around 85cps and $1.55 respectively. Net debt has been reduced to $10.9bill which is at the lower end of their target band they set a few years ago.

Looking forward BHP did lower production guidance for 2019, which was a little disappointing, but a lot of their operations are producing below capacity, so there is room to ramp up. Troubles with QLD coal and Olympic dam seem to be the main problems here. In terms of its EBITDA breakup Iron ore accounted for 39%, Copper 28%, Coal 19% and Petroleum 14%. BHP didn’t make any further comments on how the $US10.5bill in petroleum asset sales will be used/distributed except for that most would be returned to shareholders and more would be revealed later in the year.

BHP has set itself a task of becoming a low cost, simple, efficient producer of core commodities over the last five years and has largely succeeded in doing so. In FY13 it has 30 operating assets and that has been reduced to 13 as of today. They also were producing Iron Ore at just under $40t to now producing at $14t. They have been able to achieve this by disposing of underperforming assets and improvements in efficiencies such as technology. This has turned them into the high free cash flow monster they are today. Given the recent downturn in the share price, due to global events, BHP is trading at just above 13x forecast earnings and 5.8% yield. This is very attractive to me as I am of the opinion commodities, in the longer term, will continue to go higher and given that is what will propel BHP’s earnings I see a lot of value here. Other aspects to like about BHP is their recognition of the emerging electric vehicle and battery storage space. Their Nickel sulphide operations were given the green light on the back of this and at a recent conference BHP revealed that 60% of their nickel sales went to battery makers. This is projected to climb to 90% by Q4 2019. Given their net debt sits at the lower end of their $10-$15bill target they also have room to acquire tier 1 assets or quality companies. This in addition to any cash they have on hand. Finally the fact that $US10.5bill will be mostly returned to shareholders, in the short term, via either special dividends, capital returns or buy-backs also adds weight to the BHP story. I am happy adding to positions here or establishing new ones with a view to the longer term.

Australia’s largest retailer, Woolworths (WOW), also released their full year results last week, in what were seen as some solid numbers but worrying signs moving forward into FY19 and beyond. Below is their summary:

NPAT grew +12.9 %, EBIT +9.5% and Sales +3.4% over the course of the 2018 financial year. Comparable sales grew +4.3% for the year but decelerated to +3.7% in the second half and only +3.1% in Q4, Showing a real slow down. WOW attributes this to accelerating deflation on fruit and veg and less infant formula sales.

WOW noted that for the first 7 weeks of FY19 sales growth had slowed to +1.3% compared to Coles which saw sales growth of +2.4%. This is thought to be a short term trend as the Coles ‘miniature’ program proves to be very popular and pushing people to shop at Coles over WOW.

For WOW next year and beyond looks like it will be a struggle. Increasing food deflation caused by high competition and increasing costs will continue to bite into operating margins. These sit at 6.4% currently, which are higher than last year’s 6.0%, but still well below the 8.7% they peaked at a few years ago. Also return on equity has taken a nose dive with it previously sitting in the 25-30% range, to only be 15% in FY18. I can’t see how WOW can justify their 23x earnings ratio even after having a solid year, fueled by cost cutting measures and technology upgrades. Also I feel a dividend payout ratio of 84% cannot also be sustained moving forward. Even though a turnaround in BigW looks to be happening it’s not enough to bring me back to the stock. At these multiples I am an avoid on WOW and would like to see it around $18 before I even consider them worth a spot in portfolios.

Alumina (AWC) round out our report this week with their half yearly results. It has been a bumper start to their financial year with a massive profit increase on 1H17. This is despite increased costs coming from energy and caustic inputs. Below is a summary of the AWC earnings report:

It was a perfect storm for AWC in the first half of 2018 as Alumina prices jumped 35% on last year whilst costs only jumped 11% and the AUD fell. This provided higher margins and increased free cash flow. This has consequently been passed onto shareholder via very high dividends. Like BHP/RIO/WPL, AWC has passed the high capex phase of its life cycle meaning it is cash flow heavy. Alumina prices have surged on the back of multiple refinery shut downs in China and Europe and limited new supply coming online. Demand for Aluminium remains very strong with +4.7% annualized growth expected (+6.2% China).

Like any resources company AWC us correlated to the sale price of its end product, which has worked favourably for AWC for now. AWC is in the enviable position that it produces 100% of one of the largest input costs to produce alumina, in Bauxite (25% of costs). In fact they are producing excess bauxite thus are able to on sell it to third parties. AWC will produce roughly 43mt of bauxite in 2018 and will on sell approx. 6mt of that. The major constraints on the business come from energy (21% of total costs) costs as alumina uses a lot of electricity to be produced. Also caustic costs (17%) are the other variable largely out of AWC hands. In fact for every $100t caustic prices rise this eats into their EBITDA by $90mill.

For their full year 2018 AWC have lowered Alumina production slightly to 12.4mt down by 0.3mt. This is due to refinery shut downs in WA for maintenance and strikes. They have also lowered bauxite sales by 0.3mt as well. In turn they have also lowered capex costs by $10mill. The second half has started very well for AWC with Alumina prices received on avg $40 higher than the first half. Further out, whilst Alumina is expected to be in continued supply deficit in 2018 AWC expect it to come back to balance in 2019-20 after a few more refinery restarts are back online. This is largely dependent on China where most of these refinery restarts are dependent on passing environmental checks. Immediate terms risks come from restarts as new projects take 5+ years to bring online once announced, of which only two major projects are to be decided on this year and another two in the next two years to come.

AWC only trades on a forecast PE of 10.3x for 2018 and 13x for 2019. I believe the stock is discounted enough, taking into the account for new supply and possible price falls in Alumina. AWC forecast yield is currently 9.1% and 7.9% respectively. I believe AWC is an attractive proposition, even at these prices, for those looking for high income. It’s more than likely project restarts and new commissions will be delayed and drag out as China looks to clean up its air pollution and Alumina is a very energy heavy produce.

Technically the XJO was really bullish and had broken out of our current trend (purple circle), but due to the fiasco in Canberra it pulled right back in and provided a false break. We touched the 50dma and have reclaimed that short term up trend (green line) as of today. Thus overall we still remain in a bullish pattern but it could have been a lot better.

Quiet again on the economic front this week with Chinese manufacturing and services PMI the only figures worth noting. Earnings start winding down this week with PPT, RHC, NXT, BLD & CTX being the only major companies to report. There are many companies going ex-dividend this week so be aware of that when checking prices. Hope you all have a wonderful and safe week. 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.