ASX Weekly Wrap 30/04 - 04/05

The XJO saw its fifth week of gains in a row in what was also our strongest week in this Bull Run. In fact we have put on almost 350 points since our lows around 5,750 in April. This week the XJO put on 109.30 points or 1.84%. Our low was 5,945.90 on Monday and our high was 6,107.90 on Thursday. The XJO has been repeating a similar pattern for the last few weeks where our lows are seen on Mon/Tues and we gain strength and see our highs later in the week, in what is a very bullish trend.

As to why our market has performed so well in the last few weeks, well to me it looks USD related. The USD has seen some strength of late (currently at 4 month highs) whilst our AUD has seen some weakness. We now have the AUD trading around 75c, when it was close to 80c a few weeks ago. This mean our market has become cheaper for international funds to invest in. Given our banking div season and reporting season (Aug/Sep) is around the corner international funds could be loading up on our yield. I am seeing a lot of broad based buying the last few weeks which would supports my theory. There is also a theory the worst is over for the banks now the Royal Commission is over and earnings numbers appear very solid. Finally we have had a few big cap companies report strong quarterly numbers in QAN, WOW, BXB to name a few, which may mean we are in for a better than expected earnings season to come. The lower AUD also helps the miners bottom lines which has seen the likes of RIO/BHP outperform. Whatever the reason it’s a welcome relief from what happened earlier in the year. We have basically wiped out all our losses and sit flat for 2018 now. I will talk more about the technical of the XJO later on.

We had a few economic data points out last week which I will discuss briefly as we have much to cover on the corporate side of the ledger. Chinese non-manufacturing and manufacturing PMI came in early last week and really didn’t sway us in any direction. Non-manufacturing was 54.8, which was below the 55.1 expected but above the 54.6 read last month. Hence we see continued expansion here but at a lower than expected pace. Manufacturing PMI came in at 51.4, which was higher than the 51.3 expected, but lower than the 51.5 read last month. Again small contraction in growth there, but not as bad as expected. In better news the Caixin manufacturing PMI numbers came in, which is an independent survey and covers mostly small to medium sized business, with a read of 51.1, which was above the 50.9 expected and the 51.0 read last month. All-in-all we see a very solid Chinese economy still growing nicely in both the manufacturing and services side of the economy. There doesn’t seem to be many concerns at all coming from the globe’s second largest economy.

The Australian trade balance was released on Thursday, in what was a large beat on forecasts. We recorded a surplus of $1.527billion for March ($650mill expected) as well as revising February’s figure higher to $1.349bill from the originally reported $825mill. This means we now have recorded a surplus of $1bill+ for three months in a row and our last could add as much as 0.5 points to our GDP figure in Q1. Exports saw a 1% gain to a record $34.84bill, whilst imports also rose 1%. A lot of our export surge can be attributed to LNG which gained by $58bill in dollar value. Very strong figures for us again in what hopefully is a continued trend. LNG is adding another element to our trade arm along with Iron Ore and Coal. Imagine the figures we will produce if commodities really do start to heat up again and add further to our bottom line.

Finally US jobs numbers were released on Friday night in what were some underwhelming figures. The US economy added 164,000 jobs in April, below the 192,000 expected, but up from the 135,000 last month. The headline unemployment figure fell to 3.9% from 4.0% on the back of the participation rate falling. Hourly earnings also only rose 2.6% year on year, below the +2.7% expected. If anything these figures ease the fears that the Fed will increase rates at a faster than expected pace in the near future. We have seen US 10yr bond yields fall back from their 3.05% highs to around 2.94% now so expectations are also being adjusted there.

Moving onto the corporate news for the week, we saw two of the major banks released their earnings for the half year. ANZ is first up in what were solid, but not awe inspiring numbers. For the half year we saw cash earnings +4% to $3.493bill, operating income was +6%, Tier 1 capital ratio +91bps to 11%, net interest margin was down 7bps to 1.93%, impairment charges were down to $408mill from $720mill a year earlier and they maintained a dividend of 80cps.

Overall a solid set of numbers and close to what we expected. Much of ANZ’s profit can be attributed to impairment charges falling heavily since this time last year, but it was good to see operating income come in slightly higher than expected. As per the norm we saw NIM come under pressure as the cost of credit continues to rise overseas as rates remain flat here. I believe we will see the Australian banks increase rates independently of the RBA in the second half of the year as funding costs continue to rise and the banks look to pass some of this on. ANZ’s tier 1 capital ratio remains high (11%) due to the sale of its Chinese business, as it uses those funds to boost capital and buy-back shares. In mid-December ANZ announced it would purchase $1.5bill of its own stock throughout 2018, of which it has already purchased $1.1bill.

The good thing to see was ANZ maintain its dividend, which if you listened to some analysts, was at threat of being cut. At a div payout ratio of 70% I don’t feel that was ever a real threat. In years past that has been around the 80% level, so they had room to increase the ratio if they wished. It also means both NAB and ANZ have now kept dividends on hold which signals confidence in future earnings. ANZ is trading on forward earnings of 11.9x for 2018 and 11.6x 2019 with a 5.8% fully franked yield. Historically PE ratios at this point have been very good buying so I am happy to add to portfolios here with a view of a longer term hold. I am reminded of the famous Warren Buffet quote when it comes to Australian banks ‘We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.’ Think this applies 100% to the banks at the moment and most of the downside is factored in. Let’s be greedy when everyone else is fearful.

Macquarie Group (MQG) was the second of the big banks to reveal earnings this week and in stark contrast to ANZ & NAB they were a brilliant set of numbers. Headline figures saw a full year net profit rise 15% to $2.56bill and a second half result ($1.31bill) 12% above the same time last year and 5% higher than the first half of 17/18. Net operating income rose by 5% to $10.92bill, costs rose 3% and the final dividend was increased 14% to $3.20 per share. MQG saw a lift in all its divisions, except for its commodities and global markets division which saw a fall. It must be remembered that 70% of MQG earnings is annuity style, so very reliable numbers. The froth comes from its Commodities, global markets and capital divisions, hence its annuity style business saw a 6% increase in profits and the remaining 30% saw an 11% increase in profits.

MQG has forecast that its 2019 earnings will be broadly in line with 2018s, but we have to remember that MQG managers are a very conservative group. When reporting its 2017 numbers MQG mentioned it expected 2018 earnings would be in line with 2017. Then in February this year they said that overall earnings would be 10% above 2017. The end result was a 15% increase in earnings. The market loves these types of stocks as they seem to be always re-rating them higher. A theme of under promise and over deliver may see a short term sell off initially, but they tend to make it back as the numbers filter in throughout the year. The market loved the figures and stock has been bid up from $106ps to a record high above $110ps.

In case you haven’t noticed I love the new MQG. It’s a very different company to what it was before the GFC. The first purchase for many of my clients into MQG was almost two years ago around the $65 mark. We then again topped up in a selloff in the low to mid $80s region towards the end of last year. We have since seen the stock climb up to 70% from our initial entry and 30% since our top up, whilst earning a 5% yield on the side. It has probably been our best performing stock over the last two year in the large cap end of town.

MQG currently sits on 14.5x earnings and a 4.7% yield. Given MQG management’s recent history I would be happy to pay up to 15x earnings (around $114) on longer term portfolios, otherwise it’s a matter of waiting until the next dip to gain entry. If we look at forecast earnings for the next two years then MQG is still trading at a very attractive 14.4x (FY19) and 13.7x (FY20) forward multiple. Last year around earnings MQG peaked around $96ps before being sold off to $83 by September and in 2016 it peaked around $72 before being sold off to $66 in July. It does seem that MQG does give a good entry opportunity within a few months after earnings, so your patience could be rewarded with a $95-$100 entry point.

Now the major corporate news is out of the way we have a few important tid bits of news to cover, the first comes from JB Hi-Fi (JBH). In a presentation JBH made last week at the Macquarie Australia conference it noted that profits FY17/18 were to be slightly lower than anticipated at $230mill, down from the $235 - $240mill expected. It has sighted the poor performance of ‘The Good Guys’ chain as the reason for this with adverse weather conditions and heightened competition for the worse than expected performance. It also noted JBH continued to perform strongly and within expectations and that group income was to be $6.85bill+, as expected.

As we all know Amazon officially launched upon Australian shores late last year. We also know their biggest market is electronics/technology. Are Amazon already having an impact on margins for the likes of JBH? When Amazon listed its electronics pricing was on average a 13% premium to our stores here, however as soon as late February this has dropped to be an 11% discount compared on average to store like JBH. So this ‘heightened competition’ may be a direct impact of Amazon already. Remember Amazon doesn’t have to have a large percentage of the market to have a big impact. Their pricing will squeeze the margins down on Australian retailers, as they struggle to compete with the lower pricing and Amazon’s increased buying power. Take Aldi for example. It only owns 12% of the grocery market in Australia, but has seen Woolworths and Coles margins cut by 25-30% in that time. The same will happen with Australian retailers and Amazon. I continue to reiterate my avoid call on Australian retailers since I first did at their peak late 2016. They have yet to go through a major job shedding, restructuring and store closures we have seen in the US and wherever Amazon launches. I wouldn’t be surprised to see JBH share price below $15 in the next 12-24 months as Amazon takes hold.

A quick note covering Woolworths (WOW) and their third quarter sales update last week. Overall it was fairly positive as they saw overall comparable sales +3.6% (Easter adjusted), with total sales +3.4%. The food division was the best performer with +4.0% comparable sales in Q3 with everything except for Big W (-1.3%) seeing solid performance. Food price deflation is still a constant theme with food prices down 1.3% compared to the same time last year. Fruit and veg deflation remained the worst contributor with -5.4%.

It’s a good sign to see WOW continued turn around after they went through a turbulent period of negative sales growth. The issue is that isn’t the main problem with WOW moving forward. It is all about those margins and how they continue to be cut into by price deflation by the way of competition, mainly from Aldi. In 2012 WOW operating margin peaked at 8.7%, whereas today it sits at 6.0%. That’s a 31% fall in margins in 5 years (as of 2017 earnings). If we look at the Tesco model in the UK, their current operating margins are 2.4% and were well above 5.0% before Aldi entered the market. They saw a 50% fall in operating margin due to the likes of Aldi, which means WOW margins could fall to 4.3% or lower if you believe the same thing will happen here. Which I do. Smaller margins mean it’s harder to grow earnings and hence why I am a seller of WOW at these levels. They currently trade on a PE of 22x growing earnings at sub 5% with a 3% yield. To me they look over priced here and look set up for failure come any slight earnings miss.

The final company I will be covering this week is QANTAS (QAN) who also released their third quarter update last week. We saw a strong performance by Australia’s number one airline with group revenue +7.5% on the same quarter last year. Breaking that down we saw domestic revenue increase 8.0%, whilst international revenue increased 5.2%. The improvement comes from increased capacity, by 5.0% and new flight routes and better partnerships with fellow airlines. QAN said it expected a record, before tax profit, of $1.55 - $1.6bill for FY17/18.

The main concern for QAN moving forward is its exposure to a rising oil price. It does state 70% of its fuel requirements for 2019 are hedged at lower prices, so it does safe guard them to a point. If oil prices were to remain at current levels you would expect them to start eating into margins in the near future. The time to jump into QAN was back in January when it dipped below $5 briefly. I don’t feel comfortable paying $6+ for it when they will have a few cost headwinds coming their way in oil and having to start paying tax again. The question has to be asked is this as good as it’s going to get for QAN? The market is only pricing them at 10x forward PE, even at these prices, so it’s not like QAN are an expensive stock.

In our best week in some time you would expect a lot of green sectors, but every single sector managed to finish in the black. This includes the much unloved banks and telecommunications. As I said earlier I saw broad based buying across all our top stocks last week, which is why I think it was institutional funds taking long positions in our market. The above table suggest this as it’s a fairly even spread across all sectors.

I decided to look at the weekly longer term chart for the XJO. Sometimes it helps if you stand back and have a look at the bigger picture. It is very evident we sit in very prolonged, strong bull trend that established itself off the lows in 2009. During this time, though, there has been many 20% pull backs and smaller corrections along the way. At this point I feel we are in a similar period what happened between 2013 and 2015 where it was a slower grind upwards in a tighter band. We then had an exhaustive spike and subsequent correction. At the moment we are trading in that band between the blue lines. I feel moving forward in 2018 we break out of this band and hit the top orange trend line around 6,500-6,600. Consequently in 2019 we breakout out of this longer term trend and hit fresh highs. This will be driven by above trend corporate earnings and continued low rates globally. I also feel global equity markets will outperform US equity markets as more money moves in US bonds over equities. To me there isn’t any reason not to be bullish in the longer term (next 2-3 years).

Outside of the US rates are still benign, with QE still in place in Europe and Japan. Rates will rise soon but it will be gradual and I doubt even as fast as the US is increasing. As that chart I showed you last week, even with a cash rate of 4% in the US the fair market forward PE should be around 15x. We are not far off that now and with the way earnings are growing we will be closer to a cheaper valuation than expensive soon enough. The Dow Jones could conceivably hit 40,000 before the next major crash. Just as we saw industrial profits explode after World War 2 in the US I feel we are seeing the same in the technology space today.

That’s a wrap for me. I do apologise if this week was a bit long winded but we had a lot of ground to cover. For all the husbands, Dads & sons out there don’t forget its Mother’s Day this Sunday. Just thought I’d give you a cheeky heads up just in case you had forgot. I am forever grateful for my wife and the precious gifts she has given us in the last two years in our sons. She is a very special woman and I don’t think there is any way I could fully express what she means to us. Hope all the Mothers out there have a wonderful day this Sunday. Until next time please 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.