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Weekly market update - 13th of May 2019

Written and accurate as at: May 13, 2019 Current Stats & Facts

The Australian sharemarket declined -0.4% in a subdued week for markets.

The US-China trade issue flared again, prompting a sell-off in most Chinese consumer-related names such as Treasury Wine Estates (TWE, -11.5%) and A2 Milk (A2M, -2.6%). TWE’s weakness is likely to have been compounded by the CEO selling a parcel of shares.

It was the Industrials-ex financials which dragged. Listed property held up reasonably well (+0.7%), as did the banks (+0.2%). Metals & Mining gained +0.7% as a Brazilian court reversed an earlier legal decision and barred Vale from re-opening its Brutucu mine.

The disruption to Brazilian iron ore production following the closure of the Samarco and Brumadhino mines in the wake of tragic tailings dam collapses – and the temporary closure of other mines such as Brutucu while safety reviews are conducted – has resulted in higher prices. Iron ore gained a dollar last week and is now at US$95 a tonne, versus the consensus expectation of US$80 a tonne for FY19.

For the miners, this offset some of the cyclical concerns stemming from trade tensions. Fortescue Metals (FMG, +3.3%) was among the market’s best, while Rio Tinto (RIO, +0.9%) also outperformed. BHP (BHP,-0.4%) performed in line with the index. Iron ore is one of the few parts of the market which is continuing to see earnings upgrades, while management remain reasonably disciplined and are returning strong cash flows to shareholders via dividends and buybacks.

Cyclical and growth stocks tended to drag given the broader concerns around trade. Most of Australia’s ‘WAAAX’ cohort declined following several strong weeks, with Wisetech (WTC) down -4.7%,  Afterpay Touch (APT) -5.2%, Altium (ALU) -4.1%, and Appen (APX) down -6.4%. Only Xero (XRO) bucked the trend, gaining +0.9%.

Brick-maker Adelaide Brighton (ABC, -17.9%) was the worst performer in the ASX 100. Management downgraded its profit expectation for CY19 by 10-15%, citing cost pressures as well as softer construction markets.

Graincorp (GNC, -15.1%) was another notable underperformer as the indicative bid from Long Term Asset Partners was withdrawn following due diligence.  Last week’s fall means that the stock has now given up all the gains that resulted from the takeover offer.

The Australian Competition and Consumer Commission (ACCC) ruled against the tie-up between telecom operators TPG Telecom (TPM, -7.0%) and Vodafone. The ACCC’s position is based on TPG following through on its initial plan to build a 5G mobile network and therefore provide a fourth mobile operator. However TPG have stated they will no longer spend the billions required to build a credible network, citing the increased costs now that they are no longer allowed to use Huawei technology.

The outcome will be a legal tussle which is likely to be resolved towards the end of CY19 – at best – but which could drag on into mid-next year. In the near term it is a positive for Telstra (TLS, +0.9%) as it further delays a roll-out of a competitive 5G network.

The mining services companies such as Seven Group (SVW, -6.9%) and Monadelphous (MND, -3.8%) diverged from the miners. The mining service sector has been trading in line with sentiment surrounding global trade and growth.

The outlook for mining services is more closely linked with the health of the miners – which continue to deliver strong free cash flow on the back of an elevated iron ore price – and their need to perform long-delayed fleet maintenance and mine expansions. SVW’s recent earnings upgrade demonstrates that this trend is playing out.

Weaker sentiment around cyclicals is likely to have dragged on Qantas (QAN, -6.2%), although it also delivered a quarterly update which flagged softer trends in corporate travel post-Easter. Companies do trend to decrease travel around election periods and our conversation with management in the banking and telco sectors confirm that they have been cutting back on travel spending. However the update also revealed that leisure travel remains firm, while the international segment is doing better than the market expected.

The market’s 8.4x next-12-month price/earnings multiple is pricing in a ~10% fall in profits for QAN in FY20, the improvement in trends in international should allow them to maintain earnings growth. Meanwhile, the company’s sale of its Melbourne terminal is likely to underpin further capital management and buybacks, bolstering its already healthy dividend yield.

Relatively few stocks made large gains last week. The gold miners did well on risk aversion, with Northern Star (NST) up +9.6%, Evolution (EVN) +8.5% and Newcrest Mining (NCM) +3.4%.

Defensives such as APA (APA, +4.6%) and AGL Energy (AGL, +4.5%) also outperformed.

Chemical company Orica (ORI, +4.1%) delivered a better result than expected. This was largely the result several of its smaller, poorly-performing divisions doing better, rather than an improvement in its core ammonium nitrate business which continues to suffer from the outage of its Burrup plant in Western Australia.

Westpac (WBC, -0.8%) delivered its half-yearly result. It was the weakest of the three recent banking updates, as unlike ANZ (ANZ, +0.3%) and National Australia Bank (NAB, +1.1%) WBC’s Treasury and markets divisions weren’t able to offset the weakness in the core lending portfolio. ANZ continues to deliver the strongest message in terms of cutting costs.

The market was forgiving of REA Group’s (REA, +1.9%) quarterly result despite a weaker listing environment. The federal elections and effect of the effectively combined Easter and Anzac Day holidays have distorted the housing market in recent weeks, although the market will be focused on the trends that emerge following this weekend’s election.

In the latter regard, most feel the election is unlikely to move markets too much. Business have been factoring in a Labor win and some have already started adjusting their strategy accordingly. The key question is what happens to the economy post-election. We have seen strong evidence of a deceleration in the last six weeks and business have been holding back on spending. From next week, we will be looking to see if this trend reverses or whether a need for further stimulus will emerge.

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