Weekly equities note
Written and accurate as at: Feb 27, 2017 Current Stats & Facts
Macro-driven sentiment has been soft in recent weeks given the uncertainty over the next policy move from President Trump; US bond yields have fallen and we have seen a rotation away from cyclicals and back into the rate sensitives such as REITS (+3.1% mtd) and infrastructure (Transurban (TCL) +9.2% mtd). The key question is whether we are merely in a lull before his anticipated pro-growth reforms on tax and regulation are announced – which could restore the market’s confidence – or whether his policy initiatives will be bogged down by an intransigent Congress and ultimately fail to make real change. The President’s address to a joint session on Tuesday could provide some clues as to how this unfolds. Fundamentally, we believe that underlying growth in the US – which was already coming through prior to Trump’s victory – should continue to support a gradual increase in interest rates in the US (and therefore bond yields) over the medium term, which leaves us cautious on the outlook for bond-sensitives.
The market is also expressing some concern over the direction of commodity prices, particularly with iron ore near US$90 a tonne – far higher than many thought possible just one year ago – and data suggesting that inventories at Chinese ports are at a 5-year high. There is a degree of complexity here. Seasonally, iron ore inventories are higher now than at any other time during the year, as Chinese companies buy up over Chinese New Year ahead of increased demand as the northern hemisphere moves into Spring. The question is whether they have over-bought. At this point we believe the supply-demand picture looks reasonable, supported in part by the government’s efforts to close down steel plant induction furnaces (which use scrap metal) which could result in more demand for traditional blast furnace plants (which use iron ore).
There were a slew of stocks which defied the broad market weakness on the back of decent earnings results. Qantas Airways (QAN) was up 6.3% following a result which, while not being as spectacular as some of their recent reports, certainly did enough to reassure investors that some of their darker fears were not coming to pass. While demand growth was soft in the domestic market for much of 2016, Qantas’s discipline in cutting capacity shored up earnings – and they have managed to do much better than rival Virgin Australia (VAH). At the same time, they continue to take out costs. They have also pointed to signs of stronger demand in December 2016 and into the New Year, suggesting that sequential trends may be picking up. The international division was weak due to competitors expanded capacity during the year. Again, while the year-on-year change in demand looks poor, the sequential trends are more supportive as capacity additions tail off and the base effect of this event starts to wash through.
Nine Entertainment (NEC) (+6.2%), another holding in several of our portfolios, also did well as its result demonstrated continued cost control in tandem with an improvement in ratings. It is also benefiting at the margin from an uplift in advertising demand for television more broadly as commentators have questioned the legitimacy of the metrics that high-profile social media providers use to attract potential advertisers. This provided an additional – albeit temporary – tailwind.
Elsewhere, the market shrugged off a management shuffle to endorse Crown Resorts’ (CWN) (+6.3%) cost reduction programme and the acceleration of an expected special dividend. Insurance Group Australia (IAG) (+3.4%) gained following management’s assertion that the insurance business cycle is improving; we retain our caution on this view. Woolworths (WOW) (+4.0%) delivered a higher quality result that the market expected, supported by a surprisingly large reduction in shrinkage (eg. losses attributed to wasted vegetables and shoplifting). While WOW’s turnaround continues, we remain wary of the implied expectation that profit margins can climb back above 5% in the near future.
Outside of resources, Brambles (BXB) was a key large-cap underperformer, off -9.4% as management downgraded expectations, withdrawing their return-on-capital (ROC) targets for 2019 and citing greater-than-expected competitive pressures in the US.
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