Weekly equities note
Written and accurate as at: May 18, 2017 Current Stats & Facts
The market’s -0.64% result masked a significant level of dispersion last week. Resources enjoyed a bounce as commodity prices stabilised, with the S&P/ASX 300 Metals & Mining gaining 4.4%. Copper miner Sandfire Resources (SFR) (+8.6%) and zircon play Iluka Resources (ILU) (+7.5%) led the charge, while the diversified majors – BHP Billiton (BHP) (+5.0%) and Rio Tinto (RIO) (+4.6%) – also did well. Fortescue Metals (FMG) (-1.7%) bucked the trend on news that it was issuing a $1bn bond offer to refinance existing debt, while Whitehaven Coal (WHC) (-3.1%) was also weaker.
The “Big Four” banks, in contrast, endured a challenging week as the government’s surprise plan to levy a 0.06% charge on their liabilities exacerbated an environment in which their recent results had already disappointed the market. Westpac (WBC) (-3.8%) reported last week – the last of the banks to do so – and delivered solid if unspectacular results for the half. Like its peers, recent increases in mortgage prices failed to translate to margin growth and trading profits supported headline revenues and masked weaker underlying trends. WBC managed to hold costs flat, which was a reasonable result and managed to offset the margin headwind from higher-rate term deposits that they have offered in the last year.
The ultimate effect of the levy remains to be seen, as further detail emerges, but the market is expecting an impost of around 4% to earnings, on average. There was some talk that this cost could be passed straight through to mortgage customers, however this notion is complicated by the government’s simultaneous announcement that the ACCC would oversee mortgage pricing and competition, suggesting political opposition to this move. Ultimately we will wait to see if it is depositors, mortgagees, shareholders, staff or some combination thereof that wears the charge. Our concern is that this proves to be more than a temporary measure of budget repair and instead is the thin end of a more permanent wedge; a lever that the government can pull to extract value as budget pressure and the political environment allows and requires.
In the near term, we think that the levy, in combination with a lack of growth in margin and revenues and the pending APRA review into capital adequacy, provides a headwind for bank performance. National Australia Bank’s (NAB) (-0.6%) dividend looks under threat, as the effect of this levy pushes its payout ratio towards 80%, well above its peers. It is also displaying less cost discipline than its peers, with costs up 3% for the half. The new levy only applies to certain funding sources, such as corporate bonds and deposits over $250,000, and in this sense may be less punitive for Commonwealth Bank (CBA) (-3.2%), given its large retail deposit book. However in our view the underlying trends for CBA are, if anything, the weakest of the banks. They appear to have lost some momentum on cost control with costs up 1%.
We remain underweight the Big Four banks for the moment in most portfolios. ANZ (ANZ) (-4.7%) remains our preferred position. They have already taken the pain and cut their dividend and are doing the most on costs – which were reduced -2% over the half. Its redirection away from overseas and focus back on the domestic business should result in reduced provisions for bad debts and an increased return on equity. Bendigo and Adelaide Banks (BEN) (+0.7%) and Bank of Queensland (BOQ) (+2.1%) receive a notional free kick given that they fall below the cut-off of $100bn of liabilities, however historically the regional banks have not benefited from similar comparative boosts to the extent which might be expected. Macquarie Group (MQG) (-2.4%) is subject to the levy, however the effect is less than for the retail banks, given most if its business is in asset management and falls outside the scope.
Elsewhere, building products maker CSR (CSR) (-13.6%) plunged as signs of a slowdown in the Australian housing market began to emerge in its result. Housing starts in Australia have been running at around 220,000 per annum, well above its normal rate of ~180,000, and statements from management that they expect the market to cool saw a swift reversal in the stock after a strong run through 2016. Continued speculation around the potential impact of Amazon saw further weakness in retail stocks. Myer (MYR) (-14.5%) was the market’s worst performer, followed by Super Retail (SUL) (-9.2%), Harvey Norman (HVN) (-8.3%) and JB Hi-Fi (JBH) (-6.9%).
Chemical company Incitec Pivot (IPL) (-0.3%) also delivered an eagerly awaited result – the first to feature the contribution from its newly constructed ammonia plant in Wagaman, Louisiana. Management have flagged that the earnings contribution was not going to be as large as that flagged when construction started and the spread between gas and ammonia was hundreds of dollars. A compression of that spread saw an EBIT contribution of $80m, rather than ~$200m spoken of years ago, but nevertheless is a decent return and, most importantly, represents a cash flow inflection point as its capex bill swiftly declines. While demand for explosives has been picking up, fertiliser prices remain cyclically depressed, weighing on IPL’s revenues. However management have been active in controlling costs and listing productivity and efficiency, allowing them to deliver decent margins. The stock has enjoyed a good run since mid-2016, however given the cyclical low in ammonia prices and an uplift in cash flows, we believe the stock can re-rate from here and maintain our position in most portfolios.
Qantas (QAN) (+4.9%) continued its strong run post its strategy day. The current valuation multiple implies a significant reduction in earnings in upcoming years and management’s reassurance that they can continue to maintain strong profits has helped address the market’s concern.
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