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Weekly Market Review

Written and accurate as at: Dec 04, 2017 Current Stats & Facts

Last week saw some significant and ostensibly negative developments for the large end of the Australian market, in the form of a Royal Commission into financial misconduct and the announcement that the NBN’s scheduled rollout had hit a delay. Nevertheless, the S&P/ASX 300 ticked +0.1% higher.

On the macro front, the oil price softened as OPEC and Russia agreed on a widely-expected extension of production cuts through to the end of 2018, before bouncing back at the end of the week. The consensus view is that US shale drillers will remain disciplined and resist the urge to increase production at current prices, leaving Brent crude well supported at its current level of roughly US$63 per barrel. The shale rig count will be a key factor to watch with regard to oil price movements, and it is important to be mindful that this can change relatively quickly. However at this point the discount for West Texas Intermediate (WTI) crude versus Brent crude has widened, acting as a disincentive for increased shale production given they price off the former. The copper price came off 3%, while iron ore strengthened a further 3.5% and is now back at US$70 per tonne. This seems somewhat counterintuitive given expectations that winter steel mill shutdowns in China would see demand subside until post-Chinese New Year. Nevertheless, demand remains decent at this stage, although the price looks somewhat vulnerable and we would not be surprised to see it pull back from here. Bond yields were broadly flat for the week.

The strengthening expectation in recent weeks that the Federal government would be forced to capitulate to pressure for a Royal Commission into financial services meant that price reaction to the formal announcement was somewhat muted. The Commonwealth Bank (CBA) (-1.7%) was the hardest hit of the Big Four and ANZ’s (ANZ) (-0.9%) response was also relatively mild, while Westpac (WBC) (+0.2%) and National Australia Bank (NAB) (+0.2%) actually ended the week up. Many people are seeing this as the “least-worst” outcome for the banks given that a Commission defined by the Coalition is likely to be more benign than one drawn up by a Labor government and that it should be manageable as a result. This does seem a reasonable view at this point, however we are mindful that the last Royal Commission into the sector – to investigate the collapse of HIH insurance – also began with a relatively tight mandate which later broadened and ultimately published recommendations for the banks. It will be important to keep track of the Commission’s direction in case it does begin to delve into some unexpected areas.

NAB spin-off CYBG (CYB), which owns several UK-based banks, was up +4.2%. The key risk for the stock is the ultimate scale of their remediation liabilities. NAB carved out provisions for customer remediation as part of the spin-off deal, however a recent surge in claims has prompted concerns that their ultimate size may exceed this. 

Telstra (TLS) fell -1.7% for the week, downgrading earnings on Friday in response to the announcement from NBN Co that the schedule for rolling out connections will be delayed while they fix some technical issues. This means that the payments due from NBN to TLS will be reduced in the short-term, prompting the downgrade. Ironically it will probably end up being a positive for TLS as these payments are just deferred, not lost, and in the meantime it retains more customers on its own higher-margin wholesale network. Nevertheless, it was enough to prompt some selling in the market, with one large block trade from an offshore institution putting pressure on the price. TLS is now at 10.6x next-12-month price/earnings and a 6.4% dividend yield, pre-franking, and is at something of a nadir in terms of sentiment. At this point it seems that it would not take much in the way of an improvement to see a re-rating - and recent speculation that NBN Co may offer an effective discount on its larger data packages, allowing resellers to drive demand for its more expensive plans, may provide some upside.

Resources were weak despite the strength in iron ore. BHP (BHP) shed -1.4%, while Rio Tinto (RIO) (-1.3%) and South32 (S32)(-6.1%) also underperformed. Chemical testing company ALQ (ALS), which has been seen as a leveraged play on the recovery in mining services, endured a second week of falls -5.5% following its disappointing result. Gold stocks were also weak, with Newcrest Mining (NCM) down -2.2%.

Gaming company Aristocrat Leisure (ALL) (-3.7%) announced a strong result, with good momentum in its key product lines as it continues to take market share. However the stock dropped in response to the announced acquisition of American social gaming company Big Fish. In combination with the acquisition of Plarium in August, the social gaming/online casino segment of its business will now be responsible for roughly 20-25% of the company’s earnings. ALL’s strategic motivation is understandable, on the view that the demographic profile of slot-machine gamers is aging and the company wants to establish itself among the young age cohorts. The risk here is that the shelf life of a successful social game tends to be relatively short, with a high degree of unpredictability around which games gain traction and which do not. The price paid was reasonable and Big Fish is making decent earnings, while ALL’s underlying business remains strong and at 18x next year’s earnings, it is among the most attractively valued growth stocks on the ASX.

JB Hi-Fi (JBH) gained +5.8% last week as the ‘lights remained on’ even as Amazon enters the Australian market. A-REIT Dexus (DXS) (+5.7%) was also among the market’s leaders on some excitement around rising office rents and falling cap rates, although we remain wary that we are at or near peak cycle in this regard. Origin Energy (ORG) flagged aggressive cost out measures at its investor day, and a +5.7% gain suggests the market is already giving them credit for successful execution. AGL Energy (AGL) was also among the market’s leaders, up +5.5% as the market expressed relief that its pricing deal with the Victorian government was relatively benign.

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