Weekly market update
Written and accurate as at: Aug 28, 2018 Current Stats & Facts
Last week’s political turmoil weighed on the local market as it shed 1.1% whilst passinga through the busiest week of reporting season. We have been citing politics and regulation as an increasingly important source of disruption for companies and industry structures in recent times as populist winds have stiffened throughout most Western democracies. So it proved in the week past, as those sectors seen as most sensitive to political factors – such as energy and banks - took a hit on the surge of uncertainty accompanying the Liberal party putsch.
The major banks fell between -3.7% (Commonwealth Bank, CBA) and -8.2% (Westpac, WBC) on the increased likelihood of Labor prevailing in the next election. The concern here is that a Shorten government would bring greater pressure to bear on the sector and potentially hike bank taxes. WBC’s weakness was exacerbated by its quarterly update, which effectively signalled a profit downgrade as margins fell further than most people expected. Banks are battling with the rising cost of wholesale funding and an increase in the overnight index swap (OIS) spread. Normally they would offset this with mortgage price increases – however management are reluctant to pass on their higher costs to borrowers in the current environment, with margins contracting as a result.
The energy sector also took a hit as the Liberal Party’s energy policy disintegrated under internal pressure, leaving the sector facing an uncertain future. AGL Energy (AGL, -5.8%) and Origin (ORG, -4.6%) both wore some pain, although Santos (STO, +10.1%) bucked the trend with a late rally on the news of its takeover bid from privately-held Quadrant Energy. Quadrant supplies almost a quarter of Western Australia’s gas, as well as oil volumes, with some of their assets co-owned by STO. The all-cash deal is a large one, representing over 20% of STO’s market cap and funded by debt. However its gas supply to Western Australia is under long-term contracts, providing clear visibility into the underlying future cash flows and reducing leverage to the oil price.
Medibank Private (MPL, -6.1%) delivered a decent result, but also remains in the political cross-hairs given Labor’s stated intention to cap private health insurance premiums. There are some claiming that the insurance sector will be able to pass on margin pressure to the private hospitals, but this must be questioned. MPL’s margins are already high and rising, while Primary Health Care’s (PRY, -14.3%) result last week demonstrates that hospitals are already under pressure, bearing the pain of patients deferring surgery or electing for operations in public hospitals, given issues with affordability. This has not weighed on demand for private insurance – yet – but in combination with regulatory scrutiny leaves us cautious on the insurance sector.
The resource sector as a whole outperformed, falling only -0.6% for the week. BHP (BHP, -1.4%) met the market’s expectation with a good result which featured strong cost control; thus far it is faring better than many of its peers in dealing with inflationary cost pressures. Fortescue Mining (FMG, -6.3%) was weaker, while Alumina (AWC, +4.3%) delivered strong profit growth on the back of a 35% increase in alumina prices in the first half of 2018, helped by Chinese capacity discipline and outages at the Alunorte plant in Brazil.
Small caps outperformed, gaining +1.9% as market-darling tech names such as Appen (APX, +23.2%), Altium (ALU, +27.5%) and Wisetech Global (WTC, +26.2%) made strident gains. This is a challenging sector of the market, as the scale of gains made by some of the small cap tech names is starting to hurt some small cap managers who don’t own them, which can lead to capitulation and fuel further stock price gains. There are good companies in this sector, but there is also a significant degree of hope and, in some cases, hype. At the same time, there is little in the way of valuation cushion against disappointment; Australian cloud-based tech names are now the most expensive in the world. These gains made the +8.2% return from their erstwhile small-cap peer A2 Milk (A2M) seem pedestrian by comparison. A2 delivered a decent result and positive guidance.
Elsewhere, Flight Centre (FLT, -15.3%) was among the market’s worst performers, coupling a slightly disappointing result with media allegations of shonky work practices. Ansell (ANN, -8.8%) and Adelaide Brighton (ABC, -6.4%) also missed expectations. The strong price reaction to sometimes mild disappointments is a key feature of this reporting season, which has set a new record for average price volatility in stocks on the day of their result. This to some extent reflects the effect of quant investing and momentum strategies in the current market. APA Group (APA, -5.8%) fell on speculation that the takeover bid from Hong Kong’s CKI Group may not gain approval, while REA Group (REA, -6.1%) rounded out the week’s major underperformers on news that the CEO had sold down her stake.
The telco sector enjoyed a rebound on the news that TPG Telecom (TPM, +24.3%) and Vocus (VOC, +17.4%) may look to merge, easing some of the competitive pressure in the mobile segment. Telstra (TLS) gained +4.2% which, on top of last week’s gains, has seen the stock regain over 25% from its lows of late June. It serves as a reminder of how quickly sentiment can turn and prices can run from depressed valuations. The deal may not yet emerge, however it does demonstrate the desire for consolidation within the industry, given sustained earnings pressure.
Elsewhere Brambles (BXB, +6.5%) delivered a reasonable result, while Star Entertainment Group’s result (SRG, +6.4%) was not as bad as many feared. BlueScope Steel (BSL, +2.8%) is still bouncing around with sentiment towards trade tariffs, while CSL (CSL, +2.7%) continued its strong run. Nine Entertainment’s (NEC, +1.3%) result revealed that it continues to do well, with some positive trends in terms of free-to-air advertising demand.
Finally Qantas (QAN, -6.1%) delivered a strong result. Revenue was better than expected as demand remains robust in both its domestic and international segments, however this was offset by an increase in fuel costs as the oil price has climbed. The industry structure remains supportive and demand trends continue to look constructive, supporting revenue growth. Meanwhile the buyback programme continues to support earnings-per-share growth even as profits remain flat; by the end of this year QAN will have bought back over 26% of its shares over the last four years. It is currently valued at 9.9x next-12 month consensus earnings.