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Weekly market update - 13th of November 2018

Written and accurate as at: Nov 13, 2018 Current Stats & Facts

Australian equities firmed up last week, with the local market adding +1.3%. The trend in outperformance for some of the laggards of recent months continued, with Financials ex property up +2.8%, while REITs led the way with a +3.2% gain. Growth stocks generally underperformed (eg CSL (CSL, -0.8%), Aristocrat (ALL, -3.1%) and Seek (SEK, -3.8%)).

At a macro level we saw the oil price continue to fall, defying predictions that the return of US sanctions on Iran would see the market tighten up. Brent Crude is now at ~US$71, down just under 19% from its recent highs.  While higher oil prices can provide a short-term boost for some energy companies, ultimately they destroy demand and can accelerate conversion away from oil; thus a return to a lower but more sustainable price is not necessarily a bad thing.

There have been mixed fortunes in other commodities: Bulks such as iron ore have remained reasonably steady, helped by the relatively concentrated nature of supply and demand from Chinese infrastructure. In contrast, some of the base metals such as copper have found their end users under greater pressure from tariffs and trade frictions. The iron ore price was up over 3% last week, with copper down by the same amount. 

Property developer Lendlease (LLC, -17.3%) was among the worst performers as management wrote down the value of its engineering and services book by $350m, due mainly to issues with its NorthConnex contract in Sydney. This caught the market by surprise, given management assurances in August that they had taken a conservative approach and contained the issues - and the fact that they have continued to buy back stock until very recently. As a result the stock was hard hit despite construction comprising a relatively small part of LLC’s business. The market was also unimpressed with the AGM update from Domino’s Pizza (DMP, -12.1%) which revealed disappointing sales performance in both Europe and Australia. Given a high-20s price/earnings (P/E) ratio, DMP has little room for error.

James Hardie (JHX, -11.3%) rounded out the high-profile underperformers as management downgraded expected FY19 NPAT by 6% on the back of higher input prices and softer trends in US housing activity. High freight and pulp prices had been flagged in the market, however the issue is that their effect on earnings has been greater than expected and the company has limited scope to pass these costs on at this point. The softer demand backdrop was compounded by a lack of clear communication from management over their ability to continue to making inroads into market share.  Plumbing equipment stocks Reliance Worldwide (RWC, -5.4%) was also weaker in response to US housing activity.

Gas infrastructure company APA Group (APA) fell -8.8% after the government moved to block its sale to Hong Kong-based CK Group, which serves as yet another example of the increasingly frequent effect of government intervention in the market. Meanwhile casino operator Star Entertainment (SGR, -4.4%) fell as speculation that the Queensland government might approve a second casino licence for the Gold Coast surfaced again. Such a move would pose a considerable threat to SGR’s existing casinos in both the Gold Coast and Brisbane.

REA Group (REA, +8.7%) was one of the few growth stocks to buck the trend and outperform as it beat earnings expectations for the quarter, with its more diversified book proving more resilient to a softer environment than rival Domain (DHG).

ANZ (ANZ, +6.3%) also did well as management did the rounds post its recent result to emphasise the focus on absolute cost reduction. There is some speculation that regulators may try to pressure the banks into repricing their back-books of mortgages to align them with a discounted front book. However this would be difficult in practice, given the broad range of factors such as location, loan-to-value, incomes, property characteristics and the like which ultimately drive mortgage pricing. We also think there is scope for the market to be overly negative at the looming prospect of a Federal election  - while a Labor government is likely to maintain pressure on the banks, they will not want to inherit an economy in downturn from a credit crunch. 

In the chemical sector Incitec Pivot (IPL, +6.0%) gained on the back of stronger ammonia prices while Orica’s (ORI, +2.5%) result, while weak, was broadly in line with expectations.

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