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Weekly market update - 17th of June 2019

Written and accurate as at: Jun 17, 2019 Current Stats & Facts

The local market had a strong week gaining +1.7% last week, boosted by a +6.2% return from the Metals & Mining sub-index.

The iron ore price reached US$110 per tonne for the first time in five years. Over the same time the Australian dollar has depreciated and the miners have cut both per-tonne costs and capex, underpinning huge cash flow generation. Fortescue Metals (FMG)gained +12.1%, while the more diversified majors Rio Tinto (RIO, +7.5%) and BHP (BHP, +6.5%) also outperformed. The key variable to watch remains Brazilian production, which is currently curtailed as some mines remain closed while safety measures are reviewed.

Elsewhere the banks were off -0.4% in aggregate and REITs gained +0.9%.

It was a relatively quiet week for newsflow, although we saw some confessions ahead of the year end with both Challenger (CGF, -18.6%) and Star Entertainment (SGR, -15.3%) downgrading full year profit guidance. Lower equity return assumptions and the effect of disruption in the advice industry lie at the heart of CGF’s rebased expectations. We see ongoing margin pressure and, with the rating having only returned to its mid-cycle range, remain cautious on CGF. A weaker environment for private gaming rooms – reflecting a softer high-net-wealth market – is weighing on SGR.

A Strategy Day for Wesfarmers (WES, -5.6%) revealed weaker expectations for Kmart, leading to consensus downgrades. Kmart is generally regarded as the most successful of the department store formats in Australia, with decent growth in foot traffic and resonance with key market demographics. It managed to grow sales with regard to the prior corresponding period (PCP) – albeit at very low levels – however margin pressure is continuing to weigh on earnings. This is turn is driven partly by a period of strong competition from Big W – although the latter’s ability to sustain lower pricing is questionable given the greater pressure on its own earnings.

Nevertheless, Kmart’s ~10% earnings downgrade reflects the wider pressures on Australian retail. Anecdotes in the weeks following the election suggest we have not seen a deterioration in economic conditions - but neither have we seen a material improvement.

There is also the knock-on effect for retail malls, which are seeing pressure on rents and higher vacancy rates. The issue for retail REITs is compounded by the fact that there is ~$12b of retail property currently offered for sale, which is weighing on asset values. We retain a large underweight in retail in our property portfolios, preferring more defensive income streams in a subdued economic environment.  

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