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Weekly market update - 1st of July 2019

Written and accurate as at: Jul 01, 2019 Current Stats & Facts

Performance of the Australian equity market was muted last week.  Nonetheless, returned over 11.1% for FY19 as did the US S&P 500.

On balance, the backdrop for equity markets remains positive. In the US, investor sentiment was improved by the Fed’s latest announcement that every US-listed major bank had passed their annual stress test, which saw the big banks subsequently commit themselves to return $136b of combined capital to shareholders over the next 12 months.

Over the weekend, we also had some positive updates from the G20 summit in Osaka: a truce or at least a temporary reprieve in the US-Sino trade tensions was achieved by Trump and Xi, alleviating (somewhat) concerns around the outlook for global economic growth. Both parties have returned to the negotiating table, with the US agreeing to halt additional tariff hikes for now, and China in exchange will buy more agricultural products from the US immediately. In addition, US companies are also allowed to sell components again to the world’s largest telecommunications equipment manufacturer, Huawei. The Chinese telecom giant has been near the epicenter of the trade talks.

Also at the global macro level, another key agreement achieved at the summit was between Russia and Saudi Arabia, extending their current production curtailment by another six to nine months. While the OPEC+ is yet to meet (early this week) this agreement is very likely to be adopted by the rest of the countries in the alliance. While remaining below the highs achieved in April, Brent crude has come back a fair way over the latter part of June, up ~10% to US$66.55/bbl by the end of last week.

Domestically, Aussie 10-year bond yields added 4bps over the course of the week to trade at 1.32%. Iron ore, on the other hand, continued to edge higher last week to trade at US$109.2/mt. Inventory level at Chinese ports is at a four year low due to the previous underestimation of the Vale situation. Weather-related events, as well as disciplined capacity growth by the Aussie miners, could also see Australian iron ore export growth become negative this year. While it is hard to fathom iron ore prices stay elevated at the US$110-120/mt level, it is also hard to see the commodity trade on the downside of $80/mt due to the supply constraints globally. 

Metcash (MTS, -18.4%) reported its full-year result and it was not well received. In terms of the reported earnings, NPAT for FY19 was only ~3% below consensus, in stark contrast to the share price reaction. The negative response was more ascribed to the FY20 earnings downgrade. In particular, the earnings fillip the Food business has been benefiting from on the back of an onerous lease provisions write-back is going to be significantly lower for FY20 compared to the reported $18m for FY19. While this has been a known factor for earnings, the magnitude of the pullback was not fully appreciated by the market.

For its Food business, new IGA stores are opening, and price deflation is becoming apparent. This may see positive headline growth for the business for the first time in a long time, excluding tobacco. Management is set to update the market in that regard at its AGM in August, and investors will welcome any slim sight of sales growth improvement.

Outside Food, Liquor continued to do well, whereas Hardware seemed to have run into a speed bump. Management indicated that sales for the first seven weeks of FY20 are lower than that period of FY19, reflecting the loss of a QLD customer and trade softness. That said, the company still expects additional cost savings to help mitigate the adverse impact from any slowdown in construction activities next year. MTS is trading at an 11.7x FY19 P/E and a net dividend yield of 5% with fully franked dividends.

Elsewhere, Oil Search (OSH, -2.3%) declined after management elected to exercise the Armstrong option for US$450m, which will double the company’s interests in the Pikka Unit, Horseshoe Block and other exploration leases in Alaska. Although the option will be funded via existing corporate facilities, and the company has indicated its intention to divest some of these assets before mid-2020, the market remains skeptical for now. Any hiccup in executing the sell down plan could potentially see OSH run into financial issues down the road.

Lastly, buy-now-pay-later service provider Afterpay Touch (APT, +5.1%) saw its share price plunge by 10% on Friday, despite finishing the week in the black. Some investors quickly headed towards the exit after global payment giant Visa revealed it would test its own payment installments technology. 

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