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Weekly market update - 25th of November 2019

Written and accurate as at: Nov 25, 2019 Current Stats & Facts

The local market lost around 1% last week. The iron ore price rose slightly as stronger steel spreads in China – and possibly the run-down of inventories over the last couple of months – helped demand. This supported some of the iron ore miners, but was not enough to keep Metals & Mining (-0.5%) or the broader Resources sector (-0.6%) in the black.

Seasonally it is a strong period for iron ore, which may help support the sector for a couple of months. However we are mindful that the iron ore market continues to normalise as Brazilian supply resumes. Absent some sort of shock, many expect gentle declines in the iron ore price to persist over the longer term.

Bond yields fell. 10-year Australian sovereigns came in to 1.11%, down from 1.16%. Meanwhile US 10-year Treasuries fell from 1.84% to 1.77%. Again, this was not enough to drive outperformance from many of the usual bond-sensitives. Several high-profile growth stocks gave back some of their strong gains from the previous week. Afterpay Touch (APT, -7.4%) and Wisetech Global (WTC, -6.8%) were among the worst performers in the ASX 100.

Westpac (WBC, -7.0%) fell on the news that it faced civil proceedings from AUSTRAC. The regulator accused the bank of a raft of abhorrent failures in oversight and reporting on international fund transfers under obligations to anti-money laundering and counter-terrorism financing laws. Management had previously flagged the AUSTRAC investigation, while claiming the issue was not of the scale and gravity as that faced by Commonwealth Bank (CBA, -1.35%) in 2017.

This is clearly not the case – and it is surprising that the potential impact has been underestimated to this degree. The situation remains fluid, with management coming under political pressure. From an investment point of view, the question is whether the situation evolves in a manner similar to CBA or AMP. CBA’s stock price has stabilised in the last 18 months relative to the market as the company has dealt with the issue. On the other hand AMP’s (AMP, -3.2%) stock price has persistently underperformed since issues emerged in early 2018. One key difference may be that WBC’s underlying business is not under the same degree of structural pressure as AMP’s.

Metcash (MTS, -6.3%) underperformed on the news that its current contract to supply 7-Eleven would not be renewed beyond June 2020. This issue has been well flagged in the media in prior weeks. 7-Eleven want to change its supply model to daily delivery of fresh and packaged goods in one truck in a four-hour delivery window – but could not agree to pricing on the new model with MTS. The headline hit to revenue is in the order of $800m, from a group revenue of $14.6bn in FY19. However the earnings effect is likely to be proportionately lower, given the low-margin nature of the supply to 7-Eleven, with the earnings effect likely to be in the order of 3%.

There are several moving parts which will affect the ultimate outcome. 7-Eleven have indicated they will “self-supply”, going direct to manufacturers. There is some question about the economics of this model, particularly with regard to slower-moving goods, which leaves scope for MTS to retain at least part of the previous business. There is also the chance they will retain the West Australian supply contract.

The broader question remains whether the wholesale model remains relevant. The price reaction to an already-known risk suggest that the market has its concerns. We retain confidence – and the belief that the more important issue for MTS is the sales trends and price inflation returning to groceries. In both instances there have been reassuring signs. Metcash is due to deliver is HY20 results on December 5.

A2 Milk (A2M, +16.6%) was the best performing stock in the S&P/ASX 100. Its AGM update suggested margins would not decline as much as many had feared. We think the rebound was something of an over-reaction given some supporting factors – such as lower input costs – are likely to be temporary factors. Nevertheless, it also reflects the degree of negativity and shorting in the stock over the last few weeks.

Aristocrat Leisure (ALL, +10.0%) delivered a well-received result. The result itself was only a very slight beat. But the big positive was that the digital business was in-line with market expectations at both revenue and EBIT margin when the market had a lot of concerns about its performance. It also flagged a healthy pipeline of new game launches in the digital business, which should support revenue growth. The core gaming machine business continue to deliver.

The market also liked ALS’s (ALQ, +5.2%) result. Here, the market had been concerned that a downturn in exploration from smaller Canadian gold miners would see a material fall in mining test sampling volumes. This occurred, but the company managed the hit well, regaining revenue via higher prices. Meanwhile the more defensive Life Sciences and Industrial divisions of the company performed well.

Qantas (QAN, +5.3%) announced new long-term margin targets at its investor day, with a strategy to lift the Qantas domestic margin from 12% to 18% and Jetstar’s domestic margin from 14% to 22% in 2024. This would be considered a stretch by many people. However these targets are also in line with margins in other domestic markets with a stable industry structure. Even if these targets are not achieved, there is a sense that efforts to do so will still lead to material margin improvement.

Finally, Monadelphous (MND, +4.3%) downgraded HY20 sales growth expectations at the AGM, but not to anywhere near the degree that many feared. Meanwhile the company flagged that it continues to win contracts. There is a sense that the market has been waiting for this downgrade, which now may clear the deck for a strengthening cycle.

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