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Weekly market update - 25th of February 2020

Written and accurate as at: Feb 25, 2020 Current Stats & Facts

The spread of Covid-19 (coronavirus) has seen a rally in bond yields as a result of fears of the virus’s effect on global growth. At the end of last week 10-year Australian sovereigns were yielding 0.92% – down from 1.4% at the start of the year – while the US equivalent yields have fallen 45bps to 1.47%. 

Elements of this trend remained in place last week. The overall market was slightly up at 0.37% for the week and growth companies such as CSL (CSL, +1.6%) and ResMed (RMD, +1.4%) outperformed. However, there was a notable divergence with midcap tech companies Wisetech (WTC, -33.6%) and Altium (ALU, -17.7%) the two worst performers in the ASX 100. WTC delivered another half of profit growth but slashed its full-year earnings guidance as the effect of Chinese production closures fed through into global supply chains and logistics. ALU, too, delivered strong EBITDA growth for 1H but likewise guided to the lower end of its full-year expectations due to the effects of Covid-19. The scale of the stock price reaction demonstrates our primary concern with several of the market’s high-flying growth names. While they are for the most part good businesses, valuations leave little room for any disappointment.

The effects of depressed Chinese activity on resource demand – exacerbated by the risk of port disruptions preventing products from moving – is well flagged by the market. Australian miners and energy companies are under scrutiny in this regard although we remain mindful there is substantial potential for stimulus – on top of a snap-back in demand – once risk diminishes. We also note movement constraints mean some excess supply is unable to get out of China, which has helped support some specific commodity prices.

The effect on companies that sell directly into China, such as Treasury Wine Estates (TWE, +6.1%) and A2 Milk (A2M, +2.8%), is also reasonably well understood – although TWE enjoyed a modest rebound last week on speculation about takeover interest.

The market is now starting to focus on the second-order effects of the Chinese shutdown. Domestically there are risks on both the demand and supply side. There is scope for a material impact on consumer demand in Australia from reduced tourism and the delay in Chinese students returning, which could affect revenue for domestic cyclicals. This could be a contributing factor to Nine Entertainment’s (NEC) -7.2% fall last week.

At the same time, disrupted Chinese production may also potentially lead to retailers missing out on product. For example, Apple has warned the delayed return to work will have an impact on iPhone supply. In addition, building material companies may not able to source inputs – and companies may delay capital investments. Assessing the degree to which companies may feel this impact is very much on a company by company basis, given the options for alternate sourcing and inventory levels each enjoys.

While there is a material degree of uncertainty, at a headline level the market’s reaction at the end of last week reflects the view that the main effects will be relatively short-term and any persistent slowdown in China will result in stimulus measures.

Beyond the stocks already mentioned, Whitehaven Coal (WHC, -10.4%) was another underperformer. It released a disappointing set of earnings,  with EBITDA down by 68% versus the prior corresponding period (pcp). This was mainly due to lower revenues, as a glut in LNG following a mild northern hemisphere winter weighed on the coal price. WHC’s Maules Creek mine also suffered disrupted production due to labour shortages and dust storms.

Tabcorp (TAH, -10.3%) also came under pressure. It did manage to deliver 2.1% EBITDA growth versus the pcp, against a background of soft consumer spending. However the market was disappointed by poor performance in a couple of divisions – notably gaming services – as well as by increased cost expectations for the Tabcorp-Tatts integration.

Cleanaway Waste management (CWY, +20.3%) was the best performer in the ASX 100, defying market concerns to post a 6.8% increase in underlying EBIT and 15.2% gain in underlying NPAT. It has been an eventful year for CWY as it digests several recent acquisitions and flagged further capex, however it delivered an increased dividend and increased its guidance for the second half of FY20.

AMP (AMP, +12.9%) was also among the market’s best, continuing to rise in the wake of its results despite no additional newsflow. The idea of “no news is good news” may also have helped Lendlease’s (LLC) +8.1% gain last week as the result did not contain any surprises. Management indicated they remain on track to dispose of the troubled engineering division this year and reiterated the cost target for doing so. Beyond this, they have a solid pipeline of development opportunities but will require additional capital – likely in the form of joint venture partners – to unlock the value here.

Elsewhere, a surprisingly strong full-year result from Coca Cola Amatil (CCL, +8.1%) saw them outperform. CCL delivered revenue growth in the Australian business for the first time in seven years, helped by success of the Coca Cola No Sugar brand. Its Indonesian business also achieved high single-digit revenue and volume growth against the backdrop of a muted demand environment.

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