Risk Is Not A Four Letter Word

This story features ESTIA HEALTH LIMITED, and other companies. For more info SHARE ANALYSIS: EHE

 In this week's Weekly Analysis:

– Risk Is Not A Four Letter Word
– Flight Centre: All About The Margin
– Livewire – The Event, The Replay
– June Conviction Calls
– Rudi On Tour
– Nothing Ever Changes, Or Does It?
– No Queen's Holiday Edition 
– Rudi On TV

Risk Is Not A Four Letter Word

By Rudi Filapek-Vandyck, Editor FNArena

"The longer the global economy remains in the low-growth trap, the more difficult it will be to break the negative feedback loops, revive market forces and boost economies to the high growth path".
[OECD chief economist Catherine Mann in semi-annual report, released last week]

Two events last week showed investors risk is very much omnipresent in today's share market, even though it doesn't exactly look like it when money from the sidelines is flowing back in.

First we saw a sudden and sharp sell-off in aged care stocks after Ben Griffith from fund manager Eley Griffiths announced he'd had sold out of the sector in anticipation of tougher times ahead. Then Bank of America-Merrill Lynch issued a report that essentially declared the sector is about to turn ex-growth on the back of the Federal government changing co-payment rules, stating the rest of the market has been caught napping.

After Australian investors had gone into weekend mode, battling torrents of rain and stormy gusts of winds, followed up by king tides on the Eastern coast line, US investors witnessed an update on their labour market not even the most bearish bears had thought possible.

The aged care issue is typical for increased sector specific risk. Friday's shocker of non-farm payrolls update showed FOMC conviction and market consensus remain but fragile houses of cards in a global landscape that is impacted by more changes than anyone among us can keep track of.

Let's tackle aged care and sector risk first.

More Government, More Risk

In case you missed it, or aged care is not really your thing, analysts at BA-ML have declared Estia Health ((EHE)), Japara Healthcare ((JHC)) and Regis Healthcare ((REG)) "ex-growth" for the next three years as the Federal government looks to rein in spending, which means less subsidies and a more stringent approach to what services should apply and who should be eligible.

For a sector that is on a rough estimate 70% subsidised and operating on cost levels well above many unlisted peers, such change of heart can be nothing but devastating. Share prices had already been de-rated from the moment this government started flagging its intentions, after a substantial re-rating in 2015 when Eley Griffith too was on board, but nobody was prepared for the content and predictions made in the BA-ML report.

Not everybody agrees with BA-ML's dour assessment. CLSA analysts essentially called it BS on Friday and analysts at UBS and Morgans seem to agree with CLSA rather than with BA-ML.

Nobody is contesting the fact more government savings will impact on the industry's profitability, but there are offsets through higher service fees and an increase in accommodation charges. Also, analysts point out the sector is seeking independent appraisal of proposed changes and the expectation is that if the overall impact turns out too much, there will be negotiations between the government and the sector.

After all, both share a common interest in that these services need to be provided, and the sector needs to expand in the decade ahead, and both see the importance of a profitable and motivated set of operators.

The bottom line from all of the above is not whether CLSA is right, or BA-ML, or none of the calculations published to date, but that in a world wherein most governments are facing budget deficits, sluggish growth, older populations and a plethora of other challenges, the risk for a negative impact through changes in rules or government spending is increasing exponentially.

And it applies specifically to healthcare services, one of the key stress fractures for government spending caused by older populations, medical break-throughs and continuously rising costs.

Pathology providers Sonic Healthcare ((SHL)) and Primary Healthcare ((PRY)) equally had been impacted earlier, as has been the case for Ramsay Healthcare ((RHC)) in France. Already analysts have been speculating whether health insurers might face government scrutiny next as their profitability is running rampant this year, as shown in the share price performances for Nib Holdings ((NHF)) and Medibank Private ((MPL)).

This might be as good as any time to point out IVF providers, including Monash IVF Group ((MVF)) and Virtus Health ((VRT)), are equally big beneficiaries from government subsidies amidst increasing awareness/complaints their business practices are not always of the highest ethical standard. See also a highly critical Four Corners dissection of the industry in Australia a few weeks ago.

Tectonic Mega Changes

Not that long ago, Flexigroup ((FXL)) shares were trading at $3.60. Today they're exchanging hands for less than $2.00. Equally, OzForex ((OFX)) shares surpassed $3.40 in late December. Today they trade a little above $2.10. Super Retail ((SUL)) shares entered the new calendar year trading near $11.50. They're below $9.00 now.

Each year, more than 40% of companies fail to achieve their own forecasts, let alone what the market has penciled in. But investors would be well aware of the risks that come with running a company in an ever changing, competitive landscape. As the end of fiscal 2016 is approaching, we have already witnessed profit downgrades by Sirtex Medical ((SRX)), Flight Centre ((FLT)), Cardno ((CDD)) and others, as is to be expected this time of year.

Given the market's dividend pay-out ratio has been steadily increasing post-GFC, often at a faster rate than profits or cash flows, investors must now also take into account the possibility of dividend cuts. Resources stocks already have been forced to take tough medicine, now the focus will increasingly turn to financials and to industrials, in particular to those whose balance sheet and profitability have been weakened.

Woolworths ((WOW)) is going to pay out less to shareholders this year, but will the same also apply to Wesfarmers ((WES))? ANZ Bank ((ANZ)) cut its dividend and re-aligned the pay-out ratio lower while re-calibrating its strategy in Asia, will National Australia Bank ((NAB)) follow next? Does negative growth also imply a dividend cut for Flight Centre shareholders? No more special dividend from Suncorp ((SUN))?

These are all important considerations, but arguably predominantly short-term complications. Of greater importance are the tectonic shifts on macro-level that are re-shaping the future and therefore market dynamics and the outlook for sectors and individual companies. Older demographics. Lower for longer interest rates, bond yields, inflation, productivity and economic growth. The disappearance of natural competition barriers. The emergence of new technologies and in their wake, new business models and new competition for incumbents. Greater scrutiny by governments and regulatory bodies.

Arguably, these tectonic shifts have already been felt through a noticeable underperformance for the ASX20 in Australia over the past two years; this despite the inclusion of CSL ((CSL)), Brambles ((BXB)) and Transurban ((TCL)) which have been stark outperformers. The reason as to why investors do not hear or read more about all this is because members of the boards for these listed companies do not yet have any answers, and they don't like to spread panic and uncertainty while they are trying to do something about it.

For you as an investor, however, these factors should be front of mind because they are impacting on your portfolio today and poised to impact even more in the year(s) ahead.

Banks Cannot Be Arrogant

Let's be honest about this, banks have not performed in line with expectations these past few years. CommBank ((CBA)) shares, for example, are to date still down more than 11% since January 1st.

While most investors, and their advisors, remain pretty sanguine about the sustainability of the dividends on offer, completely risk-free they are not. Last week, the OECD issued a stern warning about the glut that seems to be on the horizon for apartments in Australia.

They are far from the only ones. Australia's seemingly invincible financial sector might be put to the test next year if forecasts prove correct and too much supply might trigger a price correction in a market that has been running hot on the back of Chinese buyers and low interest rates.

Lend Lease ((LLC)) is significantly exposed too.

Political risk is always a potential threat for the banks, but arguably here too the stakes are getting higher, and riskier. Opposition party Labor still wants a Royal Commission to weed out the bad apples in the industry and to force the sector into a more client-friendly attitude. The Greens intend to write in law that vertical integration, whereby banks also own wealth managers, insurers, et cetera, is no longer allowed.

The latest hype in the sector, Fintech, has thus far proved more promise than actual delivery, no doubt to much relief of managements and board members at the Big Four, but the big picture threat from new tech developments remains, and it is real. Commonwealth Bank chief executive Ian Narev in a speech to The Centre for Independent Studies last week declared "If we don't innovate successfully we're toast".

Narev: "And you can just look around and all sorts of parts of the industries that we're in — whether it is lending or payment systems — you can just see that the legacy business model is not going to work. It's actually got to evolve."

Incidentally, ASIC is currently reviewing Finance & Insurance (F&I) practices in Australia's automotive sector which can potentially re-shape the industry.

Change Is Already Here

The industry that is without a single grain of doubt most impacted from shifting tectonics is the energy sector. Long gone are the days of "peak oil", as in: not enough supply to feed the ever-growing global demand. Instead we now have the threat of "peak oil demand" and don't the Saudis know it!

If current forecasts by techno-optimists prove correct, and their numbers are growing by the day, we'll all be buying solar panels for our roofs and storing power on our premises in the not-so-distant future. Motorbikes and automobiles will go full electrical and they won't need a driver.

Crazy stuff right? Some futurologists dare to predict, with conviction, that all of this will become reality by 2020. That's less than five years away. By 2025 the world has potentially made up its mind in favour of green, sustainable, sharing and cheap.

Think about the changes that are forthcoming for owners of vast infrastructure networks that are about to become a lot less valuable: Origin Energy ((ORG)) and AGL Energy ((AGL)). If the Saudis are concerned about stranded assets in the form of crude oil reserves in the ground, what about coal reserves owned by BHP Billiton ((BHP)), Rio Tinto ((RIO)) and South32 ((S32))?

What exactly is a rapid adoption of electric vehicles going to do to business models for leasing cars, insurers, public transport, cabs, shopping malls and the second derivative services industry?

Below are a few thoughts/predictions from US-based Robert Goldman; one could describe him as a futurologist:

– In 2018 the first self-driving cars will appear for the public. Around 2020, the complete industry will start to be disrupted. You don't want to own a car anymore. You will call a car with your phone, it will show up at your location and drive you to your destination. You will not need to park it, you only pay for the driven distance and can be productive while driving.

Our kids will never get a driver's license and will never own a car. It will change the cities, because we will need 90-95% fewer cars for that. We can transform former parking space into parks. 1.2 million people die each year in car accidents worldwide. We now have one accident every 100,000 km, with autonomous driving that will drop to one accident in 10 million km. That will save a million lives each year.

– Electric cars won’t become mainstream until 2020. Cities will be less noisy because all cars will run on electric. Electricity will become incredibly cheap and clean: Solar production has been on an exponential curve for 30 years, but you can only now see the impact. Last year, more solar energy was installed worldwide than fossil. The price for solar will drop so much that all coal companies will be out of business by 2025.

– There will be companies that will build a medical device (called the "Tricorder" from Star Trek) that works with your phone, which takes your retina scan, your blood sample and you breathe into it. It then analyses 54 biomarkers that will identify nearly any disease. It will be cheap, so in a few years everyone on this planet will have access to world class medicine, nearly for free.

– The price of the cheapest 3D printer came down from US$18,000 to US$400 within 10 years. In the same time, it became 100 times faster. All major shoe companies started 3D printing shoes. Spare airplane parts are already 3D printed in remote airports. The space station now has a printer that eliminates the need for the large number of spare parts they used to have in the past.

At the end of this year, new smart phones will have 3D scanning possibilities. You can then 3D scan your feet and print your perfect shoe at home. In China, they already 3D printed a complete 6-storey office building. By 2027, 10% of everything that's being produced will be 3D printed.

– There will be a US$100 agricultural robot in the future. Farmers in 3rd world countries can then become managers of their field instead of working all days on their fields. Agroponics will need much less water. The first Petri dish produced veal is now available and will be cheaper than cow-produced veal in 2018. Right now, 30% of all agricultural surfaces is used for cows. Imagine if we don't need that space anymore.

There are several startups that will bring insect protein to the market shortly. It contains more protein than meat. It will be labeled as "alternative protein source" (because most people still reject the idea of eating insects).

And so forth, and so forth.

You and I know the trouble with most predictions is they tend to be incorrect from the moment they are made public. But there's a deeper message in all of this: change is coming. It'll be fast, disruptive and irreversible. At the very least investors should be cognisant and aware of this. Set & forget looks so eigthies and nineties!

No Relief From The Macro

Not making matters any easier is that we are truly witnessing extraordinary times in terms of low global growth, social polarisation, all-time low interest rates and bond yields, and extreme interventions and stimulus from central bankers. And the scenario to get us back to "normal", if it ever were to truly happen, is being re-written every other week or so.

The Federal Reserve wants us to believe that interest rate hikes are imminent, but the US bond market is suggesting otherwise. Let's face it, it took Janet Yellen & Co an excruciating long time before hike number one finally got on the board. We're still stuck at that same number one. Do we really believe the FOMC's rhetoric that no less than three hikes remain possible this year?

Yet, bond yields in the US and the direction for the US dollar are of key importance for the direction and outlook for global risk assets. Not to mention monetary policy decisions at the Reserve Bank of Australia.

Probably a fair bet the RBA might be "forced" into making additional cash rate cuts in the months ahead.

Meanwhile, while international attention is drawn to the British vote whether to stay united with the European Union, or not, bond experts continue to watch Japan for what could possibly be the next phase of extreme central bank policy. If Yellen & Co cannot move from their moribund state of indecision than surely the Japanese will not sit idle and allow their expensive currency to thrash what is left of positive momentum in the economy?

Another left-field event might be Saudi-Arabia abandoning the USD-peg as crude oil below US$50/bbl is not nearly high enough to solve all problems for the anxious Kingdom.

Neither of such events is likely to turn out positive for risk assets, but it is near impossible to insulate one's portfolio, let alone predict timing and exact impact.

I think the key for investors here is to not allow one single scenario to either make or break the prospective investment return for the year ahead. Investing is no longer simply picking the correct trend, or making the right call and let your winners run.

It's now about making certain that when you are wrong, and you will be at variable stages, you're not losing your trousers, and your shirt, and your socks and shoes too.

It's about deciding the level and the type of risk you feel comfortable with.

Flight Centre: All About The Margin

Those were the days! I am sure many viewers will concur, the broadcasts of Your Money, Your Call Equities on Sky Business when guests were raising voices and rolling over each other (not in a physical sense) to defend their point of view on wounded retailer and supermarket operator Woolworths ((WOW)) made for some compelling Finance TV moments.

In the end, the "nahs" won from the "yeahs" and the share price tanked to just above $20 where it has been languishing for a while now. All that wasn't even that long ago.

The "secret", so to speak, was embedded in that exorbitantly high profit margin at Woolworths' supermarkets. Those who held on to the past, or to the fact that groceries are considered "stable and defensive" have been proved wrong. Those who saw the margin, the threats, and then concluded there's only one direction for those margins have been proved correct.

A similar situation seems to be in play at Flight Centre, former market darling and vanguard of new technology and adaptations in the global tourism sector, but after three profit warnings in less than two years investors are asking the obvious question: Woolworths II?

Over the past 2.5 years, Flight Centre shares have traded as high as $54.78, but mostly they've visited, and re-visited, the mid & high $40s, and sunk as deeply as the low $30s. Now they're back at $31-something and questions are being raised about the sustainability of margins from the past.

The contrast with competitors like Corporate Travel ((CTD)) and Webjet ((WEB)) is stark, as one glance at their share price performance will tell anyone. Management at Flight Centre has conceded pure online players have been taking market share. Changing industry dynamics are having an impact too. Flight Centre sales are now spread over more carriers, meaning less chance for high volume bonuses and discounts, meaning downward pressure on margin.

The key difference here is that global travel is still expanding, and there should be plenty of acquisition opportunities across the globe, so righting the ship at Flight Centre arguably seems an easier task than what new management at Woolworths is facing, but, regardless, investors on board Flight Centre might have to be equally patient, and cop a lot of volatility in the meantime.

Trading on a Price-Earnings (PE) ratio of 12-something and offering near 5% yield, the shares don't look expensive, but that's because analysts have now declared the company ex-growth, as can be seen via Stock Analysis on the FNArena website.

Livewire – The Event, The Replay

If you aren't as yet familiar with Livewire (www.livewiremarkets.com) you might be missing out on what is arguably one of the most exciting new developments in Australia's Finance sector. It's a social media platform where professionals, big and small, exchange views and ideas and investors, like you, can read up and access it all at no cost.

You need to register first though, which is also required to access the video replays of four forums from the annual Livewire event, bringing together various high profile names from the local industry to talk shop and tips and outlooks and views on subjects such as the local share market and emerging, new technologies.

Warning up front: these video replays last about 45 minutes each. To access: http://live.livewiremarkets.com/

June Conviction Calls

Market strategists at stockbroker Morgans believe macro concerns are a little over-hyped. They see a lot of good things happening in corporate earnings and ultimately this is what is going to drive the local share market higher.

Morgans is not a big fan of portfolios built around legacy blue chips, pointing out earnings growth momentum is by no means equally divided in today's market. Investors must be picky and choosy instead.

Enter Morgans' list of Conviction Buys. New inclusions CYBG plc ((CYB)), Bellamy's ((BAL)) and Kina Securities ((KSL)) have joined re-rating NextDC ((NXT)) and GBST ((GBT)) on the list that further contains Westpac ((WBC)), Orora ((ORA)), Sydney Airport ((SYD)), APN Outdoor ((APO)), Corporate Travel ((CTD)), IPH Ltd ((IPH)), RCG Corp ((RCG)) and Vitaco ((VIT)).

AMP ((AMP)) has been removed from the list.

Rudi On Tour

I will be presenting:

– To Melbourne chapter of the Australian Shareholders' Association (ASA) on 6 July

– To a Selected Group of FNArena Subscribers, "An Evening With Rudi", in Melbourne, 6 July (sold out)

– To Gold Coast chapter of Australian Shareholders' Association (ASA) on Tuesday 12th  July at Robina Community Centre, commencing at 9:30am

– To Brisbane chapter of Australian Shareholders' Association (ASA)  on Wednesday 13th July  at the Wesley House, 140 Ann St, Brisbane, commencing at 11:00am

– At the Australian Investors' Association's (AIA) National Conference in August on Queensland's Gold Coast.

– To Chatswood chapter of Australian Investors' Association (AIA) on September 7, 7pm, Chatswood RSL

Nothing Ever Changes, Or Does It?

Yes, of course, investing in the share market is never really different and best working strategies today are the same that worked pre-GFC. Seriously. I tell you, seriously.

Now that we had a good laugh about it, let's get straight to business. This is a low growth environment. Has been since 2010 (it was masked at the time because of the V-shaped recovery from the global recession) and it is not likely to change fundamentally in the near term. I wrote a book about this (see below). This means investment strategies must adapt. You'll be turning your portfolio into a wish list for dinosaurs otherwise (and your returns will be a reflection of it).

Those not afraid to contemplate "this time is different" can subscribe to FNArena and read all about it in our bonus eBooklets 'Make Risk Your Friend' (free with a paid 6 or 12 months subscription) plus the freshly published eBook 'Change. Investing in a low growth world' (equally free with subscription, or available through Amazon and other online distributors).

Here's the link to Amazon: http://www.amazon.com/Change-Investing-Low-Growth-World-ebook/dp/B0196NL3KW/ref=sr_1_1?s=digital-text&ie=UTF8&qid=1454908593&sr=1-1&keywords=change.investing+in+a+low+growth+world

See also further below.

No Queen's Holiday Edition

There will be no Weekly Insights next week due to Queen's Birthday celebrations which is a public holiday for most Australians. My apologies to readers in Western Australia and in Queensland, but I intend to join all other Australians and allow myself a day off.

Rudi On TV

– On Tuesday, around 11.15am, on Sky Business, I shall make a brief appearance through Skype-link to discuss broker ratings for less than ten minutes
– I will be appearing as guest on Sky Business, 12.30-2.30pm, on Thursday
– On Friday, around 11.05am, on Sky Business, I shall make a brief appearance through Skype-link to discuss broker ratings for less than ten minutes

(This story was written on Monday 6th June 2016. It was published on the day in the form of an email to paying subscribers at FNArena).

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena's – see disclaimer on the website.

In addition, since FNArena runs a Model Portfolio based upon my research on All-Weather Performers it is more than likely that stocks mentioned are included in this Model Portfolio. For all questions about this: info@fnarena.com or via Editor Direct on the website).

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BONUS PUBLICATIONS FOR FNARENA SUBSCRIBERS

Paid subscribers to FNArena receive several bonus publications, at no extra cost, including:

– The AUD and the Australian Share Market (which stocks benefit from a weaker AUD, and which ones don't?)
– Make Risk Your Friend. Finding All-Weather Performers, January 2013 (The rationale behind investing in stocks that perform irrespective of the overall investment climate)
– Make Risk Your Friend. Finding All-Weather Performers, December 2014 (The follow-up that accounts for an ever changing world and updated stock selection)
– Change. Investing in a Low Growth World. eBook that sells through Amazon and other channels. Tackles the main issues impacting on investment strategies today and the world of tomorrow. This book should transform your views and your investment strategies. Can you afford not to read it?

Subscriptions cost $380 for twelve months or $210 for six and can be purchased here (depending on your status, a subscription to FNArena might be tax deductible): https://www.fnarena.com/index2.cfm?type=dsp_signup

FNArena has reformatted its monthly price tracker file for All-Weather Performers. Last updated until May 31st. Paying subscribers can request a copy at info@fnarena.com 

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