Have All-Weather Stocks Lost Their Appeal?

This story features CSL LIMITED, and other companies. For more info SHARE ANALYSIS: CSL

In this week's Weekly Insights:

– Have All-Weather Stocks Lost Their Appeal?
– Australia's Perfect Track Record In Danger
– Buffett-Mania Hits Australian Stock Market
– Resources: China Stimulus To The Rescue?
– Rudi On TV
– Rudi On Tour

Have All-Weather Stocks Lost Their Appeal?

By Rudi Filapek-Vandyck, Editor FNArena

Up one day. Down the next. And it doesn't necessarily matter what happens overseas.

I have little doubt that I am expressing many an investors' perception in that the Australian share market seems to have become a lot less consistent, predictable or reliable this month.

It is yet again a stark reminder that when push comes to shove, Australia is but a small particle in the menacing jungle that is global finance.

In other words: when the elephants roam and decide to change direction, their dust will cover and obscure just about anything locally.

Apparently, Australian shares have now become direct beneficiaries from the free money endeavour otherwise known as the Chinese stock market with large international investors playing the theme by going long China and short Australia, a strategy that has reaped many rewards in recent months, until last week when Chinese equities reversed course.

We still have six sessions left before the end of the month, which closes off the financial year locally, so don't be surprised to see more of the same, this time with active participation from local fundies squaring up their books, positions and achieved return.

On my own observation, it appears intra-day volatility has increased noticeably this month. A large cap stock can be down 1% one moment and up 1% the next, without any event or news explaining the turnaround. Many small cap stocks, traditionally the ideal place to seek and find volatility, have acted in a more benign matter this month, often against the large cap trend.

When elephants roam.

All-Weather Stocks Not Unaffected

Sometimes risk hides in places you least expect.

An intelligent market observer once said: from the moment you think you've found the key to financial markets, someone will sneek in at night and change the lock. There's a lot of wisdom embedded in that saying. It means nothing works the same all the time.

One of the stand-out observations from the past weeks is that former darlings, among which are many All-Weather Performers, have lost their traditional safe haven reflex during times of duress.

Think of CSL ((CSL)), and of Ramsay Healthcare ((RHC)), while times have been particularly hard for REA Group ((REA)), OzForex ((OFX)) and G8 Education ((GEM)).

Before I delve into some of the company specific reasons behind these share price falls, it is worth noting many of the popular, high multiple growth stocks have been among the chief beneficiaries of falling bond yields. Hence, when investors start preparing for higher bond yields, the super-high PE ratios contract and this causes share price weakness.

Because there is no dividend support (high PEs keep the yield benign), this PE correction can easily transcend into something much worse. In fact, this is what I think has happened in a select number of cases:

– PE correction pushes the share price to a lower level
– the reversal in momentum forms a bearish pattern on price charts
– technical traders spot sell-signals and jump on board the negative trend
– share price ends up a lot lower and now attracts a cautious, if not negative view from market observers
– investors are being kept at bay by "what if" considerations

The above scenario has created significant gaps between views based upon fundamental analysis and share prices that have simply kept on weakening. Take REA Group, for example. At $50 per share the forward looking Price Earnings (PE) ratio was in the mid-30s. Many an analyst suggested the share price should find its way to the mid-$50s, but instead REA shares fell to $40 and then kept on falling. They have traded briefly below $38.

Add one competitor (Fairfax's Domain) who has been making a lot of noise recently plus some below expectation numbers from the company itself as the property boom in Sydney is working against listings on the REA platform, and all of a sudden there's a lot of doubt and a very unattractive looking share price trend. Meanwhile, the many parrots on the sidelines keep repeating the PE looks too high.

Yet, on my observation, not a day goes by without a fund manager or fundamental analyst reiterating their view that, at present price, REA Group shares seem undervalued. Consensus continues to expect 20%-odd growth numbers from the company over the next 3-5 years.

Looking forward into FY16, REA Group's PE has now fallen to 21, which is below the 22% anticipated growth in earnings per share for the company. Admittedly, given ongoing boom-conditions in Sydney property markets, it is well possible there is more room for below expectations growth in the short term, which could translate into further "told you so" comments from the sidelines. But unless all those fund managers and fundamental analysts are being blinded, this remains one of few large cap stories on the Australian share market that is poised to (more than) double its earnings per share by 2020.

Clearly, something has to give, at some stage.

All-Weather Stocks Not Immune

In line with my previous writings on this subject, All-Weather Stocks are by no means 100% immune from specific share market shenanigans or even from operational challenges.

Most of these companies enjoy favourable longer-term market dynamics, often accompanied by robust barriers and moats, which means management teams at these companies have a far easier job to deliver consistent growth and rewards for shareholders.

This makes owning All-Weather Performers a more secure, less risky proposition. There is less risk the company has to issue a profit warning, which is as good as it gets in an overall environment of subdued and challenged growth conditions locally.

But nothing ever stays the same and investors should keep an eye out for any signs that market circumstances are changing irreversibly to the disadvantage of the incumbent. We've all witnessed the turnaround in fortune for Monadelphous ((MND)) and for Coca-Cola Amatil ((CCL)), once upon a time proud members of the All-Weather Performers family. The same can be said of Reckon ((RKN)).

In recent times operational imperfections at Woolworths ((WOW)) are receiving a lot of attention from mass media and the share price is finding it difficult to stay above $27 (for a company whose shares were trading well into the $30s for a long time). I wrote an in-depth story on the challenges at Woolworths in March, see https://www.fnarena.com/index4.cfm?type=dsp_news_weekly&wid=1780.

The underlying story still hasn't changed: world record beating profit margins in a market that is no longer operating in Woolworth's favour. What has changed is that catching up with the competition might remain an illusion under the current "lame duck" CEO, while his successor is likely to dump a lot of bad news into the market upon arrival. Write-offs. Lay-offs. A potential closure of the Masters' "experiment" (with even more impairment costs at first). More investments. Lower profits. It should all be expected.

On my observation: many an analyst covering the company has now penciled in last year's dividend payout (137c) indefinitely. But one can tell from current consensus estimates, quite a number of analysts believe dividend cuts are now a genuine possibility.

There is one potential upside I haven't seen popping up just yet, which is that at some point, one assumes, either private equity or a foreign competitor might become interested. It's what has happened to Coles and to David Jones. There is no reason why it cannot happen if Woolworths' shares continue weakening (the PE of 14.2 is not that attractive if one considers profits are likely to fall next year, automatically implying the real PE is higher).

Who's Next?

The demise of Coca-Cola Amatil and of Woolworths raises a number of important questions for investors. What are the chances other All-Weather Performers will be next?

On Monday, Seek ((SEK)), long seen as infallible together with REA Group and Carsales ((CAR)), issued a profit warning and investors were not pleased. The news follows on from an already disappointing interim update in February and cements a side-ways share price channel since early 2014.

Carsales and REA Group also have lost their upward momentum since late 2013, while the same can be said of smaller peers such as iProperty ((IPP), despite the latter announcing positive news to the market last week.

Clearly, the online media sector has left behind the era of easy growth and the future looks less certain, with more dangers and threats, and possibly more vulnerability too. Some analysts have started to question whether there is actually still a "moat" in place? It's now up to the management teams to convince investors they are being too cautious. August might shape up as an important inflection point for the sector.

Other All-Weather Performers that currently seem to have lost their mojo include Greencross (competition concerns plus recent growth headwinds), G8 Education (competition concerns plus recent growth headwinds plus serious doubts about longer-term merits of the acquisition based business model), as well as Wesfarmers ((WES)) in recent weeks. The latter has now become the standout in an otherwise liquor and grocery supermarket sector in turmoil. Surely the question hanging over the business is how long before contagion kicks in?

Offsetting these observations is that many of the companies mentioned in my previous updates have continued to reward shareholders with above market gains, including Ansell ((ANN)), ARB Corp ((ARB)), Domino's Pizza ((DMP)), Hansen Technologies ((HSN)), Orora ((ORA)) and Technology One ((TNE)). Blackmores ((BKL)) shares are up 122% since January.

In addition, a number of recent IPOs that were also mentioned in the December update on All-Weather Performers have posted double-digit gains since, though, admittedly, their risk profile is higher because of smaller market capitalisation and a brief track record only.

Bottom Line

Many of the All-Weather Performers had become part of the maligned "crowded trades" in the Australian share market. Large professional investors pulling back from such positions has had a visible impact, in particular for larger market cap stocks such as in the healthcare sector. Nevertheless, it cannot be denied some segments of high multiple stocks have lost their "security premium" and it'll be up to management's ability to show strong growth and sufficient comfort in August to retain/regain investors' confidence.

Meanwhile, mum-and-dad investor staples, such as Coca-Cola Amatil, Woolworths and Wesfarmers, now have enough question marks hovering above their headquarters to warrant a de-rating.

Many of recent IPOs with All-Weather potential have shown resilience, promise and good share market returns in their first year as an ASX-listed entity.

The key question investors need to ask amidst short-term disruptions taking place in the share market this month, is whether the future growth profile of popular, resilient and exceptional businesses a la CSL, Ramsay Healthcare, ARB Corp, Ansell and others, is about to fundamentally change. If not, I suggest these companies still deserve their place as part of the backbone in every long term investment portfolio.

The upcoming reporting season in August is once again going to reveal how difficult it is for Australian companies to grow profits, let alone to grow profits in a reliable and consistent manner. While it is true that genuine question marks have now appeared on the horizon for many of the outperformers of recent years, and recent disappointments from Woolworths and Seek prove investors should never shy away from asking the hard questions, but I still remain of the view the underlying thesis for the majority of All-Weather Performers remains intact.

At some point, these stocks will re-establish themselves as safer, go-to stocks in a tough environment, at least the majority of them. Whereas some investors are turning more optimistic on the prospects for cyclical growth stocks, including miners and explorers, for the financial year ahead, the departure of these investors from "crowded trades" is opening up opportunities for investors who have been waiting to snap up several of the superior growth profiles in the Australian share market, if only they wouldn't look so expensive!

Alas, for some companies the future and risk profile have changed over the year past. For many others, however, that what made them attractive in the past will make them attractive again.

Paying subscribers have access to eBooklets on All-Weather Performers, as well as a regularly updated share price overview (next update next week, post June 30th). Send email requests to info@fnarena.com

Australia's Perfect Track Record In Danger

Last week I attended a panel discussion between industry heavyweights Geoff Wilson, Anton Tagliaferro and Ben Griffiths, moderated by Matthew Kidman. For those who'd like to relive the experience, I have included a link below.

The event was organised by Livewire, which is without doubt one of the exciting new startups that is enriching the local finance sector. I have been a contributor to the platform for more than a year now and can recommend investors looking for news and insights should check it out (www.livewiremarkets.com).

During the panel discussion, Kidman made an interesting observation in that it had as yet never happened in Australia that a high point in the index was not beaten inside the subsequent 10 year period. If history is going to stick to its track record, this implies the local share market has some territory to make up for in the next 2.5 years.

Forget about dividend yields and franking, this track record is all about index appreciation. There's still some 20% that needs to be accounted for, which is by no means impossible, but is it plausible?

One thing is for sure, setting a new record high before November 2017 is going to require a lot more oomph from local shares than what we have witnessed in years past. There are no guarantees either as both US equities and Japan already experienced their "lost decades".

So is this the one decade wherein Australia will lose its perfect track record?

The link to the video: https://www.livewiremarkets.com/wires/27618

Buffett-Mania Hits Australian Stock Market

Warren Buffett has signed a major deal with Insurance Group Australia ((IAG)). Unless you've been living under a rock this month, you'd be well aware of the event.

But is it worth all the excitement and efforts to elevate IAG above the rest of its peers, if not above the rest of the Australian share market?

The way I see it is that Warren Buffett, the business man, has done a smart deal with IAG, using his status as an important tool for leverage. And I have yet to see the first commentary that suggests the outcome is not very favourable to Warren Buffett's Berkshire Hathaway.

But does this mean we all have to start buying shares in IAG?

Observation: while most stockbroking analysts fully agree the deal looks highly attractive for Berkshire Hathaway, they have more doubts and in some cases, serious doubts, whether IAG shareholders will end up better off too.

Short term, Buffett-mania accompanied by the prospect for capital management/higher dividends should support the IAG share price, but fact still remains the insurance cycle has turned and IAG operationally is battling serious headwinds to lift its profits in a meaningful way. It's not going to happen in fiscal 2015 and as far as consensus projections are concerned, FY16 is not looking flash either.

I'd be taking my guidance from the operational context rather than from a deal of which I know the other side is going to reap many benefits from it.

Resources: China Stimulus To The Rescue?

Last week I suggested most investors would be better off ignoring cheap valuations for resources stocks as both iron ore and crude oil prices looked to be rolling over, while the outlook for many industrial metals remains uncertain in the short term at least.

The team of commodity analysts at ANZ Bank backed this view (at least 50% of it) on Monday when they issued a short term trading idea, suggesting spot iron ore is poised to revisit US$53/tonne in the weeks ahead, from US$60+ last week. (The suggestion here is to go short and benefit from the reversal in price momentum).

But analysts at stockbroker Morgans are prepared to back the possibility that Chinese stimulus is forthcoming and it will be larger and more powerful than the market is willing to contemplate today. Essentially, the underlying premise here is that stimulation through softly-softly policy measures hasn't worked well, and it won't generate the desired returns. Hence the need for yet another larger-than-expected stimulus program.

According to information, Morgans stockbrokers have been discussing a report by CIMB analyst Arup Raha during their pre-market meeting on Monday morning. This report is probably best summarised by its final conclusion:

"There are many moving parts in the global economy given uncertainty over growth, policy rates, currencies and even the future of the Eurozone. It is a time to move with care but, in these trying times, it looks possible that China may just be getting ready to throw one more old-fashioned party, one with stimulus and rising investment and commodity prices."

Rudi On TV

– on Wednesday, Sky Business, 5.30-6pm, Market Moves
– on Thursday, Sky Business, noon-12.45pm, Lunch Money
– on Friday, Sky Business, 8-9pm, Your Money, Your Call – Bonds vs Equities

Rudi On Tour

I have accepted invitations to present:

– July 2, Invast, Sydney Clients and Contacts evening meeting
– August 2-5, AIA National Conference, Surfers Paradise Marriott Resort and Spa, Queensland – for more information about this event:

http://www.investors.asn.au/events/events-schedule/aia-national-investors-conference/

Note: FNArena subscribers can attend at similar discount as AIA members

(This story was written on Monday, 22 June 2015. 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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THE AUD AND THE AUSTRALIAN SHARE MARKET

This eBooklet published in July 2013 forms part of FNArena's bonus package for a paid subscription (excluding one month subscriptions).

My previous eBooklet (see below) is also still included.

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MAKE RISK YOUR FRIEND – ALL-WEATHER PERFORMERS

Odd as it may seem, but today's share market is NOT only about dividend yield. Post-2008, less risky, reliable performers among industrials have significantly outperformed and my market research over the past six years has been focused on identifying which stocks, and why, are part of the chosen few; the All-Weather Performers.

The original eBooklet was released in early 2013, followed by a more recent general update in December 2014.

Making Risk Your Friend. Finding All-Weather Performers, in both eBooklet versions, is included in FNArena's free bonus package for a paid subscription (excluding one month subscription).

If you haven't received your copy as yet, send an email to info@fnarena.com

For paying subscribers only: we have an excel sheet overview with share price as at the end of May available. Just send an email to the address above if you are interested.

Click to view our Glossary of Financial Terms