Rudi’s View: What’s Wrong With CSL?

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

Dear time-poor investor: the debate continues about what to expect from economies and equities in the year(s) ahead, plus a glimpse into the headwinds affecting the CSL share price

In Part One of this week’s Weekly Insights:

-What’s Wrong With CSL?
-T.RowePrice: Market Optimism Is Deceiving
-Corporate Debt: New Records
-Conviction Calls

What’s Wrong With CSL?

Seldom have we seen such a lacklustre share price performance from all-around star stock CSL ((CSL)) when regular defensives including Woolworths ((WOW)), Coles ((COL)) and ResMed ((RMD)) are putting in a stellar performance.

The question is on many investors’ lips these days: what is wrong with CSL?

The answer, it seems, is two-fold. On the one hand investors now realise the virus and related lockdowns are impacting on plasma collection, in particular in the south of the USA where infection numbers are thriving (so to speak).

The offsetting factor is that a higher US unemployment rate, equally a result of the pandemic, should translate into more donors, which should boost CSL’s collection abilities.

The company is offering higher incentives to US donors to compensate for the temporary interruption, and this will put pressure on its margin.

The public debate that is currently raging behind the scenes is whether one cancels out the other, or whether we are witnessing a sequence of events, i.e. first comes the dip, then to be followed by a firm boost.

Further complicating the debate is that global demand for CSL’s flu vaccines remains robust, suggesting potential for an upward surprise.

Then there is the other matter of growing potential for increased competition with a number of biotech firms across the globe successfully trialing potential future treatments that, if successful, will eat into CSL’s core products and markets.

It is this potential future competitive threat that is possibly weighing most on the share price post-April.

Keen observers will have noticed CSL is not acting like the proverbial sitting duck, keeping the fingers crossed and hoping for the best. The company announced two acquisitions already with the latest, a gene therapy product for haemophilia B, (more) tangible proof the company is not afraid to potentially disrupt itself, according to commentary by various analysts post the announcement.

Of course, one of the major attractions for owning CSL shares is the in-house pipeline of future products under development. Here the company should have a few announcements to make in 2021.

Put it all together and the correct conclusion is probably that the market genuinely doesn’t know what to do with CSL shares at the moment.

A dilemma that is further complicated by diverging views on the direction of the US dollar, a key component for translating CSL’s profits for shareholders in Australia.

One observation stands irregardless* and that is I have seldom spotted so many professional investors declaring they are buying CSL shares with a longer-term view in mind.

From Roger Montgomery, to T.RowePrice, to UBS, and numerous others; they all declared recently they have been buying as CSL shares continue to lag the overall market, instead bobbing around the $280 level – quite the distance from the $341 seen earlier in the year.

Anyone can draw his/her own conclusions from this apparent discrepancy.

*Irregardless was recently added to the Merriam Webster dictionary, causing public uproar among those aficionados of the English language who believe just because words creep into the daily usage it doesn’t mean they should thus be officially recognised.

Irregardless looks like a merger between irrespective and regardless and, apparently, Maria Carey sang the word on her 2018 album.

In case anyone wondered: irregardless had already been recognised by the Oxford English Dictionary, and it means exactly the same as regardless.

T.RowePrice: Market Optimism Is Deceiving

Global asset manager T.RowePrice organised a webinar with Head of Australian equities, Randal Jenneke for global media last week.

Conclusion number one put forward was that investors have been too optimistic in pricing in a swift V-shaped recovery in global equity markets.

No surprise thus, Jenneke’s Australian asset allocation has been directed towards a more defensive bias with “quality” and “durable profits” high on the agenda.

T.RowePrice’s strategy continues to focus on resilient earnings and structural growth stories, so no surprise the Australian equity fund has now gone overweight CSL ((CSL)).

Sectors currently held in Overweight allocations include consumer discretionary, health care (see CSL), information technology, and utilities.

Deepest Underweights are financials and banks, which is not surprising given Jenneke’s scepticism about what is currently implied and priced-in.

Underlying all of the above is T.RowePrice’s view that the world is still in the early stage of dealing with the global pandemic. And they mean early, early stage.

The most dangerous position to be in as an investor, it appears, is projecting recent share price movements for equities out much farther into the future, assuming the implied V-shaped recovery is happening and won’t be flattened or interrupted.

Jenneke cannot see the risk for an inflation outburst that some experts have been warning about, instead arguing the damage done by this year’s global recession effectively guarantees central banks will continue to fend off deflation for years to come.

He also agrees it will be extremely difficult for the Federal Reserve, and other central banks, to wind back the extreme liquidity-oriented policies with the next policy announcement from the Fed to focus on yield curve control, a la RBA and the BOJ.

Jenneke does not believe negative interest rates in the US as the next logical policy step are out of question.

Corporate Debt: New Records

We live in an era of ever-increasing debt levels, and corporates remain very much part of that story.

Corporate debt globally rose by a further 8% throughout 2019 to reach US$8.3trn, an all-time record. Fixed interest researchers at Janus Henderson note total new debt taken on board in the US by mid-year 2020 has already reached the total level of new corporate debt in 2019.

In other words: what was already happening at an accelerating pace pre-pandemic is now accelerating even faster in 2020.

Companies are making sure they will survive lockdowns and the repercussions from the virus, with total fresh debt expected to rise by a further US$1trn by year- end.

On Janus Henderson’s assessment, corporate debt has grown significantly faster than profits over the five years past.

Yet, the analysts suggest investors need not worry as central banks are supporting credit markets as much as they can in order to prevent a repeat of 2008/09.

Janus Henderson does warn a new cycle of defaults is starting here and now, which means Australian banks’ provisioning is picking up with ramifications for share buy backs and dividends for the sector overall.

Post the sudden lockdown of credit markets in March (since successfully re-opened on central banks interventions) Janus Henderson believes investors can achieve equity alike returns from owning corporate bonds of quality companies whose operations should gradually recover from the virus impact.

These returns are partially derived from spreads that currently have not fully normalised, but are expected to do so over the year(s) ahead.

With dividends from equities anticipated to remain under pressure, Janus Henderson believes corporate debt remains attractive for income-seeking investors.

That sentiment was echoed by another global asset manager specialised in corporate bonds, Neuberger Berman.

Investors worried about central banks lifting cash rates are way too early on Janus Henderson’s assessment with Head of Australian fixed interest, Jay Sivalapan suggesting cash rates are likely to stay at current (extreme) low levels for four to five years.

FNArena will be publishing a dedicated story about Janus Henderson’s latest research into global corporate debt. See the website for a follow-up story coming soon.

Conviction Calls

Portfolio strategists at Goldman Sachs have drawn the conclusion that Melbourne’s second wave lockdown will have more negative consequences than the first lockdown.

Facts supporting this assessment include:

-A much higher (apparent) level of community transmission this time;

-This second lockdown may be less successful in suppressing the virus as quickly as the first one was;

-Many of the “silver linings” from the first lockdown are unlikely to be repeated this time;

-Businesses may be significantly slower to restart on re-opening, and a higher percentage may not come back

Of course, the main offset for all of the above is that the resultant significant hit to the Australian economy also significantly increases the likelihood that the federal government in Canberra might decide to extend the provision of fiscal support.

To help investors making up their own mind, Goldman Sachs analysts have lined up some of the heaviest affected ASX-listed companies, including:

-Among retailers, Officeworks ((WES)) and JB Hi-Fi ((JBH)) are believed to have the highest exposure while 50% of Vicinity Centres’ ((VCX)) portfolio value is located in Victoria. For GPT ((GPT)) the portfolio exposure is estimated at 35%, mostly through retail assets.

Among banks, National Australia Bank ((NAB)), Bendigo & Adelaide Bank ((BEN)) and ANZ Bank ((ANZ)) are most affected through their respective mortgage books.

For insurers, Goldman Sachs estimates 29% of the personal lines premiums at Insurance Australia Group ((IAG)) and 30% at Suncorp ((SUN)) are Victoria-based.

The lockdown state represents some 29% of policies for health insurer Medibank Private ((MPL) and 22% for competitor nib Holdings ((NHF)).

Among building materials companies, CSR ((CSR)) with 25% of group revenues, and Adbri (24%) are seen as most heavily impacted.

Melbourne gaming revenue amounted to 54% of total revenue for Crown Resorts ((CWN)) in FY19. For Transurban ((TCL)), H1 saw circa 30% of all toll revenues coming from Melbourne.

Qantas ((QAN)) and Qube Holdings ((QUB)) are also heavily affected, the latter derives an estimated 16% of operating revenues from Victoria.

For online real-estate classifieds, Domain Holdings ((DHG)) will be most affected with REA Group ((REA)) having more business in Sydney and elsewhere.

Ramsay Health Care ((RHC)) is the most affected in the health care sector with circa 20% of revenues stemming from Victoria.

That ill-guided acquisition of Spotless has made Downer EDI the most exposed among services companies and contractors.

Among small caps, Lifestyle Communities ((LIC)) is 100% Victoria based, but the company might be able to catch up on sales and settlements later in the financial year, suggests Goldman Sachs.

The development business which is 50% of earnings will, however, be impacted.

Car repairer AMA Group ((AMA)) operates 35% of its sites in Victoria, with the company already declaring it remains cash flow neutral or slightly positive in the state assisted by Jobkeeper payments.

Then there is Adairs ((ADH)) whose online sales are picking up fast, while the retailer still has 44 out of its 160 physical stores in Victoria.

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Looking forward to August, stockbroker Morgans is anticipating a “difficult” reporting season ahead for diversified financials and insurers in Australia.

Headwinds vary from volatile investment markets, to extremely low bond yields and covid-19 impacting on operations, activity levels and provisions.

Morgans thinks earnings visibility will remain poor for companies including AMP ((AMP)), QBE Insurance ((QBE)), and Link Administration ((LNK)).

The broker’s favourites are (in order of preference) Zip Co ((Z1P)), Computershare ((CPU)), Link Administration, Mainstream Group Holdings ((MAI)), Kina Securities ((KSL)), MoneyMe ((MME)), then QBE Insurance.

Among those least liked, ASX ((ASX)) is the only stock currently rated Reduce (lowest rating).

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Simultaneously, a recent update by portfolio managers at stockbroker Morgans revealed Amcor ((AMC)) has been added as a defensive exposure, while additional shares in Qube Holdings ((QUB)) have been bought for the Balanced Model Portfolio.

The portfolio has sold out of Woodside Petroleum ((WPL)), while taking profits on National Australia Bank ((NAB)) shares and trimming its position in Sonic Healthcare ((SHL)).

The Growth Portfolio has equally sold out of Woodside Petroleum and taken profits on NAB, while adding Collins Foods ((CKF)) and ALS Ltd ((ALQ)).

This portfolio added additional shares in Aristocrat Leisure ((ALL)) and Lovisa Holdings ((LOV)) while reducing exposure to Megaport ((MP1)).

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Strategists at UBS see a -$100bn fiscal cliff emerging in Q4. If consumers save more during that final quarter, and further stimulus falls short of market expectations, they predict weakness for the local share market.

For now, UBS advises investors to stay Overweight cyclicals, but be alert for trend reversal into defensives.

Stocks most preferred, for now, include Aristocrat Leisure ((ALL)), APA Group ((APA)), Aurizon Holdings ((AZJ)), CSL ((CSL)), Harvey Norman ((HVN)), Lendlease ((LLC)), Mirvac Group ((MGR)), and Woolworths ((WOW)).

UBS is cautious on Adbri ((ABC)) and JB Hi-Fi ((JBH)).

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Over at Morgan Stanley, the conviction in a V-shaped recovery remains intact with the Australia Macro+ Model Portfolio retaining a positive skew towards financials, bulk commodities, gold and the energy sector.

The portfolio has added Ampol ((ALD)), Super Retail ((SUL)), Santos ((STO)) and Viva Energy Group ((VEA)) to further skew its exposure to cyclicals and the recovery theme, while using quality and more defensive exposures as the key funding source.

As such, Morgan Stanley has been selling out of Medibank Private ((MPL)), Xero ((XRO)) and Woolworths ((WOW)) while moving Underweight CommBank ((CBA)).

More Conviction Calls in Part II on Friday.

(This Part One story was written on Monday 13th July, 2020. It was published on the day in the form of an email to paying subscribers, and again on Thursday as a story on the website. Part Two will be published on Friday).

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 the direct messaging system on the website).

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