Retail Spending: A Matter Of Confidence

This story features SUPER RETAIL GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: SUL

In this week's Weekly Insights:

– Retail Spending: A Matter Of Confidence
– Australia? No Thanks!
– Not Easy To Be A Miner In Australia
– General Insurers About To Copy The Banks
– Presentation at PhillipCapital

By Rudi Filapek-Vandyck, Editor FNArena

Recently I ran into a staff member of a financial services provider in the corridors of the Sky Business studios in Macquarie Park, Sydney. His greeting was: I read your bearish outlook for the Australian share market. With so many retailers issuing profit warnings, you must be pleased with yourself?

My response was something along the lines of: Excuse me? When I warn investors about profit warnings, and then companies start issuing these warnings, that's not being bearish, that's being correct. It proves that my market analyses are still fairly accurate, timely and ahead of the curve and I would like to think this is why many among you, the readers, make the effort to read my Weekly Insights.

It's intriguing how people inside the financial industry cannot distinguish one from the other.

****

Regarding the corporate profit warnings that are currently hitting investor sentiment in Australia, I think it's worth reflecting on the opening sentences from last week's Weekly Insights:

One would have to be a blind bull not to see the immediate earnings outlook for corporate Australia is a bit fragile right now. Consumer sentiment is suffering from Canberra-itis, business leaders say they have the right investment intentions but evidence is patchy, the upturn in domestic building and construction is slower than usual and uneven, iron ore has surprised to the downside and the Aussie dollar is still around US93c.

While retailers are attracting most of the attention, for obvious reasons as consumer spending had surprised to the upside since last year and share prices for the sector had performed accordingly, there have also been profit warnings from traditional media companies and from local IT services providers. Personally, I find the latter two sectors as intriguing as is the downside surprise in consumer spending.

Australia is expected to successfully migrate away from capital expenditure in the mining and gas industries, but businesses outside these sectors remain rather reluctant to actually open the purse and spend. How else can we explain the fact that advertising sales continue to disappoint, while the upswing in software and IT services still hasn't arrived (and continues to be pushed further out on analysts' projections)?

In the meantime, the share market is taking no prisoners which then leads to the rather comical observation that when Super Retail ((SUL)) recalibrates its profit guidance downwards for the third time in 2014, the share price actually rallies to the upside. Now there's one easy observation to make about current market positioning and expectations. Note also, the share price had slumped from above $13.50 to near $8 since late 2013.

There is, however, one other easy to make observations that deserves to be highlighted from this month's corporate profit warnings. Whereas a vulnerable, soul-searching consumer stock such as Pacific Brands ((PBG)) is forced to reduce guidance for the year by no less than 25%, and another retailer, The Reject Shop ((TRS)), is forced to lower FY14 guidance by no less than 15%, super-trooper Flight Centre's ((FLT)) profit warning merely comprised of a few percentages less growth than previously suggested. But Flight Centre is still growing this year, by some 7-8% instead of the usual double digit pace.

This is precisely the difference -in quality and in downward protection- that I have been talking and writing about since I started analysing the Australian share market from a different angle in the post-GFC era. Put in simple terms: Flight Centre is an All-Weather Performer. Pacific Brands and The Reject Shop are not. Super Retail looked like they could be worthy of the same label as Flight Centre, but some serious questions are now attached to the business. Three profit warnings in a relative short time span is a lot to deal with, even if a share price of $8 doesn't look expensive.

Herein lies, still, the dilemma for investors in the Australian share market in 2014. You know that when you are buying shares in Flight Centre, you are buying into a company that is a gazillion times more robust, and solid, and strong, and profitable than the large majority of alternatives. By now, however, the price for a stock like Flight Centre is reflective of the fact that just about everyone has caught up on this difference in quality and risk. The same goes for Ramsay Healthcare ((RHC)), for Carsales.com ((CRZ)), for Amcor ((AMC)) and for CSL ((CSL)) – for an excel sheet overview of All-Weather Performers, see bottom of this story.

This also explains as to why I have been so adamantly opposed to the army of couch commentators who have been predicting doom and gloom scenarios for Australian banks. The recent reporting season saw only one disappointment, from perpetual laggard National Australia Bank ((NAB)). For all others, the surprise remained to the upside and valuations/price targets rose as a result. Are Australian banks cheap? No, they definitely are not. But they are not about to issue profit warnings a la Pacific Brands and The Reject Shop, and they will increase their dividends in the year ahead.

Note, for example, Goldman Sachs analysts have been the latest to turn positive on the outlook for ANZ Bank ((ANZ)). Many of the recent improvements in views for the sector are based upon less bad debts than previously assumed. This adds to banks' profitability (and thus to shareholders' returns). In ANZ's case, there's the added appeal of a successful expansion into Asia. Goldman Sachs projects a total shareholder return of no less than 14% in the twelve months ahead, of which 5% comes from dividend.

Banks are trading at a premium for exactly the same reason as are Ramsay Healthcare and the other All-Weather stocks mentioned. It's not just about dividend yield and SMSF investors in a low interest rate environment; it's equally about low risk for a major disappointment. Critics are correct in that Australian banks are not 100% risk free, but so far the sector is enjoying more tailwinds than headwinds and house prices in Australia are poised to remain elevated for much longer than US hedge funds can afford to be short. Quite ironically, it may well be that the key risk lies with property markets in China, exactly the risk that is usually associated with direct China exposures such as BHP Billiton ((BHP)) and Rio Tinto ((RIO)).

While it is true that banks' share prices tend to underperform the broader market from the moment the RBA starts raising interest rates (there's plenty of historical evidence to support this view), it is also true that "market underperformance" does not automatically equal "massive sell-off". It is equally true the Australian economy is providing little comfort for the RBA to start hiking interest rates anytime soon. On Monday, economists at UBS, who predict two rate hikes of 25bp in early 2015, acknowledged exactly that, admitting there's reasonable doubt about their timing for RBA rate hikes given weak indicators for consumer spending and confidence.

Which takes us back to where we started this story: for today's share prices of domestic retailers to represent a good investment opportunity, irrespective of the weakness that has already occurred, there needs to be a real and sustainable upswing in consumer spending. How realistic is this?

There are plenty of reasons to assume this won't happen. ANZ Bank recently issued an analysis suggesting the rise in the terms of trade has artificially allowed for larger wage increases than would otherwise have been the case. On this basis, ANZ Bank now predicts a deterioration in the terms of trade, which is happening right now and expected to last a whole lot longer, shall translate in tepid growth in wages only. One would have to assume that companies' ongoing drive to reduce costs while domestically oriented companies are still feeling downward pressure on margins, are equally pointing towards substandard wage increases in Australia.

Within this context it is interesting a recent OECD study has pointed out there has been a negative trend in wages throughout developed economies, including Australia (!), since the GFC.

Further exacerbating the negative climate is an unpopular government (despite a change of the guard in late 2013) with economists at Citi, for example, calculating the proposed changes in the first Abbott-Hockey budget will reduce spending power for the average household in Australia by no less than $602 from mid-year onwards, and then again by a further $464 in the following year.

The positive news is, of course, many of the proposed changes might never make it through the Senate. Hence why economists at Deloitte Access Economics are predicting most of the budget backlash won't happen until FY16 (past mid-2015). They are thus predicting an upside surprise later this year (and for FY14 in general), to be followed by a downbeat performance the following year.

Economists at UBS are even more optimistic. They believe consumer spending in Australia is now effectively supported by the RBA in that if sentiment does not recover quickly from its present slump, the RBA will simply keep interest rates lower for longer and this will  turn around spending through the wealth creation effect of rising property prices. UBS also sees positive effects from a repeal of the carbon tax through lower energy prices.

Most of all, UBS acknowledges all the headwinds cited above but believes once sentiment improves, Australian consumers will start reducing their savings, which are still at elevated level, and spend more. UBS also maintains the Australian dollar should fall towards US85c and this will provide extra stimulus for the Australian economy.

A weaker AUD, traditionally seen as a negative for Australian retailers as their input costs rise through foreign imports (at a delay), has thus far assisted Australian retailers in fending off foreign online competition. As shown in the graph below, domestic retailers are enjoying ever so stronger momentum in their online sales, while international competitors are now seriously losing ground.

All of the above suggests retailers in Australia are facing a rather murky outlook, with some positives and some negatives and with a lot hinging on a weaker currency and a sustained improvement in consumer confidence. It's probably a fair assumption to make that the RBA is on their side.

In terms of sector exposure, most analysts seem of the view that JB Hi-Fi ((JBH)) is currently the obvious, stand-out, undervalued and misread stock in the sector. Because of exposure to the upswing in housing, because of an improvement for flat panel TVs, because of a lessening in competition in consumer electronics. Some analysts believe the company will announce capital management soon.

On current market expectations, JB Hi-Fi shares are trading on a FY15 PE of no more than 13.4x, offering a yield of 4.6%, carried by single digit growth in earnings per share for both FY14 and FY15. The consensus price target sits at $20, more than 10% above today's share price.

In terms of lower risk, however, Flight Centre remains the stand-out with consensus forecasts anticipating a return to double digit EPS growth in FY15. Projected dividend yield is 3.9% on FY15 estimates. Current consensus target sits no less than 23% above the share price. Even if that proves wildly optimistic, history shows the odds remain very much in favour of a positive surprise for the year(s) ahead, regardless of the premium that is built-in.

Australia? No Thanks!

The local JP Morgan strategist visited clients in Asia recently and the observations made during the conversations that took place merit the attention of local investors. First up is that foreign investors, at least the ones based in Asia, are still Underweight Australian equities. They have been Underweight for a while now, and there doesn't appear to be any inclination to change this.

Observations made by JP Morgan include a general wariness of the stronger-for-longer Australian dollar, which is effectively reducing appetite to seek exposure to Australia, a general view that earnings growth is not strong in Australia while the market's valuation is perceived to be on the high side, in particular if one removes Mining stocks. There's no urge whatsoever to seek additional exposure to China. This extends to mining stocks in general.

Australia is still seen as a high yielding market and as such REITs investors remain keen, investors in bank shares not so. Interestingly, Asian investors seem of the view that high prices for domestic housing markets are likely to remain a feature for Australia for much longer.

Not Easy To Be A Miner In Australia

Miners continue on their relentless quest to cut spending and lower the costs of operating mining and other operations. A recent report by New York headquartered Cowen & Co is further testament to that.

What makes the Cowen research unique is that it draws comparisons between the US, Canada and Australia and the latest sector update clearly suggests Australian miners are not doing as successful a job as their counterparts in the US, while Canadian miners are having difficulties to keep up with US peers too. Could any of this be related to currency matters?

Another conclusion that stands out from the report is that lowering the costs for doing business is far from easy and as straightforward as investors tend to think. Cowen suggests the industry is creating its own set of smoke and mirrors by reducing capital expenditure which then lowers the general costs for running the mining operations. Not so, but that's how it shows up in the statistics.

Bottom line: miners are still reducing costs and are now at a stage where longer term growth potential is being reduced, concludes Cowen. And Australian miners are doing it tougher than elsewhere (see graph about further rising costs below).

General Insurers About To Copy The Banks

It's usually the banks in Australia that feature in analyses about how a highly concentrated market virtually guarantees rational pricing and thus protection to the downside when dynamics get a bit rough. But what about the general insurers in Australia? A recent sector analysis by Shaw Stockbroking suggests investors should compare Suncorp ((SUN)) and Insurance Australia Group ((IAG)) to the Big Four in banking, with the domestic market for Personal Insurance (motor, home & content) equally as highly concentrated as is the banking home loan market, suggest Shaw analysts.

The bottom line, suggests Shaw, is that both Suncorp and IAG's margins are poised to surprise to the upside, and both will boost shareholder returns via increased dividends, capital returns, or bolt on acquisitions over the next three years -just like the banks have done when faced with slower top line loan growth. Investors should also note: Shaw does not like QBE Insurance ((QBE)) despite a potentially much larger shareholder return in the twelve months ahead.

Presentation at PhillipCapital in Sydney

In three weeks, I will be presenting at a Seminar organised by PhillipCapital in Sydney.
Date: Monday 7th July 2014, 6.30pm until 9.30pm (my presentation is 6.30-7.30)
Location: PhillipCapital, Level 9/56 Pitt St, Sydney
Access is free

(This story was written on Monday, 26 May 2014. 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)

****

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.

****

MAKE RISK YOUR FRIEND – ALL-WEATHER PERFORMERS

Things might look a lot different today than they have between 2008-2012, but that doesn't mean there are no lessons and conclusions to be drawn for the years ahead. "Making Risk Your Friend. Finding All-Weather Performers", was published in January last year and identifies three categories of stocks that should be part of every long term portfolio; sustainable yield, All-Weather Performers and Sweetspot Stocks.

This eBooklet 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 June available. Just send an email to the address above if you are interested.

Click to view our Glossary of Financial Terms