A Solid Defence, Yield And Growth

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

In this week's Weekly Insights:

– A Solid Defence, Yield And Growth
– Amcor: That's Why!
– Australian Banks: It's Complicated
– Commodities: Divergence Rules!
– BHP: More Excitement Than Is Warranted?
– And Finally…
– Rudi On Tour Visits Brisbane In September

A Solid Defence, Yield And Growth

By Rudi Filapek-Vandyck, Editor FNArena

There's a lot wrong with how we, the media and commentators, report about the share market.

All those tables and reviews showing top and bottom performers. All the requests for "what's your tip for the year ahead". The worst one, of course, is the Sun-Herald's SharesRace.

It's not so much that what is displayed is wrong, it is the underlying message that investors should try to catch the star-performer of the moment, and all shall be alright.

The world of finance shares this focus on the "glamour attack", which sees winners being elevated to all-conquering deities, with just about everything else being reported on in the media. Who directed that last movie? Don't know, but it has Eric Banna in it. In the recent World Cup Football (sorry, showing my European roots here) all the attention went to the beautiful goals which coloured the tournament, but the two finalists were ultimately those with the best defense. Even Vincenzo Nibali, this year's winner of the Tour, will readily admit he needs the rest of the team to support him throughout the grueling three-week experience.

Last week I attended a highly informative presentation by US-based value investor, Altrinsic, a partner of National Australia Bank in the international equities department. The goal of the event was to inform about new developments in healthcare, both revealing and fascinating, but what caught my attention was the general intro in which Altrinsic explained it had looked at international equities through the prism of Type 1 and Type 2 stocks. The first type can be described as an in-house version of my All-Weather concept -solid, quality franchises that offer sustainable growth for shareholders- and the second type comprises of the vulnerable cyclicals that are everything but All-Weather performers.

Altrinsic is an international investor. Given one of the core characteristics that make a Type 1 company high-quality and reliable is the size of the company, so few companies in Australia land on their radar. Current favourites (large holdings) include pharma companies Roche, Novartis, Sanofi and GlaxoSmithKline, alongside Nestle, Deutsche Boerse, Bank of Yokohama and Diageo.

When I asked which companies had been on the radar in Australia as being Type 1, the response did not surprise: your banks. But maybe not now given full valuation. And CSL ((CSL)).

The chart below is from the presentation, clearly showing Altrinsic's long term strategy alternates between larger and smaller exposures to Type 1 and Type 2 companies. Right now, the gap between the two is as wide as it's been, with the exception of December 2008, and now starting to narrow.

Source: Altrinsic

The underlying message here is: don't neglect your defense, but you need some attacking power too. Without going overboard. Note since global equities recovered from the bear market of 2000-2003, Type 2 stocks have never made up more than 50% of total portfolio exposures at Altrinsic. Most of that time, their weight has been well below half.

In essence, this process whereby international managers such as Altrinsic are moving to a "less underweight" rating for lesser reliable cyclicals by shedding some exposure to highly valued Type 1 stocks has already started. And we have all witnessed its effects in the local share market.

Invocare ((IVC)) shares are no longer trading above $11.80. They are at $10.50 now, and have been below $10 recently. Ramsay Healthcare ((RHC)) shares are no longer at $50. They are now at $47, and they have been at $44. The earlier mentioned CSL has come down from $72 and is now trading below $67.

Within this context, here's an interesting observation analysts at Morgan Stanley put to their clientele last week, in response to continuous feedback mostly centred around "one cannot buy any of the high PE stocks in Australia, they are way too expensive". Observe the analysts: during the last two reporting seasons, in February and in August last year, many of these so-called too expensive high PE stocks significantly outperformed – because the companies delivered and sometimes over-delivered on high expectations.

Report the analysts: The average outperformance of the selected Magnificent Seven stocks over the six weeks of result periods is 7.9%, with mid to high single digit returns for the majority since 2010; that's 4x two reporting season periods. More broadly, the top decile of high-PE stocks have outperformed during periods of financial results by 1.5% on average.

The key question this year will be: can they repeat it again? Morgan Stanley analysts have ongoing high expectations for Magellan, while acknowledging the danger for each high PE stock in case the growth profile suffers damage, like has been the case for Navitas ((NVT)), but they remain confident of high, quality growth numbers that will be delivered by Domino's Pizza ((DMP)) and by REA Group ((REA)). The latter two predictions come with Strong Conviction.

The most important shift, I believe, relates to investing in dividend stocks. Anecdotal evidence, including our own bi-monthly Investor Sentiment Survey, suggests SMSFs and other retail investors are heavily overweight yield stocks, such as the local banks, and their returns stand to suffer from this in the year's ahead, in the absence of recalibrations of portfolios. This point was again emphasised by portfolio strategy researchers at Goldman Sachs in a recent update, titled "Why retirees need more growth, less yield".

This report suggests a portfolio combining yield and growth would have generated nearly three times total return generated by a yield only approach over the past fifteen years. Something to think about, surely?

Readers of my Weekly Insights might reflect back on my "The 'Retain A Quality Of Life' Investment Portfolio" from last week, which consisted of three different baskets of stocks, combining yield, reliability and growth, without going overboard in the risk appetite department.

The research conducted by Goldman Sachs reflects my own and supports statements and suggestions made during my live presentations:

"Despite earning 20% less income in year 1, our growth approach typically managed to catch-up and surpass the level of income on the ‘High Yield’ portfolio within 2-3 years. After 10 years, the growth strategy was earning 2.5x as much."

Read and re-read, I'd say. Make sure you don't believe all the crap others tell you about yield is for older people, blah blah. Make sure you don't leave it too long, or you risk boxing yourself into that sole option of high yield stocks, and that is an inferior strategy, no matter which angle one takes.

Here are Goldman Sachs' current favourites to combine yield with growth in the Australian share market: Seek ((SEK)), ANZ Bank ((ANZ)), Carsales.com ((CRZ)), Flexigroup ((FXL)), Henderson Group ((HGG)), IOOF ((IFL)), Lend Lease ((LLC)) and Super Retail ((SUL)).

I note quite a few of those stocks were also mentioned in last week's Weekly Insights.

Amcor: That's Why!

How does one end up being personified with one of the best performing stocks in the Australian share market? In my case, it happened with Amcor ((AMC)). Not a week goes by or someone somewhere calls in or sends a message or raises a hand after an on-stage presentation and then opens with "we all know Amcor has been one of your long-standing favourites, when nobody else is positive about the stock" [include a few more paragraphs] and then the final question: why?

This is probably as opportune a moment as any other to highlight that gain have no commercial or any other benefits in talking up Amcor.

The short answer is: my market research led me to Amcor in 2009. Given the strong performance of the stock since, I have never understood why so many other experts and commentators have stuck to their dismissal. If the share market is always right, and it would be difficult to reason otherwise given we're talking five long years of strong outperformance, doesn't this provide us with an important insight about these experts and commentators, more so than about Amcor?

I received another Why?-message over the weekend and this time I had the luxury of simply being able to pluck two paragraphs from the weekend edition of the Australian Financial Review, which I happily repeat because they do sum up my own view almost perfectly:

“Packaging company Amcor probably offers the best combination of yield and growth outside the resources sector” (according to UBS).
 
"UBS is tipping Amcor to pay a grossed-up dividend yield above 4.5 per cent in fiscal 2015 and achieve earnings growth above 10 per cent over the next three years."

Note: that's 10% growth in each of the next three years.

Also note: I do have some concerns about the company's linkage with tobacco and fizzy drinks, but they are of a longer-term nature.

That's why.

Australian Banks: It's Complicated

Australian banks. Most stockbrokers hate them with a passion by now. Clients and all kinds of other investors in Australia own them in supersized portions and with no intention of selling, so the banks can be held at least partially responsible for the low volumes that have accompanied this new bull market for equities.

The same goes for the small army of share market analysts and commentators, most of whom have been calling the banks significantly overpriced and no longer worth buying, but no matter how hard and for how long these views have been expressed, bank shares are still up there, showing no intention of coming crashing down to earth.

Last week, I attended a presentation by US-based investor Altrinsic (see above). When I asked the question which stocks in Australia had their interest, the response was as predictable as can be: the banks, but not now they've used up their dough and reached what seems like the limits in valuation.

The latest sector update by Macquarie shows how well Australian banks have performed, and still are. I'll let the three charts below do all the talking. Sure, the day will arrive, at some point, when these overviews show negative performances instead of steady gains, but who's going to bet that day is going to be tomorrow?

In the background, I can hear all you SMSF operators responding with: that's why we own and don't sell the banks! (I know, I have been on your side since the middle of 2009). My main concern is that you have become too accustomed to owning lots of banks and reaping nothing but benefits from them. Never fall in love with a successful investment. Make sure you don't let the sector become too large. Nothing wrong with re-calibrating the portfolio. It'll prove a good thing later on.

Commodities: Divergence Rules!

Since late last year, I have been trying my best to convey the message to investors that there's a commodities revival building, but the impact on the share market in Australia is likely to be confusing and spread out over smaller pockets of strength, more so than a uniform one-dimensional rally like the one we experienced (and truly enjoyed) between 2003-2008.

The latest sector update by Goldman Sachs expresses exactly this view. Here's the main underlying thesis that dominates Goldman's view:

"Major commodity markets such as copper, oil and iron ore remain impacted by the structural shift in their supply cycles – from an investment to an exploitation phase. These commodity markets have shifted into a period of strong supply growth and rising mining productivity following a decade of over-investment in production capacity. As new capacity is exploited more efficiently, we expect industry cost curves to shift downward, reversing the cost inflation of recent years."

Goldman's conviction views are: Bearish on iron ore, gold and copper, bullish on nickel, zinc, aluminium and palladium.

BHP: More Excitement Than Is Warranted?

We have seen this movie before. It was February this year and everybody got very excited after what seemed like a strong operational performance. There appeared at least one commentator on Financial TV who predicted BHP Billiton ((BHP)) shares were on their way to $50. But it all deflated as quickly as it had built up and the share price landed back at $35 instead of the $40-plus that was widely expected.

Now we're back above $39, after a truly strong operational performance in the June quarter, and it seems but logical to ask that same question: is now the time for BHP shares to finally break through the $40 barrier again and stay above it?

Let's ask the question to the team at Morgan Stanley who have been, and still are, among the most bullish in the market on BHP.

Morgan Stanley rates BHP Overweight against an In-Line sector rating, which means the analysts consider BHP attractive on a relative basis. No changes have been made post the production report and as things stand right now, BHP's earnings per share are about to make a dive south in FY15, and then post a rather benign recovery. So why would anyone own the stock? Is it simply because most others are poised to do even worse?

Not so. Morgan Stanley sees dividend support of 4% (where have I read this before?) and sums up several factors that should support the share price: efficiency savings, potential for share buy backs, and potential for spin off of non core assets.

My personal observation of BHP's consensus forecasts (see Stock Analysis on the website) paints a similar picture: post the production report that caused general euphoria, forecasts have been lowered (believe it or not) from 20% growth in FY14 and minus 9% in FY15 to 17% growth in FY14 and minus 4% in FY15.

This, I believe, sums it up quite nicely. BHP has to work really hard, and probably requires a little support from prices and a weaker AUD, to potentially stay in the black in the year ahead. It's relative attractiveness shows up in the form of a likely small retreat in profits if things do not work out in optima forma. This is sharply different from the fall-of-a-cliff experiences that await the likes of Atlas Iron ((AGO)).

Don't take my word for it. Believe Morgan Stanley instead. And Goldman Sachs (see above).

And Finally…

Perpetual's observation: Investors seem to over-emphasise the relationship between economic growth and share price growth. An oldie, but goldie which I am keeping under my wraps for one of my future endeavours into the deepest enigmas of the share market…

Rudi On Tour Visits Brisbane In September

I have yet to book accommodation and flights, but on Wednesday, September 3, I will be presenting in Brisbane twice, in the afternoon and in the evening, on behalf of the local chapters of the Australian Investors' Association (AIA) and the Australian Technical Analysts Association (ATAA)) respectively. More details to follow.

(This story was written on Monday, 28 July 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)

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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

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.

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