August 2016 Reviewed: The Same, The New, The Numbers

This story features HARVEY NORMAN HOLDINGS LIMITED, and other companies. For more info SHARE ANALYSIS: HVN

In this week's Weekly Insights:

– August 2016 Reviewed: The Same, The New, The Numbers
– Rudi On Tour (note change of date)
– Nothing Ever Changes, Or Does It?
– Rudi On TV

August 2016 Reviewed: The Same, The New, The Numbers

By Rudi Filapek-Vandyck, Editor FNArena

"In our reporting season preview we flagged that stretched market valuations implied that either market expectations were too low or that stocks were too expensive. The latter now appears to be the case."
[Morgans Chief Economist, Michael Knox]

On the final day of the month, iconic retailer Harvey Norman ((HVN)) provided investors and market watchers with an almost perfect illustration of what had become an all too familiar script during this year's August reporting season.

The operational performance was strong, better than expectations, with all divisions showing growth. There's plenty of cash, and even more franking credits, hence the 55% jump in dividends, lifting the payout to 100% of profits. Analysts' expectations rose for the years ahead and consensus price target lifted to $5.26 from $4.70.

The share price rallied, but is now trading around $5.35, which is above consensus target, albeit not excessively so. No surprise, one broker downgraded to (an equivalent of) Sell and now the balance in the FNArena database stands at two Buys, two Holds and three Sells.

Those with a positive view point at the strong momentum that is likely to last throughout the new financial year, with consumers continuing to reach for electronic gadgets while the late cycle characteristics of the housing-related operations are seen as a relatively safe bet.

Those with a more cautious view see a downtrend emerging in the domestic housing cycle, while the one-off boost from Dick Smith's demise is not to be repeated. Those with a negative view suggest current momentum probably has another six months to go, tops, with a genuine possibility the retailer is at or near peak cycle profits. Their warning: investors should not be chasing peak multiples on peak profits, or else.

Shareholders in Harvey Norman share the same experience as with their peers on the registers of companies such as JB Hi-Fi ((JBH)), Amcor ((AMC)), Corporate Travel ((CTD)), Treasury Wines ((TWE)), Orora ((ORA)), Ramsay Health Care ((RHC)), Domino's Pizza ((DMP)), and others.

Bottom line: many of the strong performers yet again continued to showcase as to why they trade at a sector or market premium, and why they deserve their premium, but they are only worth holding on to if investors remain convinced the growth story still has more legs, irrespective of the many question marks that remain.

Meanwhile, the price chart for Harvey Norman continues to be nothing short of impressive, with no end as yet showing up for the solid, uninterrupted up-trend since late 2012.

The Alternative

Harvey Norman et al are merely the exception in Australia, so there are plenty of alternative scenarios around. We might as well stay on the final day of the reporting season, when large cap building materials stalwart Adelaide Brighton ((ABC)) released its interim financials.

Expectations beforehand were far from spectacular, but still, they were too high for Adelaide Brighton. Competition in lime, declining volumes in cement and plenty of doubt whether recent price increases won't need to be reversed. It wasn't a major shock, simply no medal performance, with plenty of weakness and vulnerabilities, and the result itself was below expectations.

Similar to Harvey Norman, Adelaide Brighton seems to be swimming in cash and the company has decided to pay out more to shareholders in the form of a special dividend. The share price did receive a little bit of punishment post the release while analysts were forced to slightly lower estimates. The share price sits close to the 200 moving average, which should provide support, as does the yield on offer. The latter means Adelaide Brighton shares are not genuinely "cheap".

None of the stockbroking analysts covering the stock in the FNArena database has a Buy rating on the stock. Most will tell their clients: limited downside, due to yield support and the promise of more specials. Ex-special dividends, Adelaide Brighton shares yield some 5%, fully franked. Harvey Norman shares, despite being on higher multiples, still yield circa 5.5%, also fully franked.

One is firmly in defensive mode, with little prospect other than (potentially) a little bit of top line growth, trying to protect its long term shareholders from too many downside risks. The other is firing on all cylinders, with a healthy balance sheet, conservative accounting, international operations… and a share market valuation above its historical average.

Welcome to investing in the Australian share market post August 2016 where struggling companies are maybe "cheap" on a market-relative comparison, but they're not necessarily in their own right, while those with strong and battle-hardened business models are without exception trading on elevated multiples.

Turnaround Potential

As per standard practice, there is always the potential to jump on turnaround stories. This year's come back sector du moment has been mining services with stock broker targets and valuations often tripling after contractors and engineers released financial reports that triggered sufficient confidence the worst is behind and cautious optimism might be the appropriate way forward.

A few problems have risen to the surface nevertheless. One is many share prices have already rallied hard in optimistic anticipation, and share prices are oft seen already trading above price targets despite a doubling or tripling of the latter. Secondly, this is early days under the best of circumstances, and too early under all other scenarios.

Compare, for example, price charts for Monadelphous ((MND)) and for RCR Tomlinson ((RCR)) to see the difference in potential turnaround experience. Needless to say, Mr Market takes no prisoners in case of any slippage or disappointment and present optimism is based more on hope and speculation than on tangible evidence.

There is turnaround potential elsewhere through the likes of Asaleo Care ((AHY)), FlexiGroup ((FXL)), Cleanaway Waste Management ((CWY)), Coca-Cola Amatil ((CCL)), Computershare ((CPU)), GUD Holdings ((GUD)), Infomedia ((IFM)), Shine Corp ((SHJ)), Super Retail ((SUL)) and, of course, Woolworths ((WOW)).

A reminder from Warren Buffett himself: "Turnarounds seldom turn". "Buyer beware" plus "timing is important" come to mind as well.

The Fallen Angels

A lot of attention always goes out to high multiple stocks that experience a stumble, like REA Group ((REA)). To put the REA experience into context: the share price did rally hard leading into the result, while I thought the risk was always going to be to the downside because real estate listings have been lacklustre of late.

Going back three years, such has been the experience of REA Group shareholders in pretty much every reporting season, yet the shares today are still up some 4.5% for the calendar-year-to-date (ex dividend), and they are up strongly on a 12 month flash back, as well as over the past 24 and 36 months.

This, however, is not going to be the script for every market darling that failed to live up to expectations in August. APN Outdoor ((APO)) comes to mind, as well as Cimic ((CIM)) and, of course, Blackmores ((BKL)). All three are now faced with the difficult task of convincing investors last month's disappointment was just a one-off.

There's no denying, however, the fall-of-a-cliff experience in 2016 goes to the local aged care accommodation providers. As I write these sentences, Regis Healthcare ((REG)) is down -16.44%, Japara Healthcare ((JHC)) is down -15.44% and Estia Healthcare ((EHE)) is down -12.70%; on the day!

These losses come on the back of already ginormous sell-offs in August. No doubt, this sector will soon become the target for battle hardened, experienced value investors. For all others there are a few valuable lessons in this sorry saga:

– Do not draw long term confidence from short term price action. One thousand traders, a dozen algorithms and five investors pushing up the share price are still wrong when the proverbial hits the fan;
– A rising tide does lift all boats and makes all look healthy, strong and attractive
– An ebb tide separates the weak, vulnerable and low quality options from the strong and high quality companies
– But even the strong and high quality stocks get sold down when a full sector downturn arrives
– It is easy to fall in love with the long term growth story, while overlooking the short term context and dynamics

Other notable "disappointers" in August include G8 Education ((GEM)), Mesoblast ((MSB)), QBE Insurance ((QBE)), AMP ((AMP)), CSG Ltd ((CSV)) and Platinum Asset Management ((PTM)). Many of these names are the living proof for Warren Buffett's warning, see above.

All-Weather Performers

Putting my personal bias aside for now, there are always upside and negative surprises, even among the reliable and the strong. CSL ((CSL)) didn't manage to live up to expectations, providing evidence that buying a troubled division and turning it around is easier said than done, even for an experienced management team as is CSL's. But the All Weather Performers, on my observation, as a group continue to deliver more upside surprises and further ongoing signals of solidity and strength, than downside disappointments.

Within this framework, the best performing sector among All-Weather Performers in 2016 is Paper & Packaging with all three of Amcor ((AMC)), Orora ((ORA)) and Pact Holdings ((PGH)) delivering positive surprises, triggering higher forecasts, valuations and price targets, and enjoying share price improvements since reporting. Further adding to the sector's appeal, both Amcor and Pact subsequently announced additional acquisitions.

Blackmores came out with a shock guidance that is going to reverberate for a long while, but Ansell's ((ANN)) turnaround appeal has been remarkably well-received.

Yield Appeal

The banks showed up their operational challenges and vulnerabilities, as did Telstra ((TLS)), but most bond proxies in the share market, it has to be pointed out, delivered neatly in line with analyst expectations, or even slightly better. The big issue here is not so much operational reliability or not, it is the dilemma between ongoing yield appeal and the share market preparing for higher interest rates in the USA.

Many of the so-called bond proxies (AREITS, Infrastructure) are trading on elevated valuation, even after general weakness in August. Analysts' preferences are all over the shop, depending on whether one favours inner strength (like Goodman Group ((GMG)) or sectorial attractiveness (like Dexus ((DXS)) because of booming office prospects) or cheaper valuation.

In generalised terms, there doesn't appear too much wrong with growth prospects at Transurban ((TCL)), Sydney Airport ((SYD)), APA Group ((APA)), and the likes. For the typical AREITs, there are concerns for retail, and also for residential, in particular apartments in 2017, but all seems well for offices, Sydney in particular.

As said, there will be times when bond proxies simply will be out of favour.

August 2012 – The Numbers

Expectations before the flood of FY16 reports opened up were as low as they've been in a long time, with average EPS projected to decline by -10%. But this number is heavily distorted by the large falls that were expected from miners and from oil and gas producers. Excluding these sectors, underlying EPS was expected to grow by 5-6% and corporate Australia didn't quite get there. Suffice to say, and this is a general observation, not a personal statement, this year's August reporting season as a whole failed to excite.

Most companies still find it difficult to show top line growth, with cost management and capital management front of mind for management teams and company boards. No surprise hence why many a strategist is trying to contain expectations for the year ahead. Both UBS and Ord Minnett are sticking with 5500 for the ASX200 by end-of-December this year. Citi has put forward 5750 for mid-2017.

One stand-out feature from August were many cautious, if not disappointing outlooks provided by companies, while many others decided to stay mum on the subject, indicating it's genuinely tough out there, with uncertainties a-plenty.

In terms of beats and misses, FNArena's numbers signal a marked deterioration from February, but otherwise not anything fundamentally different from experiences in 2015 and 2014. The average price target throughout the month improved by 3.7%, which seems unusually high for August. Offsetting this observation is the fact that stockbrokers are now researching more smaller cap stocks plus share prices were already at elevated levels.

The latter explains the skew towards more downgrades than upgrades, with the gap between the two closing towards the latter part of the month when share prices started weakening on macro considerations.

All in all, the major conundrum seems to be that EPS growth expectations for the year ahead, ex-resources, are not higher than circa 7%, which is unusually low this early into the new financial year. If we also exclude the banks, estimated average EPS growth jumps to 11%, which is a much more palatable starting point given every year sees expectations decline significantly as the year grows older.

Apart from a much contested come-back for the mining and the energy sector, the big questions that now lay ahead are: can banks do better than benign expectations and how much will be left of today's average growth estimate by the end of fiscal 2017?

Many specialised consumer-oriented companies performed remarkably well in August, including the likes of Baby Bunting ((BBN)), Bapcor ((BAP)), Fantastic Holdings ((FAN)), Nick Scali ((NCK)), Reece Australia ((REC)), Shaver Shop ((SSG)) and Vita Group ((VTG)).

Plus BlueScope Steel ((BSL)) continues to prove there's no natural limit to the upside when the tide really does turn after many horrible years in the doldrums. The likes of Capitol Health ((CAJ)), Billabong ((BBY)) Cardno ((CDD)) Cover-More ((CVO)) and Wellard ((WLD)), on the other hand, still show plenty of evidence that once you are in the doldrums, it's not that easy to climb out of it.

As per always, plenty of small and micro caps around that are showing lost of promise, including Catapult Group ((CAT)), Class ((CL1)), Costa Group ((CGC)), GTN Ltd ((GTN)), Hub24 ((HUB)), Motorcycle Holdings ((MTO)), Nanosonics ((NAN)), Reliance Worldwide ((RWC)), and others.
 

Rudi On Tour

Please note the date change for upcoming presentation in Chatswood.

I will be presenting:

– To Chatswood chapter of Australian Investors' Association (AIA) on September 14, 7.15pm, Chatswood RSL

– Christmas Special for Chatswood members of Australian Investors' Association (AIA), December 14, 7pm

– To Perth chapters of Australian Investors' Association (AIA) and Australian Shareholders' Association (ASA) on 7 February 2017

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.

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
– On Wednesday I will host Your Money, Your Call, Sky Business, 8-9.30pm
– On Thursday, I will appear as guest on Sky Business, 12.30-2.30pm
– I'll re-appear later on Thursday for an interview on Switzer TV, Sky Business, between 7-8pm
– 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 5th September 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 August 31st. Paying subscribers can request a copy at info@fnarena.com

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