Two Threats To Conquer

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In this week's Weekly Insights:

-Two Threats To Conquer
-Conviction Calls: Citi, Bell Potter, Canaccord, and Morgans
-Aristocrat Leisure: It's Not A Gamble
-2016 – L'Année Extraordinaire
-All-Weather Model Portfolio
-Rudi On TV
-Rudi On Tour

Two Threats To Conquer

By Rudi Filapek-Vandyck, Editor FNArena

Never underestimate financial markets' ability to surprise.

Events and outcomes during the FY17 financial year are an excellent case in point. Commodities and resources stocks were left staring into the abyss of eternal oblivion at the start of calendar 2016, but by December they were the star performers, destined to continue their rally, but all fell apart pretty quickly into the new calendar year.

Gold stocks who had become everyone's favourite all through 2015 and during the first half of 2016, quickly deflated, then rallied again, fell off a cliff, rallied again, fell, rallied, and then fell more.

Banks had turned into everyone's favourite whipping boy, but that rally in late 2016 made them a lot of friends, again. May once again proved a bridge too far and shareholders are since left licking their wounds.

And High PE growth stocks and yield/income providers such as Transurban ((TCL)), Sydney Airport ((SYD)) and Goodman Group ((GMG)) experienced a lot of turbulence after years of steady climbing share prices, thanks to sudden sell-offs in government bonds.

There was a collapse in the oil price, an unexpected outcome in the Brexit vote, a change in policy direction at the Federal Reserve and then the election of That President in the USA.

Quite amazing, really, that throughout all the turbulence, and the unexpected surprises contrary to market predictions, the Australian share market (ASX200) has managed to return 14.1% for the twelve months to June 30, 2017.

[Graph: UBS]

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The total return may look mightily impressive, in particular against the background of two low returning years prior, the broader context is a lot less so. The ASX has actually been one of the softer performers over the year, especially in the second half when dividends proved necessary to scrape in a positive return for the six months to June.

As a comparison, the global MSCI returned almost 10% just in the second half. For the June quarter, the ASX200 fell -2.4% to post its worst quarterly return since 1Q16 when the index declined -4.0%. In both cases a weaker oil price was partially to blame.

Further adding to the string of ongoing surprises, shares were hit by a sudden spike in volatility during the final days of June, just when it appeared that window dressing by institutions would allow the local market to finish the financial year on a strong and positive note.

As it turned out, central bankers in Europe and elsewhere stood up to crash the global party. Not that any of this will stop the industry from greasing the marketing machines in the weeks and months ahead. Double digit returns cannot be advertised in every year. Gotta make hay while the sun shines.

The FNArena/Vested Equities All-Weather Model Portfolio rediscovered its mojo in the second half, outperforming in all five months post January, pipping the broader market at the post for the half. It has been a great come-back on the back of having no exposure to banks and resources stocks.

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Investors would be wise to pay attention to the two major forces that have held back the share market's performance in the second half. In my view, those forces are a benign outlook for corporate earnings growth and the potential for higher bond yields.

The latter is spooking part of the investment community and one can hardly blame investors. Rising bond yields look scary and they can inflict a lot of damage in the share market, as witnessed, for example, in recent share price action for Newcrest Mining ((NCM)), Healthscope ((HSO)), Westfield Corp ((WFD)), TechnologyOne ((TNE)), CSL ((CSL)), Macquarie Group ((MQG)) and Carsales ((CAR)), to name but a few. Yes, indeed, the pull back in all of these share prices can largely be retraced back to rising yields on government bonds since June.

It is my personal view that 10-year government bonds globally should not continue to climb in the six months ahead, with central bankers merely trying to shake up market complacency in the absence of inflation. But one should never underestimate the potential for market mayhem as the central bankers' wake up call from June is now forcing large funds, hedge funds, and many others to reposition their portfolios. This is not by default a process that guaranteed will unfold smoothly and without any hiccups.

Attention must thus be paid to the potential for further weakness ahead.

Subscribers who've missed my assessment from Friday, can still read Rudi's View: My Name Is Bond via the Rudi's Views section on the FNArena website, or use the following link: https://www.fnarena.com/index.php/analysis-data/rudis-views/

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When it comes to profit forecasts, Australia is about to experience its best reporting season since August 2014. Forecast average EPS growth could come out as high as 17% next month. But that is not the number to focus on. The significant turnaround in fortunes for miners and energy producers is artificially pumping up the market average. Underlying, a large number of companies and whole sectors are seriously struggling.

Earnings forecasts in Australia started to top out in January and they have been in steady decline since. Today, as analysts are preparing for the reporting season in August, many more question marks are being asked about whether companies will be able to meet market expectations, or even their own guidance, without last minute accountancy tricks or one-off benefits.

More importantly, such question marks seem rife for the outlook beyond FY17 when weakness in domestic housing and/or consumer spending can have a pronounced impact.

All this is happening in a share market that is, on average, trading at premium valuation, meaning vulnerabilities can open up quickly in case of negative surprises from either central banks, bonds, governments, or simply reported profits.

Then again, one should never underestimate companies' abilities to provide compensation and/or upside surprise. Link Administration ((LNK)), Viva Energy ((VVR)) and Hansen Technologies ((HSN)) all announced well-received acquisitions in recent weeks. Beleagured Telstra ((TLS)) is rumoured to be working towards securitisation of its recurring NBN receipts. The BHP ((BHP)) board remains under pressure to release more shareholder value. Rio Tinto ((RIO)) is believed to be one of few only in the resources sector with ample cash flows to extra-spoil shareholders.

There will be plenty of dividends from miners and energy companies, but maybe not as much optimism looking forward as during the prior two reporting periods.

In general terms, companies that are not running out of puff and whose business models and sector dynamics can  facilitate ongoing growth, even when things get tougher for large parts of the Australian share market, remain in my view excellently positioned to withstand increased volatility and challenges in the year ahead, even in the face of rising bond yields, as long as the latter don't trigger a share market rout or a rampant reflation trade a la late 2016.

It's the companies that land in struggle street or whose outlook is turning ex-growth that investors should be wary of. Despite a benign confession season thus far, August is going to reveal plenty of surprises either way.

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Every reporting season builds up its own character and market impact, through multiple surprises and disappointments. This is why forecasts about the share market's outlook are best made after August instead of in June.

However, unless the mood changes markedly during the local tsunami of corporate releases and updates throughout the four weeks of August, I am inclined to stick with a cautious and benign outlook for the Australian share market.

In practical terms, this means I am more sympathetic to the view as expressed by UBS strategists recently that the ASX200 by year-end may well not be far off from where the index is sitting today as opposed to others who publish forecasts a la 6400 by mid-2018.

The prospect of twelve percent upside over twelve months is by no means out of the question, and certainly 2016 has shown us all it can be done in a heartbeat, but somehow it makes a lot of sense to assume further gains will be harder, in the face of the challenges ahead.
 

Conviction Calls: Citi, Bell Potter, Canaccord, and Morgans

Shares in casino operator The Star Entertainment Group ((SGR)) have found it difficult to attract a lot of love and affection from investors over the year past. One glance at the twelve month price chart shows exactly that.

But is it justified? Star Entertainment enjoys a perfect score on the FNArena Sentiment Indicator of 1.0, meaning every single broker in the database with an opinion on the stock is rating the stock a Buy, or an equivalent of Buy. Consensus price target of $6.07 suggests the share price is some -20% too cheap (dividend payouts not included).

The latest to step into the limelight and sing the praises of the stock, Citi, didn't hold back either. Calling the stock "THE" value opportunity on the Australian share market, Citi has elevated The Star its Top Pick among Gaming stocks in Australia, predicting double-digit growth in FY18 will overwhelm investor scepticism and this should lead to a re-rate for the shares.

On Citi's assessment, the price should be more than 30% higher, at $6.65. Admittedly, this is the highest target among the brokers lined up on the FNArena website, but even the lowest target is more than 12% above where the share price currently trades.

A classic case of show me concrete results first? Or are the brokers missing something? August will probably deliver the answer.

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Tech sector analyst Chris Savage at Bell Potter has lined up his favourites ahead of the August reporting season. Favourites are always selected according to relative valuations, so don't expect any of my personal favourites to show up anytime soon. The best stocks such as Altium ((ALU)), WiseTech Global ((WTC)) and TechnologyOne ((TNE)) can hope for is a Hold recommendation, and that's exactly how Bell Potter is rating them at the moment, alongside Melbourne IT ((MLB)).

There are currently no Sell ratings for the sector on Savage's assessment. His Key Picks are Integrated Research ((IRI)), Appen ((APX)), Adacel Technologies ((ADA)) and Empired ((EPD)). Within this select group, Integrated Research is Bell Potter's Number One Favourite.

The stockbroker is anticipating a positive update from company management shortly, which should act as a catalyst for a share price that already is running upwards. Empired has had a bit of a wobbly existence on the ASX and has been chosen on the premise of a successful turnaround. Adacel issued a profit warning in early May, but this is clearly not impacting on Savage's outlook. Appen is everybody's favourite exposure to artificial intelligence (AI). More insights to be expected in August.

The above tech sector favourites have also been included in Bell Potter's "Stock Picks for FY18" which otherwise comprise of:

-Among Financials; Macquarie Group ((MQG)), National Australia Bank ((NAB)), Suncorp ((SUN))
-Among Diversified Financials; BT Investment Management ((BTT)), Challenger ((CGF)), Janus Henderson Group ((JHG))
-Among Discretionary Retail and Intellectual Property; Super Retail ((SUL)), Premier Investments ((PMV)), IPH Ltd ((IPH))
-Among Resources; Pantoro Ltd ((PNR)), Regis Resources ((RRL)), Fortescue Metals ((FMG)), FAR Ltd ((FAR)), Gold Road Resources ((GOR)), Galaxy Resources ((GXY))
-Among Agriculture; a2 Milk ((A2M)), Synlait Milk ((SM1), Huon Aquaculture ((HUO))
-Among Healthcare and biotech; Paragon Care ((PGC)), iSelect ((ISU)), Viralytics ((VLA)), Medical Developments ((MVP)), Mesoblast ((MSB)), Starpharma ((SPL)), Bionomics ((BNO))

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Canaccord Genuity, which specialises largely in small cap stocks here in Australia, just released its Australia Focus List, effectively the stockbroker's 11 favourite stock picks for the quarter ahead. These 11 stocks are: AMA Group ((AMA)), Beach Energy ((BPT)), Catapult Group International ((CAT)), Credit Corp ((CCP)), Galaxy Resources ((GXY)), Imdex ((IMD)), Impedimed ((IPD)), Infigen Energy ((IFN)), Kogan ((KGN)), Metals X ((MLX)) and Skydive the Beach Group ((SKB)).

Small cap industrials specialists at Ord Minnett have nominated Huon Aquaculture ((HUO)) as their Key Pick, while Collection House ((CLH)) is now their Bottom Pick.

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Stockbroker Morgans has removed Orora ((ORA)) and Speedcast ((SDA)) from its list of High Conviction Stocks. Explains the broker: "Our overall favourable view on both stocks remains undiminished, but some near-term headwinds present an opportunity to lock in profits. In an expensive market, investors have been unforgiving when it comes to unexpected earnings surprises."

Instead, Morgans has added Australian Finance Group ((AFG)) with market scepticism seen as overdone and the mortgage brokers network seen offering good value, an attractive dividend yield (8%-plus) and potential for market share gains, acquisitions and a positive surprise in August.

Other stocks that remain on the High Conviction List are ResMed ((RMD)), Westpac ((WBC)), Oil Search ((OSH)) and Bapcor ((BAP)).

Note to paying subscribers: all Weekly Insights updates since early February this year have included updates on Conviction Calls, with the sole exception of last week's (July 3). See Rudi's Views on the FNArena website to access the archive of past updates.

Aristocrat Leisure: It's Not A Gamble

Shares in poker machine manufacturer and (increasingly) online gaming software developer Aristocrat Leisure have been on an absolute tear in the past eighteen months. While it can be argued the underlying trend has been positive for years, with the share price climbing from below $3 in 2013 to $10 by early 2016, the shares have gone parabolic since and last month narrowly missed the $24 mark.

For most investors, this is as far as their interest stretches. A stock that continues doubling in price surely must now be overheated and ripe for a fall a la Bellamy's or Blackmores? Not so, says a growing pack of analysts who cover the stock. Last month Goldman Sachs expressed their admiration for the strong growth achieved, with the explicit notion there should be a whole lot more growth on the horizon.

As a matter of fact, analysts at Goldman Sachs were so much in awe, they asked themselves the question: can Aristocrat Leisure shares potentially reach $30? Having taken another good look in what exactly is supporting current growth, and what should be in the pipeline, the analysts' conclusion was: yes, sure, definitely possible. On their projections, it really doesn't require much in terms of upside surprises in the years ahead.

The sales desk at Citi has no such reservations. According to their Bull case scenario, Aristocrat Leisure shares are likely to reach $30 and they will do so on solid growth momentum which seems secured until at least 2022. Expanding market share, growing online popularity and successful new titles (Lightning Links, Dragon Link) can achieve just that, argues Citi, with Conviction.

On my observation, the growth story at Aristocrat has by now captured the attention of many in the local share market. Apart from some profit taking here and there, and the occasional wobble on bond market concerns, I suspect this will translate in continuous buying support. At $22, plus or minus, the twelve month's out Price-Earnings (PE) ratio is still below 22x with USD exposure further adding to the strong growth attraction. Given the robust growth outlook on consensus market projections (55.1% EPS growth in FY17, followed by 17.4% in FY18, and more beyond) this certainly continues to look attractive, in particular with low expectations for the broader market, and falling, post August.

The FNArena All-Weather Model Portfolio likes industrial companies with a solid multi-year growth outlook and Aristocrat Leisure has been included since last year. We are not too worried about short term weakness or whether the shares will actually reach the $30 mark or not.
 

2016 – L'Année Extraordinaire

It was quite the exceptional year, 2016, and I did grab the opportunity to write down my observations and offer investors today the opportunity to look back, relive the moments and draw some hard conclusions about investing in the world today.

If you are a paid subscriber to FNArena, and you still haven't downloaded your copy, all you have to do is visit the website, look up "Special Reports" and download your very own copy of "Who's Afraid Of The Big Bad Bear. Chronicles of 2016, A Veritable Year Extraordinaire" (in PDF).

For all others who still haven't been convinced, eBook copies are for sale on Amazon and many other online channels. You'll have to visit a foreign Amazon website to also find the print book version.
 

All-Weather Model Portfolio

In partnership with Queensland based Vested Equities, FNArena manages an All-Weather Model Portfolio based upon my post-GFC research. The idea is to offer diversification away from banks and resources stocks which are so dominant in Australia, while also providing ongoing real time evidence into the validity of my research into All-Weather Performers.

This All-Weather Model Portfolio is available through Self-Managed Accounts (SMAs) on the Praemium platform. For more info: info@fnarena.com

Rudi On TV

This week my appearances on the Sky Business channel are scheduled as follows:

-Tuesday, 11.15am Skype-link to discuss broker calls
-Thursday, interview on Switzer TV, between 7-8pm
-Friday, 11.15am Skype-link to discuss broker calls

Rudi On Tour

– I shall be participating as debate monitor at the upcoming National Conference of the Australian Investors Association (AIA) at the Marriott, Surfers Paradise, 30 July-2 August

– I will be presenting in Adelaide on November 14th to members of Australian Investors Association and other investors, 7pm on November 14th inside the Fullarton Community Centre, 411 Fullarton Rd, Fullarton. Title of presentation: Investing In A Slow Growing World – An Update

(This story was written on Monday 10th July, 2017. 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 the direct messaging system on the website).

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BONUS PUBLICATIONS FOR FNARENA SUBSCRIBERS

Paid subscribers to FNArena (6 and 12 mnths) 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.
– Who's Afraid Of The Big Bad Bear? eBook and Book (print) available through Amazon and other channels. Your chance to relive 2016, and become a wiser investor along the way.

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

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