Early Beginnings Not AbFab

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In this week's Weekly Insights:

-Early Beginnings Not AbFab
-September Index Changes
-Conviction Calls
-Rudi Talks – Uncomfortable Truths About Investing
-Rudi On TV
-Rudi On Tour

Early Beginnings Not AbFab

By Rudi Filapek-Vandyck, Editor

[Your Editor caught the flu over the weekend. Hence why Weekly Insights this week is in a shorter format.]

We are almost halfway through August, but nowhere near half the number of corporate results that are scheduled to be released before the 1st of September. Not sure why Europe and the US can do such a better job in spreading their corporate announcements, but in Australia the concentration always sits heavily in the second part of the month.

It seems even worse this year with the FNArena Corporate Results Monitor only showing 30 company results thus far, and the calendar says it's already August 13th. We are expecting a total tally in excess of 300 by early September, so these numbers give us a good idea of what is yet to be unleashed upon us.

By now, I hope you are all aware FNArena has dedicated a special section on the website for the monitoring of Australian corporate results. We are currently keeping track for August with updates occurring every day:

https://www.fnarena.com/index.php/reporting_season/

The first impression is not that fantastic, unfortunately. Whereas companies in the US know how to be loved and adored, and how to beat market expectations, it always seems Australia is playing to its own rhythm and rules, and they never look as attractive in comparison.

So far we registered five "Beats" (a little over 20%) and ten "Misses". The latter means we registered more misses than "In-Line" corporate results (nine), but it's early days yet, and given so many reports still remain unreported, it would be rather foolish to try to come up with far-reaching conclusions.

On a macro-level, global tensions are likely to remain with us, I believe, and with the ASX200 struggling, if not treading water in between 6200-6300, it seems the catalyst to move higher is not coming from local profit reports. So far, nobody genuinely seems in a selling mood either, so maybe that's the positive take-away.

In terms of stockbroking analysts' responses, FNArena registered seven downgrades in ratings against one solitary upgrade, thanks to Tabcorp ((TAH)), and Monday's weekly update on changes to valuations & price targets and to earnings estimates shows there is a helluva lot of activity taking place on both sides of the ledger – see story on the website.

Maybe stories like the one revealed by Tabcorp can still turn this August reporting season into a positive experience in that market expectations for share market laggards -"value" stocks in funds management parlance- might be too low. Certainly, Suncorp's ((SUN)) release would add more evidence to that, and CommBank ((CBA)) released its weakest set of numbers since the GFC and its share price went up!

But then, what to think of REA Group ((REA)), once again proving investor scepticism was unfounded. The share price has been rallying since the FY18 release, and so it should. REA has been, and still is, one of my favourite companies in the Australian share market, and here is why:

https://www.fnarena.com/index.php/fnarena-talks/2018/03/13/star-stocks-csl-rea/

The share price peaked near $95 in June and subsequently fell all the way to $81, where, as every technician will tell you, the 200 days moving average is situated. Why this share price fall? I believe it was a combination of general angst about the potential impact from a slowing housing market in Australia, plus the usual concern that High PE stocks might be priced for perfection.

Usually, REA Group shares fall after the release of financial numbers so there is an argument to be made such concerns are valid. This year, however, weakness has preceded the release of FY18 numbers and thus the share price added some $6 in quick fashion.

This year, also, we anticipated the peaking and falling in the share price so the FNArena-Vested Equities All-Weather Model Portfolio had reduced its exposure at a higher price and we have been buying extra shares post the results. We don't always manage to turn share market volatility into our advantage, but it's great when a plan works as it was intended to.

Magellan Financial is not of an equally High PE nature, but its experience this month has been similar. First came the sell-off, then the release of FY18 numbers and the subsequent rally. What these observations do is putting one big question mark behind the idea that the share market is always correct and share price action prior to financial results can be relied upon.

That's a big negative, thus. (The February reporting season provided similar evidence).

I also note the share price of James Hardie ((JHX)) put in a big swing upwards prior to results date, only to subsequently dive as the released financial numbers didn't quite meet analysts expectations. Here the belief remains that James Hardie is a high quality business with ongoing strong market fundamentals in the US.

Every single price target put forward by stockbroking analysts monitored by FNArena (see Stock Analysis) remains well above the share price.

We might well be witnessing a clear divergence between short term disappointment and longer term potential. The counter-argument is that James Hardie seems to be building a habit for short term disappointments, and the past two years or so have seen a few.

As per always: the choice is yours.

I see a similar theme behind the punishment that descended upon Orora ((ORA)) last week, as well as for ResMed ((RMD)) where share price weakness has proved of a very limited, short term nature.

One of the important "misses" was delivered by Rio Tinto ((RIO)) early in the season this month. Rio Tinto's result is important because it flags one of the most important issues for Australian companies: rising costs and how best to deal with it.

Investors should heed the warning because I suspect this won't be the last we will hear about it, and so do analysts at Macquarie. On Monday, they zoomed in on local energy companies predicting this running reporting season won't be a smooth experience for investors with many oil&gas companies expected to disappoint, and higher costs will be the main culprit if Macquarie's analysis proves correct.

The analysts consider Woodside Petroleum ((WPL)) the safest best in the sector. They downgraded Beach Energy ((BPT)) in anticipation of a negative surprise yet to be released.

The nastiest profit warning so far has been delivered by EclipX ((ECX)), previously enjoying the share market's benefit of the doubt because its leadership team consists at its core of the team that once upon a time successfully built FlexiGroup ((FXL)). But that was then, now is very much different.

This month's profit warning has seen funds managers like Wilsons dump their stock and the share price was clobbered on the day of the negative admission, despite the share price having been in a sustainable downtrend since November last year. You don't keep telling your shareholders all is running smoothly, and then come out with quite the severe profit warning, effectively admitting you have not been truthful or you don't genuinely have full control and understanding what is going on inside your business.

EclipX is a complex business, and management now has a trust issue. Its reputation has been tarnished. Unfortunately, the stock was part of the FNArena-Vested Equities All-Weather Model Portfolio and we have been selling down our exposure. Risk cuts both ways.

Whereas every commentator and his side-kick always gets hyper-excited about the risk that comes with seemingly expensively priced stocks that miss expectations, I am willing to wager that most investors' pain during reporting season comes from "cheap" looking stocks that simply become a whole lot cheaper.

Compare EclipX with ResMed and Orora, and draw your own conclusions.

Baby Bunting ((BBN)) once again proved sometimes the share market simply requires evidence, even if all the signs and predictions are there. Competitors have gone bankrupt, sold out their inventory, leaving Baby Bunting with short term headwinds, but also with a lot of market share potential beyond these short term headwinds.

The share price had been lingering around $1.40, doing nothing much, and on low volumes. Now we're talking $2.34, and potentially a lot more in the years to come, assuming management can keep the engine humming and no other unforeseen barriers pop up.

The biggest challenge for investors this month is to be able to distinguish short term impact from longer term potential. The macro picture is not getting easier. The Australian economy will remain running at multiple speeds for different sections. We'll have federal elections early in 2019. The RBA will sit on its hands and the housing cycle locally will weigh on consumer sentiment and household budgets.

Most importantly, the disruption and growth stemming from new technologies is not going to disappear.

See also last week's "August Reporting Season Preview: Potential Beats & Misses"

September Index Changes

Once this August reporting season is done and dusted, Standard&Poor's will announce its latest decisions as far as main indices are concerned in Australia.

If predictions by Wilsons Advisory are anything to go by, there could be some interesting developments afoot. Such as Brambles ((BXB)) possibly losing its inclusion in the ASX20 in favour of Aristocrat Leisure ((ALL)).

As far as the ASX100 goes, Wilsons suggests TPG Telecom ((TPM)) and possibly also Perpetual ((PPT)) might be ejected with Reliance Worldwide ((RWC)) and WorleyParsons ((WOR)) the most likely replacements.

But it's in the ASX200 where changes really count as here fund mandates start and end, with potential big implications for smaller cap stocks that enter and lose out. Potential new inclusions are Viva Energy Group ((VEA)), Elders ((ELD)), Emeco Holdings ((EHL)) and Bingo Industries ((BIN)) while those most at risk for losing their current spot include Genworth Mortgage Insurance Australia ((GMA)), Greencross ((GXL)) and Australian Pharmaceutical Industries ((API)).

As always, most changes are likely reserved for the ASX300 where Beadell Resources ((BDR)), Retail Food Group ((RFG)), iSelect ((ISU)), Sky Network TV ((SKT)), iSentia ((ISD)), Ainsworth Gaming ((AGI)), ImpediMed ((IPD)) and Mortgage Choice ((MOC)) are believed to be at risk, but possibly also Magnis Resources ((MNS)), Amaysim ((AYS)), Servcorp ((SRV)) and Class ((CL1)).

Candidates lining up to be included in the ASX300 are Pinnacle Investment ((PNI)), Clinuvel Pharmaceuticals ((CUV)), OM Holdings ((OMH)), Jupiter Mines ((JMS)), Sundance Energy ((SEA)), Nearmap ((NEA)) and Megaport ((MP1)) while Wilsons also believes Viva Energy ((VEA)), New Hope Corp ((NHC)), Praemium ((PPS)), Aurelia Metals ((AMI)), Wagners Holding ((WGN)), Polynovo ((PNV)) and Integral Diagnostics ((IDX)) stand a chance for index inclusion as well.

For some of these names, inclusion in the ASX300 is poised to attract attention from local investors who up until now might not even know some of these companies are actually listed.

As always, the above are but best guesses put forward by Wilsons. Ultimately it is Standard&Poor's who makes the decisions and they have in the past not always followed through on what seemed but logical inclusions and exclusions.

For those prepared to play the theme/date (index changes to be announced on the morning of 7 September), Wilsons makes the following suggestions: best ideas for upside surprise are Pinnacle Investment, Clinuvel Pharma and Nearmap, while Sky Network TV and Reliance Worldwide seem most poised for a negative share price impact.

The latter because once included in the ASX100 small cap fund managers usually have to sell as the stock then officially becomes too large to still be considered a small cap.

Conviction Calls

Analysts at Wilsons have reiterated their Conviction Calls while the August reporting season is ramping up. This can be a dangerous exercise with each reporting season throwing out unexpected beats and misses, but we'll leave those considerations to them.

Still included on Wilsons Buy list, with High Conviction, are Afterpay Touch ((APT)), Bravura Solutions ((BVS)), ARQ Group ((ARQ)) -this is the former Melbourne IT- Collins Foods ((CKF)), Ruralco ((RHL)), Ridley Corp ((RIC)), Citadel Group ((CGL)), ImpediMed ((IPD)), Mastermyne ((MYE)), NRW Holdings ((NWH)), Pinnacle Investment ((PNI)) and Noni B ((NBL)).

Those responsible for the Model Portfolio at Morgan Stanley have sold out of AGL Energy ((AGL)) with the company itself flagging a tougher outlook ahead and with political risk refusing to lay down. The portfolio has been buying extra shares in Lend Lease ((LLC)) and Tabcorp Holdings ((TAH)) while topping up its cash holding to 4%.

Needless to say, Morgan Stanley analysts have viewed recent market updates by Lend Lease and Tabcorp in a positive light. The leverage to the international infrastructure and property development via a well-managed, long term diversified product pipeline is now seen as attractive while Tabcorp fits in the mould of defensive earnings growth, supported by synergies and the migration to online.

In general terms, strategists at Morgan Stanley have been preparing their clientele (and everybody else who pays attention) to migrate into a more defensive mindset and portfolio composition. In Australia, the strategists do not necessarily believe "value" stocks are the place to be, and they advocate investors take a stock-based approach instead of resorting to a typical sector or investment style.

The new mantra, suggest the analysts, should now be "growth you can trust" and if it is yield you are after, choose sustainable cash yield.

In a fresh update on general strategy last week, Morgan Stanley analysts argue there might be a soft trend towards "value" stocks in the Australian share market right now, but it won't turn into a big portfolio switch a la late 2016, because by now investors are well aware (and they will be reminded of this) that many of the so-called "value" stocks in the share market are essentially fundamentally challenged.

In terms of quantitative analysis, Morgan Stanley argues momentum seems to have run out of puff, which puts growth stocks heavily dependent on momentum most at risk short term. Ideas put forward include Brambles ((BXB))  in a negative sense, alongside Qube Holdings ((QUB)), Spark Infrastructure ((SKI)), Challenger ((CGF)) and Aurizon Holdings ((AZJ)).

These are all "least preferred" for the time being.

Most preferred ideas are Metcash ((MTS)), CSL ((CSL)), Sonic Healthcare ((SHL)), Ansell ((ANN)), JB Hi-Fi ((JBH)), BlueScope Steel ((BSL)), Macquarie Group ((MQG)), Cochlear ((COH)), Flight Centre ((FLT)) and Insurance Australia Group ((IAG)).

Possibly equally noteworthy: The analysts had earlier Independence Group ((IGO)) on their Least Preferred Ideas list, but have now removed that stock following share price underperformance.

Rudi Talks – Uncomfortable Truths About Investing

I can report a recording of my seminar to members of the ASA has been added to the FNArena Talks section of the website. It shows one hour of introduction, slides, conversation and questions around the main themes that have characterised both share market dynamics and my personal analysis over the past five years.

Not everybody is going to like my analyses, conclusions and observations, which is why the title reads "Uncomfortable Truths About Investing In The Australian Share Market".

Here's a direct link to the recording: https://bit.ly/2Oc5w02 (or visit FNArena Talks)

Rudi On TV

This week my appearances on the Sky Business channel are scheduled as follows (flu permitting):

-Tuesday, 10.30am Skype-link to discuss broker calls
-Friday, 11am, Skype-link to discuss broker calls

Rudi On Tour

-Presentation to ASA members and guests Wollongong, on September 11
-Presentation to AIA members and guests Chatswood, on October 10
-Presentation to ATAA members and guests Sydney, on 18 October

(This story was written on Monday 13th August 2018. It was published on the Monday in the form of an email to paying subscribers at FNArena, and again on Wednesday as a story on the website).

(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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(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.) 

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