Rudi’s View: All Eyes On November 3

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Dear time-conscious investor: US election remains too uncertain to call; a new strategy for dividend-seekers; plus one under-reported record from the August results season

In this week’s Weekly Insights:

-All Eyes On November 3
-Income Seekers Need A New Strategy
-Time To Say Goodbye
-Stats, Damn Lies, And Corporate Profits?

All Eyes On November 3

By Rudi Filapek-Vandyck, Editor FNArena

The share market is always a collection of different narratives that often exist in opposition to each other.

One of the popular narratives that has attracted quite some attention these days is that tech stocks in the US had become separated from fundamentals and had started to exhibit typical bubble-like characteristics.

There are pockets on US share markets that definitely lend support to this view.

But there is the equally apposite observation that many of the emerging technology disruptors are genuinely enjoying boom-time conditions, and there is a lot of growth hiding underneath those elevated share prices.

Apart from the fact that we are experiencing mega trend-changes that will reshape society as we know it, tech stalwarts such as Apple, Microsoft and Alphabet sit very much at the centre of tomorrow’s Brave New World.

Another popular narrative is that Australian shares have been underperforming the US because the ASX doesn’t have equivalents to the American technology-driven market leaders.

Here the opposing narrative, equally accurate, is that covid-19 caused a lot more damage to corporate profits and dividends in Australia than it did elsewhere.

And as I never stop emphasising during my presentations to investors, every reporting season in recent years, time and again, reveals a much weaker performance from the local Top20 than it does for Australian companies in general.

The same observation stands for last month’s August results season during which the performance of local large caps Westpac ((WBC)), Insurance Australia Group ((IAG)) and Telstra ((TLS)) -yet again- stood in sharp contrast to what was achieved elsewhere.

If shares are guided by corporate profits, why would Australian indices rise in tandem with US equities?

US equities have deflated noticeably over the weeks past, which should be expected given the strong rally that preceded, but all-in-all, indices are still above levels of July (go figure!).

Over here in Australia, while some downward pressure is exhibiting itself, if we take a multi-month view it can easily be argued local indices have essentially tracked side-ways since June, in line with lacklustre corporate earnings and economic data hit by a second lockdown in Victoria.

So pick your pick, but I still have to see a genuinely valid reason to become concerned about my exposure to the share market.

Those investors worried about historically elevated looking valuations might want to consider that interest rates, consumer price inflation and bond yields are all near an historical low – and they all have a beneficial impact on growth assets (see also further below).

Equally important: earnings for corporate Australia, in general terms, are currently very depressed, likely looking forward to 2-3 years of recovery (same story for those hard-hit dividends).

It is probably not very smart to be too negative about corporate profits that are likely to continue growing in the years ahead, whether it be through mega trend-changes or from a depressed, covid-19 level.

None of the above repudiates that valuations still matter in the share market, and they do, which is why we are experiencing weakness for markets globally in September.

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Having said all of the above, as investors we should never underestimate the impact of sentiment on the direction of equity markets, and more precisely; the impact from changes in sentiment.

September is traditionally a weak month for US equities and this year we are facing the extra complication of a tightly contested US presidential election.

Some market commentators like to highlight historical parallels between when Republicans are in power, versus when Democrats are, or when the incumbent stays in power or loses the election but that’s very much analysing the world through the eyes of Harry Hindsight.

I think it’s much more important whether financial markets, this close to the November 3^rd election day, can comfortably start preparing for one outcome or the other.

Back in 2016 most portfolios would have been positioned wrongly, but this year? Who’d been foolish enough to take a 100% bet either way?

It is true that challengers Joe Biden & Kamala Harris are ahead in the polls, but uncertainty reigns, and one outcome that is very much feared, and seen as a genuine possibility, is there won’t be a clear outcome on the day.

For example, one telling detail I picked up recently is that Republican voters are most likely to vote in person on the day while Democrat voters have signaled they prefer to cast their vote through US post.

Take a guess why the sitting president and Republican supporters have been actively undermining postal voting.

In recent days I have heard stories about American ex-pats living in Sydney who are trying to vote but are as yet to receive the official document.

What if the initial results show a probable win for the incumbent, but then the postal votes swing the balance in favour of Biden-Harris?

As I wrote last week, the last time we had no clear outcome on US election day share markets didn’t take it well. Investors don’t like uncertainty, and they prefer to vote with their feet if only to tell themselves they are managing the risk.

History shows the weakest period of the calendar year usually runs from mid-September till mid-October, but this year’s election uncertainty is likely to linger a few more extra weeks.

Meanwhile in Europe, Boris Johnson is preparing for a hard Brexit, willing to violate negotiated agreement and international law.

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Last week's Weekly Insights:

https://www.fnarena.com/index.php/2020/09/17/rudis-view-plenty-of-clouds-diverging-scenarios/

Why today's share market valuations might not be too high:

https://www.fnarena.com/index.php/2020/07/23/forecasts-not-valuations/

Income Seekers Need A New Strategy

If there is one category of investors that has been hit hard by covid-19 this year it is your typical passive seeker of income through dividend paying companies on the local stock exchange.

Although it can also be argued many of the local staples for receiving dividends have been caught inside a downward sloping trading range for a number of years now.

All the bank share prices peaked in April 2015. The Telstra share price today is not that far off from when Australia’s own sovereign fund, the Future Fund, decided to offload its equity in order to start a genuine, diversified, multi-asset, global portfolio.

Whatever one’s view, requirement or level of passivity, it’s probably a fair assumption to make that 2020 is forcing income-seeking investors to have another good look at the portfolio and its long-term objectives.

A recent strategy update by DNR Capital, post the launch of its Australian Equities Income Fund in March, might provide some inspiration and suggestions for those investors searching for fresh sources of income.

The DNR Fund identifies four categories of income-providing equities:

-Growers; high-conviction stocks that may be paying a below-market dividend yield, but with a clear path towards delivering a sustainable and growing income profile in the medium term. Examples: REA Group ((REA)) and Seek ((SEK)).

-Compounders; quality stocks operating within a robust industry structure that have a strong competitive position, underpinning attractive and sustainable income growth. Examples Amcor ((AMC)) and IPH Ltd ((IPH)).

-Cows; stocks with a solid balance sheet and capital management potential that are being undervalued on traditional earnings-based metrics. Examples: Aurizon Holdings ((AZJ)) and Wesfarmers ((WES)).

-Yielders; quality companies at attractive valuations that are delivering sustainable and cash-backed dividends, however with little growth. Examples: Suncorp Group ((SUN)) and BHP Group ((BHP)).

A fifth category I’d like to add is a small group of more traditional yield/income providers on the ASX that might as well be regarded the local Dividend Aristocrats; offering relatively high yield backed by growth and with an extremely low chance of having to cut the payout to shareholders.

When I recently updated the lists on the All-Weather Stocks section on the FNArena website, I identified exactly five such ASX-listed securities. Available for paying subscribers only.

Time To Say Goodbye

Shortly after arriving in Australia in late August 2000, I witnessed the demise of iconic local company names such as Pacific Dunlop and Mayne Nickless.

Both conglomerates had been around for as long as most Australians could remember. Pacific Dunlop’s origin traced back to 1899 while Mayne Nickless was founded in 1886.

Pacific Dunlop had been a proud member of the ASX’s Top20, but by the time I arrived had shrivelled to a sick corporate entity struggling forth. Its legacy lives on through Cochlear ((COH)) and Ansell ((ANN)) today.

Underwear sellers Pacific Brands had also once been part of the great Pacific Dunlop. It was acquired and delisted from the ASX in June 2016.

The leftovers from Mayne Nickless are today incorporated into Mayne Pharma ((MYX)).

In my online presentations this month, I look back at those experiences from twenty years ago and tell investors it’s most likely time to ring the bell for two other iconic Australian brand names; AMP ((AMP)) and Telstra ((TLS)).

It is my observation, the boards of these two companies have come to the conclusion a successful turnaround of the moribund business model is increasingly looking unlikely.

AMP is effectively waiting for a suitor to turn up and buy the whole lot, preferably cheaply priced, probably with a plan to unleash value through selling off parts of the failing financial services provider.

Telstra, it is already rumoured, is quietly preparing for a business split in two, three or four units, in order to -finally- unlock value for shareholders.

The latter process might still take two years from now, but it seems the inevitable outcome for the former government-owned telecom monopolist whose main claim to fame is having destroyed billions of dollars in shareholder capital while promising an unsustainable dividend along the way.

How many dividend-hungry Australian retirees have been lured in by that juicy looking yield since the late nineties, only to end up with less capital and ongoing uncertainty about what the dividend might look like next year and thereafter?

I guess we will never know.

The Australian Shareholders Association (ASA) has promised a copy of the recording of my webinar to their members on Tuesday. Once received, we will add this broadcast to the FNArena Talks section on the website.

In the meantime, paying subscribers can download the slides of my presentations via the Special Reports section, which is easiest accessed via the drop-down menu starting from ANALYSIS & DATA (scroll down).

Stats, Damn Lies, And Corporate Profits?

One of the under-reported observations from the recent August reporting season is the ever-widening gap between statutory profits and “underlying” profits, with the latter increasingly being promoted by ASX-listed businesses as the true marker of overall performance.

It goes without saying, there can be multiple, valid reasons why companies switch to underlying profits, and it does not by default indicate fraud or deception is now high on the agenda.

But on calculations published by the AFR’s James Thomson on 31 August, the gap between statutory and underlying profits has grown as wide as $28.6bn -76.5%- for the 172 members of the ASX200 that reported during the month.

$37.3bn versus $65.8bn “underlying” – it’s hard to fathom this is not an all-time record and surely it must act as a warning to shareholders that more scrutiny might be required during times of corona and lockdowns.

Within this framework, ASIC last week reported it had intervened in four cases of financial reporting by four local companies.

These four in question are (with quotes from the official ASIC communication):

-Nitro Software Limited ((NTO)) – The decision to reduce both its contract assets and deferred revenue balances relating to client software subscriptions by $14.7 million in its financial report for the half-year ended 30 June 2020. ASIC had raised concerns on the recognition of the equal and offsetting contract assets and deferred revenue from the inception of multi-year subscription contracts at 31 December 2019.

–Kresta Holdings Limited – The decision to reduce the gain recognised on a sale and leaseback transaction by $997,000 in its financial report for the half-year ended 30 June 2020. ASIC had raised concerns on the amount of the gain on the sale and leaseback of a property under a new standard on lease accounting in the financial report for the year ended 31 December 2019.

-Elixinol Global Limited ((EXL)) – The decision to impair goodwill, inventories and other assets by $60 million in its financial report for the half-year ended 30 June 2020. ASIC had raised concerns about the reasonableness and supportability of free cash flow forecasts used in assessing goodwill for impairment at 31 December 2019 having regard to historical performance and market conditions.

–LawFinance Limited ((LAW)) – The decisions to reclassify $41.6 million of liabilities from non-current to current and to restate comparative information to recognise $19.6 million of fair value gains on liabilities in the following period in its financial report for the half-year ended 30 June 2020. ASIC had raised concerns on the classification of liabilities and recognition of fair value gains on liabilities in the financial report for the year ended 31 December 2019.

According to Thomson’s analysis, by far the largest contributor to the gap between statutory and underlying profits came from asset write-downs by the likes of Boral, Qantas and Woodside Petroleum.

(This story was written on Monday 21st September, 2020. It was published on the day in the form of an email to paying subscribers, and again on Thursday as a story 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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