Rudi’s View: The Trend Remains Up

This story features BANK OF QUEENSLAND LIMITED, and other companies. For more info SHARE ANALYSIS: BOQ

In this week's Weekly Insights:

-The Trend Remains Up
-CSL Optimism Creeping Back In
-Conviction Calls
-FNArena Talks
-Research To Download

By Rudi Filapek-Vandyck, Editor FNArena

The Trend Remains Up

Now that April has been replaced by May, and the share market has put in another strong performance (up 20%-plus since October ex-dividends), investor worries about high asset prices and the risk of a downward correction are once again rising.

While a temporary pull-back does not necessarily need a trigger or a reason, a deeper correction does require a fundamental shift. In the current context, I believe such a shift would either be triggered by sharply rising bond yields in response to the market's changing view on inflation or by corporate profits not living up to expectations.

Bond yields rose sharply during the first quarter of the calendar year, but tensions have subsided and the general view remains that whatever comes our way in terms of consumer price inflation is simply off last year's low base and caused by restrictions on imports and international supply chains that will be resolved in due course.

Last week, economists at Handelsbanken summarised the inflation question as follows: "A spike this year, but the inflation scare is hype". Bond markets can still become more volatile, of course, as short term economic data remain notoriously difficult to predict, but for now the inflation scare has subsided. Bond yields the world around are lower than in March.

And central bankers have kept repeating their mantra that inflation is still ephemeral, and will be, unless labour markets are a whole lot stronger. Another point made by Handelsbanken is the global pandemic is causing long-term damage to employment rates. Both the FOMC and the RBA locally want to see much tighter markets for jobs.

Then again, there is no such thing as 'never' in financial markets. Robert Kaplan, president of the Federal Reserve Bank of Dallas, has become the first to openly disagree with the 'nothing to see here'-message from Fed Chair Jerome Powell. And the Bank of Canada has announced its intention to start reducing the size of weekly bond purchases, otherwise referred to as 'tapering'.

Bonds selling off sharply earlier in the year (yields rising) caused a few ructions here and there, predominantly for quality and growth stocks trading on higher valuations, but it did not pull markets in a downward spiral. Markets merely traded sideways while exhibiting a lot of volatility. Next time may not necessarily be much different.

A much more dangerous threat will come from corporate earnings not living up to expectations. Here the importance of the results released by Australian banks this week cannot be over-estimated.

Westpac In Focus

On Monday, Westpac released interim financials that at first glance look nothing short of phenomenal. Statutory net profit improved by 189%. Cash earnings increased by 256%. Cash EPS of 97c more than tripled from twelve months ago. The half-yearly dividend of 58c compares with the 31c the bank paid out for the full financial year of 2020.

Of course, as we are all too aware, last year's comparables represent a decade low for many companies, including banks such as Westpac, as the global pandemic forced countries into lockdowns and international trade and travel into a halt. So the real question is how these results compare with market forecasts and what is already priced into share prices.

Westpac's financial performance has proved better than expected on key financial metrics, so expect upgrades from sector analysts in the days post the event. In the lead up to this week's results, share prices for the banks had held their own as many in the market were anticipating strong recovery results, supported by reserve write-backs, leading to analyst upgrades and yet another boost to valuations.

Judging from Westpac's release, it looks like those expectations have been vindicated, as was also the case with Bank of Queensland ((BOQ)) in mid-April. The not so good part in this story is that shares in Bank of Queensland are still trading below the level of late February, suggesting the market is not prepared to fully reward the better-than-expected operational performances.

This could be somewhat of a worry, short-term, though Westpac shares rose a full 5% on the day of the results release in an otherwise lacklustre, energy-deficient market.

On Wednesday this week, Amcor ((AMC)) and ANZ Bank ((ANZ)) are scheduled to release respectively quarterly and interim results, with National Australia Bank ((NAB)), Eclipx Group ((ECX)) and Irongate Group (IAP)) to follow on Thursday, and Macquarie Group ((MQG)), News Corp ((NWS)) and REA Group ((REA)) on the calendar for Friday.

This week also includes a three-day conference organised by Macquarie which will see yet more companies providing updates (circa 100 companies in total are participating).

Next week sees results from Pendal Group ((PDL)), GrainCorp ((GNC)), Orica ((ORI)) and Xero ((XRO)), among others (check out the FNArena calendar for more names, dates and details).

More Punishments Than Rewards

Corporate market updates have been a rather mixed affair in Australia over the past few weeks.

A weak result from Coles ((COL)) got rewarded, but Woolworths' ((WOW)) got punished. Charter Hall ((CHC)) upgraded guidance for the third time this financial year, but its share price still has not recovered in full from the sell-down early in the year. This despite some analysts predicting the company can still beat its freshly upgraded guidance in August.

One of the stand-out market updates recently was surely delivered by steel manufacturer BlueScope Steel ((BSL)) whose fresh indication simply blew away analysts forecasts on stronger prices and higher margins, showing the ultimate definition of operational leverage. According to management's latest indication, BlueScope will outperform last year's financial performance by a factor 11x, or thereabouts – completely unheard of under pre-covid circumstances.

The problem is many an analyst questions for how much longer these goldilocks dynamics can be sustained, and thus BlueScope Steel shareholders have not been rewarded either. (The company will announce a rather negligible dividend in August).

On the other side of the ledger we find the likes of Kogan ((KGN)) and ResMed ((RMD)) whose market updates did not quite meet expectations, with strong growth numbers from last year one of the key hurdles, and share prices have been punished in response.

I have not collated any specific data regarding market updates in April and into May, but anecdotal observations suggest it has been a whole lot more difficult to please the market than it is to receive punishment and rejection.

Last year's covid-beneficiaries in particular now have a high hurdle to overcome.

Maybe some fatigue is creeping in while others are anticipating the seasonal weakness in May?

More Upgrades Are Forthcoming

As with BlueScope Steel and others, investors might prefer a more cautious approach following a stellar recovery from last year's pandemic lows, but strategists at the likes of Macquarie, Morgan Stanley and Wilsons remain convinced the current upgrade cycle for corporate profit estimates has a lot further to run, still.

Which is why, as I have been highlighting in recent weeks myself, this week's corporate updates, banks in particular, are of paramount importance. Sentiment might be fatigued. Investors can question the ongoing potential post mid-2021. But history shows if profit forecasts keep rising, share prices will catch up, eventually.

Profit forecasts in aggregate in Australia have been rising for eight consecutive months now. Thanks to covid (credit where it's due), but Australia is now enjoying its strongest upgrade cycle in many decades; stronger also than comparable contemporary cycles in Europe and the US.

In the end, while the ASX200 is not too far off from the all-time high reached in mid-February last year, projected earnings in aggregate are, notwitstanding a phenomenal recovery, still some -7% short of where forecasts were pre-covid, on Morgan Stanley's assessment. The team of strategists does believe Australian companies are able to bridge the remaining gap, starting with the banks this week.

All that is needed to pull the market's earnings per share back to pre-covid forecasts, says Morgan Stanley, is a good result from the banks, followed by the next mark-to-market for miners and other resources companies. That should fix it. Most commodity prices have remained stronger for longer thus far in 2021.

Macquarie remains a big fan of the commodities-inflation-higher bond yields narrative for the remainder of 2021. Wilsons too believes the big drivers underneath Australia's profit growth outlook are the banks and materials sector, effectively the Big Four Banks plus Macquarie Group ((MQG)) combined with large caps BHP Group ((BHP)), Rio Tinto ((RIO)), Fortescue Metals ((FMG)), Woodside Petroleum ((WPL)), and Santos ((STO)).

On Wilsons' forecasts, EPS earnings will still be below pre-covid levels by the end of FY22 (next year), but it is the prospect of ongoing improvement that will keep a positive tone in the market, Wilsons believes. This broker holds a high conviction on copper miners.

Wilsons also observes the local technology sector has been one of few sectors having suffered earnings downgrades over the past three months, as investors might have figured on the basis of how the likes of Appen ((APX)), Kogan, Temple and Webster ((TPW)), Nuix ((NXL)), Bigtincan Holdings ((BTH)), and others have been treated these past few months.

On average, however, Wilsons does not believe the sector has dramatically underperformed the broader market, even with the absence of positive earnings revisions. This might signal that the market is increasingly separating the wheat from the chaff when it comes to structural growth, quality and tomorrow's megatrends.

CSL Optimism Creeping Back In

After putting in yet another rally attempt late last year, the CSL ((CSL)) share price has suffered another down-draught in calendar 2021 which took the share price from above $300 to below $246 in March.

These are big numbers, at face value, but in percentage terms (-18%) they represent no more than what smaller cap disappointments can lose in a single day.

One need not look far to figure out why 2021 has not been the kindest for the CSL share price. Market consensus forecasts have steadily declined, with FY21 and FY22 converging; implying no growth next year and, depending on the direction of the US dollar, potentially a negative re-adjustment for shareholders in Australia.

The consensus target price has equally declined to $297 from $316.

But, with bond yields in calmer waters and the US dollar no longer declining, the CSL share price has steadily managed to climb its way back above $270. A recent update by stockbroker Jarden suggests there is room for more optimism on the operational side, which no doubt explains part of the recovery.

As explained in my earlier expose, the market is awaiting signs that the collection of plasma is normalising in the US. The two analysts at Jarden recently met up with one of CSL's competitors in the space and returned with several indications the outlook for the industry overall seems to be improving.

Signal number one is that plasma volumes have stepped up noticeably in April. The connection with the Biden administration's successful vaccination roll-out is that US citizens have become more confident they can visit collection centres without getting infected by the coronavirus.

An additional benefit has come from the fact that previously regular donors have been visiting less and this has improved the overall quality of plasma collected during the downturn. As a result, there are more plasma proteins in the volumes collected, which pushed up the average yield per litre by some 4-5%, reports Jarden.

If the recovery in volume proves sustainable, it is likely the market will quickly start viewing CSL and competitors through a positive lens again. However, that kick up in average yield per litre plasma is almost by definition not something anyone would have thought about, opening up the possibility for positive surprise in August.

Other more benign positives mentioned in the Jarden research report are the repurposing of plasma put aside to unsuccessfully develop a treatment for covid. Those volumes represent a slight compensation for the damage done by the virus through fewer visits to collection centres.

Plus Canada is about to allow donors to be paid in Alberta. Jarden believes this will make Canada self-sufficient pretty soon and allow the industry to redirect volume into other geographies.

Jarden recently set up shop in Australia, having previously operated in a close relationship with Credit Suisse for research coverage of NZ and ASX-listed companies. It does not form part of the seven stockbrokerages monitored daily by FNArena. Jarden's twelve month price target for CSL is $334.80, higher than the rest-of-the-seven beating price target of $330 set by UBS. Jarden's recommendation, unsurprisingly, is therefore set on Outperform.

Conviction Calls

Stockbroker Morgans has updated its Best Ideas for the Australian share market. As some readers might remember, the list contains no less than 41 stocks, so there is no shortage in opportunities as far as this broker is concerned.

Might be worth zooming in on the changes that have been made since the prior update about one month earlier. Have been removed: Westpac and Zip Co ((Z1P)). Have been added: ANZ Bank ((ANZ)), Sonic Healthcare ((SHL)), Reliance Worldwide ((RWC)), Tyro Payments ((TYR)), and Whitehaven Coal ((WHC)).

Meanwhile, market strategists at Macquarie retain a preference for companies that benefit, either directly or indirectly, from higher commodity prices. Macquarie's Model Portfolio has exposure to BHP Group, Mineral Resources ((MIN)), OZ Minerals ((OZL)), Woodside Petroleum, Northern Star Resources ((NST)) and Origin Energy ((ORG)).

A second group of favourite exposures benefits from higher bond yields, in inflation adjusted terms, with the focus on Westpac, ANZ Bank, Suncorp ((SUN)), QBE Insurance ((QBE)), Insurance Australia Group ((IAG)), Janus Henderson ((JHG)) and Computershare ((CPU)).

Macquarie's portfolio has underweight positions in companies that are consumers of commodities, such as Amcor ((AMC)), Orora ((ORA)), Pact Holdings ((PGH)), James Hardie ((JHX)), Adelaide Brighton ((ABC)), CSR ((CSR)), as well as Reliance Worldwide, Brambles ((BXB)), and Ansell ((ANN)).

FNArena Talks

Weeks ago already, I shared my market insights with podcast spark your F.I.R.E. (audio only):

https://podcasts.apple.com/au/podcast/financial-markets-with-rudi-filapek-fnarena/id1450103785?i=1000517106346

Research To Dowload

The previous Weekly Insights had the wrong link for the Edison research report on Kazia Therapeutics ((KZA)):

https://www.fnarena.com/downloadfile.php?p=w&n=80A391E5-0C4B-2D4C-1942C471B820F45B

(This story was written on Monday 3rd May, 2021. 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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