Rudi’s View: Woodside, Webjet, Lendlease, Goodman Group & The Lottery Corp

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In this week's Weekly Insights:

-Recession? The Other Type
-Here Endeth The Housing Bull Market
-Dividends For Mum?
-Conviction Calls
-FNArena Talks
-Behind The Curve On Climate

By Rudi Filapek-Vandyck, Editor FNArena

Recession? The Other Type

Market strategists at Morgan Stanley remain of the view that equities in the US will end up at lower levels before investors can comfortably assume a bottom has been established in this cycle of unwinding and de-rating after years of central bank largesse and exceptionally low bond yields.

And while lots of debates are being held about whether economies in the US, China and elsewhere might be heading towards an economic recession, Morgan Stanley makes the point there is that other type of recession -in corporate earnings- that might prove more important for equity markets in the weeks/months ahead.

"…we need to distinguish a potential profits recession from an economic one. Regarding the former, odds are growing that sequential profit growth has peaked and will turn negative at least for a few quarters, as inventory levels normalize and costs stabilize from all-time high margins".

Viewed from an Australian point of view, I certainly sympathise with that approach. Unless we are now underestimating the true pain among Australian households, and what is yet to come through on the back of RBA tightening, the Australian economy should not face an economic recession this year or next.

But corporate earnings are what ultimately decides which stocks are cheap and which ones are still expensive, and that cycle is definitely turning in 2022. See also 'more to read' further below.

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Recent research by JP Morgan focused on the ability of corporate Australia to maintain margins throughout a time of cost pressures and rising funding costs. One of the conclusions drawn is the key grocery names on the ASX — Coles ((COL)), Metcash ((MTS)) and Woolworths ((WOW)) — should be able to maintain the margins enjoyed during the pandemic era.

But there are several companies that enjoyed a margin windfall that is now coming under closer scrutiny. Question marks are rising for Ansell ((ANN)), Carsales ((CAR)), Premier Investments ((PMV)) and Super Retail ((SUL)).

On a more positive note, JP Morgan's analysis also suggests multiple so-called covid-winners should be able to at least maintain their margin, if not increase margin post-pandemic.

These companies include CSL ((CSL)), Healius ((HLS)), JB Hi-Fi ((JBH)), James Hardie ((JHX)), Nine Entertainment ((NEC)), Steadfast Group ((SDF)), and Seek ((SEK)).

And when it comes to identifying covid-losers who should see a margin recovery, the research points at Corporate Travel Management ((CTD)), Crown Resorts ((CWN)), Flight Centre ((FLT)), Monadelphous ((MND)), and Qantas Airways ((QAN)).

Back to Morgan Stanley where positive expectations are warming up for the final quarter of the running calendar year (don't say all is lost too early!):

"We sense not only are we passing “peak Fed” but that more positive catalysts will arrive by the fourth quarter as inflation decelerates, China stimulus accelerates and the US midterm election campaigns heat up."

More Reading:

-Quo Vadis, Corporate Profits? https://www.fnarena.com/index.php/2022/06/02/rudis-view-quo-vadis-corporate-profits/

-Don't Fight The Fed: https://www.fnarena.com/index.php/2022/05/26/rudis-view-dont-fight-the-fed/

-Trend Is Turning For Corporate Profits: https://www.fnarena.com/index.php/2022/05/12/trend-is-turning-for-corporate-profits/

-A Bear Market Anomaly That Confuses: https://www.fnarena.com/index.php/2022/05/05/rudis-view-a-bear-market-anomaly-that-confuses/

-Peter's Portfolio Reviewed: https://www.fnarena.com/index.php/2022/04/13/rudis-view-peters-portfolio-reviewed/

-2022, The Big Adjustment: https://www.fnarena.com/index.php/2022/02/17/rudis-view-2022-the-big-adjustment/

Here Endeth The Housing Bull Market

As the saying goes, life has a few certainties we can all rely upon. We will all die, at some point, and pay tax – even though we may wish otherwise.

And as the RBA, in line with other central banks, hikes interest rates and effectively makes borrowing and the price of money more expensive, the up-trend in domestic property prices comes to an end, with follow-though impact for household spending and the broader economy in general.

What might feel uncomfortable to some is the fact the RBA has only just started and Sydney house prices have already clocked off on four months of declining prices, with Melbourne now showing three months of declines. Market analysts at Wilsons, however, are not too worried about it.

They label the early impact "as expected".

Wilsons sees a 12-18 months process unfolding during which the general debate will concentrate on how high the RBA can/will be able to move in this tightening cycle.

Wilsons' base case scenario is for a -10% fall in housing values, possibly -15%, with the bulk of the decline showing up in 2023. As these cycle corrections seldom develop as planned, there is a chance of a greater price fall, say -20%, but the analysts add the RBA would not want to see any more weakness beyond this point lest it causes a deep recession for the Australian economy.

What makes this cycle different from the past is that household debt-to-income and house price-to-income ratios are significantly higher than in the past. While mortgages are theoretically stress tested by the banks for a rise of between 2.5% to (more recently) 3%, Wilsons is of the view Australain households cannot cope with this level of financial stress.

The key question then becomes: at what level can/should the RBA stop tightening?

Wilsons thinks today's neutral rate is around 2%, which is higher than some other expert voices who believe it could now be as low as 1.5%, but certainly not as high as indicated by the local bond market where forward indications through the futures market are signalling a cash rate of 3.5% next year.

Among the proponents of 'tell them they're dreaming, the local cash rate is unlikely to move past 1.50%' is the local team of fixed interest specialists responsible for managing the Absolute Return Bond Fund at Franklin Templeton. In a press release last week, the team warned that

"The monetary action being taken right now will manifest itself in significantly weaker growth over the coming 12 months. The extent of monetary policy will be a determining factor."

Even if its own 1.5% cut-off proves too low, there remains plenty of conviction at Franklin Templeton RBA tightening won't be nearly as aggressive as implied by Australian government bonds.

Whatever the case, Wilsons believes the secular decline in mortgage rates is now kaput, finito, over and done – with major consequences for the pricing of properties.

While the projected house price decline will not go on indefinitely, Wilsons still maintains property investors should expect a much more benign outlook once the current tigthening cycle has run its course.

Dividends For Mum?

A suggestion via email that would make a lot of sense most times and under most circumstances:

"My Mum is a pensioner and she has about $100,000 in the bank. She has no debt and owns her own home. I suggested to her that if she puts some money, say $50,000,  in shares, say a bank share, she would get better income and also get some franking credits if she lodged a tax return."

What do I think? Don't do it.

The last thing you want to be doing is having to explain to your mum why that fabulous idea of yours has shrunk her capital. While I sympathise with the underlying premise, and I would agree under most scenarios and circumstances, (still) mounting risks in 2022 mean the preferred option here should be for your mum to wait and see what exactly will transpire over the months ahead.

Maybe revisit your idea by early next year and see whether the share market by then carries less risks. Money lost is just that, and your mum is not in a position to make up for it otherwise.

When the overall risk has receded, I suggest pick an ETF with high yield, and franking on top. No need to leave your mum's hard earned money exposed to single-company risk.

Things will become better (less risky), but it won't happen overnight, or next week, or even next month. Be patient.

Conviction Calls

A deep dive into ASX-listed REITs amidst rising bond yields (RBA is in hiking mode) and slowing economic growth has led Macquarie analysts to the conclusion that investors should not treat this sector with a one-size-fits-all approach.

Slowing economic growth is likely to create more vacancies for Offices, for example, while pressure on household budgets should translate into headwinds for Retail assets. Meanwhile, long WALE assets have been highly priced, argues Macquarie, and this represents its own type of risk.

Rising bond yields on the back of tightening central banks do pose serious headwinds for the sector, as it is one of the most obvious bond-proxies on the ASX, but Macquarie points out most listed REITs are already trading at a serious discount to Net Tangible Assets (NTA) valuation, and there are lots of offsetting features, sometimes REIT-specific.

Were balance sheet weakness to become an issue, Macquarie points at Scentre Group ((SCG)) and Unibail-Rodamco-Westfield ((URW)) as most at risk. It'll become more difficult for funds managers, such as Goodman Group ((GMG)) and Charter Hall ((CHC)) to outperform market expectations from here onwards, and margins for your typical developers are most likely at risk; think Lendlease ((LLC)) and Mirvac Group ((MGR)), among others.

On the positive side, Macquarie reports five REITs screen positively while also carrying an Outperform rating from the broker; Abacus Property Group ((ABP)), Centuria Industrial REIT ((CIP)), HealthCo Healthcare & Wellness REIT ((HCW)), Dexus ((DXS)), and GPT Group ((GPT)).

P.S. WALE = weighted average lease expiry and your typical representative on the ASX would be Charter Hall long WALE REIT ((CLW)).

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Emerging Companies analysts at JP Morgan, a fancy way of saying we focus our attention on small cap companies, have nominated Iress ((IRE)) as their current Top Pick.

Least preferred, or Bottom Pick, is Flight Centre ((FLT)).

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JP Morgan's Model Portfolio has sold out of AGL Energy ((AGL)) and replaced Dexus ((DXS)) with Lendlease ((LLC)), while adjusting relative exposures to Woodside Energy ((WDS)) and BHP Group ((BHP)) following the spin-off of the latter's Petroleum division into the former.

An Overweight exposure to financials has led the portfolio to underperform in May.

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The duo of software enthusiasts -"passionate" on their own account- at Shaw and Partners remains of the view investors are too bearish on local software companies.

Their Top Picks for the sector in Australia remain Whispir ((WSP)), Gentrack Group ((GTK)), Keypath Education International ((KED)), Elmo Software ((ELO)), and Readytech Holdings ((RDY)).

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Citi analysts responsible for researching consumer-oriented stocks in Australia believe the no love approach from investors thus far this year has gone way too far.

One of the central conclusions that underpins that view is Citi's conviction that Australian households have plenty of scope to reduce their rate of saving in response to cost of living and interest rate pressures.

On that basis, Buy ratings remain in place for discretionary retailers Bapcor ((BAP)), Super Retail Group, Premier Investments, Baby Bunting ((BBN)), and Harvey Norman ((HVN)).

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A most interesting research update has been released by the precious metals team at UBS, which has decided to pull back gold price forecasts on increased competition from quality credit, positive US real rates and market sentiment overall improving.

UBS recommends "investors who hold gold as a long-term hedge not to add or build up exposure, but we also advise adding some downside protection for 2H".

As far as forecasts go, UBS has now penciled in US$1,800/oz for end-September, from US$1,850 previously, and US$1,700/oz for end-2022, from US$1,800, while the forecast is for a gold price of US$1,700/oz by the end of June 2023.

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When the facts change, I change my mind. What do you do, Sir? This iconic quote from John Maynard Keynes would have been on the mind of market strategists Andrew Tang and Tom Sartor at stockbroker Morgans when they last reviewed their list of Best Ideas for investors in Australian equities.

Having added Aristocrat Leisure ((ALL)) and Domino's Pizza ((DMP)), the duo decided it's time to cull their list. The general risk-off sentiment among investors is likely to translate into weaker share prices for longer, while changes in analyst coverage equally had an impact.

Companies that lost their inclusion: Atlas Arteria ((ALX)), Atomos ((AMS)), Cochlear ((COH)), HealthCo Healthcare & Wellness REIT, Hub24 ((HUB)), Namoi Cotton ((NAM)), Universal Store Holdings ((UNI)), Volpara Health Technologies ((VHT)), Waypoint REIT ((WPR)), and Woodside Energy.

Bank of Queensland ((BOQ)), Panoramic Resources ((PAN)), Ramelius Resources ((RMS)) and Red 5 ((RED)) have been removed due to a change in analyst coverage.

Still on the selection are 35 Best Ideas, including Wesfarmers ((WES)), Macquarie Group ((MQG)), ResMed ((RMD)), BHP Group, South32 ((S32)), Santos ((STO)), Seek, IDP Education ((IEL)), NextDC ((NXT)), Nufarm ((NUF)), Lovisa Holdings ((LOV)), Pro Medicus ((PME)), Whitehaven Coal ((WHC)), Karoon Energy ((KAR)), HomeCo Daily Needs ((HDN)), TechnologyOne ((TNE)), Corporate Travel Management, and Webjet ((WEB)).

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Macquarie's Model Portfolio continues to seek solace in a barbell strategy combining overweight positions in Resources and in Defensives.

The first group includes BHP Group, South32, Woodside Energy, Newcrest Mining ((NCM)), Northern Star ((NST)), Pilbara Minerals ((PLS)), ALS Ltd ((ALQ)) and Seven Group Holdings ((SVW)).

The second group consists of Coles, Woolworths, CSL, Ramsay Health Care ((RHC)), Healius ((HLS)), Goodman Group, GPT Group, Steadfast Group ((SDF)), and The Lottery Corp ((TLC)).

The broker suggests high dividend paying resources companies will remain supported as we approach the August reporting season.

Separately, market strategists at Wilsons recently also made the case for adding more Quality Defensives to investment portfolios.

In line with this view, investors are being guided towards CSL, APA Group ((APA)), Transurban Group ((TCL)), Insurance Australia Group (IAG)), Medibank Private ((MPL)), Suncorp Group ((SUN)), Brambles ((BXB)), Goodman Group, Amcor ((AMC)), Orora ((ORA)), Coles Group, Metcash, Woolworths, and Telstra ((TLS)).

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Barrenjoey equity strategist Damien Boey remains convinced markets are approaching peak inflation angst, which should translate into moderating discomfort and a peak in bond yields too.

As the Federal Reserve continues to hike by 50 basis points at each upcoming meeting, calls for the central bank still operating behind the curve will find less and less acceptance, the strategist surmises.

Boey suggests investors should position for peak rates volatility and slowing growth. His personal favourite quant exposures are Quality and anti-momentum.

FNArena Talks

Peter Switzer decided it was "the greatest interview with Rudi on the big issues around investing". It lasted around 26 minutes and the video is available via Youtube:

https://www.youtube.com/watch?v=RyH_Fny55HI&t=2015s

In addition, I will be presenting at the upcoming Australian Gold Conference in Sydney, June 14 &15. I am scheduled for the Wednesday afternoon:

https://www.goldevents.com.au/

Behind The Curve On Climate

Last week, I had the privilege of attending an off the cuff, frank and no-holds-barred meeting with abrdn chief economist Jeremy Lawson, who in previous roles served the RBA, the OECD and then-prime minister Kevin Rudd.

Lawson made no bones about it: the world is well past the point whereby the general increase in temperature can still be limited to 1.5 degrees Celsius. Despite all the political rhetoric, the ESG trend and general mood-shifts in the electorate, it will not get better from here onwards.

It is his view Australia can serve as an example of why the global energy transition cannot progress rapidly enough as governments, at all levels, grapple with how to migrate away from fossil fuels without leaving dependent local communities in the lurch.

So what should we then prepare for? Should we still prepare for anything?

Lawson has developed a habit of asking the room of attendees what they think the ultimate increase in temperatue might look like. Answers usually vary between three to four degrees Celsius. Note: the audience usually consists of professional investors and asset allocators.

Oddly enough, it is this pessimism that feeds into Lawson's optimism the world will eventually find a way to prevent such an outcome, which would be disastrous for the climate as we know it today.

Lawson is a non-believer in carbon capture and storage (CCS) but he does see plenty of potential in newly developed and developing technologies. Ultimately, any success will be dependent on governments' willingness, and ability, to cut through short-term political cycles, is his view.

For investment firms such as abrdn, the challenge comes down to deciphering which of the traditional, 'old economy' companies are genuinely embarking on strategies to reduce carbon emissions and which ones are merely delivering lip service. Lots of selling porkies, smoke-and-mirrors tactics and hoping for the best going on at the moment, as one would expect.

When asked the question back, Lawson stated he was hopeful the world can manage to limit the global temperature increase to 2.25C.

(This story was written on Monday 6th June, 2022. 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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