Your diarist welcomes you back for the May edition of the Burrell Blog. In this edition, Chris provides an update of his key themes for 2015, and takes a closer look at the ‘Big 4’ banks.
Commonwealth Bank shares were trading at $50 in June 2011 and again in June 2012. Two years later in June 2014 CBA traded at $80, a capital gain of 60% and a total return over the two years of over 70% including dividends.
CBA continued to appreciate and in March 2015 reached a high of $96.69. Based on 2015 earnings per share estimated at $5.64, this is a price earnings ratio of 17.1 times. What explains this trading pattern?
Dividend Yield Driver
The key theme outlined earlier this year for consideration by investors is the dividend yield driver. As fixed interest rates in Australia have fallen, banks and other quality industrials with good yields have had their prices bid up. For the banks, the rule of thumb seems to be a dividend yield around 5%. There has been wide publicity about the short term cash rate falling, most recently to 2% and this coincides with falls in recent years in the Australian 10-year bond yield to 2.32%.
The historical average yield on 10-year bonds is in excess of 6%, so there has been debate as to when bond yields might tick upwards. In fact in the 3 weeks to May 20, the Australian 10-year bond yield increased from 2.32% to around 3%, a stunning increase of 0.7%. This increase in the long term bond rate coincided with a flat reporting season from the Australian banks.
These two factors were a sufficient catalyst to see a correction in the banking stocks as outlined by Bruce McLeary in the table. This means that bank stocks are now trading on more reasonable price earnings ratios. Leaving aside the Commonwealth Bank, ANZ, National Australia Bank and Westpac are trading on reasonable valuation multiples around 12 times and dividend yields above 5%. Bruce has calculated target prices based on the 5% yield number which again puts the banks in a favourable value proposition.
Property
Listed property: This theme sees more positive moves driven largely by low interest rates, demand and valuations. The Sydney property market has been strong, with interest rates the culprit in the popular press. However at the Annual Stockbrokers Conference a year ago, the CEO from Stockland noted that successive NSW state governments had not focussed sufficiently on creating land available for building in Sydney, in contrast to Victorian state governments of both persuasions. In Victoria, building has now occurred all the way to Tullamarine Airport and where sites such as VFL Park became available when the Etihad Stadium was built, Victoria redeveloped that land and made it available for housing blocks. It is suggested at the next census that Sydneysiders may receive a shock in the growth numbers for the Melbourne population.
Australian Treasury is relying on the Australian housing sector to take up the growth as mining capital expenditure has declined sharply. This is positive for businesses within that sector.
Resource Stocks: Supply / Demand Balance for Minerals and Energy
Following the dramatic falls in some commodity prices in the December 2014 half year, your diarist indicated that the best predictor of future pricing was to look at the supply and demand for individual commodities. This led to a positive view on the recovery in oil prices to $60-$70USD. Positive views are also held on copper. On the negative side, there remains some pessimistic views on iron ore. In respect of steaming coal prices, there is a sense such have bottomed but by not that any dramatic recovery is under way. Rather a more gentle recovery is forecast.
Other Minerals: Lithium and Mineral Sands
Tesla battery gigafactory was brought forward in the past month with a pre-sale of $800M USD of storage batteries. Lithium is scarce and the use of lithium in next generation storage batteries should ensure a positive outlook. With respect to mineral sands, there are also positive signs in this market for a recovery with positive comments in recent days from the Iluka CEO. Alumina may be added to the positive list of other minerals.
US Economy and the US Dollar
The positive view in the US economy has continued with recent statistics and unemployment now falling. The positive view on the US dollar has also borne fruit. What is more difficult is to consider the value of the US stock market. In January 2014, Chris Probyn, Chief Economist, State Street Global Advisors in his annual visit to Brisbane, indicated a positive view on the US stock market and the US dollar. 12 months later in January 2015 he thought that Australian investors in the US stock market would see currency gains but not further gains on average from the US stock market.
This is somewhat akin to the CBA price being overvalued in March 2015. One can look at a market for some time and have a view that a stock or a market is fully priced. What is difficult or perhaps unable to be predicted are the catalysts for a correction. However rising long term interest rates in the USA are the most likely catalyst and the recent moves in Australia and correction in the banks may be a canary in the mine for the US stock market.
That is not to predict in any sense a correction such as the GFC, but a healthy 10% correction in the US stock market appears overdue. At a recent Schroder’s presentation which your diarist attended, the charts coincidently showed CBA and the US stock market as materially overvalued, whereas UK, Australian and European stock markets showed better value.
Weaker Resources Sector: AUD Impact and M&A Activity
In the last 24 hours, the overseas activity has not been for Australian resource stocks, but rather the Chinese government committing large funds to the socialist Brazilian economy and to iron ore and oil companies in that country. The weakening Australian dollar is off-setting to some extent the weaker commodity prices as is historically the case.
Digital Disruption and Competition
The advent of Google has disrupted many businesses, as customers search for information, independent reports on products and services, model selection and price. Diversion of some sales to retail online sites continues. Where the consumer chooses to visit a physical store, he/she is more informed and likely to strike a keener price deal.
In other sectors of the Australian economy, competition between suppliers and businesses remains keen, so that for investors, identifying stocks with return on equity above a satisfactory level remains no easy task.
Between the mining sector which has little control over its selling prices and sectors digital disruption and competition, identifying good investment propositions is a disciplined task. Thus companies that own their intellectual property, have a measure of price control resulting there from, have overseas sales, a nil or low level of debt and good management remain key characteristics of investments in the sweet spot. ResMed is an example of this and the flat March quarter results are more likely a buying opportunity.
Medical, including Medical Appliances
ResMed noted in the previous paragraph and Nanosonics are two companies which have added to positive returns. Nanosonics issued a press release on the 18th May reporting a new study showing the Nanosonics Trophon® system is the only high level disinfection for ultrasound probes proven to be effective globally. The Nanosonics Trophon® disinfection cabinet is fast becoming the new global medical device of choice. Thanks to our Burrell Portfolio Manager, Dylan Katzer who identified this stock some time ago.
Deloitte Fantastic 5: Agribusiness, Gas, Tourism, International Education and Wealth Management
The CSIRO has identified 21 industries and Deloitte have the Fantastic 5 of areas where they believe Australia has natural advantage. Crown is a company in the tourism sector which should continue to benefit from tourism sector growth. The global interest in equities ownership should see Computershare benefit.
Possible X-Factors
In considering factors that might upset reasonable returns, Australian GDP growth and unemployment, political and international uncertainties were reflected upon. Five months into the year, the possible X-factor that concerns your diarist most are rising longer term interest rates and the impact these might have in reassessing USA stock market values.
Federal Budget
Confidence has been poor in both the Australian consumer and business surveys over recent times. The Federal Budget was designed to reverse this negative consumer sentiment, partly through small business and spending incentives. Let’s hope it works!
Happy Investing …
Chris Burrell
If you would like to further discuss, feel free to leave a comment or send me an email This email address is being protected from spambots. You need JavaScript enabled to view it..
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