Welcome to this edition of the Burrell Blog for 2016!
Share prices at 30 June 2016 were unduly impacted by Brexit. The Burrell view was that the market should recover from Brexit as the dividend yield driver in Australia was a stronger force and this in fact occurred with the index recovering from 5058 on the 28th of June 2016 to around 5500 currently. The uncertainty of the Australian election is now being replaced with a focus on two uncertainties in the USA:
- The increasing probability that the Fed will increase the US interest rates by 0.25% as early as the September meeting. The economic case has strengthened. September seems likely to your diarist for the same reason that the Reserve Bank of Australia did not want to be seen to be raising interest rates during the election. Thus the Fed may raise rates in September or probably leave any tightening until early 2017, given the November presidential election.
- Thomas Ross Burrell OBE always had the view that elections were an excuse to do nothing, at least as far as investors and businesses were concerned. Thus the uncertainties around an Australian election are now being replaced by uncertainties around the USA election process. The despair by many around the political processes in the USA is not assisting investors or business to make decisions.
Against this backdrop, the low interest rates both domestically and overseas have seen the strange phenomena of life insurers and pension funds allocating money away from equities into long dated, low or negative yielding government bonds. While this is touted as a low risk strategy, in fact it is a high risk strategy because the probability of losses from longer dated government bonds is almost certain to lead to negative returns over the next several years.
The parallel to long duration in the bond markets has been the search for consumer staple companies, particularly in the USA, where prices have outperformed the broader market while sales and earnings have trailed. This has also occurred in consumer staple stocks in other markets e.g. Nestle and global health care stocks.
There are also elements of a repeat of the 2000 tech bubble in the USA with respect to stocks such as Facebook, Amazon and Netflix trading on valuation multiples not seen since the tech bubble. However this phenomena does not extend across the whole of the US market with other technology stocks priced reasonably e.g. Cisco.
Digital disruption is impacting on many companies and resulting in lower growth rates. As a rule of thumb, where a company is on valuation multiple of more than 20x, but earnings per share (EPS) growth is less than 20% p.a., then against the current market back drop, there need to be convincing reasons not to sell such stocks either listed in Australia or internationally. In the morning meetings with our advisors, the view that is being mentored is to give as much consideration to the sell side as to the buy side. Many investors also do not pay enough attention to what stocks should be sold from a portfolio to preserve capital, even if sometimes stocks are sold at a capital loss on the basis that to hold may result in even more downside risk. A senior institutional broking advisor from Melbourne said to me many years ago that he made his returns by looking at stocks which should be sold, because he found most of the competition were looking at what to buy. In Australia, a run up in some of the health care stocks and industrials is observed, where growth rates may not justify high valuation multiples.
The likely US interest rate increases taken together with the probability of a further interest rate cut in Australia means that funds earmarked for international investments in say 6-12 months’ time may be best held in a US dollar account. Burrells are able to provide this service.
Against this backdrop, there remain significant positive investment stories. At its AGM, the international pharmaceutical company, Roche announced a significant positive result in a drug for Multiple Sclerosis (MS). Last year, Merck, another international drug company, was successful with its registration of Keytruda, a treatment for melanoma. If indeed this two year period shows significant breakthroughs in both melanoma and MS treatment, then that is something we can all feel positive about.
In the larger Australian stocks, the banks have recovered based on the yield driver since Brexit with NAB being under $25 in February and again in June 2016, currently showing a 10% price improvement to over $27. In the resources sector BHP having bottomed under $15 in Jan/Feb 2016 is trading above $20, notwithstanding this week’s bad news on the independent report for the failed tailings dam in South America. Woolworths has recovered from $20.74 at 30 June to the $23/24 range, following the announcement of the likely successful exit from the Masters hardware debacle. However the CEO and CFO are reducing expectations that Woolworths profits will rebound to higher levels quickly. Woolworths management are saying the turnaround is a three year journey and given the margin reductions in the core food business in the June results, your diarist can only agree.
The reporting season was mixed. Companies such as Seek continued to do well and announced further investments in their international HR network. A smaller company Select Harvests which had fallen from $13 in August 2015 to under $4 in April 2016 has recovered with the almond price to around $6.70 currently. For those interested in agricultural stocks, the long term health driver for consumers to eat muesli for breakfast rather than Corn Flakes as a positive theme, together with the strong brands of Lucky package nuts and the Sunsol muesli brand commonly seen on supermarket shelves.
In an economy that is less than exciting with many companies showing low growth, those companies which are able to grow at say 7% will be rewarded by the market with higher growth multiples. The Mantra hotel group reported solid growth, but apparently not sufficient for some pundits which currently sees the stock around $3, notwithstanding the growth profile of properties joining the Mantra hotel management group over the next 18 months. The hotel management companies seem to make more money than the owners - certainly the Hilton girls appear to have sufficient funds for the occasional champagne or overseas trip!
The listed property market has been rewarding being up 17.3% in Australia in the 12 months to June 2016. This is the third year in a row that the listed property market has performed strongly. We do query whether the broader property index has reached a plateau with the distribution yield down to 3.3%, suggesting the price may have been pushed as a long term bond surrogate. Against this backdrop the Sydney office market is relatively strong with 3-4% rental growth, competition for quality properties and incentives declining. Unfortunately the same cannot be said for Brisbane office market, which continues to suffer from over supply, in no part contributed to by state government property construction.
In summary, investment markets overseas are seen against a backdrop of interest rates at lows not seen during your diarist’s lifetime which in turn have supported equity valuations in the USA in particular at high levels, although not uniformly so. The Australian equities market, partly because of our connection to China, has seen the world assign lower valuation multiples to Australian companies. This means the dividend yields in Australia continue to be attractive, supported by franking.
Consumer staples and selected health care and technology stocks both internationally and in Australian should be reviewed for high valuation multiples not supported by high growth in earnings per share. On the buy side, opportunities arise where stocks are growing at say 7% and valuation multiples are not excessive. Burrells continue to receive research on both Australian and international stocks which are in the sweet spot. So the lesson as usual is to regularly review portfolios, showing no attachment to stocks which may exceed prudent valuation, while at the same time looking for buying opportunities where fundamentals are supported by insightful research reports and good company strategy with competent management.
The themes for 2016 remain a helpful guide post and are listed below.
Themes for 2016
↗ Dividend yield driver
↗ Interest rate cycle headwind
o Central banks in different parts of the cycle
↗ Segment stocks in Burrell Universe into four segments
o Other high yield, but steady/lower growth
o High growth & sound business model, management, Balance Sheet, ROE > 10%
↗ Adopt a realistic view on China, not a sentiment view
o Markets wholly reactive to China as a proxy to demand growth for energy & mineral resources. There is relatively well developed themes so looking for inflection points in calendar 2016.
↗ US economy and the USD
↗ Digital disruption and competition
↗ Australia innovation stocks: medical appliances; global champions
↗ Weaker resources sector = lower A$ = Mergers & Acquisitions (M&A)
↗ Deloitte Fantastic Five: agribusiness, gas, tourism, international education and wealth management
↗ Property: more positive moves driven by low interest rates, demand and low valuations
↗ Possible X factors
A. US stock market valuations and possible correction
B. $20 oil
Disclaimer & Disclosure: Burrell Stockbroking Pty Ltd and its associates state that they and/or their families or companies or trusts may have an interest in the securities mentioned in this report and do receive commissions or fees from the sale or purchase of securities mentioned therein. Burrell Stockbroking and its associates also state that the comments are intended to provide information to our clients exclusively and reflects our view on the securities concerned and does not take account of the appropriateness of the recommendation for any particular client who should obtain specific professional advice from his or her Burrell Stockbroking Pty Ltd advisor on the suitability of the recommendation. Whilst we believe that the statements herein are based on accurate and reliable information, no warranty is given to its accuracy and completeness and Burrell Stockbroking Pty Ltd, its Directors and employees do not accept any liability for any loss arising as a result of a person acting thereon.
This document contains general securities advice only. In accordance with Section 949A of the Corporations Act, in preparing this document, Burrell Stockbroking did not take into account the investment objectives, financial situation and particular needs ('relevant personal circumstances') of any particular person. Accordingly, before acting on any advice contained in this document you should assess whether the advice is appropriate in the light of your own relevant personal circumstances or contact your Burrell Stockbroking advisor. If the advice relates to the acquisition, or possible acquisition, of a particular financial product, you should obtain a Product Disclosure Statement relating to the product and consider the Statement before making any decision about whether to acquire the product.
Burrell Stockbroking Pty Ltd (ABN 82 088 958 481), a Participant of the ASX Group and the NSX.