In this month's blog, your diarist considers the importance of being guided by good research and a sense of value, rather than sentiment or simply asking whether it's a good company.
Market Correction
Four weeks ago, the October blog noted a correction in the Australian stock market from 5,700 on the 2nd September to 5,150 on 13th October, a fall of 9.6%. In the USA, the Dow Jones Industrial Index fell from 17,280 on the 19th September to 16,117 on the 16th October, a fall of 6.8%. Your diarist posed the more probable view to be that a fall of 7-10% is likely to be the extent of the fall. Our conclusion was that investors were more likely to benefit by buying the dips rather than a strategy based on sentiment e.g. to sell down. The current correction had produced some excellent buying opportunities and we encouraged readers to talk to a Burrell advisor in terms of portfolio or index selections. It had been February 2014 since the markets were at those levels.
These predictions proved correct with the Australian market recovering from 5,150 on the 13th October to 5,549 on the 7th November i.e. 7.6% and the Dow Jones Industrial Index from 16,117 on the 16th October to 17,614 on 11th November i.e. by 9.3%.
The main reason for the disparity between the USA and Australian stock markets concerns the different economic drivers. In the USA, the economy continues to recover with unemployment now at levels below those of Australia. Who would have thought this would be the position when the Australian economy seemed so strong through the global financial crisis? In Australia, the softening commodity prices across all major commodities including iron ore, steaming coal and gold has given more negative sentiment to the local bourse. Fortunately the housing and tourism markets are recovering and the Australian economic score card remains positive although modestly so.
In this environment, it is important to be guided by good research and a sense of value, rather than sentiment or simply asking whether it’s a good company.
Medibank IPO
The tendency for mum and dad investors to simply ask if it is a good company is to the fore in the Medibank Private IPO. The government advertising campaign, gives the impression of a government guaranteed investment, which the Medibank Private IPO is not. It is clear that many in the population initially responded to the Medibank Private IPO marketing - this is a once in a lifetime opportunity to gain access to the stock. Of course, clients are aware that once the stock is listed, investors will be able to buy it every day, so the question is whether subscription will add value to the portfolio and in turn this requires an analysis of the industry, business and likely pricing levels.
A month on, it seems unlikely that Medibank Private will be rated as one of the more attractive government IPOs. The Burrell strategy was that if the stock could be acquired around the $1.80 level, list around $2.10 and then over 18 months appreciate to over $2.50+, then this would be a reasonable result for investors. Pricing remains unknown which is a significant issue in itself. For every other stock on the market we know what the price is and can make a decision whether or not to buy at that price. The fact that the government chose to scale back firm bids to 8% fails to understand that many broking clients only respond to firm stock and are not overly interested in submitting multiple general applications. It will be interesting to see how many of the 750,494 pre-registrants proceeded to subscribe. Strong broker bidding is suggestive of a price towards the upper end of the range. A factor not generally present is the policyholders applications which may well be the difference in this float being successful.
Burrell sees significant longer term risks in Medibank Private and will not regard it as a blue chip stock for the long term in many portfolios. The strategy is more to realise a gain over an 18 month period and look to more attractive business models. The major risks in the long term concern the ability of the health insurance industry to continue to raise health insurance premiums at double the inflation rate, to have the baby boomer medical expenses met by younger current members on an annual basis as there are insufficient reserves carried forward from previous years and the equalisation payments paid into a fund to cover companies such as Medibank Private who have higher levels of poor risk.
In the short term however, there is a commonly held view that Medibank Private management will be able to extract costs over the next few years, which they have been unable to do under government ownership and that this will drive profit levels.
We are comfortable with our ‘subscribe’ recommendation on Medibank Private, but suggest a comparison be made regularly with the major insurers such as IAG who are well provisioned, have high fully franked dividends and lack some of the negative industry features of the health insurance industry. Finally, if the analysis of a gradual increase in Medibank Private price to around $2.50 is correct, then those who subscribed in the IPO may wish to place limit buy orders to top-up on listing.
Industrial vs Resources
The prices for most commodities have softened over the last 12 months. The performance of the resources sector has consequently lagged during this period.
In contrast, the banking sector has performed strongly and taken over the heavy lifting of the resource sector. The recovery of the housing sector in Australia continues to support bank share prices, as does the low yield on fixed interest deposits as investors seek higher returns from fully franked banking dividends.
Industrials, the third sector requires careful analysis. Historically it is more difficult to obtain market and alpha returns from the industrial sector, but selected companies have a number of attributes desirable for investment. ResMed is one example which Burrell have recommended for some time as a leading company in the global sleep apnoea space, it has a strong return on equity, no debt, a large degree of control over the price of its product (as compared to most resource companies who have little or no control over the selling price of international commodities) and owns intellectual property which acts as a barrier to entry. A number of these companies are included in the Burrell 35, a benchmark portfolio with weightings adjusted to reflect prospects based on research including financial ratios in the Burrell Universe.
Happy Investing …
Chris Burrell
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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.
Burrell Stockbroking Pty Ltd (ABN 82 088 958 481), a Participant of the ASX Group and the NSX.