Welcome to the October edition of the Burrell Blog for 2016.
Beyond the US Presidential Election
All eyes on the USA, the Aug/Sep Blog noted that elections are an excuse to do nothing, at least as far as investors and businesses were concerned. The uncertainties around the Australian election result had been replaced by uncertainties around the USA election process.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.
During October, the intense focus on the USA presidential election campaign continued. With the polls showing Hilary Clinton with a 10-14 point lead, there is a high probability that the former Secretary of State will be elected president. The USA stock market has reflected this view in that there has been no major negative movements after the presidential debates. The Clinton website has extensive policy documents around a number of key topics, which are well summarised in the last edition of Time magazine. While there will be concern about the increase in income tax rates and some nervousness around pharmaceutical companies, the focus on a more responsible budgetary outcome and a safe pair of hands is a satisfactory outcome for world markets. The more interesting question is whether the discontent with the Republican presidential campaign will be reflected in a change in Congress from Republican to Democrat.
Concerns in respect of pockets of over valuation both overseas and in Australia were detailed in the Aug/Sep blog. Low bond rates have resulted in high bond prices, strong prices for consumer staple stocks and global health care stocks and elements of a repeat of the 2000 tech bubble in the USA. During October, there have been some reversals in each of these sectors with longer term interest rates in Australia and overseas moving up, and several stocks reporting lower earnings growth such as Netflix seeing material adjustments to their stock prices.
In Australia, some more dramatic corrections in sectors where Burrell saw over valuation occurred during October. In health care, Ramsay Healthcare fell by $10 and Healthscope by 28%. In infrastructure, Sydney Airports fell by 10%. In property, the property index fell by 14%. In telecommunications Vocus fell by 39% and TPG by 42%. On the other hand resources continued to firm from unsustainably low levels.
The Australian experience of correcting the overvalued sectors and stocks, is healthy. A key question is whether this will be followed in the USA, or whether there might be a more general correction of say 10%. More than a third of the S&P 500 index US companies are scheduled to post earnings this coming week. Within the companies that have already done so, 80% have beaten earnings expectations and 64% topped sales estimates. Goldman Sachs chief equity strategist David Kostin has had a rethink on the outlook for US earnings, a downwards revision. Kostin and his team now expect earnings to increase by 5% this year, 10% in 2017 and 5% in 2018. A US flat earnings outlook is not supportive of high valuation multiples in some sectors. It is to be hoped that we will see further individual stock price responses between now and February 2017 in the US market.
Ingham are the market leader in the production of chickens in Australia and number 2 in New Zealand. There has been a deal of negative publicity around this IPO, due mainly to the vendor being a venture capitalist who bought the business from the Ingham families at a lower price several years ago and has extracted some further consideration by the sale and leaseback of properties. Let’s analyse the IPO by asking the two questions: a) is it a good business and b) is it a good price?
In respect to the first question, the Ingham’s business is the leading chicken meat business in Australia. It is a fully integrated business from the science of the breeders ie. the parent birds, the incubation of the eggs, the contract broiler farms to grow the chicks and then the processing. The graph below indicates why investors should add this stock to a watchlist. While the price of chicken meat has hardly moved per kilogram in the last 15 years, the price of beef has more than doubled such that a kilogram of chicken meat is around a third of the cost of beef.
The result of this responsible attitude by the chicken industry has been that their profits have grown with volume which is up some 300%, while beef volumes have risen less than inflation.
So the answer to the first question is that Ingham’s have a demonstrably good business. While there is likely more competition from Tegal in New Zealand as chicken meat can now be imported for the first time since August 2016 from New Zealand to Australia, the growth drivers above together with the short life of raw chicken meat and the high level of health standards required, means that this is an attractive industry.
In terms of the second question ie. that of valuation, the valuation range indicated in the product disclosure statement is reasonable. As buyers, we are more interested in the bottom end of the range than the top end, but what’s new. Burrells have a 28 page independent research report on the Ingham’s IPO available on request. We have also formed views on the comparative stocks of Tegal in New Zealand (“Buy your Tegal Turkey”) and Pilgrim’s Pride in the USA.
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.