Welcome to the May edition of the Burrell Blog for 2018.
Themes selected each 12 months are useful explainers of market movements. The updated list is below, together with the balance of the commentary. Refer also to the April Blog.
↗ Dividend yield driver
↗ Interest rate cycle headwind
- Central banks in different parts of the cycle
↗ Adopt a realistic view on China, not a sentiment view
- Markets whollyreactiveto China as a proxy to demand growth for energy & mineral resources.
↗ Weaker resources sector = lower A$ = Mergers & acquisitions (M&A)
↗ Deloitte Fantastic Five: agribusiness, gas, tourism, international education and wealth management
↗ $US economy and the USD
↗ Digital disruption and competition
↗ Population, demographic: Baby Boomers, immigration, sea change
↗ Australia innovation stocks: medical appliances; commercial biotech; IT
↗ Segment stocks in Burrell Universe into four segments
- Other high yield, but steady/lower growth
- High growth & sound business model, management, Balance Sheet, roe > 10%
↗ Possible X factors
- US stock market valuations and possible correction
- Regulatory & geographical risk
Digital Disruption and Competition
Continued to absorb research and advisor time in understanding the factors associated with digital disruption and competition. For example, the arrival of Amazon in Australia has seen the share prices of listed property trust (LPT’s) owning retail shopping centres fall. In a previous blog, it was noted that the Hurstville shopping centre had increased rent after Myer vacated by rotating the Myer space into a food court and services resulting in an increase in rent from $15M to $40M. In this instance, the vacating of Myer was not such a negative event. Similar factors saw Westfield fall from $11 in July 2016 to $7.50 in late August 2017, where client buying was subsequently rewarded with a takeover from Rodamco. The Amazon factor has also provided a buying opportunity in Brambles. Again the fall in Brambles stock to a level $2 under valuation failed to understand that Amazon is not a universal negative for logistics and distribution services. Rather, Amazon has the second largest area of distribution centres in the USA to Walmart. While the Amazon model does not require bricks and mortar retailers, it does require large amounts of distribution space for all of those Amazon vendors whose goods are required to be delivered.
Digital disruption is everywhere, but insight in considering the winners and losers is important. Burrells have suggested to clients to for some years the strategy of carrying at least one of the digital stocks in their portfolios. While the stocks selected from time to time have depended on valuation, the migration of the rivers of gold from newspapers to realestate.com.au (property), Seek (HR), and carsales.com.au (cars, boats etc) have proven a sound strategy. Australia is a competitive landscape. When ALDI arrived, the Burrell view was that ALDI did not need to achieve the 80%+ market share it has in Germany. Having gained a foothold, if ALDI could change the response of the incumbents Coles and Woolworths, then those stocks would suffer a decline in margins and reflect a period of poor returns. In fact this is what happened and we continue to see responses to ongoing competitive threats in the consumer staples stocks.
Australian innovation stocks
Australian companies have been successful with medical appliances such as the bionic ear and Nanasonics with its global antiseptic device. Of even greater success in recent years is Resmed which is tackling sleep apnoea globally. In IT, Aconex invented software to manage major construction projects. This software has been adopted by many of the major construction companies, so that plans and compliance certificates from contractors and sub-contractors can be shared seamlessly. The company was recently the subject of a takeover by Oracle a Fortune 50 company. Sirtex has been taken over recently for it’s SIR-spheres that deliver radiation to fight liver cancer.
Segmenting stocks in the Burrell universe into four segments has proven useful.
Banks are currently subject to regulatory risk with the Royal Commission. The most probable view is that the banks are currently good buying against the negative sentiment caused by the Royal Commission. For example, Westpac fell $2 by $6B of market capitalization. It is highly unlikely that penalties or other regulatory measures would cost Westpac this amount, unless draconian regulations result. Similarly Bank of Queensland has fallen $13 to $10 and on a yield of 7.4% fully franked, regulatory risk would seem more than priced into the current market price.
Other high yield but steady / lower growth stocks include some disrupted sectors such as Telstra. The Telco space is disrupted by the NBN and TPG obtaining spectrum to operate as a fourth mobile carrier in Australia. Industries that are disrupted tend to show negative shareholder returns, but there comes a point where to the value investor, the opportunity to buy is compelling.
Resources have shown a stellar recovery with the resources index falling from over 4200 in August 2014 by half bottoming in January 2016 at 2100 and then recovering all of the fall in the two years subsequently. A wild ride, but justified by the Burrell view on China that their economy would continue to demand Australia’s resources and that given the Australian position is in the bottom cost quartile for many minerals produced, one would expect our companies to recover.
Companies that are high growth and sound business model, management, sound balance sheet, ROE> 10% have continued to attract market support and high valuations. In a low inflation environment, companies both in Australia and overseas showing 7% + growth have commanded a PE in the 15-20 x range i.e. the valuation of higher growth companies has been sought after by the market with old world economy stocks which aren’t showing growth dealt with harshly by the market. This dichotomy in valuation seems to be the new paradigm that takes a little getting used to for some of the older heads in the modern stockbroking industry.
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