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The Experts

Michael McCarthy
+ About Michael McCarthy
Michael McCarthy is chief market strategist for CMC Markets in Australia. He has over 30 years of experience in financial markets – specialising in equity trading and trader education.

Woodside shares plummet despite equity raise

Tuesday, February 20, 2018

At the resumption of trading this week, Woodside Petroleum shares plummeted. The successful completion of the institutional leg of a capital raising seemed to leave the market unimpressed, or at least with some indigestion.

Analysts are re-cutting their numbers, and projected target prices are moving up AND down. The offering to individual investors opens on Wednesday. How will they decide whether or not to take up their 1 for 9 entitlement at $27?

At the heart of the analysts’ stoush is the question of strategy. Is this a prudent re-focusing of development priorities or a timid response to a joint venture split? Is Woodside buying Exxon’s Scarborough stake a sign of frustration at difficult joint venture negotiations or simply the result of a disciplined and carefully considered investment process?

Perhaps more importantly; are those who are now suggesting Scarborough is a low quality growth option the same critics who for the last two years criticised Woodside’s lack of growth options?

It can be difficult for investors to decide when the “experts” disagree. Each investor must make up their own mind. Nobody knows the future and the answer to these questions will not be clear for three to five years.

Stepping back from the argument, it’s worth remembering the development of oil and gas fields is a high risk, potentially high reward activity. Woodside have demonstrated their ability to bring vast projects online successfully, and the foresight in building the Pluto processing plant with capacity to handle production from fields as yet undeveloped is an example of their longer term, strategic thinking.

Investors who agree that in a carbon dioxide constrained universe, gas is the answer, may see the current Woodside share price weakness as an opportunity:

As an investor I’d be delighted at the opportunity to buy Woodside shares at $27. And as a trader I see a buying opportunity developing. There is important support near $28, and that’s where I’m setting my price alert.

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Myer stock replacement strategy

Tuesday, February 13, 2018

Some stories are comforting because they are familiar. Others seem like a recurring nightmare. Myer shareholders may be forgiven if they place last week’s half year profit results in the latter category.

First half sales fell by 3.6%. There is an impairment charge coming and management did not give a number. The six month profit of $37-$41 million doesn’t leave much room to move. 

Perhaps worst of all, CEO Richard Umbers said “Myer…remains resolutely focussed on foot traffic and sales across all channels….” With respect to Mr Umbers, this is the greatest “der” moment of reporting season. The problem is, it looks like there is still no “how” to go with this “what”.

The market response was predictable. Share trading volumes surged. Myer shares found a new all-time low. And on Monday, six major brokers downgraded the stock. Earnings downgrades are the recurring part of the Myer shareholder nightmare.

Yet many investors are holding on. The psychological aspects of investing can make it hard to act on the poor investment choices we all sometimes make. Shareholders who think that Myer’s prospects look very dim but are unable to push the sell button may consider a stock replacement strategy.

This involves selling the stock and redeploying most of the proceeds. A small amount is spent on Myer call options. With the stock trading at 54 cents the right without obligation to buy Myer shares at 65 cents at any time up until June (Myer June 65 call) was offered at 2.5 cents. 

Holders of a call option do not receive dividends. If Myer edges higher to 60 cents the holder of the call option will receive little benefit. However if Mr Solomon Lew, a vulture fund or anyone else makes a takeover bid, the call option holder participates in all the gains above 65 cents. In the meantime most of the capital (say 54 cents less 2.5 cents equals 51.5 cents per share) is safely in the bank or invested in another stock.

The stock replacement strategy is the “no regrets” way to sell an underperforming stock.

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How low can the US go?

Tuesday, February 06, 2018

The action in US markets over the last two trading sessions (Friday and Monday night) is pointing to a rout. The confidence and exuberance that took US indices around 10% higher in January has melted along with bond markets. Two important questions confront local investors – how low can it go, and how will it affect Australian shares?

Some investors are scratching their heads and wondering what has changed. The short answer is very little.

The trigger for the sell-off was stronger than forecast wages data on Friday night, indicating wages are growing in the US at an accelerated 2.9%. This raised inflation expectations, and with it the forecast number and size of interest rate rises this year. This in turn took US ten year bonds to their highest yield in four years, and close to a technical bear market. Investors shifted focus from the strengthening US economy that is driving rates higher to the impact of higher rates on company bottom lines and share valuations, and the selling began.

It looks like a good, old-fashioned market panic is on. At the moment the downward momentum in US markets is strong. Valuing a market is fraught, but an examination of Pes in light of prevailing interest rates can help. Over the period 2014-2017 the average ten year bond yield in the US was close to 2.20% and the average forward PE for the S&P500 was 16.2x. As at this morning, the PE stood at 16.7x and the ten year bond yield 2.76%.

One way to read this is that the S&P500 has further to fall to reach a PE that reflects the changed interest rate environment. If that PE is around, say 15.5%, there is a further 8% or so for the index to fall.

This co-incides quite nicely with the big picture technical outlook:

On the weekly chart the accelerating up trend produces multiple trend lines at increasingly steeper angles. The sell down has breached the higher of these trends. Investors may note the support level close to 2,400 intersects the lower, longer term up trend. This technical support zone is also roughly 8% lower.

This analysis points to a rocky ride for equity investors over the coming weeks.

However Australian investors may fare relatively better. The PE comparison for the Australia 200 index is currently 15.7x versus a four year average at 15.2x. However the interest rate environment is very different. The average ten year bond yield for the comparison period is 3.1%, versus the current level close to 2.9%.

This points to a much gentler local downdraft. The technical picture shows multiple major supports between 5,950 and 5,650. Predicting the turning point is always difficult. Nevertheless, the positive economic outlook means there is a potential buying opportunity coming for investors well placed to buy a corrective dip.

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AWE Limited – game on

Tuesday, January 30, 2018

The energy sector is in focus after a third bidder for AWE threw their hat into the ring. A rising oil price and the potential for an all-out bidding war have investors wondering how high the AWE share price can go – and who’s next?

This is a vast improvement from the low point for the sector a year ago. The oil price that plumbed prices below US $30 a barrel is now trading at more than double that price. AWE shareholders are doing even better. After touching lows at 31 cents last year it traded at $1 after the latest bid from Mitsui.

Mitsui are long standing players in Australian energy markets with a presence established in the 1950’s. While the all-cash bid is non-binding until there are 50.1% acceptances, it is a far cleaner bid than many of the highly conditional takeover proposals of recent years. Given the previous best bid, from locally listed Mineral Resources (MRE), was both lower and composed of scrip and cash, shareholders may consider Mitsui’s bid superior.

The trading of up to $1 after Mitsui’s 95 cents per share bid indicates there are some willing to risk their funds on a higher bid. This is not a forlorn hope. All three bidders are trade groups with potential synergy benefits, not private equity groups whose only concern is buying cheaply. Given the third player is state related China Energy, there is no concern about the depth of pockets.

However it plays out there is no doubting the benefit to AWE shareholders of a competitive bidding environment (above). The energy sector is ripe for further moves, particularly on small players with higher quality assets. Investors looking to M&A activity as a portfolio kicker in 2018 could also consider mining services and media as sectors with potential for consolidation.

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Seven West in the SWiM

Tuesday, January 23, 2018

How the mighty can fall. A stock that traded above $15 pre GFC and close to $8 in 2010 is now trading at just above 60 cents. It’s grabbed the number one spot in its industry and has a management team with a strong operating track record. There is a clear value argument, despite the fact the consensus forecast is for a further edging down in revenues in the next three years.

Why is this stock trading cheaply? 

Seven West Media (SWM) is perceived as an “old” media stock. Certainly, Seven Television, Pacific Magazines, various radio stations and WA News (papers) are part of the conglomerate. However, it has online exposure as well, most notably through Yahoo and its digital television channels. 

This straddling of the old and new means SWM does not have the high-growth profile of a purely new media start up. On the other hand, there is an argument that it well placed to roll with the evolution of the industry. The hard reality of online media is that profitable business models are difficult to identify. And having legacy income streams can support media groups as they continue the search.

After sustained pressure, earnings have dropped by more than 50% from 2014. Now, the consensus forecast suggests analysts believe the group is close to base earnings. The drop in share price to record lows puts SWM on a more attractive earnings multiple. At current prices the P/E ratio is 6-7 times both next year’s earnings and the average of the next three years. Despite the pressure on the business this compares well to a market multiple around 18 times earnings.

Further, the shares paid 4 cents in fully-franked dividends last year. If it does the same this year, that’s a dividend yield (including franking) north of 8.5%. Consolidation in the sector may also mean potential takeovers or mergers. 

The outlook for media revenues remains clouded, with further disruption of traditional models likely. In my view SWM’s share price is at a level that makes it a potentially higher risk, and a potentially higher reward investment. Please consider.

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Telstra - out with the old

Tuesday, January 16, 2018

A new year, a new beginning. Time to revisit the investment strategy and reset the portfolio. For many investors, this will mean further moves towards growth exposures (materials, consumer discretionary, IT) and away from defensive themes. In my opinion there is one stock that should be on everyone’s sell list – Telstra (TLS).

Telstra has served many investors and the broader Australian share market very well. It introduced a generation to direct share investment, and it remains the most popular Australian stock with more than a million shareholders. Investors who bought into the first or third issue of shares (T1 and T3) have received above average dividend streams for many years and bought their shares at less than the current stock price. T2 investors may be less impressed:

However, history and sentimentality have little useful role in portfolio construction.  Share markets price the future and unfortunately for Telstra the future positives are harder to see. Questions about growth beyond the NBN roll out in an increasingly competitive environment mean analysts are unlikely to lift their earnings outlook anytime soon. A lack of positive catalysts usually means share prices languish at best.

Poor recent share price action adds to this negative outlook – at least in the short term:

Note well the two gaps on the chart – the fall from $4.40 when the stock went ex-dividend in mid-August and the plummet in late August after TLS told the market it couldn’t monetise the NBN income as previously announced. 

These gaps are highly significant to chartists.

They act as important support and resistance levels. A closing of the gap is considered a strong signal for further moves in that direction. Unfortunately for TLS shareholders a failure at a gap is also highly significant.

That’s what occurred last week. TLS shares traded up into the gap. A closing price at or above $3.83 would have closed the gap and likely sparked trader buying. However, when the share price peaked at $3.78, then dropped below $3.75, the signal became decidedly negative.

Despite investors natural affection the combination of fundamental and technical negatives could see TLS tests the low at $3.34. A breach of that level brings long term targets below $3.00 into play. Committed long investors may consider selling now to buy back at their leisure.

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US tax cuts – sell the fact

Tuesday, December 19, 2017

By Michael McCarthy

Despite a lack of legislative success, many US investors are pinning their hopes on the White House. A promise to slash corporate tax rates alongside other tax reforms has investors piling into US shares, creating new all-time highs. Naturally, this strength is spreading around the globe. Local shares that could benefit have received particular support.

However, the promise of tax cuts has been around for a long term. Corporate earnings momentum is positive, supporting higher share prices, but the US S&P 500 index is up more than 30% since the election. There is a similar effect with stocks exposed to US growth, such as Boral, Computershare, Cochlear and James Hardie. There is a real possibility that tax cuts are already factored, and that the delivery of the tax cuts could spark a “sell the fact” move. 

If the markets do adjust downward as the legislation is delivered, in my view, James Hardie (JHX) is particularly vulnerable. 

JHX benefitted from both the potential for tax cuts and the promise of a large and stimulatory infrastructure spend. The difficulty in gaining the approval of both houses of the US parliament for ANY legislation is apparent. Yet JHX’s share price is once again approaching all-time highs around $23.00.

It’s not just a “sell the fact” move that is potentially troublesome for JHX shareholders. Should the tax reform or infrastructure bills become unpassable the market judgement could be severe. On the other hand the best case scenario – both bills passed by both houses - may not add much to the current share price given the roughly 30% rally this year.

In valuation terms JHX looks more expensive at around 30 times earnings. The dividend yield is a relatively low 2%. Given a limited upside potential and a number of possible damaging scenarios, JHX shareholders may want to lock in gains before the fate of the tax legislation is known.

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Bursting Bitcoin’s bubble

Tuesday, December 12, 2017

These days it seems any market that goes up for two sessions in a row is a bubble. This is of course nonsense. While the chaotic nature of bubbles makes definition difficult, there are characteristics of bubbles on which many traders agree.

Those new to cryptocurrencies may know there are other examples besides Bitcoin. They may have heard of Ripple, Etherium and Bitcoin Cash. In fact in June this year the number of cryptocurrencies exceeded 900, and it now stands at more than 1,300. The universe of digital money is exploding as well as the prices.

What makes traders think Bitcoin is in a bubble right now? There are three requirements to tick off. The first is that the gains in the market are increasingly higher and faster. The price action becomes exponential. This is the first marker of a bubble, and is already occurring in Bitcoin.

The second characteristic of a bubble is a version of the argument “it’s different this time”. This saying alone is enough to make experienced traders groan. However by their nature cryptocurrencies ARE different. They are created (mined) digitally. You’ll never hold a Bitcoin in your hand. They are unregulated. Governments and central banks have no say in the supply, the relevant interest rates, the exchange and the records of transactions. 

The “it’s different” argument is important because it permissions market behaviour that is unusual. Despite eye-watering gains and dramatic volatility, new and potential participants are not deterred. Extravagant and enthusiastic optimism rules.

The third characteristic of a bubble is the giveaway that the end is coming. A term commonly used is a “blow-off top”. This price action can vary enormously, and there are many chart based patterns that fit the description. Most of them involve an even larger gain than previous moves quickly followed by a sharp reversal that takes the price below its starting point. Examples include “island reversals”, “evening stars” and “a hanging man”.

The Bitcoin market is yet to make a blow off top.

The newer aspects of digital currencies do not exempt them from their organic nature. Market prices are an organic function of human behaviour, not a product of a mathematical process. Bitcoin prices are subject to the same conditions and drivers as any other market, although many will dispute this during the “it’s different” phase.

The anonymous and unregulated use of cryptocurrencies was the initial driver of their success. They are used to circumvent government currency controls and make illicit purchases. There is a contradiction in them becoming mainstream financial instruments, potentially alienating the original users. Here may lie the seeds of crypto destruction.

Now that Bitcoin is moving into the mainstream with the listing of futures contracts, family, friends and clients ask; “Is it too late? Should I buy Bitcoin?” The problem is that despite what we know, no one can say with certainty when or at what price a bubble will burst. Bitcoin may collapse tonight, or it may reach $100,000 US dollars first.

Perhaps the answer lies with one of the best salesman I’ve ever come across. He was a ruthless blackheart who could seduce minds with his soft patter – so his motives may not have been pure. It was 2000, about a year before the tech bubble burst. He overheard a group of traders ridiculing the height and valuation metrics of the Nasdaq index (it gained a further 65% before imploding). He interjected:

“Sure, the fools are dancing. But the even bigger fools are sitting on the sidelines.”

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Buying the farm

Tuesday, December 05, 2017

Shareholders in the Australian Agricultural Company (AAC) have had their patience tested. A shock loss in the first half of the year has the share price plumbing two year lows. However, the implementation of a major strategy shift is well underway and AAC could turn sharply as investors see the benefit of a shift to quality over quantity.

Despite recent discussions there is ample evidence of thematic investing paying handsome dividends – think commodity super cycle, dividend yields, housing recovery etc. The key is identifying the trend and investing before share prices take off.

The pure foods produced in Australia and New Zealand are highly sought by a rising consumer class across Asia. Stocks such as A2 Milk and Bellamy’s are buoyed by this investing theme, but their share prices reflect well established support. Investors looking at “buying the worst house in the best street” could have AAC on their list.

The cattle farmer is transforming its brand, investing in an integrated supply chain and (finally!) adopting suitable technology to drive productivity. In the last year it has launched in Singapore and Taiwan, bought more of its product internally and invested in data analytics. In my view these investments will restore AAC to a more profitable footing. Investors with the same view may wish to move before the market does.



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Flexible thinking

Tuesday, November 28, 2017

By Michael McCarthy

Flexigroup (FXL) is in the “new” consumer finance space. It offers technology enhanced payment systems and solutions across a diverse range of industries. Earnings over the past few years faltered as the company dared to innovate. Taking risks means sometimes getting it wrong. The 66% plus slide in the share price since 2013 indicates many investors thought Flexigroup got it wrong.

The share price slide brings Flexigroup to lows not seen since 2011. Earnings fell from a peak 29 cents per share in 2015 to last year’s 24 cents.  Forecasts show a consensus 23 cents for 2018, before a return to growth in 2019.

However at its AGM on Monday, the company highlighted its success with payment cards. Key commercial relationships with traditional consumer credit channels and newer industries such as travel could have analysts re-cutting their estimates.

Admittedly a number of Flexigroup ’s woes stem from self-inflicted injuries. It’s arguable that in the past Flexigroup ’s product suite was too diverse and unfocused. There are also questions over the company’s ability to deliver, and prove up what look like sound business ideas into reliable earnings.

In my view, the share price is encouraging investors toward a higher risk / higher potential reward scenario. The volume growth in card business suggests to me Flexigroup  may have found a winner. Despite the lower estimates of earnings for 2018 the PE ratio is around seven times. The dividend yield at current constrained earnings is over 5% with franking.

The technical picture is also supportive. A double bottom formation is in place. The share price has moved above the $1.55 support level, and is testing the $1.63 resistance. A break above this level would signal a new uptrend. The MACD indicator at the bottom of the chart adds to the positive picture. The leading black line has crossed the lagging red line, and both moved up through the zero line, indicating a postive otlook with momentum.

For investors Flexigroup may represent a long term hedge. A portfolio full of banks is common in Australia. They are all potemntially vulnerable to disruption in the payment space. Owning a disruptor like Flexigroup  may offset some of the risk. And a lower share price for Flexigroup is the right time to examine the risks.

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