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Paul Rickard
+ About Paul Rickard

Paul Rickard has more than 25 years’ experience in financial services and banking, including 20 years with the Commonwealth Bank Group in senior leadership roles. Paul was the founding Managing Director and CEO of CommSec, and was named Australian ‘Stockbroker of the Year’ in 2005.

In 2012, Paul teamed up with Peter Switzer to launch the Switzer Super Report, a newsletter and website for the trustees of SMSFs. A regular commentator in the media, investment advisor and company director, he is also a Non-Executive Director of Tyro Payments Ltd and Property Exchange Australia Ltd.

Follow Paul on Twitter @PaulRickard17

Health insurance premiums should be falling, not rising

Thursday, February 16, 2017

By Paul Rickard

New Health Minister Greg Hunt was quick to champion last Friday that the average increase in health insurance premiums of 4.84% was the “lowest increase in a decade”. And he is right - the 4.84%, to take effect from 1 April, looks positively modest compared to 5.59% in CY16, 6.18% in CY15 and 6.2% in CY14.

But the stock market celebrated the outcome for the listed insurers Medibank Private and nib, the first and fourth ranked insurers by number of policyholders, who together cover 36% of the market. Both companies rose by more than 2% following the announcement.

While Medibank’s average premium increase of 4.60% and nib’s 4.48% are below the industry average, what does the stock market know that the Minister or his Department doesn’t appear to understand?

(Minister for Health Greg Hunt. Source: AAP).

Very simply, the health insurers are becoming more profitable as margins increase. And I am not talking about the efforts of the insurers to lower their administrative expenses such as marketing and paying claims. The gross margin, that is the difference between premium revenue and health claims paid, is improving. Look no further than nib’s full year profit statement last August, which shows that since 2013, nib’s margin and the average gross margin across the industry have been rising. They are getting towards multi-decade highs!

Source: nib Investor Briefing

Market leader Medibank increased its gross margin from 14.2% in FY15 to a phenomenal 16.6% in FY16. This meant that gross profit from its health insurance business increased by 22% or $185m, from $842m to $1,026m. And this occurred in an environment where it continued to lose customers and market share.

Medibank is now being rewarded with an increase in premiums of 4.60%, following an average increase of 5.64% the previous year.

Now, to be fair to Medibank and nib, the insurers work hard to manage claims expenses, and some of the initiatives they have taken, such as service quality guarantees from the private hospitals, are helping to reduce costs. However, the only justification cited for the increase in premiums is that health costs are rising, when it is blatantly obvious that the insurers are also becoming more profitable.

Take one measure of profitability - return on equity. nib reported that for FY16, its return on equity (ROE) rose by 11.7% to a very healthy 25.8%. Medibank’s ROE for FY16 was around 26.4%.

With such fantastic ROEs, shareholders have been handsomely rewarded. Shares in Medibank today sit at $2.82 - a 41% increase on its December 14 IPO price of $2.00. nib has done even better, with its shares trebling in price over the last five years.

NIB Holdings (NHF) - 5-year chart

Source: Yahoo!7 Finance, 16 February 2017

While shareholders are rejoicing in the short term, the longer term problem is that as health insurance premiums soar, policyholder lapse rates increase. And this is made worse by the fact that the people who abandon health insurance are typically the “most profitable” customers, the people who claim the least amount. The young and the healthy.  

Short term profit considerations are winning at the expense of the industry’s longer term viability. It is in the industry’s best interests to keep a lid on premiums.

If the Minister was being briefed appropriately, he would be saying to the insurers “no further increases”. And even if he was being advised that the increase in margin was ”temporary”, he should have waited until Medibank and nib had posted their profit results for the December half to get the latest picture on profitability before approving the premium increases. For the Minister’s information, Medibank reports tomorrow (Friday) while nib reports on Monday.

My guess is that these will show further evidence to support the thesis that premiums should be falling, rather than rising.

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The Switzer Dividend Growth Fund

Friday, February 10, 2017

By Paul Rickard

Let me declare upfront – I have a personal and financial interest in the success of the Switzer Dividend Growth Fund. I am a Director and in effect a part owner of the responsible entity, Switzer Asset Management. So, no question that I am conflicted.

With that disclosure out the way, here is my road test of the Switzer Dividend Growth Fund.

The Switzer Dividend Growth Fund

The Switzer Dividend Growth Fund aims to provide investors with tax effective income and long-term capital growth by investing in a core portfolio of blue-chip Australian shares. The portfolio will be managed to deliver capital returns in line with the market, while providing investors with an attractive income stream paid quarterly.

It will invest in a portfolio of quality, high-yielding Australian shares with an emphasis on companies that are paying fully franked dividends and which have the ability to grow these dividends over time. Typically, this will be approximately 30 to 50 stocks drawn from within the largest 200 companies, which have:

  • sound balance sheets;
  • desirable dividend streams and the capability to grow dividends while maintaining a sustainable payout ratio;
  • dividends that are fully franked or close to fully franked;
  • moderate to low volatility; and
  • strong secondary market liquidity on the ASX.

The Fund is somewhat unique in that it is one of the first funds in Australia to explicitly adopt the ‘dividend growth’ mantra, a very popular and fast growing investment category in the USA. It will also be quoted and traded on the ASX.

Investment Management

Switzer Asset Management will manage the Fund and has appointed an Investment Committee comprising Peter Switzer, Charlie Aitken, George Boubouras and yours truly to do this. The Investment Committee will be supported by the investment management team at Contango Funds Management.

While Switzer Asset Management has limited funds management experience per se, having been recently re-configured, the Investment Committee members have considerable equities market experience and expertise. Further, Contango, led by MD and Chief Investment Officer George Boubouras, is the investment manager of two very successful listed investment companies, Contango Microcap (CTN) and Contango Income Generator (CIE), as well as the manager of several institutional equity mandates.

ASX Quotation

Following a path that has been pioneered by Magellan and others, the former with the spectacularly successful Magellan Global Equities Fund (ASX Code MGE), the Switzer Dividend Growth Fund will be quoted on the ASX under the stock code SWTZ. This means that investors can buy or sell units on the ASX through a stockbroker or share trading account, with settlement through the CHESS system. Investors will also be able to see the prices at which other investors are prepared to exchange Units.

In addition to publishing an end of day NAV (net asset value) per unit, Switzer Asset Management will also publish an indicative NAV throughout the trading day in real time. With the Fund providing support as a market maker, investors should be able to trade their units (sell their units or buy more units) at a price that is very close to the underlying NAV. No premiums or discounts.

Other features

Distributions will be paid quarterly, in January, April, July and October. A distribution re-investment plan will also be available.

Although the PDS makes no forecast about distributions, given the style of the fund, investors should expect a distribution a little higher than the current ASX 200 yield. This probably means around 4.5% to 5.0% pa, franked to around 80%.


The investment management fee is 0.89% pa, including GST. There are no performance or other fees.

This fee is about middle of the range. Lower than many active equity funds, but more than some of the broad-based listed investment companies and of course, more than ETFs that passively track an index.

Who will it suit?

The Fund will be well suited for equity investors who desire tax effective income, including SMSFs. The quarterly distribution should be popular with these investors.

Further, because the Fund will be managed with the aim of delivering capital returns in line with the market, the Switzer Dividend Growth Fund should also be able to be used as part of a “core” equity holding for those investors using a “core and satellite” investment approach, or who want to complement individual stock holdings.

How to invest

The initial offer opened on Monday, 30 January and will close on Friday, 17 February. Quotation and listing on the ASX is scheduled for Friday 24 February. Thereafter, investors will be able to purchase units on the ASX through their stockbroker or share trading account.

To take part in the initial offer, investors will need to review the Product Disclosure Statement (PDS) and completion an application online or on paper. This, and more details, are available here. The minimum application is $2,500.

Click here to invest.

As always, please review the PDS carefully, and if you need assistance, please consult your financial adviser or other investment professional.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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New NAB offer should suit yield seekers

Thursday, February 09, 2017

By Paul Rickard

Yield starved retail investors are set to embrace the return of ASX listed bank subordinated notes. Yesterday, the National Australia Bank launched the first retail offer in some years with an issue that is set to raise at least $750m.

Investors are being offered a note that pays interest quarterly at a fixed margin of 2.2% over the 90-day bank bill rate. With the 90-day bank bill rate around 1.75%, this means an interest rate of 3.95% for the first 90 days. Thereafter, the interest rate will be reset each quarter based on the then current 90-day bank bill rate. For example, if the bank bill rate rises to 2.5%, investors will receive 4.7% for the quarter, if it falls to 1.0%, investors will receive 3.2% for that quarter. 

NAB Subordinated Notes 2 will be quoted on the ASX and trade under stock code NABPE. They will be NAB’s first Basel III compliant retail Tier 2 instrument. Holders of NABHB (an earlier issue of subordinated notes made in 2012 which is not Basel III compliant) will be invited to re-invest into the new notes.

Subordinated Notes vs Capital Notes

Subordinated notes differ to the more familiar bank hybrid or capital notes issues, such as NAB Capital Notes, Westpac Capital Notes, Commonwealth Bank PERLS, etc., and pay a lower effective interest rate. The main differences are:

  • unlike bank hybrids, which are perpetual, they have a fixed term. In this case, the term is 11.5 years;
  • in the event of a wind-up, they are ranked higher than bank hybrids. Because they are Tier 2 capital instruments, they rank ahead of all Tier 1 capital instruments such as bank hybrids or ordinary shares;
  • the interest payment is not discretionary, and is cumulative. It is, however, still subject to a general solvency condition;
  • there is no mandatory conversion into ordinary shares which could happen with hybrid issues if the bank breaches a capital ratio. However, there is a non-viability trigger event condition, where APRA may require the conversion of the notes into ordinary shares if NAB gets into severe financial difficulty.

The 2.2% margin on these notes compares to the circa 3.8% margin that bank hybrids are trading at. At the other end of the risk scale, the major banks are paying retail investors around 2.0% on 90-day term deposits, a margin of 0.25% over the 90-day bank bill rate. While term deposits are effectively government guaranteed, there is considerable re-investment risk as the rate must be re-negotiated every rollover.

Offer Details

The notes have a fixed term of 11.5 years and mature on 20 September 2028. In addition, NAB has the right to redeem the notes after 6.5 years on 20 September 2023 at par, and thereafter on each quarterly interest date. This option is only available to NAB - noteholders cannot request that the notes be redeemed early. Other details are set out in the table below.

How to invest

In addition to a broker firm offer (brokers nominated include Morgans, Macquarie and JB Were), NAB shareholders and holders of National Income Securities or NAB Capital Notes can invest through the security-holder offer. There is no general public offer. 

A re-investment offer is being made to holders of NAB’s existing subordinated notes, NABHB. While participation is voluntary, NAB has indicated that it will most likely exercise its right to redeem these notes early on 19 June 2017.

The offer is due to open on Thursday 16 February.

Bottom Line

While secondary market bank hybrids arguably represent better value (3.8% compared to 2.2% for not that material a difference in risk profile), considerations such as brokerage and thin markets also need to be taken into account. Further, with many investors being so cashed up and the banks really squeezing cash deposit rates, this issue will find broad appeal.

ImportantThis content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
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The super bull market

Thursday, January 12, 2017

By Paul Rickard

Following gains of 3.0% in November and 4.4% in December, the Australian sharemarket is up another 2.0% in January. In fact, it has added more than 22% since its low a tad over 11 months ago on 10 February. Most commentators say that it is just a case of the Australian market watching the lead from the US markets and playing “follow the leader”, but there could also be a one-time local factor at play.

This is the Government’s changes to the superannuation system, which became law on 15 November.

And because these changes don’t take effect until 1 July, we may not have seen their full impact yet. One thing is for sure - when the super system last underwent major surgery in 2007, the flows into super were massive, and this was one factor that drove the S&P/ASX 200 to reach the dizzy heights of 6828.7 in November 2007. While the scale of the current changes isn’t as dramatic, it will certainly lead to large flows into super - and into the equities market.

The super changes

The big change is the reduction in the non-concessional contributions cap from $180,000 to $100,000 per annum. From 1 July, you will only be able to make up to $100,000 of personal after-tax contributions into super each year, rather than the $180,000 limit that applies in 2016/17.

When combined with the ‘bring forward rule’, which effectively allows people under 65 years of age to make three years’ of contributions in one go, the change in the cap is very material. Currently, a person under 65 can apply this rule and make $540,000 of non-concessional contributions in one go. If they wait till 1 July, they will only be able to contribute $300,000.

For a couple where both parties can access this rule, they can potentially get $1,080,000 into the super system prior to 1 July, but if they miss this deadline, then they will only be able to contribute $600,000.

The opportunity to get a big one-off amount into super is closing fast.

But there is also another change that will encourage some superannuants to make contributions before 1 July. This change has received far less coverage and wasn’t part of the original Government package announced in the May budget.

As part of the implementation of the $1.6m cap on how much money can be transferred into the pension phase of super, the Government has created new rules around who can make a non-concessional contribution. These relate to the person’s total super balance - that is, the amount they have in the super system in both accumulation and pension phases.

From 1 July, if your total super balance is $1.6m or more, you won’t be allowed to make any non-concessional contributions at all. If your super balance is between $1.5m and $1.6m, your limit (under the bring forward rule) will still only be $100,000, and if your total super balance is between $1.4m and $1.5m, your limit will be $200,000. Your super balance will be measured at the preceding 30 June - so for 2017/18, as at 30 June 2016.

Bottom line - people who have a total super balance of $1.4m or more have even more reason to take action before 30 June.

Will these changes impact the sharemarket?

Of course, to make super contributions, the money has to come from somewhere. For some superannuants, this might mean selling existing assets such as shares or property. Capital gains tax implications will need to be considered. 

Others might simply draw down on existing savings. It is also not beyond the realms of possibly to suggest that some advisers will recommend that clients draw down on their mortgage offset account or access other low cost finance so they can make contributions. This opportunity won’t be repeated again.

And while SMSF members can potentially consider ín-specie’ transfers, retail and industry fund member, who make up two thirds of the system by value, will be required to find new funds. 

Put this all together and the likelihood is that there will be considerable flows of new money into the super system, and as Australian equities are the major investment asset of Australian super funds, some 30% to 40% will find its way into the sharemarket.

Have we already seen the impact of these changes? The $64 question, but going by past experience, it takes some time for complex super changes to filter through and importantly, for clients to act.

Time to act

The clock is ticking down to 30 June. While there are so many factors that can impact equity prices and trying to time markets is incredibly difficult, my hunch is that the impact of these changes hasn’t been felt yet. If I had a choice of making my super contributions in January/February, or leaving it till June, I would get it done sooner rather than later. That said, the most important thing is to make sure you take advantage of this opportunity and make personal contributions to the maximum possible extent by 30 June. 

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Making LICs accountable to their shareholders

Thursday, December 15, 2016

By Paul Rickard

One of the bizarre Australian Securities Exchange (ASX) rules is that listed investment companies (LICs) such as Argo, AFIC, Milton Corporation or WAM Capital still have 14 calendar days after the end of the month to tell their shareholders what their net tangible asset backing is.

Net tangible assets, or NTA, is the industry’s standard measure of what each share in the listed investment company would be worth if all the assets of the LIC were sold at market and the proceeds returned to shareholders. As LICs typically only invest in marketable assets like other company shares, the price that an investor would buy shares in the LIC on the ASX should, theoretically, be the same as the LIC’s NTA.

However, because the market to buy or sell shares on the ASX in a LIC is real rather than theoretical - it is what a willing buyer is prepared to pay meeting what a willing seller is prepared to receive - the price that LIC shares trade at can sometimes be at a material premium, or discount, to the NTA. For example, if the NTA is $2.00 and the shares are trading at $2.10, then they are said to trade at a premium. Conversely, if they trade at $1.90, they are trading at a discount.

Keeping the market and investors fully informed about the NTA helps to minimize the premium or discount.

There are other reasons for NTAs and trading prices getting out of whack. The graph below from Argo (ASX:ARG), one of the major broad-based LICs with assets of $5.0bn, illustrates the pattern over the long term. It suggests that market cycles play a big part. Premiums of up to 15% have prevailed in the latter stages of strong bull markets, while discounts have tended to occur in the depths of bear markets. 

Argo (ARG) Premium or Discount to NTA

A more recent phenomenon is that premium/discounts tend to correlate with investment performance. Premiums are paid for LICs that are exceeding their investment targets, while underperforming LICs are traded at a discount.

While this is not entirely irrational behavior on behalf of investors, LICs are investing in marketable securities and are not transforming or improving the assets. There is no “value add” to the asset. To be fair to both the buyer and seller of the LIC, the traded price should be as close as possible to the NTA.

Why aren’t LICs reporting more frequently? 

Well, there is no reason except that the ASX rule says that they have 14 days to report. And it is not a question of technical difficulty, because one LIC, Perpetual Investment Company, is already doing this daily, while more than 10 LICs are doing it weekly. Moreover, for quoted managed funds, the new investment vehicle that will arguably pose a big threat to the LIC model, daily and intraday NTAs are being provided. Funds like Magellan Global Equities (ASX:MGE), which is an actively managed quoted ASX fund that is open-ended, provides in real time an indicative NTA and publishes this on its website. 

The good, the bad and the ugly

So, let’s name and shame the LICs (minimum $100m). We will look at the calendar month just completed, November 2016, and the day in December they reported their November NTA to the market via the ASX.

Firstly, the good.

The not so good (bad).

And finally, the ugly.

* Had not reported as at 2.00pm on 14 December

ASX must change the rules

The 14 day calendar rule is way behind the times. The ASX should pull this back to a maximum of five days. Next, LICs should be required to report weekly.

If the ASX feels a little bolder and really wants to promote a transparent market, it would make a single leap and require all LICs to report daily - by 4.00pm on the following working day.

Another issue for the LIC market is that IPO investors paying the selling commission that goes to brokers and other financial intermediaries. Sure, this happens in all IPOs, but a case can be made that the investor is purchasing a unique set of assets. Bit different when it is just marketable securities. But this is a story for another day.

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Healthscope or Ramsay?

Thursday, December 08, 2016

By Paul Rickard

With the health care sector cheapening by the day, several leading value investors are looking at Australia’s private hospital operators, Ramsay Health Care (RHC) and Healthscope (HSO), as possible investment plays. With the tailwinds supporting the health industry still blowing, Roger Montgomery for one has come out quite strongly for Healthscope. But is Ramsay a better option?

I will have a go at weighing them up. But first, an update on the performance of the health care sector.

It has been smashed over the last couple of months as investors have moved into resources, financials and cyclicals. Since peaking on 25 July, the healthcare index has lost 15.4% (to 7 December) compared to the broader market’s net gain of 1.0%. This follows five years of outstanding performance, as the chart below details. It shows the S&P/ASX 200 and the healthcare index using a common base. Over the last five years, the healthcare sector has returned 183%, approximately three times the broader market’s 63%.


Source: Data from S&P Dow Jones

The recent fall in Australia has followed the lead from the USA, where healthcare stocks are also on the nose. While the US S&P 500 has returned 10.5% so far this year, the health care sector in the US is down by 3.8%.

But steep falls translate to opportunities for value investors, and the private hospital operators, with their low level of uncontrollable risks, are very much at the top of the agenda.

So, is Ramsay or Healthscope a better opportunity?

Ramsay Health Care

Ramsay is Australia’s largest operator of private hospitals, and ranked in the top five globally. Ramsay Health Care reported core net profit of $481.4 million for the year ended 30 June 2016, a 16.8% increase on the previous corresponding period. Core earnings per share (EPS) grew by 17.7%. 

On a group revenue base of $8.7bn, Australian private hospitals accounts for just over 50%. Ramsay is also the largest private hospital operator in France, through the Ramsay Générale de Santé group. Revenue from France contributes about 35% of the total, while the UK business pulls in 10%.

Ramsay’s strengths include a fantastic track record of delivery and performance (it has met or exceeded every forecast it has issued), a stable and experienced Board and management team, a very focused strategy, an exportable business model and a very disciplined investment process. It has a pipeline of greenfields and brownfields projects, where it adds beds, operating theatres and new hospitals. In Australia, it's also making an expansion into the pharmacy business. It currently operates over 200 hospital pharmacy dispensaries across its global hospital portfolio, and is in the process of establishing community pharmacies in strategic locations, concentrating initially on locations in close proximity to its hospitals in Australia.

Concerns from analysts and investors mainly relate to Ramsay’s overseas acquisitions, particularly the business in France. This centres on the challenging political environment, which is not supportive of the private health sector.

Ramsay peaked on the ASX on 1 September at $84.08 shortly after announcing its full-year results. It closed on Wednesday at $68.04, down 19.1% from its high. 

Ramsay Health Care (RHC) 

Source: Yahoo!7 Finance

Ramsay reaffirmed its profit guidance for FY17 at its AGM on 9 November. It is targeting Core NPAT (Net Profit After Tax) and Core EPS (Earnings Per Share) growth for the Group of 10-12% for FY17.


Healthscope is Australia’s second largest operator of private hospitals. In FY16, the Australian hospital business delivered revenue of $1.95bn (cw Ramsay’s $4.4bn), up 5.1% on FY15. Operating EBITDA (Earnings Before Interest, Tax, Depreciation and Amortisation) of $355m was up by 8.3%, and represented 82% of Healthscope’s earnings.

The other 18% comes from pathology services outside Australia. New Zealand generates 12% of group EBITDA and has been growing strongly, while 6% comes from Malaysia and Singapore.

At a group level, operating EBITDA rose by 7.1% in FY16 on revenue growth of 6.2%. Ramsay, on the other hand, grew core operating profit by 16.8%.

Healthscope is viewed by some analysts as having a stronger pipeline of greenfields and brownfields projects. Recent brownfield sites at Gold Coast Private, National Capital Private in the ACT, and Knox Private (VIC) have seen admissions growing at a faster rate than the broader market. In 2017, it is set to complete projects at Darwin Private (NT), Holmesglen Private (VIC), Norwest Private (NSW) and Northpark Private (VIC). In 2018, the new public/private 450 bed Northern Beaches Hospital in Sydney is set to open.

The company’s balance sheet is strong, with gearing (net debt/net debt + equity) at 30 June sitting at 35.5%. On the same measure, Ramsay’s was 60.8%.

Ahead of its AGM on 21 October, Healthscope issued a profit warning. It said that “the Company has experienced slower than expected revenue growth in Hospitals in the first quarter. Despite this recent softening in hospital activity during the period, Healthscope remains confident that the industry fundamentals have not changed and the long term demand outlook for the Hospitals division remains strong”. It went on to say, however that “if the trend for the first quarter was to continue, it is likely that Operating EBITDA growth for our Hospitals division would be flat year on year. “

Healthscope floated on the ASX in July 2014 at $2.10 per share, and peaked on 29 September at $3.17. It got smashed after its profit warning, and last night closed at $2.28, down 28.1% from its high.  

Healthscope Limited (HSO)

Source: Yahoo!7 Finance

The Brokers

The brokers are marginally positive on both stocks, but slightly more disposed to Healthscope. On a multiple basis, Ramsay is trading at a considerable premium to Healthscope, being priced on a multiple of 26.4 times forecast FY17 earnings compared to Healthscope’s 20.7 times. This premium narrows in FY18, with Ramsay at 23.4 times and Healthscope at 19.3 times.

On valuation grounds, the brokers have a consensus target price for Ramsay of $79.75, 17.2% above Wednesday’s close. Healthscope’s target price of $2.63 is 15.3% above the close of $2.28. 

Broker Recommendations and Target Prices

Source: FNArena

Broker Earnings Forecasts

Source: FNArena (as at 7 Dec 16) 

One other factor to consider - the short sellers are active in Healthscope. The latest ASIC figures show that 153.6m Healthscope shares are sold short, or 8.85% of its issued capital. This is a reasonably high figure, placing Healthscope in the “top 15” of short sold stocks. By comparison, short sales in Ramsay are 4.3m shares or 2.11% of its issued capital. 

My View

There is no doubt that Healthscope is priced more attractively than Ramsay, and is arguably, better value. However, it can take time for the market to re-rate a stock, and I prefer to back “form” over “potential”. With Ramsay guiding to earnings growth of 10 to 12%, and Healthscope flat, I can’t see this rerating happening quickly. Ramsay remains my pick.

Disclosure: The author and his SMSF own shares in Ramsay Health Care.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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Does TPG stand for 'too pricey for growth'?

Thursday, December 01, 2016

By Paul Rickard

Investors in Australia’s leading second tier telco, TPG Telecom (ASX Code TPM), must be starting to believe that TPG is now in the “too pricey for growth” category, as the market has smashed TPG’s share price from a high of $12.93 on 29 July to yesterday’s $7.14. That’s a fall of over 45%!

TPG Telecom Share Price - Last 12 months


TPG’s share price slide stems from disappointing the market with its profit guidance for the FY17 year. Although TPG’s FY16 results broadly met expectations, TPG said that it expected an underlying EBITDA of $820m to $830m in FY17 compared to $775m in FY16. This represents a growth rate of 6% to 7%, which is interesting, but hardly inspiring for a company trading on a high multiple.

The forecast also acted to support concerns that competition is intensifying in the telecommunications industry, pressuring margins. Competitor Vocus’s fall from grace has also hurt, with TPG losing 9% on Tuesday following Vocus’s profit warning.

The TPG business

TPG, which is 34% owned by David Teoh and his family, has three major business units. iiNet, which was acquired in August 2015, TPG Consumer and TPG Corporate. Earnings are split evenly, with iiNet earning $242.6m, Consumer $255.7m and Corporate $269.3m.

Composition of EBITDA Growth


TPG Consumer has 885,000 broadband subscribers and 304,000 mobile subscribers. With iiNet, this gives the group 1,868,000 broadband subscribers and 475,000 mobile subscribers. Despite these impressive numbers, growth is slowing - with broadband subscribers growing by 1.4% over the half year, and mobile subscribers by 2,000, or just 0.4%.

Group Broadband Subscribers

Revenue per subscriber has plateaued, with ARPU (average revenue per user) from NBN customers falling from $67.40 per month in the first half to $67.20 in the second half. There were similar falls for on net ADSL bundles. With subscriber numbers also stalling, revenue growth in the second half was almost flat compared to the first half, and second half EBITDA in TPG Consumer of $130.6m was up by just 4% (or $5m) on the first half.

TPG’s Corporate division includes the old AAPT business, and provides services to business and wholesale customers. Its infrastructure includes overseas submarine cables and a national core network of fibre connecting the major capital cities. It grew underlying EBITDA by 11.1% in FY16. 

With a view to long term growth, TPG is participating in a mobile spectrum auction in Singapore, where it is one of two remaining bidders. It says that should it win the auction, it will move quickly to establish a substantial operation in Singapore, which it will fund from existing debt facilities and cash generated from Australian operations.

The Brokers view

On valuation grounds, the brokers are largely positive on TPG. The current price of $7.14 sits well below the current consensus price of $9.40, implying potential upside of 32%. Many see the price fall as excessive. That said, several brokers reduced their target price following the FY17 profit guidance.

The main concerns centre on intensifying competition in the consumer business, in particular margin compression as the NBN rolls out, and trading multiples given the (now) single digit EBITDA growth rate.

Individual recommendations and targets (source: FNArena) are:

On a forecast basis, TPG is trading on a multiple of 15.6 times FY17 earnings, and 14.3 times FY18 earnings. The dividend is forecast to be 15.5c in FY17, putting the stock on a yield of 2.2%.

My view

Any stock that falls 45% must be interesting, particularly when it has largely delivered on its targets. The only thing that has changed is that the market’s growth expectations were way too high, and perhaps a growing realisation that competitive pressures in the telco industry are intensifying.

However, unless management is being very conservative about their forecast, the lack of EBITDA growth does surprise and I am struggling to get that excited about it. A swing factor that could go either way is that according to the latest ASIC figures, 3.74% of the company’s shares (or 31.7m) are sold short. While this is not that high, almost 60% of the company’s shares are under the control of two shareholders - the Teoh family and listed company, Soul Pattinson (ASX: SOL). While the shorters more often than not get it right, a short squeeze on some good news could see a very sharp appreciation in price.

One to watch and perhaps put on the buy list if it gets hit again.

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Don't bet on Boral

Thursday, November 24, 2016

By Paul Rickard

It's somewhat ironic that Boral’s slogan is “build something great”, because if Boral’s acquisition of Headwaters, a US manufacturer of building products and marketer of fly ash, proves to be successful, then it will be transformative for Boral and it will be a great Australian company again. But history is betting against Boral.

The track record of Australian companies making acquisitions in the USA and the UK is littered with failures. To cite just a few examples: NAB with Yorkshire/Clydesdale Banks in the UK; AMP with Pearl Insurance in the UK; BHP with US shale oil and potash; Slater & Gordon with Quindell. Even Boral’s earlier acquisitions in the US haven’t worked - last year, Boral’s USA division returned just 5.0% pa on the funds employed, and this followed a woeful 0.7% pa in FY15.

That doesn’t mean foreign acquisitions can’t succeed. Obviously, some do, but because a premium is paid to win control and the economics usually rely on those elusive “synergy benefits”, more fail than succeed. Maybe it's also a reflection on the ability of Australian management to compete in bigger markets, rather than the smaller and relatively homogeneous market in Australia.

And while it looks like the institutional market has given this deal an early thumbs up, with more than 90% of institutional shareholders participating in the capital raising to fund Boral’s acquisition, this hasn’t always proved to be a good predictor. The market also gave the thumbs up to raisings by Slater & Gordon, Vocus, and back in September/October, to JB Hi-Fi for its acquisition of Good Guys. Institutions paid $30.25 and $29.40 respectively for shortfalls in the JB Hi-Fi issue - JB Hi-Fi shares closed yesterday at $26.62.

Can Boral succeed? I hope so, because our market needs great companies that are prepared to take measured risks to grow. They have a great CEO in Mike Kane who knows the US market, so that’s a good starting point. But this $3.5bn acquisition looks like a big deal ...

Headwaters Inc

I need to acknowledge upfront that I had never heard of Headwaters Inc. until Monday, nor did I know much about fly ash, so my data source for this article is the Boral “spin” document (otherwise known as the Investor Briefing). It's more than likely that my situation is not unique.

The acquisition of Headwaters brings US$1.1bn in revenue and adjusted EBITDA in FY16 of US$218m. Headwaters operates through two core divisions - building products and construction materials. Building products operates from 34 locations, generates 65% of the revenue, and manufactures products such as trim and siding, stone, block, windows and roofing that are primarily used in the residential market. Construction materials collects fly ash from 68 sources and distributes this from 25 terminals to the US construction industry. Fly ash is a by-product from coal fired power stations, and is used as cement substitute in ready mix, in asphalt and as filler in engineered products.


Boral’s substantiates the acquisition by saying firstly that the deal is transformative. It significantly increases Boral’s exposure to large addressable USA building and construction markets which are experiencing positive momentum. With exposure to more diverse and growing end markets, Boral will be better positioned to deliver sustainable growth and improved earnings. Boral’s USA business will contribute 38% of group revenue when Headwaters is fully integrated, up from 19% today.

The second reason cited is the strategic fit with Boral’s existing business. The combination of complementary businesses adds scale to Boral’s USA footprint. It significantly scales Boral’s fly ash business, creating a national platform and going from a US$100m business to US$450m business. Boral is bullish on demand for fly ash from rising demand for cement, fly ash prices, and the opportunity to increase margin.


Boral is also keen on the growth prospects for light building products, such as trim, siding, moulding, shutters and decking, and views Headwaters as delivering a platform that provides geographic breadth and attractive niche products for high- and low-end housing.

From a financial point of view, Boral says that there are substantial synergies and that the deal is EPS accretive on a proforma FY17 basis. It estimates synergies of USD100m pa within four years of transaction completion. Boral is buying Headwaters on an implied acquisition multiple of 10.6 times forecast FY17 EBITDA, which falls to 7.5 times if the full annual synergy benefits are realised. The acquisition will need to be approved by regulatory authorities, as well as a vote of Headwaters shareholders. Closing is expected mid calendar year, 2017.


Boral is funding the transaction of US$2.56bn (about A$3.51 bn) through a A$450m institutional placement at $4.80 (completed yesterday), a renounceable entitlement offer of A$1.6bn, debt funding of A$1.1bn and the drawdown of existing cash. Boral’s gearing (defined as net debt to net debt and equity) will rise from 20% to 30%.

The entitlement offer will also be conducted at a price of $4.80, a 22% discount to Boral’s closing price last Friday, and a 15.1% discount to the theoretical ex rights price of $5.66. It will be conducted on a 1 for 2.22 basis - that is, an entitlement to 100 new shares for every 222 shares already held. For example, if a shareholder owns 2,000 Boral shares, they will be entitled to purchase 901 new shares at $4.80 each.

Retail shareholders will have 3 choices. Take up the new shares at $4.80; sell the entitlements on the ASX, with trading to commence today under stock code BLDR; or do nothing. If they elect to take no action, their entitlements will be auctioned in a shortfall bookbuild. If institutions are prepared to pay more than an effective $4.80, then retail shareholders will receive any excess over $4.80.

The timetable for the funding is set out below:

What to do

The risk/reward trade says to get out, wish the Boral team well, and watch from the sidelines. That doesn’t necessarily mean selling your Boral shares (unless you need the cash or have a better investment idea), but it does mean not putting more money in to take up your entitlements.

Shareholders who have a reasonable parcel and can access low brokerage should consider selling their entitlements on the ASX. Trading only goes for seven days and ceases on Friday week (2 December). Shareholders with small parcels should take no action and let their entitlements be sold into the retail shortfall bookbuild.

Disclosure: The author owns Boral shares.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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Banks are back in favour

Thursday, November 17, 2016

By Paul Rickard 

Cast your mind back to February. Financial stocks were on the nose globally. In Australia, we followed suit and trashed the prices of the four major banks. The market was worried about a commodity slump causing havoc to bank balance sheets through exposures to troubled miners and mining service companies, expected capital demands and the possibility of dilutive capital raisings to accommodate the Basel IV regulatory framework, the prospect of dividend cuts and the banks being “ex-growth”.

Less than nine months later, and partly on the back of “Trumpomania”, four out of these five drivers have largely evaporated. The first driver, the lead from offshore markets, has really turned around. So far in November, which covers both pre and post the US election, the US S&P 500 Financials Index has added an astonishing 12.41%. In Europe, the STOXX 600 Banks index has returned 5.43%.  In Australia, our gains are more modest, up by just 4.22%.

No one is talking about the commodity price “slump”, and while dividend cuts haven’t quite gone away, they are pretty much factored in. ANZ did cut its dividend, while CBA, NAB and Westpac were able to hold their dividends unchanged. And while payout ratios for the latter two are touching 80%, there appears to be growing confidence that any dividend cut in FY17 will be modest, and more than likely, won’t occur until FY18, if at all.

The capital question

On the question of banks needing to increase their capital ratios and the impact of Basel IV, the Chairman of APRA, Wayne Byres, has put this on the backburner. Speaking last Friday at a conference in Melbourne, he said that “2017 will be a year of consultation. We don’t expect to have final standards before this time next year. And even if that is the case, they won’t take effect until at least a year after that”.

This means no bank capital raisings in 2017, and that the earliest that the banks would need to comply with any new capital standards is 2019. That doesn’t mean that the banks can take it easy, because he also went on to say that “capital accumulation remains the appropriate course for most ADIs (authorised deposit taking institutions)”.

However, each of the four major banks sits comfortably above their target capital ranges, generally considered to be a CET1 (common equity tier 1) ratio of between 8.75% and 9.25%. At 30 September, ANZ was at 9.6%, CBA 9.4%, NAB 9.77% and Westpac 9.5%. While these ratios will come down when the September balance date banks (ANZ, NAB and Westpac) pay their final dividend, and the target range will increase when APRA concludes its consultation process, the banks should be able to meet any new requirements through organic capital generation, dividend re-investment plans and the continued sale of non-core assets. “With sensible capital planning, the actual implementation of any changes should be able to be managed in an orderly fashion”, he said. 

Dilutive capital raisings are off the agenda.

That leaves us with “the banks are ex-growth”.

Are the banks ex-growth?

The banks are considered ex-growth for four reasons. Firstly, credit growth in the economy is low, running at an annualised rate of just 5.4% in the year to September.

Net interest margins have been under pressure, partly because of a change in funding sources and more emphasis on stable, longer-term retail funding, but mainly due to the very low interest rates. When the RBA reduces the cash rate and you are pressured to cut your lending rates, but can’t cut your deposit rates because you can’t cut a 0% or 0.01% deposit rate any further, margins get squeezed.

Next, there is the credit cycle, which is seen as at an historic low in terms of the losses banks have been booking. If losses are going to increase, this will reduce bank profits. Finally, if banks are increasing their capital base (either by issuing more shares via a DRP, or selling assets which in turn takes away revenue sources), it's extremely difficult to grow EPS (earnings per share).

Looking at the recent bank financial results, that’s exactly what happened. For all banks, the second-half profit was flat on the first half, full-year profit growth was low single digit, and year-on-year EPS growth was flat to negative.

But, does Trumpamania change this? Potentially, yes. Not with the credit cycle or an increasing capital base, but he could influence credit growth if he gets the US economy firing, companies start to invest again, and this spreads to Australia. More likely however, he is impacting the expectation that interest rates in the US will go up, which as the lead market, will influence Australian rates. Australian bank net interest margins could start to improve.

And even if our banks can’t do much to improve the revenue outcome, profit growth can come by cutting costs. Of course, the old adage goes that you can’t “shrink your way to greatness”, but do you really believe that our banks are lean and fighting fit? And with the kids now doing their banking on mobile apps, the imminent removal of cheques and the cashless society, think of the billions that can be saved when the banks start to wind down their branch networks.

I don’t buy the line that the banks are necessarily “ex-growth”.

Bank sector looks like value

According to FNArena, the banks are trading on forecast multiples ranging from 12.0 times to 14.0 times FY17 earnings, and 11.7 to 13.8 times FY18 earnings. Forecast dividend yields range from 6.5% to 5.5%, plus franking credits. These aren’t super cheap multiples, particularly compared to some banks offshore, but they are also not that high compared to the multiples they were trading at two years’ ago.

Importantly, most of the reasons to be negative about the sector have ameliorated.

I think the sector is in buy zone. Given the extraordinary run since Donald got the gig, it may need to pullback a little first, however I expect that this sector will outperform the market. If you want to see my views on the individual banks, you can read about this in the Switzer Super Report.

Disclosure: I and my family’s SMSF are shareholders in each of the four banks.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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Can you do anything about the pension changes?

Thursday, November 10, 2016

By Paul Rickard

Around 500,000 elderly Australians will shortly find out about the fate of their fortnightly pension payment. There will be about 170,000 winners and 326,000 losers as new asset test limits apply from 1 January 2017 to the receipt of the Government aged pension.

Originally announced back in May 2015, this is the implementation of the Coalition’s plan to reduce the dependence on the aged pension by more wealthy retirees. Passed with the support of the Greens, there are two changes to the assets test. There are no changes to the income test.

The first change

Firstly, the value of assets that a pensioner can hold before their full pension is reduced is being increased. This means that about 170,000 retirees will see a small increase in their regular fortnightly pension payment.

For example, the threshold for a home-owning couple increases from $296,500 to $375,000, meaning that couples who have assets (excluding the family home) which are valued between $296,500 and $375,00 will now get the full pension from 1 January (see Table 2).

Assets include property (outside the family home), shares, cash and term deposits, motor vehicles, household contents and most importantly, superannuation account balances.

Table 1 - Full Pension Thresholds - Singles


Table 2 - Full Pension Thresholds - Couples

The second change

The second change is to the taper rate, which is the rate at which pensions start to reduce. This is being increased from a rate of $1.50 per fortnight reduction in the pension to a rate of $3.00 per fortnight reduction in pension for every $1,000 of assets in excess of the threshold.

The net effect of these changes is that around 235,000 pensioners will see their pension reduced, while about 90,000 will cease getting any pension at all.

For example, consider a home-owning couple with combined assets of $500,000 (excluding the family home). The maximum pension for a home-owning couple is currently $1,322.40 per fortnight, or $34,382 pa. As their assets are above the threshold, they currently receive $1,017.15 per fortnight. From 1 January, with a higher threshold but also increased taper rate, their pension payment will fall to $947.40, a decrease of $69.75 per fortnight or $1,814 pa.

Approximately 90,000 pensioners will stop receiving any payment. Tables 3 and 4 show the maximum assets that a pensioner can have to receive a part pension. For a home-owning couple, the maximum amount of assets (excluding the family home) that a couple can own will reduce from $1,178,500 to $816,000.

Table 3 - Part Pension Thresholds - Singles

Table 4 - Part Pension Thresholds - Couples

The only “good news” for those who will lose their part pension is that they will continue to be entitled to a Commonwealth Senior’s Health Card, meaning that they will be eligible for Medicare bulk billing and less expensive pharmaceuticals.

If impacted, what can you do about it?

The answer is not a lot, apart from investing in the family home. Obviously, you can spend your wealth and reduce your net assets, but there are only so many overseas trips you can take. Replacing one asset with another doesn’t change the equation.

There are strict rules about gifting assets to another family member, which could see any gifts counted in the test as “deprived assets”, so this also doesn’t change the equation. Within the rules, you are allowed to gift up to $10,000 in a year and no more than $30,000 over the past five financial years.

A more obvious strategy is to invest in the family home – renovate, add an extra bedroom, build a pool, etc. This is attractive because it is not counted in the assets test, is free of any capital gains tax, and historically, has proven to be a good investment for many families.

Of course, you can over capitalise on any property. The old adage is still largely true - you want to own the worst house in the best street, rather than the best house in the worst street. And property is not a liquid asset, so if you need to find some cash to meet some unexpected expense, such as major hospital bills, you can’t sell one of the bedrooms.

The Government got this wrong

The problem with the new rules is that the taper rate is just too high. Because the pension reduces by $3.00 per fortnight for every $1,000 of assets, or $78 per year, this means that a pensioner would need to earn at least 7.8% pa after tax on their investment assets to be better off. Otherwise, they may as well jettison their assets and seek the safety and reliability of the pension.

While an after-tax return of 7.8% pa is not out of the question, it is pretty difficult, particularly if investing in defensive assets. This is why several pensioners will look at strategies such as investing in the family home to legally reduce assets. Moreover, people in their late fifties or early sixties who are more than five years out from pension age will think about gifting and other strategies to reduce assets, so they can actually receive the aged pension when eligible. In the long term, this will cost the taxpayer more.

The Government was badly advised on these changes. The taper rate shouldn’t have been lifted higher than $2.00 per fortnight, an effective investment rate of 5.2% pa.

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