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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

Downsizers and first home buyers get a leg-up

Thursday, December 14, 2017

By Paul Rickard

On the same night that the eyes of the nation were fixed on Canberra with the vote on the legislation to allow marriage by same-sex couples, the Government had another win as the Senate passed two measures to improve housing affordability. Announced back in the May Budget, the measures involve the superannuation system and were opposed by many in the “rent seeking” superannuation industry and on the floor of the parliament by the ALP. The changes will provide a small incentive for some older Australians to downsize, and assist first home buyers to save a deposit faster and help to overcome one of the barriers for getting into the housing market.

Neither measure is a silver bullet for the housing affordability problem, but they are a step in the right direction. They don’t come at a huge cost to Government revenue (foregone tax), and won’t have any long term impact on prices in the housing market. If anything, by making the super system a little more aligned with that other primary retirement objective, home ownership, they will actually be a boost to the super system in the long term.

Here’s a run-down on the two changes and who they might suit.

  1. 1. Downsizing 

Persons aged 65 or over who downsize by selling the family home will be able to make a non-concessional contribution to super of up to $300,000 from the proceeds. These contributions won’t be subject to meeting any work test, will be in addition to the current non-concessional cap and won’t be subject to the $1.6m balance test for making non-concessional contributions. If a couple, then potentially $600,000 could be contributed to super.

The only qualification is that it must be from the sale of your principle residence owned for the past 10 or more years.

Downsizing is rarely driven by just financial reasons, with lifestyle, health and family reasons more often cited as the main factors. For those who are receiving the age pension, there  remains a financial disincentive to downsize as the family home is exempt from the pensioner assets test and the net proceeds from the downsizing (whether invested in cash or back into the super system)  is included in the assets test. And this measure won’t do anything to improve the availability of suitable properties. But, it should prove popular with self-funded retirees who can then invest their savings in a 0% or worst case 15% taxing environment, and free up homes that no longer meet their needs for younger growing families.

  1. 2. First Home Super Saver Scheme

At the other end of the housing market, first home buyers will be able to make voluntary salary sacrifice contributions into super, and withdraw these together with associated earnings for a deposit for their first home. 

The Government says that first home buyers will accelerate their savings by at least 30% using the First Home Super Saver Scheme (FHSSS). For example, an individual earning $70,000 pa who makes annual salary sacrifice contributions of $10,000 for 3 years will be able to withdraw (after all taxes - see below) $25,892 for a deposit. This is $6,210 more than the $19,681 they would have saved if investing after tax dollars ($10,000 less $3,450 tax) for 3 years in a bank account earning 2% pa. (You can access a calculator here )

The Scheme allows up to $15,000 per year and $30,000 in total to be contributed. While it will count within the individual’s concessional super cap of $25,000 per annum, both members of a couple can take advantage of the measure, meaning that potentially $60,000 can be contributed.

Special taxing arrangements will apply to these super contributions. Like other salary sacrifice contributions, they will come out of a person’s pre-tax income and then be taxed at 15% when the contributions hit the super fund. Inside the fund, the contributions will earn a deemed rate of interest (currently around 4.78% pa), with the interest amount then taxed at 15% pa.  On withdrawal, the whole amount will be taxed at the individual’s marginal tax rate, less a 30% tax offset. This means that the maximum tax rate on withdrawal will be 17%.

From a home saver’s point of view, participation in this Scheme should be really easy. No new super account required, just instruct your employer to salary sacrifice and pay this amount to your super fund marked as a FHSSS contribution. 

Individuals who are self-employed or whose employers don’t offer salary sacrifice can still make voluntary contributions to the FHSSS, and then claim the contributions as a tax deduction (subject to the $25,000 cap on concessional contributions). This means that savings effectively come out of pre-tax income. 

Non concessional contributions (from after tax monies) can also be made, subject to the overall limit of $30,000 and $15,000 in any one year. These won’t be taxed on entry or exit, but could benefit (marginally) from the higher deemed rate of interest.

To qualify, you must be over 18 and have never owned ‘real property’ in Australia before. If you have owned or own an investment property or vacant land, you will not be eligible to use the FHSSS. But you won’t be ineligible if your partner has owned a property before, and you haven’t. To access the savings, you will need to purchase a residential property (including vacant land to be built on), sign a contract to do so within 12 months, and occupy the premises for at least 6 months of the first 12 months after it is practicable to do so.

Despite comments that “$30,000 doesn’t really give you much of a deposit for the Sydney or Melbourne markets”, this measure will prove to be popular when first home-owners realise that it is a “no-brainer”.

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Short sellers get smashed

Thursday, December 07, 2017

By Paul Rickard

This week’s rally in the leading retail stocks is great news for investors, and a blow to the short sellers. Finally, these professional investors are wearing some of their own medicine.

Over the last three days, JB Hi-Fi has added 8.4% to close yesterday at $25.35, Harvey Norman is up by 3.5% and Super Retail Group is 2.1% higher. Even department store disaster Myer has put on 2.0%.

There is nothing like a short covering rally to separate “the men from the boys,” and when they happen, they can be pretty ferocious. And this is exactly what we’ve seen.

What triggered the rally? 

Firstly, Amazon arrived……………and didn’t conquer. After so much fanfare, it finally launched its Australian website on Tuesday with 17 categories of goods ranging from clothes to electrical items. But this underwhelmed most analysts because the range is patchy, and the pricing variable. Some items were cheaper than Amazon’s bricks and mortar (and increasingly online) competitors, other items were more expensive.

Further, Amazon’s much lauded logistical and delivery systems knowhow isn’t on display with the Australian offer. Sure, you can get free delivery if you order goods worth more than $49, but this translates to a wait of three to 7 business days if you live in one of the capital cities. In the bush, it is seven to 10 business days. And if you pay $9.99 per order for “priority” delivery in Sydney, Melbourne or Brisbane, it will largely be next day delivery rather than same day delivery. Hardly ground breaking. Hardly disruptive.

Amazon Australia Delivery Schedule and Cost

Source: Amazon

Overall, Amazon’s debut offer was considered to be a bit “lame”.

The other factor that drove the short covering rally was a surprise jump in retail turnover of 0.5% for the month of October. This came after a very tough period for retailers, and suggests that in the lead up to the critical Christmas holiday period, consumers may be ready to open their wallets a touch.

These two factors were enough to drive the short sellers to take some cover. Unfortunately, we won’t know for some days just how many short positions were covered, as ASIC reporting on short sales is still woefully behind the market action. The latest report from ASIC shows that a staggering 17.4m JB Hi-Fi shares worth around $440m are sold short. This represents 15.14% of the total number of JB Hi Fi shares on issue - roughly 1 in 6. For Harvey Norman, 9.48% of the shares have been sold short, while the position in Super Retail is 5.36%.

What do the brokers say

The brokers are still cautious on the retailers. They know that Amazon will ramp up its offer, launch Amazon Prime, and innovate to attract customers. Even if it doesn’t win that much market share, the presence of Amazon will keep downward pressure on prices and hurt operating margins for the existing retailers.

According to FN Arena, JB Hi-Fi, Harvey Norman and Myer are fully priced. The consensus broker target price for JB Hi- Fi is $24.58, 3% below its closing price yesterday. Only Super Retail has upside to its target price.

Buy recommendations are hard to find. Myer doesn’t have any, while JB Hi-Fi has one (with 5 neutrals and 2 sell recommendations). On multiples, the major retailers are cheap, trading around 12 times forecast FY18 earnings and 11.5 times forecast FY19 earnings. Yields are over 5%.

Broker Recommendations/Forecasts


Bottom Line

The short covering rally came earlier and was stronger than I had expected. I think there is value in the retailers, but investors can afford to be patient as it is unlikely that the short sellers have given up. These guys have deep pockets and know that the “Amazon scare” has further to play out. 

And I would specifically exclude Myer from any buy list. At the right price, it is JB Hi-Fi or Super Retail for me.

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Can the healthcare sector get any healthier?

Thursday, November 30, 2017

By Paul Rickard

One of the standout features of the Australian sharemarket is that the healthcare sector goes from strength to strength. Already in 2017, the sector is up by 28.5%, with stocks such as CSL and Cochlear hitting 52-week highs this week. Over the five years to 31 October, the sector has returned 20.12% pa - outperforming the broader market as measured by the S&P/ASX 200 by an amazing 9.82% pa.

Over 10 years, a period which includes the peak of the market in 2007 and the full impact of the GFC, the broader sharemarket has returned (including dividends) a relatively unimpressive 3.20% pa. The healthcare sector, on the other hand, has returned 12.29% pa. To put this into perspective, $100,000 invested in the sharemarket at that time would now be worth (with dividends re-invested) $137, 024. The same $100,000 in the healthcare sector would be worth a staggering $318, 721!

So, why the strength in the healthcare sector?

Firstly, the same demographic and technology factors that are driving the demand for healthcare services globally (particularly in developed nations) are driving the demand for services in Australia. As the population ages, the demand for services increases, and expectations about what can be treated are raised. While some of the cost is met by the public directly, most is borne by government, and this expenditure has been growing at a rate well in excess of the inflation rate - closer to a rate of 3% to 4% over the inflation rate.

Secondly, we have some absolutely terrific healthcare companies. Our largest by market capitalisation, CSL, is the global leader in blood plasma products and number two in influenza vaccines. Resmed is the best at products to treat and manage sleep apnea, while Cochlear leads in the field of hearing implants. Ramsay Health Care is one of the leading private hospital operators, with operations in Australia, France and the UK.

Finally, the distortion of our local market caused by the overweight representation of banks and resources companies has meant that our local fund managers have been desperate to invest outside these sectors, and arguably, have paid way above the mark to invest in the healthcare sector. This problem has compounded over the last few years with so many of our large cap companies seeming to be “growthless”. The major banks, big insurers, retailers, Telstra and the big miners have struggled to grow earnings. Consequently, a huge premium is being paid for companies that can demonstrate consistent growth. The CSL's, Resmed's, Cochlear’s and Ramsay’s fit right into this category, and are arguably, super expensive.

The data below from FN Arena for the four largest healthcare companies paints the picture. On the major broker forecasts, CSL is currently trading on a multiple of 32.2 times forecast FY18 earnings and 28.0 times forecast FY19 earnings. Cochlear trades at an even more remarkable 41.7 times FY18 and 36.8 times forecast FY19 earnings!

It closed yesterday at $183.70, putting it 20.4% higher than the consensus broker target price of $146.26. Only Ramsay Health Care, which has recently been the target of short sellers and has been dragged down due to the lacklustre performance of Australian competitor Healthscope, is trading under the consensus broker target price.

How to play

Three longstanding investment adages are: 1. The trend is your friend; 2.You never go broke taking a profit; and 3. Let your profits run. Each is relevant here.

While Australian healthcare stocks are very expensive, not only compared to the broader Australian market but also compared to global healthcare sector peers, the trend to higher prices is clearly intact. As I noted earlier, I think it has been exacerbated by the underperformance of the large cap market stocks and until we start to see some rotation back into these stocks, healthcare stocks are likely to remain well bid.

Take a profit? Maybe with stocks such as Cochlear (the most obvious candidate) or CSL, but I could have argued exactly the same course of action when their share prices were $10 lower or even $15 lower. Let your profits run wins!

So, if you are long healthcare stocks, hang on for the ride. Maybe a little bit of profit taking to put some money into the bank, but not much more than that. If your portfolio is underweight, I think you may need to be very, very patient. Apart from perhaps Ramsay Health Care, I can’t advocate buying at these prices.

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Will Amazon launch today?

Thursday, November 23, 2017

By Paul Rickard

I don’t know about you, but I am sick and tired of hearing about Amazon’s Australian retail “assault”. The latest speculation is that it is set to launch in time for the Black Friday/Cyber Monday sales (Black Friday is the official start of the US Christmas sales season and follows the Thanksgiving holiday tonight when stores open for 24 hours and offer massive sales. Cyber Monday is the online sales equivalent, starting next Monday). According to one report, Amazon Marketplace sellers have been told to have their pricing, stock and details ready for an internal testing phase with a small number of customers that is due to kick off today.

The fact that this report was covered so extensively in our media tells you just how good the Amazon PR people are at getting the message out. It also tells you just how much fear there is about the power of Amazon with investors and in the broader retail industry.

Back to the fear in a moment, but firstly, what do we actually know about Amazon’s preparedness for its retail "assault” in Australia? Arguably, only three things. Firstly, they have invited small/specialty retailers to register to participate in the Amazon Marketplace - Amazon’s online platform for third party sellers. Next, they have taken a lease over a warehouse/distribution centre in Dandenong South in Melbourne’s south east. And thirdly, they have applied to register several patents in Australia.

In summary, not a lot. Hopefully, we will know a little more after today.

In regards to the fear factor, the Amazon “assault” has certainly taken a toll on the share prices of Australia’s major listed retailers. Since the start of the year, JB Hi-Fi’s share price has fallen by 20.4% from $28.04 to $22.31, Harvey Norman is off by 24.1% from $5.15 to $3.91, and Super Retail Group (the owner of stores under the Amart, Rebel and SuperCheap Auto brands) is off by 22.7%. Myer has almost halved to $0.71 ( for other reasons as well as Amazon), while Myer’s suitor, Premier Investments, which operates stores under the Just Group, Peter Alexander and Smiggles brands, is down by 4.4%. All this in a stock market which has risen by 5.7% this year.

Professional short sellers have led the charge, making retail stocks the most “short sold” sector on the ASX. According to the latest daily figures from ASIC, JB Hi-Fi is the fourth most shorted stock with 15.86% of its ordinary shares, or 18.3 million shares, worth around $410 million sold short. Harvey Norman makes it into 14th place with 9.44% of its shares sold short.

What do the brokers say

The major brokers see value in the retailers, but like the rest of the market, share considerable fears about the impact of Amazon. It is not so much about the timing of Amazon or how aggressively they roll out their range of products, but in the short term, the impact on the retailers’ cost base as they invest in service, technology and logistics to compete, and over the medium term, the impact on margins as price competition intensifies.

Excluding Myer, the other major discretionary retailers are each trading below the broker consensus target price. According to FN Arena, the upside potential ranges from 15.3% for Super Retail Group to 5.9% for Harvey Norman.

On near term pricing multiples around 10 - 11 times forecast earnings, the stocks look cheap. Forecast dividends are yielding in excess of 6% (fully franked).

How to play
Although the discretionary retailers are cheap, there is nothing to say that they can’t become cheaper still.  Because the market knows that Amazon has very deep pockets and expects it to be around for the long term, it doesn’t really matter whether Amazon opens for business in Australia today or not till next March. The Amazon scare isn’t going to go away.

For value buyers, the clue could be to follow the shorters. These professionals have been “on the money” with the whole Amazon scare - early to take positions, patient, and sellers into any rallies. If, and when, the shorters start to close their positions, this is could be the clue for others to buy.
Watch the shorters.
Disclosure: The author and his SMSF own shares in JB Hi-Fi.

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Will Woodside ever be great?

Thursday, November 16, 2017

By Paul Rickard

News that Shell has finally quit its investment in Woodside Petroleum by selling for $3.5 billion its remaining 111 million shares or approximately 13.5% of the company at $31.10 per share is a medium term positive for Woodside shareholders. At long last, this overhang has been removed from the market.

But it is also worth reflecting that this is Shell’s third sell-down of Woodside. After having a takeover offer to buy 100% of Woodside famously rejected by the then Treasurer Peter Costello on “national interest” grounds in 2001, Shell sold its first tranche of 10% of Woodside in 2010 at $42.23 per share. It sold another tranche of 9.5% in 2014 at $41.35 per share.

That Shell is now exiting Woodside at a price 27% lower than it achieved in 2010 when the stockmarket was a whole lot lower is a reminder of just how painful the last decade has been for Woodside shareholders. While oil prices play a part in this saga, Woodside has also woefully underperformed.

In fact, Woodside has been one of Australia’s most disappointing companies. So much promise, so many expectations. I think of Woodside as Australia’s “gunna do” company - big ideas, big plans, and no execution.

And I say this not only as a current shareholder, but as someone who first bought shares in Woodside in 1978 when the North West shelf project was in the conceptual phase. My very first share purchase.

Forty years later, I am still asking the same question - can Woodside ever be great?

The Woodside Strategy

For shareholders looking for “greatness”, Woodside’s strategy paints a pretty uninspiring picture (see below). It has three horizons, with the first going out to 2021, and the third starting in 2027 (yes, in 10 years’ time!). Horizon 1 is about “cash generation” through lower capital intensity developments, exploration and expanding the LNG market. Horizon 2 is titled “value unlocked” and Horizon 3 is “success repeated”.

Woodside Strategy

To be fair to Woodside, they have been working hard on costs, margin and return on equity. At a portfolio level, production costs have fallen by 36% since 2014 - from US$7.60 per barrel of oil equivalent (boe) to US$4.90 boe in the first half of 2017 (Woodside reports on a calendar year basis). Gross margin has increased from 43% in 1H 2016 to 48% in 1H 2017, and return on average capital employed has moved into the high single digits.

However, Woodside is not exactly a growth business and production has flat lined. Last year, Woodside produced 94.9 MM boe, up 3% on 2015’s 92.2 MM boe. For 2017, Woodside has guided to produce 84-86 MM boe.

While Woodside has some growth options with Wheatstone, which has just commenced production and has the potential to produce up to 13MM boe when fully operational, the North West Shelf and Pluto are exhausting assets. Collectively, these two assets produce 94% of Group earnings before interest tax, depreciation and amortisation (EBITDA) (North West Shelf 33% and Pluto 61%). There are projects underway in Persephone and Greater Enfield, and expansion options for Pluto. The company is also exploring in Myanmar and Senegal, but the long trumpeted Browse project looks as far away as ever from getting out of the conceptual phase and into detailed design. In fact, some analysts interpret Shell’s sell-down of Woodside as confirmation that they have given up on the Browse project.

What do the brokers say

According to FN Arena, the major brokers are luke warm on Woodside and are struggling to find meaningful upside for the stock. The consensus target price of $29.90 sits at a 3% discount to yesterday’s closing price of $30.77, with 2 buy recommendations, 2 sells and 4 neutrals.

A little bit of caution is required with broker target prices and resource companies, because as long term valuations, so much depends on the forecast for the underlying commodity price. While Woodside has long term contracts for the supply of LNG, the LNG price is a function of the oil price. If the analysts are bullish on the oil price, then their target prices for Woodside will increase.

On a multiple basis, the brokers have the stock trading at 19.8 times forecast FY17 earnings and 19.9 times forecast FY18 earnings, which is high relative to its peers.  With a dividend payout ratio of 80% (which some brokers feel is too high), they forecast a full year dividend of 93.5 US cents for FY17 (A$1.23) and 95.5 US cents for FY18. This gives it a forecast yield of 4.0%.

Bottom Line

Woodside is a relatively low risk way to take exposure to the energy sector because it has some great Australian assets and the company is focused on cash generation and improving returns from existing projects. Taking Shell off the share register won’t impact the broker valuations, but will remove an overhang that could impede stock price gains if the oil price takes off.
Worth holding in the portfolio, but it is hard to see the company ever being classified in the “great” category.

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CommBank shines some light

Thursday, November 09, 2017

By Paul Rickard

After three underwhelming profit reports from the ANZ, NAB and Westpac, bank “earnings season” finished yesterday with CBA delivering a solid first quarter update. The market gave it the tick, with the share price rallying 2.7% to close at $80.27.

On a headline basis, CBA’s cash profit looked pretty good. At $2.65 billion, this was up around 10% on the corresponding quarter in 2016, and up 6% on the average of the last two quarters.

A big fall in loan impairment expenses, down 20% on the last two quarters, and an improvement in net interest margin (NIM) were the drivers. At a record low of just 11 basis points (0.11% of gross loans), the impairment charge was just $198 million compared with $322b million for the same quarter in 2016.

The net interest margin also improved, as CBA was able to reprice home loans and other assets, and reduce liquid asset balances. Volumes also ticked up, although the overall growth in the home loan book at an annualized rate of 2.7% was below system growth and well down on the rate of 6.9% achieved in FY 16/17. Overall, operating income grew by 4%.

Operating expenses also grew by 4% (no positive jaws), but CBA said part of this increase was due to provisions for project work relating to regulatory actions and compliance programs. This covers work to remediate shortcomings in its anti-money laundering controls, but not the cost of any fine imposed should AUSTRAC’s civil penalty proceedings be successful.

A highlight of the result was the generation of capital from earnings and through the de-risking of the asset book.  This saw the CET 1 (Common Equity Tier 1) ratio remain at 10.1%, notwithstanding the payment of the September dividend that knocked 55 basis points (0.55%) off the base. 

When the sale of its Australian and New Zealand life insurance operations to AIA completes in 2018, it will increase the capital ratio by 0.7%. CBA’s pro-forma CET1 ratio on 30 September is now 10.8%, above APRA’s 2020 “unquestionably strong ” benchmark of 10.5%.

While APRA might yet make some further modifications in relation to the risk weights used for assigning capital for higher risk mortgages, the bottom line for CBA is that it has met its capital targets and dilutive capital raisings are now wholly off the agenda. Like Westpac and ANZ, it won’t be too far down the track before it can start to think about returning capital, and if earnings increase, dividends can also increase.

Challenges remain

Challenges remain, however. Firstly, CBA (like its peers) is virtually growthless. Low single digit volume increases is barely growth, and while NIM has improved, there is a limit on just how often the asset book is repriced. Then there’s the impact of initiatives such as killing foreign ATM fees and reducing fees on old style transaction accounts, as well as the loss of earnings from divested assets to factor in. Revenue growth is going to be a struggle.

On the cost side, the Bank will feel a little constrained on addressing costs too aggressively until such time as the AUSTRAC proceedings, APRA’s independent prudential inquiry into governance, culture and accountability at the CBA, and shareholder class actions are out of the way. No headlines like NAB’s “6,000 jobs to go”.

But it does need to address its cost base, and quickly. And while the cost of these inquiries, court proceedings and potential fines is manageable, they will act as a huge distraction for management and continue to sully CBA’s reputation, making it harder to increase share in the key consumer markets.

The appointment of a new CEO to replace Ian Narev could be the trigger that gives CBA some clear air.

What do the brokers say

Citi was one broker to upgrade its recommendation following the result, from sell to neutral. This sums up the analysts, who are in aggregate neutral on the stock and see it as pretty fully priced. While there may be some minor revisions to target prices and earnings estimates in the coming days, the consensus target price is $77.63, about 3.3% below yesterday’s closing price. CBA is trading on a multiple of 13.9 times FY18 and FY19 forecast earnings.

Individual broker recommendations (source FN Arena) are as follows:

Bottom Line 

It wouldn’t surprise me if yesterday’s market action goes down as a bit of a “relief rally”. The worst is probably behind CBA (and hence its bounce from a low of $73.20 on 8 September), but yesterday’s update was no stunner. Better than the others, but not brilliant.

I am no seller of CBA, but in the absence of the new CEO and clear air, I prefer others who can get a little more serious about cutting costs. ANZ by a nose.

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Midcaps lead the way as ASX beats the yanks

Thursday, November 02, 2017

By Paul Rickard

For the first time in many months, the Aussie stockmarket has outperformed our yankee cousins. In October, it added 4% to take the year to date gain to 4.3%, or with dividends included, a not wholly unimpressive 8%.

The US market, as measured by the broader S&P 500, added 2.2% in October. Year to date, it stands at a more impressive 15% or 16.9% if dividends are included. The tech heavy NASDAQ 100, which includes Apple and the FANGs (Facebook, Amazon, Netflix and Alphabet, the parent of Google), is up by a cool 25% in 2017.

And while a return of 8% for 10 months looks ok, many investors are not witnessing this level of return. This is because the aggregate number masks the performance of the underlying components, and the top stocks, which make up the bulk of many retail investors’ portfolios, continue to underperform.

The following table shows the performance of the different components. The top 20 stocks have only returned 4.2% (including dividends) in 2017, due to the underperformance of the banks, retailers and Telstra, which are all struggling to grow revenue. Of the top 20, only CSL and Macquarie could currently be described as genuine ‘growth’ stocks.

ASX Component Returns, October and CY 2017
The midcap 50, which represents stocks ranked 51st to 100th by market capitalization, has returned an astonishing 15.5% in 2017. The small ordinaries, which represents stocks ranked 101st to 300th by market capitalization, roared back to form in October with a gain of 6% and is now up by 11.9% this calendar year. Improving metal and oil prices, and increasing activity in the resources sector, is helping this part of the market which has a higher weighting to materials and energy stocks.


The midcaps are also quite different to the ASX 200. Shown below is a pie graph of the sector weights for the Midcap 50. Financials, which is the biggest sector on the ASX 200 by market capitalization, with a weight of 37.2%, makes up only 18.8% of the Midcap 50. Other relative underweights include Consumer Staples, Energy and Real Estate. Overweights (compared to the ASX 200) are Materials, Consumer Discretionary, Health Care, Industrials and Information Technology.

Midcap 50 Sector Weights

36 of the 50 stocks that make up the index are in the black for the year, with Flight Centre the best performer, up almost 50%. Building materials and resources companies are strongly represented in the top ten.

Midcap 50 - Top 10 Performers in 2017

Only 14 stocks are recording losses, the worst being one of the best performers in 2016, Dominos Pizza, with a loss of 28.3%. Interestingly, the bottom 10 includes retailers JB Hi-Fi and Harvey Norman, which have suffered due to concerns about Amazon, and telecommunications companies TPG and Vocus.

Midcap 50 - Bottom 10 Performers in 2017

How to play

While some of the stocks in the midcap 50 are getting a touch expensive, the top 20 stocks are likely to remain somewhat of a drag on the market. Until such time as the major banks and Telstra can demonstrate revenue growth of more than a few percentage points, the market will look elsewhere for growth. In this environment, midcaps and small cap stocks will remain well bid, more so if commodity prices stay firm.

Apart from investing in some of the stocks directly, managed investment options are also available. On the passive side, both iShares and SPDR have ETFs (exchange traded funds) that track the S&P/ASX Small Ordinaries Index. The former trades on the ASX under stock code ISO, while SPDR’s trades under SSO.

VanEck has recently transformed one of its ETFs to track the Midcap 50 Index. The VanEck Vectors S&P/ASX Midcap ETF trades under stock code MVE.

Actively managed investments include Investors’ Mutual Australian Smaller Companies Fund, Eley Griffiths Small Companies Fund, Spheria Australian Smaller Companies Funds and a plethora of listed investment companies such as QV Equities (QVE), WAM Capital (WAM) and Perpetual Equity Investment Company (PIC).

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Hard work ahead for new Wesfarmers’ boss

Monday, October 30, 2017

By Paul Rickard

New Wesfarmers boss Rob Scott, who will take over from outgoing Managing Director Richard Goyder next month, has a big job in front of him. Yesterday, Wesfarmers released its September quarter sales and production results which showed that the conglomerate has its problem children.

Wesfarmers largest division by earnings, the Coles supermarket division, only managed to grow food sales in the 1st quarter of the year by 0.3% compared to the same quarter last year, down from a growth rate of 0.6% in the final quarter of 2016/17 and an average of 1.0% for the year. Arch competitor Woolworths, which is due to report quarterly sales figures on Monday, has already advised the market that for the first eight weeks of the quarter, it grew food sales at around 5.4%. While Coles pointed to the impact of price deflation, particularly with fresh produce, being beaten by such a big margin is in the embarrassing category.

For shareholders, it has probably also come at the expense of margin as the supermarket wars continue to rage.

Comparable Store Sales Growth

 * Adjusted for the timing of Easter

Problem child Target continued its horror run, with sales falling by 6.4% compared to the corresponding quarter 12 months earlier. Wesfarmers is working hard on the “reset” of Target product, price and range, but it is yet to show up in increased customer purchases and more losses can be expected.

Although it is too early to label the  purchase of the 244 store Homebase hardware chain in the UK a mistake, it looks like it is going to take some time before “Bunningsisation” pays off. Store on store sales decreased by 11.9% in the quarter. Bunnings Group Managing Director Michael Schneider admitted that “the performance of Homebase is disappointing”, but was encouraged by the early success in the UK of the first 8 Bunnings Warehouse pilots.

Stars in the Wesfarmers conglomerate included Bunnings Australia and New Zealand, which grew sales by 10.8% in the quarter, the Kmart department stores and the previously “unloved” Officeworks, which lifted sales by 7.8%.

If current trends continue, it is not that far away before Bunnings in Australia and NZ contributes more to group earnings for Wesfarmers than Coles.

Wesfarmers also released production figures for its coal mines. While total coal production in the September quarter for its Curragh mine was down 1.6% on the June quarter, the twelve month figures for the year to September showed an increase of 25.6%.

Buy or sell?

Wesfarmers shares have traded in a very tight range over the last 12 months, from a high of $45.60 to a low of $39.52. Following a fall yesterday of 2.9% to $41.49, it currently sits mid- range.

Wesfarmers (WES) - Oct16 to Oct17 (source CommSec)

Over the last two months, Wesfarmers shares have marginally outperformed Woolworths. This is partly because expectations for Woolworths were too high, but also the market recognizing that Wesfarmers was trading on a significantly lower multiple.

That said, the major brokers see Wesfarmers as fully valued and are not that positive on the stock. According to FN Arena, of the eight major brokers that analyze the stock, there is only one buy recommendation (from Macquarie). There are four neutral recommendations and three sell recommendations. 

The broker consensus target price is $41.09, a 1% discount to yesterday’s closing price.

Comparing Wesfarmers to Woolworths, the brokers still have Woolworths trading on a higher multiple of forecast FY18 earnings (20.4 times versus 16.4 times for Wesfarmers). They see earnings growing more strongly at Woolworths as the recovery in the supermarkets business continues, and Woolworths gets on top of its problem child (Big W). This results in the multiples narrowing in FY19. Like Wesfarmers, the brokers don’t see much upside in the price, with the consensus target price of $26.27, a 4.4% premium to yesterday’s closing price.

Trading Multiples (Wesfarmers and Woolworths)

Bottom Line

I can’t get excited by either Wesfarmers or Woolworths and think that this is a sector to remain underweight. If I had to choose one, I prefer Wesfarmers because it is still significantly cheaper, it is paying a higher yield, and arguably, the conglomerate model can add strength and reduce volatility.

The UK acquisition is a concern and needs to be kept under close security. For now, I think you have to give Wesfarmers management the benefit of the doubt and sufficient time to make it work. But it is off to a wobbly start and the clock is ticking.

For the time being, I can’t see Wesfarmers breaking the trading range. Buy in the high thirties, sell in the mid forties.

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Does AGL’s Andy Vesey need to fall on his sword?

Thursday, October 19, 2017

By Paul Rickard

While it is not exactly unusual for a stock to trade at a 11% discount to the broker target price, it is getting on the high side and shareholders (and Boards) should ask questions as to why. In this category is energy generator and retailer AGL.

AGL’s share price closed yesterday at $24.20. According to FN Arena, this represents a 10.7% discount to the consensus broker target price of $27.10. It is also a 14.8% retreat from the share price high of $28.42 achieved in April this year.

And although utility stocks have eased in general, I think one of the key reasons for its underperformance is that CEO Andy Vesey overplayed his hand with the Federal Government over negotiations for the Liddell power station. AGL’s refusal to consider selling Liddell was one of the factors that drove the Government to adopt its National Energy Guarantee (announced on Tuesday), which is the long run, will hurt electricity retailers such as AGL.

Vesey argued that it would cost AGL hundreds of millions of dollars to keep the fifty year old Liddell power station operating past its targeted shut down date of 2022, and that producing electricity from coal was not part of AGL’s go forward plan. Further, AGL could make up the shortfall through other sources including green energy.

He may be right about the cost of keeping the ageing Liddell operating, but it was his refusal to consider putting it up for sale and testing whether another operator wanted to try their hand that really got up the Government’s nose. After all, AGL effectively bought Liddell for just $1 (plus the cost of remediating the site) when it purchased Macquarie Generation from the NSW Government in 2014.

If AGL doesn’t want to run Liddell, why not see whether there is a willing buyer who might pay $1 or more for it?

Of course, Liddell is not AGL’s only fossil fuel power station. There’s the main asset of Macquarie Generation, black coal Mt Piper in NSW, the brown coal Loy Yang in Victoria, and the gas fired Torrens in SA. AGL doesn’t want a competitor undermining its position as an integral supplier of base load power to the grid.

Vesey has painted a wholly different picture for AGL as it exits the generation of electricity from fossil fuels by 2050. In the future, AGL will not only be producing and distributing green energy, but it plans to be a service provider to its customers, helping them to store and produce their own roof top solar, use smart meters in the household to optimise demand and manage devices, and potentially, operate charging stations for battery operated vehicles. So called “new energy”.

But the reality is that AGL earns most of its profit from the generation of electricity from coal and gas fired power stations. It is arguably Australia’s largest “big polluter” (to quote a phrase loved by the Greens), and this isn’t going to change in the medium term. The “new energy” business touted by Vesey lost $3 million in FY17, admittedly an improvement on the loss of $12 million the year before.

The market has decided that the Government’s intervention in the gas market and the establishment of the National Energy Guarantee, which will require retailers to contract to purchase dispatchable power plus the end the subsidy to green energy from 2020, will put downward pressure on wholesale energy prices. This will be a headwind for AGL.

What do the brokers say

The broker analysts are reasonably positive on AGL.  Of the seven major brokers tracked by FN Arena, there are four buy recommendations and three neutral recommendations. The consensus target price is $27.10, with Morgans the lowest at $25.10 and UBS the highest at $29.20.

The brokers see AGL earning 153.7c per share in FY18, rising to 177.8c per share in FY18 (a growth rate of 15.6%). This has AGL trading on a multiple of 15.7 times forecast FY18 earnings and 13.6 times FY19 earnings. The forecast dividend yield is 4.8%.

AGL has recently reconfirmed profit guidance for FY18 of an underlying profit in the range of $940 million to $1,040 million - an increase of 17% to 30% over FY17’s profit of $802 million.

Bottom line

I think that there will be consistent pressure on AGL by Government, Australian Energy Market Operator (AEMO) and the Australian Competition and Consumer Commission (ACCC) to reduce wholesale power prices, and that the best days of AGL extracting monopoly style rents are behind it. AGL will find it harder to grow revenue than some broker analysts are forecasting. Reduce.

On the question of Andy Vesey’s tenure, I think the jury is still out. AGL shareholders will be better served if the company is seen to be working with the Government and community, rather than being accused of executing a plan to boost profits.

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Is your business ready for the elderly Asian consumer?

Thursday, October 12, 2017

By Paul Rickard

Many Australian businesses are highly geared to the affluent middle class consumer in Asia. High profile stocks such as ASX-listed Blackmores and Bellamy’s readily come to mind, with their sales of vitamins and organic food products to Chinese consumers.

But there are also hundreds of others, usually privately-owned, Australian businesses providing products and services to the booming consumer market in Asia. The Asian century is finally upon us!

And while this is the “now”, companies (and investors) will need to re-think how they approach Asia because the demographics are changing. According to Deloitte, the balance of power in Asia is shifting.

In its Voice of Asia (third edition) report, Deloitte says Asia will be home to 60% of the world’s over 65s by 2030. Asia’s over 65s will be the largest and fastest growing market in the world, growing from 365 million people in 2017 to 520 million people by 2027. By 2042, just a quarter of a century away, the over 65s in Asia will exceed the entire population of the Eurozone and North America combined, and number 1 billion shortly after the middle of the century.

While the ageing population will create challenges for growth in some nations, it will also generate a growth cluster of new business opportunities, with the potential to produce some very large winners at an industry level.

Country winners and losers

According to Deloitte, the median age in Japan is now over 47 years. It is the oldest country in the world, and the average resident in Japan today is 25 years older than was the case in 1950. Hong Kong, Korea and Singapore all sit well above the median age for Asia at a whole of 31.0 years. Even China at 37.6 years is on the high side, and interestingly, is the same as Australia.
At the other end of the scale, The Philippines at 24.6 years is the youngest, followed by India and then Indonesia (see table below).

Median Age by Country in 2017 (yrs)

Projecting ahead and looking at the impact of both an ageing population (in some countries) and the “demographic dividend” of an increasing workforce in others, Deloitte calculates that the biggest losers from demographic change over the next decade will be Hong Kong, Taiwan and Korea. China will also be a loser, with demographic changes reducing the Chinese economy by 4.2%.

Demographic addition/subtraction to size of economies over next decade

Winners will be India, The Philippines and Indonesia. Following the rise of Japan and China in decades past, Deloitte predicts that India will drive the third great wave of Asian growth, with its potential workforce set to rise from 885 million people today to 1.08 billion in twenty years’ time. And like Japan and China before them, it won’t only be more workers, but better trained and educated workers with rising economic potential.

Cynics will say that they have heard this before about the potential for India and that it has consistently failed to deliver. The gap between China and India has increased, not decreased, no doubt in part due to the “price” India pays for being the world’s largest federated democracy. Time will tell, but on paper at least, you can’t argue with the demographic factors at play.

Industry winners and losers

An ageing population will create huge tailwinds for some industries, and headwinds for others. In the former, health, medical and pharmaceuticals; financial services such as asset  management, wealth advisory, insurance and the management of retirement savings; travel, particularly airlines and luxury accommodation; luxury goods; age appropriate housing and consumer goods purchased by the elderly.

Headwinds will be slower to develop because the Asian population is increasing in aggregate. Long run losers are likely to include goods consumed by babies, kids and young adults; childcare services; educational services; cafes/takeaway food and the entertainment industry.

Minimising the impact of ageing

Deloitte suggests that Asian countries can act to minimize the impact of an ageing population and declining workforce on economic growth. Strategies include raising the retirement age; encouraging a higher level of participation by women in the workforce; welcoming working age migrants; re-skilling the workforce to be more productive and increasing birth rates.

Act sooner rather than later

Like all megatrends, the business winners will be those who identify the trend early and act appropriately. Markets and investors position for tailwinds, and prefer to exit positions facing headwinds when the wind is more like a breeze rather than a gale. Be prepared to act sooner rather than later.
If you would like to see my interview with Chris Richardson from Deloitte Access Economics, you can view it here.  The full Deloitte paper can be downloaded here.

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