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The path to 6000

by Charlie Aitken

We get plenty of feedback from clients that forecasting the ASX200 to be 6000 in the next 12 to 18 months is a “big call”.
 
However, in reality forecasting the benchmark Australian equity index to rise +15% I would classify as one of the less controversial calls we have ever made. In fact, I would go as far as saying it’s not a big call at all and I find it amusing the AFR labels me “the most bullish man in Australia”. The most bullish man in Australia forecasting the market to rise just +15% to 851pts below its all-time high??? What one earth is everyone else doing?
 
Today I want to run a basic scenario analysis about why I think the 6000 call is not a big call. I want to let you into how my simplistic Australian equity strategy setting mind works.
 
Let’s start at the very top.
 
20 stocks account for 68% of the ASX200. For the ASX200 to rally +15% it has to see leadership from the 20 largest stocks. It is mathematically impossible for 6000 to be seen without the top 20 stocks doing the heavy index lifting.
 
For the purpose of today’s exercise I am going to assume all 20 top 20 stocks rise +15%. I am then going to work backwards from those +15% higher share prices and see what P/E’s and dividend yields those stocks would command using current consensus FY14 and FY15 EPS and DPS estimates.
 
For the sake of simplicity I have not differentiated between CY and FY reporters. For each stock the next full reporting year is “14” the one after “15”.
 
The answers are in the table below.



 
Can you see why I think the 6000 call isn’t a big call??
 
Note well these P/E’s and dividend yields are set off current consensus forecasts for 14 and 15. I firmly believe consensus EPS and DPS forecasts for every stock in the table above (ex Newcrest) are too low, but particularly, big iron ore miners, big banks and Telstra.
 
But the really bullish bit is that even without the consensus EPS and DPS upgrades that will come, the multiples and yields above would support the +15% target share prices regardless. 18.1x 14 with a 3.80% yield, 15.8x 15 with a 4.11% yield. These are average multiples pre consensus earnings and dividend upgrades
 
I remember a little over 12 months ago in an attempt to justify the “end of the bear market in Australian equities call”, which was a genuinely big call, we ran a very similar table to support our “goldilocks = 5200” forecast. That table, while simplistic, proved very accurate.
 
I genuinely believe over-analysis leads to paralysis and more often than not the most simplistic approach to forecasting proves the most accurate. Think like a private investor would.
 
While many professional investors would say 18.1x consensus 14 earnings is a stretch, personally I think you are seeing a classic cyclical share price up turn ahead of earnings and dividend growth arriving. What needs to be remembered is that for the big miners, consensus iron ore price forecasts for the years ahead remain ridiculously bearish, while for the big 4 banks credit growth assumptions and BDD assumptions are also ridiculously bearish. In the case of TLS analysts have missed the translation from top line growth to bottom line growth.
 
One of the key reasons I remain I maximum bullish mode on Australian equities is the average analyst forecast is so timid. This clearly includes our top 20 stocks. What you will find from now is consensus starts edging up, analyst by analyst, stock by stock, with what I call stealth upgrades. Stealth upgrades are the opposite of death by 1000 cuts.
 
We have seen textbook “stealth upgrades” in the banking sector for the last 12 months, which will continue, and stealth upgrades are starting in big miners and TLS. Yet the major forward consensus earnings and dividend upgrades always occur on confirmation of earnings from a historic period.
 
That is why in the near term we remain maximum bullish the Australian banking sector, feeling the pending FY13 reporting and final dividend season will lead to meaningful EPS and DPS upgrades for FY14 and FY15.
 
Just to remind you of what will be “buy the fact” days for the Australian banks.
 
ANZ 29th of October
NAB 31st of October
MQG 1st of November
WBC 4th of November
CBA 1Q14 6th of November
CBA AGM 9th of November
 
You all know our positive view on banks and even on +15% higher share prices than here, those shares prices can be justified on P/E and particularly dividend yield. That’s even using consensus EPS and DPS numbers that are too low.
 
But, if I look at the table above there is a clear heavy index weight standout…
 
BHP Billiton is cheap, genuinely cheap, at a +15% higher share price and using what are very conservative EPS and DPS forecasts.
 
I believe current BHP consensus earnings estimates for FY14 and FY15 will prove -15% to -20% too low in AUD terms. There is no heavyweight stock in that top 20 above cum larger consensus upgrades than BHP. It’s that simple.
 
The BHP earnings and dividend underestimation is a macro and micro issue. It starts with medium-term iron ore price forecasts that are too low: ditto oil/gas prices, is exacerbated by AUD/USD forecasts that are too high, while the cream on the underestimation cake is a lack of appreciation for BHP’s +16% cu equivalent production growth over the next 2 years. Let’s not even start on cost over-estimation or group margin underestimation.
 
In my view BHP analysts are underestimating earnings, margins, free cash generation, ROE and dividends. Below is the current USD consensus EPS forecast for the next 4 years. It shows very timid growth. It shows absolutely no faith in BHP CEO Andrew Mackenzie delivering on his free cash flow growth slide.
 
As you know, I met with Mackenzie recently and I am backing him to deliver. The first evidence of this will be at the February interim.
 
BHP USD EPS forecasts


 
The conclusion of the exercise above is that the 6000 index target is easily attainable over the next 12 to 18 months as the market starts to focus on deliverable 14 and 15 EPS/DPS. I stand strongly by my call that it’s not even a big call.
 
Yet what the table above is telling you that if you own enough banks and Telstra etc., DO NOT SELL THEM, but that marginal new money committed to Australian equities should be focused on stocks like BHP where the greatest total return potential upside now lies.
 
I simply can’t get to 6000 on the ASX200 without banks, TLS and BHP playing a major role. BHP will close this gap below relatively while concurrently driving the blue index line towards 6000.
 

Published on: Monday, October 14, 2013

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