WHEN will Australia stop underperforming?

April 2012

The US  Dow Jones at 13200 is within 7% of its all time high, following ongoing US economic recovery (refer previous Blog). Just as the US led us all into the last three years of the global financial crisis (GFC)  by being myopic, the same inward focus is leading the world back to some level of economic normality. The US ship is so large in economic terms that this turnaround makes Greece irrelevant. Not that the growth is strong, but it is sustaining led by their leadership in technology (Apple >$US 600), exports eg mining equipment (Caterpillar),  and the domestic consumer spending again. Housing will lag in the US, but this happened in QLD in 1992 when the recovery was led by other sectors and housing came out last.

In contrast the market that should be doing well based on economic performance going into the GFC is Australia. But performance is disappointing with the S&PASX index at 4337 only 1000 points above the March 2009 lows & 2400 points below the 2007 highs.  At an internal presentation yesterday a senior analyst from an independent research house mused that we might regain that high in the next three years, but most would see that as beyond their current expectations. As does your diarist.

The table below shows the current market price discount to analyst expectations for the four leading resource stocks and the banks.

  Analyst Valuation Market Price
BHP 51.00 34.64
RIO 87.70 66.32
Newcrest 42.00 28.63
Woodside 66.25 35.14
ANZ 32.00 22.90
CBA 62.40 50.24
NAB 31.67 24.53
WBC 29.00 21.87

This table is critically important to the performance of most client portfolios as the banks and major resource stocks make up a material part of Australian portfolio performance. The December  2011 Half Year was one of the poorest for some years because the resources and banks did not perform. The Table reminds us to be value investors and avoid those sentiment newsrags like Eureka that opined all should exit the market in Dec2011 at exactly the wrong time.

But why are the leaders lagging? Reasons include: poor government at Federal & State – the QLD election result is one positive step; a lack of confidence in BHP & RIO management with RIO’s botched Alcan acquisition & BHP Petrohawk; the mining & carbon taxes providing overseas investors with an “AVOID AUSTRALIA” flag;  banks talking up their cost of raising funds; the Reserve Bank failing to manage the economy and exchange rate  by reducing interest rates and weak growth across the three Australian eastern seaboard capital cities. But mostly it is a lack of confidence in Australian investors berated by negative overseas news stories who are paying off mortgages and hoarding cash when they should be buying shares.

Now your diarist is confident the market will recover to the analyst valuations in Table 1 and it will happen sooner rather than latter. Sharemarkets have a reputation for climbing the wall of worry and there is no better example than the US in recent months.

Here is a list of factors that are positive for market recovery:

  • Sentiment has improved since the December 4056 level with the market up 300 points and many portfolios now up for the year from 1july 2011. Before Xmas most just wanted to go on holidays. March Qtr 2012 has seen clients wanting to reengage and understand where the value is in the market. Some stocks with clear value propositions such as Computershare and Crown moved up ~$1.00 during March, after positive news flows.
  • US economic news is positive  and debt issues in Italy have stabilised . There is no Armageddon although the failure by Europe to follow the US and stimulate the economy first so countries have  the ability to deal with the debt issues will see southern Europe close to recession for sometime. Once this view is generally accepted, the negative sentiment on Europe should continue to wane. The US shows how quickly some good news flows can recapture the agenda. Southern Europe will give some further incidents from time to time.
  • Woodside Petroleum has commenced introducing gas into the Pluto lng facility. Woodside under Voelte has built and completed Pluto ahead of the new wave of lng plants eg Gladstone and in advance of future  capital cost inflation. The new managing director is formerly from Exxon, the world’s largest oil co and the best at allocating capital to achieve higher rates of return.
  • Bank dividends are 6.5-7% fully franked. Grossed up for franking credits, these rates can only fall as the market price of bank shares recover on better confidence. Wow how spoilt are we in Australia! Many banks overseas are just beginning to commence paying dividends again after the GFC. The Telstra dividend also looks assured for many years to come at 28cps, being 8.4%ff.
  • A major misconception from overseas is that our residential property market is likely to collapse. With the shortage of housing, this is simply not going to occur and the overseas broker visiting fact finder tours are coming to this realisation. The likely resurgence in the $US as that economy recovers does mean the $US carry trade is probably no longer going to provide liquidity to our market.
  • BHP and RIO have failed to share the spoils of the resources boom with shareholders. The BHP board in particular have seen their shareholders as growth shareholders who don’t require dividends. In a world that is aging, these comments by the former chief financial officer show a lack of understanding. Newmont gold has adopted a progressive dividend policy paying 40% of free cashflow to shareholders and their stock price has responded accordingly. What mining company cannot grow with 60% of free cashflow – and  they might avoid some of their poor acquisition decisions. The RIO agm is in Brisbane on 10May. You might consider writing to the chairman in advance of this meeting asking for a progressive dividend policy. Your diarist intends to ask a question. Some of the cash has been used for on-market buybacks. At current low prices, buybacks of BHP & RIO are positive for continuing shareholders.
  • Newcrest, while also suffering from a low dividend payout and production issues in the last period, the Wafi -Golpu discovery in Papua New Guinea is spectacular,  the production issues likely to prove temporary and the Toronto Stock Exchange dual listing will assist liquidity and price discovery.
  • The cash rate is below the dividend yield and likely to fall further. The cash rate has also crossed below the yield on property trusts as the property sector has largely completed the reduction in debt. As the retention of capital to buy cheap buildings reduces, property trust yields should recover from 5% towards 6 and 7% over the next two years. These changes indicate  the growth risk assets of equities and property trusts are likely to appreciate.
  • Listed property is likely to out perform physical property because the listed property trust index fell by 75% during the GFC.  It is an over sold sector trading at a discount to net assets and should recover over time.

With portfolios up financial year to date, it will take little positive news to provide a satisfactory return for the June 2012 year end. A 6-8% return in a year we saw the sovereign debt crisis in Europe as a result of the GFC would be a satisfactory result and repeat the return for the 2011 financial year, which on average was of a similar order.

Remember buy when stocks are cheap – now – and don’t let negative sentiment cloud the decision making. Table 1 will be much closer to valuation over the balance of this year.

Happy Investing…

Chris Burrell

If you would like to further discuss, feel free to leave a comment or email ctburrell@burrell.com.au.

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Disclaimer & Disclosure: Burrell Stockbroking Pty Ltd and its associates state that they and/or their families or companies or trusts may have an interest in the securities mentioned in this report and do receive commissions or fees from the sale or purchase of securities mentioned therein. Burrell Stockbroking and its associates also state that the comments are intended to provide information to our clients exclusively and reflects our view on the securities concerned and does not take account of the appropriateness of the recommendation for any particular client who should obtain specific professional advice from his or her Burrell Stockbroking Pty Ltd advisor on the suitability of the recommendation. Whilst we believe that the statements herein are based on accurate and reliable information, no  warranty is given to its accuracy and completeness and Burrell Stockbroking Pty Ltd, its Directors and employees do not accept any liability for any loss arising as a result of a person acting thereon.

This document contains general securities advice only. In accordance with Section 949A of the Corporations Act, in preparing this document, Burrell Stockbroking did not take into account the investment objectives, financial situation and particular needs (‘relevant personal circumstances’) of any particular person. Accordingly, before acting on any advice contained in this document you should assess whether the advice is appropriate in the light of your own relevant personal circumstances or contact your Burrell Stockbroking advisor.

Burrell Stockbroking Pty Ltd (ABN 82 088 958 481), a Participant of the ASX Group and the NSX.

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