The conclusion to this month’s blog is that the Australian stockmarket has priced in an overly negative view of a Chinese downturn and the continuing European sovereign debt crisis. The more likely outcome is that as these issues are dealt with by the various authorities, the Australian stockmarket will stage a relief rally.
However, there are some risks to this view, particularly with respect to Europe. To consider these matters further and to provide some interesting updates, following are comments from several presentations attended recently, mostly from the Australian Stockbrokers Conference in Melbourne.
The new Pluto LNG plant costing $13b was commissioned in March 2012. In the last week of May, it was producing at 65% capacity as against 20% planned for May, in fact in one week it ran at 90%. Pluto LNG adds 1/3 to Wooodside’s production i.e. approximately 20MMboe on top of the existing 60MMboe. The new CEO and several senior executives are from Exxon Mobil, the best global allocator of capital in the oil and gas industry. This is an impressive management team. The LNG presentation included projected supply and demand curves for LNG which indicates continuing tight supply. Finally, the LNG price has remained almost a fixed percentage of the oil price. The Australian share market is significantly under pricing this stock currently trading in the low $30’s as compared to valuations of $50 and above. Please ask your advisor for the current research report or visit our website.
Greg Robinson, CEO showed the continuing tight supply of gold. He commented that if the gold price was to fall to US $1100 from its current level, then the current low Newcrest price could be justified. On the other hand, if the gold price holds or appreciates from the current level, then in his view Newcrest is severely underpriced. The company has several brown fields expansions at its existing operations with a focus on a reliable predictable performance including Gosowong 400koz pa, Telfer sustainable production 500-600koz pa for 10 years, Hidden Valley stabilised production 300koz pa and Bonikro (West Africa) consistent production at 100koz pa. The organic growth program for Lihir has a path to increase gold from 650kozpa to 1.2Mozpa, Cadia with a path to increase gold from 500koz pa to 800koz pa and copper to 90ktpa while the exploration star is Wafi Golpu to progress from prefeasibility to feasibility with first production expected around 2018 of gold 600-800kozpa and copper 300-500 ktpa. Finally, there was a graph showing correlation between the gold price and gold stock prices which over time was very high, but in recent months Newcrest has departed from this correlation. Given some diversification into gold makes sense particularly in the current global economic conditions, Newcrest should be considered for inclusion in most portfolios.
Atlas Iron and Fortescue
The business model for Atlas Iron is to have a low cost group of mines based on third party access to infrastructure. To date that model has produced iron ore mines in Western Australia at a fraction of the full cost and so the business model is highly profitable. By contrast, Nev Power CEO Fortescue Metals Group Ltd has a business model based on major incremental additions from 55mt pa to 155 mt pa achieved by various infrastructure modules. While the market is a disbeliever, Nev Power is clearly of the view that Fortescue will achieve these projected increases in output over the next 18 months and that Fortescue is considerably undervalued by the market. On a supply and demand basis, his view is that the current iron ore price of around $130-140 per tone is sustainable and compares well to high cost mines in China. While the debt is currently high, Fortescue projects that this debt will be rapidly paid down as the expansion is realized.
David Farley, CEO, AACo gave a presentation which somewhat changed your diarist view of this stock. While the return on equity remains low, and grazing property prices have fallen, David Farley noted the following positives:
- This is the first time in Australia’s history that Asia has demanded significant beef production, as compared to former generations which were dependant on the UK market (lost when the UK entered the EEC) etc.
- AACo has superior stock control with the new tagging system allowing individual tracking of cattle so that the attrition rate should be reduced from 4% to hopefully less than 2%.
- The proposed abattoir in northern Australia will save material cost in the transport of beasts to abattoirs on the eastern and southern seaboards of Australia and improvements of technology allow for a low cost operation.
- The majority of shareholders in AACo are foreign as they understand global and Asian demand for protein is a compelling trend over the next 30 years.
Bernie Brookes, CEO had as his thesis that the internet sales of the established department stores such as Myer and David Jones would increase from the current 1-2% in Australia to the approximately c. 16% of comparable overseas companies in the US and the UK. He saw the Australian experience over the next few years to follow the playbook of those overseas countries. Myer currently are devoting considerable resources to the continual upgrades of its website, increasing the number of stock items (sku’s) and increasingly having suppliers agree that the price online should be equivalent to the store price. The margin overall on internet sales will be lower than store because of the mix of sales for example ladies will continue to go to the stores for fashion items, even though they may browse on the internet in advance of going to the store. Bernie Brooks also notes that while the USA has a culture of catalogue sales and separate big box stores in various locations, the Australian shopping centres with diverse range of stores in the one location will mean that in-store shopping will continue to be attractive as an enjoyable experience to the shopper. The retail sector remains very out of favour but this presentation indicated retail in a more positive light.
David Cassidy – UBS Equity Strategist
David looked at the bear points and the bull points for the current equity backdrop. He considered global and Australian price/earnings ratio concluding that share price valuations are reasonably low relative to history both globally and in Australia. This compares to high household debt and high priced housing stock which gives a negative view on Australian residential property.
Euro-zone stress remains the key headwind for equities. For the US economy, moderate recovery is underway. Looking at the Australian sectors, the Australian mining sector has underperformed. China has slowed, commodities have eased, and costs have exceeded expectation. David predicted that the market has become too bearish on calendar year 2012 China prospects. Leading indicators are ticking up and policy easing is on the way. While he sees that the peak has occurred in commodity prices, the large mining capital investment in recent years leads to his view that flattish commodity prices are enough for some earnings to increase for companies as volume comes through. In respect of commodity prices, he sees iron ore, copper and oil as resilient, with thermal coal under pressure. For the Australian banking sector, valuations are unexciting but solid. Banks have been rerated moderately on a) yield theme, b) mining selling, c) lack of big earnings downgrades.
In terms of earning drivers, the bad debt levels for the banks are benign. In respect of the property sector, the bull point is that a number of Australian REIT’s are trading at discounts to net tangible assets. The conclusions from this presentation are as follows:
- Plenty of worries but they seem to be well discounted
- Valuations look good value particularly verses fixed interest and property
- Corporate earnings have been good in the US and Asia but lack lustre domestically
- Lower $AUD and RBA rate cuts should help the earnings cycle
- Commodity prices have likely peaked. Big caps are generating great cash flow but the sector is arguably more of a trading proposition.
Your Diarist’s View
The concern about China is over done and presents a buying opportunity. While China has slowed the property bubble, it should be congratulated for doing so. As we go to press China has approved $23B in new steel making facilities which will jolt iron ore off a six month low and increase the iron ore price to $152 mt in the second half. China has also reduced interest rates. The low valuation and high yield applicable to the Australian stock market are becoming a more significant factor in the minds of investors, as the cash rate falls to 3.5% and term deposit rates are also falling. Australian residential property remains subdued. The real risk remains Europe. On balance the better view is that Europe will act to avert major crisis. This may mean further loans or liquidity from the European Capital Bank (ECB) or even direct equity injections at attractive prices for banks short of capital. The real risk to this European scenario is German Chancellor Angel Merkel. In comments on 7th June, she said “We need more Europe, we need not only a monetary union but also need a so called fiscal union, in other words more joint budgetary policy, “Merkel said. “And most of all we need a political union that means we need to gradually give competencies to Europe and give Europe control”. Ceding more control to Brussels seems a pipe dream and unlikely to be useful in the near term to deal with the European Sovereign debt crisis. While the G8 realised the need to change the politicians in southern Europe to achieve some traction with this crisis, it seems a change in German leadership may also be necessary as a precondition to a lasting solution to the European sovereign debt crisis.
On a portfolio level, there are now significant valuation differences for stocks held in portfolios and carefully thought out and regular portfolio reviews are more essential than ever.
If you would like to further discuss, feel free to leave a comment or email firstname.lastname@example.org.
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