Income Report / Income Report: 4 post-election income opportunities

By Market Matters 22 May 19

Income Report: 4 post-election income opportunities

Market Matters Income Report 22nd May 2019

A more muted session for local stocks today with the recently hot banking sector taking a breather. The market response following the election has clearly been a positive one with a number of key sectors doing particularly well. In today’s note we’ll look at some income opportunities following the surprise election result on Saturday.

Currently, the ASX 200 is flat, with most strength coming from the consumer discretionary sector, while real estate names are lagging  

The Income Portfolio had an outstanding week this week, rising 2.18% on the back of returns of over 8% from NAB, CBA and CSR.. In the current financial year, the portfolio is up +6.89% vs the benchmark (RBA + 4%) of +4.88%.  Since inception, the portfolio has returned 11.41%, earning above the benchmark which currently sits at +10.32%.

4 post-election income opportunities

There are a number of key takeaways from an investment standpoint flowing from the weekends election.  In today’s note, we’ll look at  4 income opportunities that are worth considering.

1 Hybrids

The proposed change around franking credits was seen as a negative for the sector and given that’s now not happening, the sector should benefit. Going into the election, we did see an impact in the hybrid market with spreads increasing from the low 3% range to the mid 3% range – 5-year major bank hybrid credit spreads for example moved from around 3% above BBSW in January, to 3.55% leading up to the election. Normally, spreads are somewhere between 3% & 4% so the move simply took hybrids from being on the expensive side, to around about fair value. Since the result, these spreads have come in by at least 10bp, or in other words, spreads are now below 3.40% for mid-range securities

Hybrids should retain their appeal for retail investors and we think spreads will continue to tighten – moving towards 3% for issues that have around 5 years till first call. That mean prices would go higher.  We certainly plan to maintain our exposure to hybrids  in the MM Income Portfolio and now the franking issue has been settled, we may see one of two new issues coming to market.

MM likes the following Hybrids with varying maturity profiles 

NABPF Chart

2 Housing related stocks

Thanks to a Coalition victory, no changes will be made to capital gains tax & negative-gearing which is clearly a positive for housing. On top of that,  APRA are now reducing lending requirements on new mortgages to better reflect the low interest rate environment. The regulator has proposed a relaxation of serviceability measures that would effectively increase borrowing capacity – a good thing for house prices and activity. In the long term supply and demand have the biggest impact on house prices however short term, sentiment and the availability of credit are the key drivers.  

We talked about both Stockland (SGP) and CSR in the income note two weeks ago (here), and we pulled the trigger on CSR, adding it to the income portfolio at $3.37. The building products company has done well since showing a paper profit of ~10%. 

MM remains bullish CSR targeting ~$4.20

CSR Chart

Stockland was clearly in the vortex of housing negativity with exposure to residential property along with retail, however with no changes to key legislation plus early signs that house prices may be stabilizing along with further interest rate cuts now likely, the outlook for SGP has improved, and the market has bid the stock up strongly .

MM would be interested in SGP back around ~$4.20 

Stockland (SGP) Chart

3 Consumer Stocks

Flight Centre (FLT) downgraded earnings expectations at the end of April and the stock fell sharply. It was a poor update following a poor period of sales, however the obvious question  is to what extent did the election have on consumer appetite to book travel? 

FLT’s customer base is skewed primarily to the demographic that were likely to lose income if Labor’s proposed changes to franking credit legislation got up. Uncertainty often breeds inactivity and that was shown in the downgrade. At MM, we share a similar customer demographic to FLT and the election had an impact on our business. One common rhetoric was – we’ll see what happens with the election then decide. From our own business, we’ve seen a post-election bounce – the same could well be true for FLT.

On an Est P/E of 16.62x relative to downgraded earnings (not cash adjusted) and an expected yield of 4.42% fully franked, FLT looks interesting.

MM is interested in FLT around current levels as an income opportunity

Flight Centre (FLT) Chart

4 Resources

Much of the focus in recent times has been around capital management at the bigger end of town, with Fortescue (FMG) burning brightest in this respect. However, Coal stocks are now more interesting  under a Coalition Government with lower required emission controls.

While it’s dangerous to buy resource stocks for yield, Whitehaven Coal (WHC) is all about cash generation in the shorter term with no real meaningful capex and a big end of year dividend likely. On forecasted numbers for FY19, WHC trades on a P/E of 7x while it is expected to pay a big final dividend of at least 15cps taking the full year yield to over 8% - with the risk being to the upside in September.

MM likes WHC around current prices

Whitehaven Coal (WHC) Chart

Conclusion

MM remains keen on hybrids and expects spreads to continue to tighten 

MM remains bullish CSR & would buy SGP into weakness

We are keen on both FLT & WHC around current levels

**Watch for alerts**

James & the Market Matters Team

Disclosure

Market Matters may hold stocks mentioned in this report. Subscribers can view a full list of holdings on the website by clicking here. Positions are updated each Friday, or after the session when positions are traded.

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