Income Report / Income Report; 4 stocks we considered, 2 of which we’ll likely BUY (AGL, SUL, CMW, FMG)

By Market Matters 10 October 18

Income Report; 4 stocks we considered, 2 of which we’ll likely BUY (AGL, SUL, CMW, FMG)

Market Matters Income Report 10th October 2018

The market has opening marginally lower again today, however we now expect some consolidation of the aggressive sell off that has played out over the past week, particularly aggressive in the last 2 sessions.

When we started the Market Matters Income Report mid-way through last year it was designed to be a once a week update on income opportunities with a fundamental rather than technical bias, giving more insight into the investments we’ve considered and either added to the portfolio, or not.

In our daily Market Matters Reports we try to keep things fairly simple, straight to the point and provide a clear view, without going into too much of the detail that has underpinned the formation of that view. We see the MM Income Report a little differently, putting a bit more meat on the bones.  Today we’ll look at 4 Income Opportunities in equities as we move to ‘tweak’ the composition of the Income Portfolio, reducing Hybrids and increasing exposure to equities into the recent ~5% decline in the market.

As it stands, we have a ~51% allocation to equities, ~45% in defensive income securities (hybrids / Bonds and the like), and 4% cash. That’s a defensive stance for this portfolio and given that composition, you’d expect the portfolio to have lower volatility but with lower growth potential than the equity market, which is essentially what’s it’s been delivering to date.  

On the week the portfolio dropped by -0.38% against the backdrop of the market that fell -1.39%. For the financial year to date, the market is now down around 2.50% while on an accumulation basis (including dividends) it’s down by -1.19%. For the FY to date, the Income portfolio has added a modest +1.40% while the portfolio is up 7.48% since inception (5th July 2017) against a benchmark of 1.51% and  6.95% respectively.

With the market’s sell off from the 6373 high to around ~6000, a drop of ~5.2%, we’re getting close to a buying opportunity for stocks. Today we’ll look at opportunities to reduce our defensive hybrid allocation and increase our exposure to stocks.

1 AGL Energy (AGL)  $19.62

AGL Energy (AGL) has pulled back from its 2017 high of around ~$27.80 to close yesterday at $19.62, a ~30% drop in the share price versus a market that has rallied over that period.

AGL Energy (AGL) Chart

AGL typically trades on a P/E multiple of 15x (5 year average) yet today we see the stock languishing on a multiple of just 12.5x, making it about 17% cheap, or for those that look at ranges, more than 1 standard deviation below the norm. AGL is expected to yield an attractive 5.96% fully franked and the technical picture looks good. At a high level, this stock would sit nicely in the MM income Portfolio.  

AGL Energy (AGL) Valuation Metrics

However, stocks don’t generally trade down 30% from their highs and at such a deep discount to usual multiples without a good reason. In the case of AGL, they’ve had a drop in earnings and the market has become concerned about policy and competition in the Energy sector.  

Some key points here;

1.    The Government wants to reduce retail power prices, and AGL sells power.

2.    The Government (through the ACCC) now has greater control over energy prices, so in the short term, the ACCC becomes the default price setter of retail energy which reduces differentiation, increases competition and ultimately reduces margins.

3.    When you have a Government under pressure and they have identified the price of your product as an election issue, it’s not a good thing  

4.    There is a clear lack of definitive longer term policy around energy, and that creates uncertainty for AGL

5.    The potential change of Government throws in another challenge insofar as Labor would increase controls on energy pricing to include wholesale pricing as well as retail pricing-  that would be another large issue for AGL.

Overall, a cheap yield stock that looks attractive at current levels on the charts, however for MM, there’s too much political uncertainty and potential  influence on AGL’s earnings in the next 12-24 months to buy it at current levels. A pass for us.

2 Super Retail Group (SUL) $9.02

Super Retail Group (SUL) sits in a sector we’re not necessarily too keen on however that doesn’t mean we won’t consider it. Retail has been tough with the performance of some names in the sector highlighting that theme, however a number have actually done well. We have Nick Scali (NCK) in the MM Income Portfolio with a small weighting and that’s been a reasonable investment while other names like Kathmandu (KMD) which we’ve covered in the past have had a good 12 months. Super Retail Group (SUL) trades on 11.3 x expected earnings for FY19 which makes it 18% cheap relative to its 5 year average while it’s expected to yield 5.60% fully franked.  

Super Cheap (SUL) Valuation Metrics

SUL operates brands including SuperCheap Auto, Rebel Sports, BCF and Macpac – generally outdoor leisure brands and is one of Australasia’s top 10 retailers. When they reported in August they beat expectations and the stock rallied strongly to a high of ~$10.50 - we’ve now seen the stock trade back to $9.00. Retail sales data has been better than market expectations of late, yet the market remains collectively bearish the retailers.  In MM’s view, this sets up the strong possibility for a move in the direction of most pain, which is up.

MM is bullish SUL around $9.00 – watch for alerts

Super Retail (SUL) Chart

3 Cromwell Property (CMW) $1.055

CMW is a property and funds management company that we didn’t cover in our review of the sector last week, although it has been flagged on one of our technical scans this week. It trades on 13.2x funds from operations (FFO) while yielding an attractive ~7% unfranked making it an interesting income opportunity. In the last few weeks we’ve seen a number of corporate tussles playing out in the sector, which is often the case when views on the sector are turning – remember, bottoms in markets / sectors / stocks happen when the majority are bearish and negativity is high. It certainly feels like negativity in the property sector has built significantly over recent weeks – it now simply feels like a known known.

CMW looks excellent from a technical standpoint, targeting a move up to $1.30, however we simply can’t get excited over the fundamental picture (yet).

Cromwell Property (CMW) Chart

In August, they reported FY 18 numbers in line with expectations however their guidance was soft for FY19 with dividend expectations of 7.25cps representing a 13% decline v FY18, while at the earnings level they flagged a decline of 4.3%. While the share price has come back 10% since then pricing in that decline, it’s still trading at a decent premium to the sector. That implies that the market likes the story / management etc however it also means it’s unlikely to be the target of any sort of corporate activity relative to a property stocks trading at a discount to their assets.  

Here’s a chart of CMW relative to its peers. The white line in CMW, the Orange is its peer group – CMW remains overvalued relative to peers

4 Fortescue Metals (FMG) $3.71

Investors familiar with Fortescue Metals (FMG) will appreciate the chart below. It tracks FMG share price (orange) with the lower quality Iron Ore price (IO58%) over the last two years. There is a clear correlation between FMG share price and the price of lower quality Ore. We are now seeing lower quality Ore rise, yet FMG has remained soft – simply put, we think its being held down as a ‘short’ proxy for emerging markets – and area that has been under significant pressure, but it is close to bottom in our opinion.   

We intend to average our existing position in Fortescue (FMG) into current weakness, up weighting by ~2% to ~5%. Watch for alerts

Fortescue Metals (FMG) (orange) v lower quality Iron Ore

Hybrids – some movement in the ranks

This week we’ve seen ANZ announce $711M in after-tax expenses and revenue reduction for 2H18. The impact of this announcement on ANZ’s common equity tier 1 ratio is expected to be less than 10 basis points of risk weighted assets. The software write-off has no impact on this ratio.  

That said, this is a small negative for ANZ’s credit quality, and if we look at the ANZPD which sits in the portfolio, this screens  relatively expensive.

We plan to remove ANZPD from the MM portfolio , using the cash to increase equity exposure.

Source; Shaw & Partners



As equity markets fall, it makes sense to reduce the defensive income securities and up weight income equity exposure.

1. AGL looks cheap historically, but risks remain fundamentally.

2. SUL is cheap historically and we are bullish

3. CMW pays a good great dividend but is expensive relative to peers

4. FMG has diverged from the 58% Iron ore price, we are bullish.

Have a great day!

James, Harry & the Market Matters Team


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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