Income Report / Income Report: A ‘personal view’ from one of our analysts’ (CBA, TCL, BPT, BHP, WEB, CCP)

A slightly different income note today however if we can’t mix things up in this sort of a market, when can we? We’ve included the personal view of one of our analysts, a good overview of where we sit, MM’s key picks in areas raised while I’ve also address our view on Credit Corp (CCP), a stock we’ve had a handful of questions on in the last day or two, understandable given it’s declined by more than 60%.

After rallying more than 5% yesterday, the ASX is trading down 3.50% today hovering around ~5100. Most selling today targeting the high growth, high valuation type stocks, Afterpay (APT) down more than 20% at time of writing while National Storage (NSR) is down ~19% after having a bid for the real-estate company withdrawn.

Overall, the ASX 200 is currently trading down -173points / -3.28% at 5119.

ASX 200 Chart

The Income Portfolio had negative performance during the week of -8.22%, a soft result given the composition of the portfolio with the ASX200 Accumulation Index down a shade over 10%. Metcash (MTS) caught a bid in the supermarket panic buying, while a timely purchase of CBA on Friday were the only gainers for the week. Despite paying a dividend in the week, Ive Group (IGL) dragged 28.6%, while the two real estate exposure – SGP & ABP – also fell more than 20%. Performance for the current financial year is now -12.05% versus its absolute return benchmark of +3.44%. Since inception, the portfolio remains positive (just), +1.08% vs the benchmark of +14.36% - clearly some work to do.

A ‘personal view’ from one of our analysts’

This morning one of our analysts at Shaw sent around his personal views on the market, it was an internal email  however with Hinze’s permission I have included here for our subscribers. While this is a slightly different sort of approach in todays income note, I think it’s important to reinforce our overall stance, provide a different take and importantly some context around the recent market movements.

From Andrew Hines….It is crazy times – but for what it’s worth, here are some personal observations on markets and the current crisis. I’ve been an equity analyst for 26 years, and I’ve never seen volatility and market moves as large as what we’ve experienced over the past two weeks.  However, I’m more bullish now than I’ve been for a long time – I think this is one of those once in a decade opportunities to buy quality assets at cheap valuations. You just need to dodge the debt grenades.

For the past three years investors were complaining that equity valuations were too high and that buying opportunities were scarce. This culminated last year in a raft of brokers upgrading valuations by adjusting discount rates down. When you need to change a long term discount rate to justify an asset valuation, you know markets are stretched. The market was looking for an excuse to sell-off, and COVID-19 is it.

Reasons to be positive; 

·       The impact of COVID-19 is a transitory event, it is not a structural change to the global economy.

·       COVID-19 is clearly a nasty virus, with higher infection and mortality rates than influenza – but to keep it in perspective, the Centre for Disease Control (CDC) currently estimates that between 31-51 million people have been infected with the flu since 1 Oct 2019, which has resulted in 17-24 million medical visits, 370-670k hospitalisations, and 22-55k deaths.

·       Central banks have moved global interest rates to effectively zero, and governments are announcing major fiscal stimulus packages – when the COVID-19 episode is over, the global economy will be in one of the most stimulatory environments ever seen.

·       The global financial system is in much better shape than the GFC – the combination of regulated solvency requirements and better lending practices should mean that bad debts are not going to be as severe, and banks are better able to cope with whatever bad debts materialise.

·       The oil price sell-off is a separate but related event – Putin has seen the opportunity to create chaos in the US shale industry and he is going for it. Saudi had no choice but to follow suit. A low oil price is actually positive for the global economy – oil at US$20-30/bbl is equivalent to a large personal tax cut for most consumers. It is highly beneficial to the airline, resources, agriculture and travel sectors. Oil prices below US$50/bbl are not sustainable, and supply will react reasonably quickly (particularly in the US) – but unless Putin or the Saudis chicken out, low prices are with us for the rest of the year.

Reasons to be cautious;

·       The current crisis has turned into a liquidity crisis – every asset class is being sold down including gold. In a liquidity crisis, rational investment decisions don’t work in the short term.

·       There are going to be bankruptcies. Leveraged companies with an earnings hole in 2020 may not survive without government and/or lender assistance – that is likely to be the target of the next wave of fiscal stimulus, although governments will be careful not to bailout poor businesses that should have failed anyway.

·       The snowball effect from company failures leading to unemployment leading to bad consumer debts, and lower consumer spending will exacerbate the downturn. Corporate balance sheets are generally in good shape – it’s consumer debt that is the problem this time.

Where do I think the opportunities are?

·       The banking sector – The Australian banks are now trading below book value for the first time since 2003. Prices have dropped below GFC levels and yet the banks are in much better shape today than in 2007/08. Like 2011, you can buy the Australian banks with a positive carry – even allowing for a substantial cut in dividends, you are being paid to own the banks today, and once this episode is over, there is substantial share price upside in the sector.

Note: MM’s No1 pick is Commonwealth Bank (CBA)

Commonwealth Bank (CBA) Chart

·       Quality fixed assets – Companies like Sydney Airport and Transurban are owners of quality fixed assets that will see demand and activity levels return to normal levels reasonably quickly – probably no more than 6 months away. The only issue to watch is debt – avoid companies with near term debt maturity, or debt covenants likely to be breached. The assets are now very cheap, but the capital structure might be wrong – you don’t want to fund an equity raise if one is likely.

Note: MM’s No 1 pick is Transurban (TCL)

Transurban (TCL) Chart

·       The Energy sector – as noted above, the oil price is not sustainable at these levels. The Australian energy stocks have been sold off in-line with the oil price, they will bounce back next year when prices recover. In the meantime, their cost of production is low, balance sheets are ok and they are cash flow positive.

Note: MM’s No 1 pick is Beach Energy (BPT)

Beach Energy (BPT) Chart

·       The resource sector – prices have finally come back to reasonable valuations. Balance sheets are in the best shape ever. Cash flow remains very strong because commodity prices have held up very well. Iron ore is still US$90/t and coking coal has actually gone up to $163/t during this sell-off. There is also the potential for significant M&A activity. BHP and RIO have limited internal growth options given the low capex and asset sale programs of the past four years – if they actually deliver on their ‘capital discipline’ message to investors, then now is the time they should be acquiring distressed assets. When the current global lockdown is over – the fiscal stimulus (particularly in China) could see commodity prices rip higher again.

Note: MM’s No 1 pick is BHP Billiton (BHP)

BHP Billiton (BHP) Chart

·       Quality companies that you always wanted to own but missed in the run up -  Cochlear? CSL? Macquarie Bank? COH and CSL actually haven’t sold off that much, but they are still the same businesses from three months ago – and now you can buy them at more reasonable valuations.

Note: MM likes COH, CSL, RHC, MQG, BIN, MFG, ALL that fit this ‘fallen angel’ category.

Cochlear (COH) Chart

·       Peak fear names – What about Qantas? At $3 there may be more downside – things will get worse before it gets better for airlines – but we’re close to peak fear, and quality airlines like Qantas may emerge in a much stronger position. Does the competition go bust?

Note: MM No 1 travel pick is Webjet (WEB)

Webjet (WEB) Chart

Bottom line – look for opportunities into this sell-off

One stock in focus, for the wrong reasons

In the past few days, I’ve had a raft of questions about Credit Corp (CCP), clearly a well owned stock. CCP is a debt collection business that in an environment like this, should do better than it has. The stock peaked on 21st February at ~$38 and closed yesterday at $15.52, down ~60%. CCP now trades on an Est P/E of 10.25x and is projected to yield 4.64% fully franked over the next 12 months based on about a 50% historical payout ratio. This is a stock the market has traditionally loved with a consensus target still sitting at $33.88, although that hasn’t changed since before the rout, so why the aggressive re-rate on huge volumes?

A few things at play here however the main issue is debt / balance sheet strength. The stocks that have been most heavily sold are those that carry higher debt and CCP fits that bill. At last reporting date in January they had net debt of $206m with gearing of 30%, however they have a covenant in their lending arrangements which says that they need to keep gearing at less than 60% of financial asset carrying value. The takeaway here is that this is a leveraged business where debt is higher than we’d like and the value of the assets underpinning that debt has likely declined.

Collection House (CLH) is one of their competitors and in mid-February they were suspended from trade with an alarming announcement. In short they effectively said that collection practices were too aggressive and need to be changed,. The change would result in lower earnings from their purchased debt ledgers (PDLs) and that in turn would reduce the value of the PDLs on their balance sheet. That move seems to have triggered an issue with senior lenders. In short we think CLH is in a world of trouble and that has focussed attention on CCP.

While CCP is a higher quality business than CLH,  it seems clear that traditional debt collection practices are under the microscope and this could have a negative impact on the value of their inventory (which is essentially purchased debt). If the carrying value of inventory changes it puts pressure on the balance sheet at a time when the market is very focussed (and rightly so) in financial strength rather than growth.

I can also remember CCP during the GCF, it traded down to ~60c and very nearly went out the back door.

MM has no interest in CCP despite the sharp decline

Credit Corp (CCP) Chart

Conclusion (s)

We are bullish on well capitalised companies into current weakness

We are negative on Credit Corp (CCP)

Use this current weakness to improve the quality of portfolios

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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