Income Report / Income Report: ABC downgrade and implications for our portfolios (ABC, CSR, GMA)

By Market Matters 31 July 19

Income Report: ABC downgrade and implications for our portfolios (ABC, CSR, GMA)

Market Matters Income Report 31st July 2019

As we suggested this morning, the market is starting to lose some steam around all-time highs with the breadth of buying declining. This morning we’ve seen a downgrade from building materials company Adelaide Brighton (ABC) and this highlights one of the theme’s I spoke about in a recent video update with Harrison (click here), namely that while the market is currently fixated with lower interest rates which provides a bullish backdrop, the earnings season will likely provide more insight into the reasons why rates are being cut, which is of course, weaker economic conditions which ultimately impact earnings – we’ve seen the first example of that today with ABC.

As we motor into reporting season we remain cautious on the domestic consumer and therefore sectors that are linked to discretionary spending - retailers for instance and particularly the likes of JB Hi-Fi (JBH) and Harvey Norman (HVN) that have been rallying ahead of results.

At lunchtime today, the ASX 200 is trading down -21pts or -0.32% to 6823.

ASX 200 Chart

The Income Portfolio had another reasonable week, climbing 0.44% helped by a market that cracked all-time highs. The biggest drag to performance came from both Rio Tinto (RIO) & GMA which had fallen 3% in the 5 sessions to yesterday’s close. Most of the other holdings traded marginally higher in the week, but the recent addition of Flight Centre (FLT) contributed the most to the portfolio’s gain, adding more than 4% in the week. The portfolio continues to outperform its benchmark of RBA + 4% for what is almost the first month of the financial year, adding 1.37% thus far vs the benchmark at 0.40%. Since inception the portfolio is up 17.98% vs the benchmark of 11.32%.

For those interested in investing for income in a low rate environment, Market Markets does run an Separately Managed Account (SMA) which is open for investment. The portfolio is based on the MM Income Portfolio below. The SMA has now passed its first anniversary and performance has remained sound printing an overall gain of 10.16% for the year to June 30. The June update can be viewed - Click Here.

**Adelaide Brighton (ABC)** Downgrade & Implications

This morning building materials company Adelaide Brighton (ABC) has downgraded full year earnings expectations.  While this is not in the Income Portfolio, we hold ABC in the Platinum Portfolio and there are implications from today’s downgrade for other property / building related stocks we hold.  The stock is trading down ~16% at $3.63

ABC has downgraded full year profit expectations by around 23% relative to market expectations. ABC are a December year end, and they now think that underlying net profit after tax will be in the range of $120-130m. Market expectations were for $164m implying a 23% downgrade to the mid-point of new guidance range. They say this is a consequence of a softening residential housing market along with competitive pressures in QLD and SA. They also said no dividend will be paid for the first half which is prudent.   

MM’s key takeaway: This is a poor update and the stock should be trading lower which it is.  On the new guidance the stock is now trading on around 18x which is expensive. With no yield, it’s hard to get excited about ABC and for that reason we’re not adding to our relatively small 3% holding in the Platinum Portfolio, although we’re not cutting it either at this point.  

Adelaide Brighton (ABC) Chart

Implications: The income portfolio holds CSR which is impacted by this downgrade – the stock is trading down -5% The weak trends playing our in ABC are a clear negative read-through the short term, however our underlying view is that the housing market has at least stabilised and we’re closer to a bottom (as discussed below from GMA). CSR is on 14x while yielding over 8% grossed for franking. They report half year earnings on the 5th August. 

MM are holding this for yield and will await their earnings.  

CSR Limited (CSR) Chart

Genworth (GMA) $3.15: Reported  1H19 results this morning and as always, it’s a fairly complex set of numbers. Overall written premiums were down substantially which was no surprise and the lower written premiums mean more excess capital available for share buy-backs along with special dividends. To that end, GMA this morning announced a big 21.9cps special dividend  (unfranked) in addition to their 9cps fully franked ordinary dividend. This is a strong move by the mortgage insurer.

GMA’s reported net profit was strong at $88.1m however that includes an unrealised gain on their investment portfolio – stripping that out, the underlying result was a profit of $43.1m  for the half, and given their usual second half skew in earnings, they remain on track to meet full year expectations for an underlying profit of $105m.

In terms of commentary around the economic outlook, they talked about house price moderation continuing, although they sighted stabilisation in most cities bar Perth. We like tracking delinquencies, not just from the perspective of GMA but  more broadly, and the below table shows that deliquesces were up, but not materially so. Western Australian continues to see the highest rates followed by QLD.

GMA paid a fully franked dividend of 9cps in March, plus they have announced another 9cps to be paid next month in addition to the special dividend of 21.9cps unfranked. This takes total yield for the 12 months to over 15% inclusive of franking credits, clearly a strong result from a stock that has had a fairly volatile time. We originally bought GMA on the expectation of high yield thanks to excess capital and that is now playing out. 6%/ 25m shares are short sold in GMA and today’s announcement around the special dividend and reasonable earnings should prompt covering here meaning the stock has a strong chance of popping hard.

At time of writing, Genworth is trading up ~10%.

MM remains bullish GMA for income.

Genworth (GMA) Chart

Conclusion

A poor update from ABC which has had negative implications for our position in CSR. We are holding both stocks for now.

A strong result from GMA and we remain bullish the mortgage insurer.

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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