Views at a Glance / Income Report; CBA less bad, Listed Investment Companies (LIC’s) & Eclipx (ECX) downgrade

By Market Matters 08 August 18

Income Report; CBA less bad, Listed Investment Companies (LIC’s) & Eclipx (ECX) downgrade

Market Matters Income Report 8th August 2018

A reasonable morning on the market today with financials dragging the market higher thanks to ‘better than feared’ reports from CBA & AMP. BHP is also doing its bit to help the index higher, up ~1% as metals and oil crept up overnight. Reporting is dominating the news in Australia and this comes on the back of a very strong quarterly reporting period in the US, where 82% of companies have beaten expectations, a record proportion of beats.

While we don’t expect that positive undertone in Australia, overall earnings are expected to increase by 8% on the year and with the index trading around 15.5x forward earnings, our market isn’t cheap, but we’re not expensive either.

In terms of the MM portfolio for the past week, the portfolio fell -1.25% during the week due to the Eclipx downgrade, however remains up 0.11% for the financial year, and 6.12% from inception tracking above its benchmark (RBA + 4%) which currently equates to 6.00%.

CBA Results – broadly inline with expectations

The CBA result was out this morning and it was messy however that was to be expected amid charges from the money-laundering settlement, margin pressure from short-term funding costs (CBA have not repriced loans higher) and the overall financial cost of ongoing regulatory issues.

Actuals v expectations – about inline

Underlying trends

Loan growth: running at 2% for the FY18 financial year for the bank and its Australian business

Margins; the Australian loan to deposit spread fell by 2 bps from 1H18 to 2H18 and so did the net interest margin, however NIM over the year reamins 5bps higher

Credit Quality; this was better with new and increased impaired assets falling from $1.25B in 1H18 to $882M in 2H18 plus we saw past due loans remain stable

Trading Income; this was weak however that was well flagged

Costs; overall costs were higher thanks to one offs however costs in the underlying business are being well managed 

Capital; Tier 1 capital remained flat at 10.1%

Summary; There was always going to be very little incentive for CBA to deliver a strong result today, however the result announced this morning is a reasonable one on an underlying basis and importantly, better than the market may have feared. The headlines will highlight that CBA have booked the first drop in profit since 2009 thanks to weak revenue growth and higher costs however assuming conditions remain as they are, that trend should flip back at the next set of results.

Commonwealth Bank (CBA) Chart

Listed investment Companies (LICs) – a deeper dive

In the Monday Morning Q&A there was a question about a new structure of LIC being rolled out by PM Capital called the PTrackERS, which incorporates an innovative feature whereby an investor has the option to sell out at Net Tangible Asset (NTA) value in 2025. This feature is squarely designed to help the LIC trade close to the value of its assets (rather than at a discount to their assets as many do). The MM Income Portfolio currently holds one LIC and one Listed Investment Trust (LIT), which for the sake of this conversation is a similar structure.

ALF is the LIC and this security trades at a steep discount to the value of its assets. We originally added the LIC to the portfolio at $1.06 based on its large discount to NTA and market neutral approach however that discount has largely remained in place, and currently sits around 15%. Our thesis was that the resumption of dividends would be the catalyst to see the gap close and therefore the company could rally on 1. Portfolio performance & 2. Reduction of discount. As it stands, ALF is still trading at $1.06 while it holds assets worth $1.22 on a post-tax basis, plus performance over the last month has been strong up by +3% which is not yet being shown through the NTA calculation. We bring this up in relation to PTrackERS simply to highlight the reason such a feature is being rolled out, to avoid the discount LICs can develop. In terms of ALF, we remain patient holders looking for resumption of dividends and closure of the gap between share price and NTA.

MXT on the other hand trades at a premium to its NTA , with the current price of $2.07 being a 3.3% premium to the value of assets which sits at $2.0038. Why buy something at a higher price to the value of the underlying assets? In the context of MXT we wouldn’t. This is a fixed income security and the company has made it clear that if suitable deals are available, they will raise additional capital, which would be done at NTA. MXT seems to be on the approved list of some planners, and it resides in a number of SMAs that are forced to buy it when new funds land, hence the price ticks along above NTA (for now). While we like MXT in the portfolio, buying at NTA makes more sense than paying a 3.3% premium to it simply to get set.

The stable of Wilson LICs are also an interesting talking point. You can be rest assured, for now at least, the PTrackERS feature giving investors the opportunity to liquidate at NTA after 7 years won’t be rolled out by Geoff and Co, given their stable of funds typically trades at a decent premium to NTA. What you will see from WAM (and this is smart) is them using their shares (which are trading at a premium) to buy shares in other LICs at a discount. They can continue to acquire them and ultimately in theory they can consume the other LIC (at a discount to their assets).   

Australian Leaders Fund (ALF) Chart

Eclipx (ECX) – Cleary disappointing but now an opportunity

After market on Monday, ECX came out with an earnings downgrade and the stock suffered a meaningful sell off closing down yesterday by -40.79% at $1.80.  While the move was clearly a significant one, the stock did bounce late in the day up from the $1.66 low as the selling pressure started to subside, and today that theme has continued with the stock edging back up to $2.00. This is a stock that usually trades less than 1m shares per day, however yesterday 62.5m shares went through the bourse – simply a huge day of in ECX.

The diversified industrial business that does fleet management, vehicle rentals and online auctions (it owns Grays Online) said that profit would be in the range of $77- 80m for FY18 which implies growth on FY17 of 13-17% versus prior guidance for growth of +27-30%. This is a downgrade in terms of profit by around ~10%, yet the stocks dropped by ~40%.

The current issues are around their Right2Drive brand and Grays Online which both have performed below expectations. The core leasing business remains strong. ECX say these are short term cyclical factors given a lack of delinquencies through banks (which supports the sale of equipment through Grays) and longer utilisation of equipment given the level of infrastructure build playing out across Australia. (a lot of heavy machinery is sold through Grays)

While ECX has a September year end,  market consensus for profit sat at $88m for the year,  so assuming the midpoint of the new guidance is achieved (implies $78.5m) this is an ~11% downgrade to market numbers. We saw two brokers out with notes yesterday post the update with Citi downgrading from buy to hold and reducing their price target from $4.50 to $3.17 which is still a long way from the $2.00 the stock is currently trading at. JP Morgan have maintained the rage keeping their $4.40 PT and overweight call while Credit Suiise has cut them to a  neutral rating with a $1.90 target. While yesterday’s announcement was clearly weak, the SP reaction was significant. We hold ECX in the Income Portfolio with a 3% weighting and yesterday’s  move in that stock had around a  -1.2% influence on overall performance of the income portfolio, taking back the solid performance from the portfolio over the past month. We have a bias to add to the position around current levels rather than cutting the holding, however at this stage, our cash levels remain low.

Eclipx Group (ECX) Chart

Reporting

Reporting kicked up a gear today with CBA out this morning as outlined above while we also saw AMP publish results that were in line with the company’s update a fortnight ago. The market has clearly enjoyed the lack of surprises from both companies as AMP currently trades 2.39% higher, and CBA up 1.85% on the day. We’ll cover AMP in the afternoon report later on.

Suncorp is out tomorrow with their full year numbers while we have Nick Scali (NCK) out on Friday - we covered expectations for these companies last week – click here to view.

Following these results, Telstra (TLS) is the next cab off the rank on the 16th August then no other companies in the portfolio report until Fortescue (FMG) on the 20th.

TLS have recently downgraded their numbers and launched a significant plan to turn the struggling Telco around, so it’s unlikely we’ll get any variance on the markets expected numbers, however more insight into the 4 pronged attack that TLS outlined in June. At the end of July we saw Telstra release the first phase of its previously announced simplified mobile plan changes with new ‘Peace of Mind Data’ plans while trimming the total number of plans at the same time. It also introduced ‘Companion plan’ options, although it will only be offered to existing subscribers and not advertised on its website.

They are all positive steps for TLS however for the market to regain confidence in the Telco and have faith that the turnaround is happening, the pace of the changes need to pick up and this will be the main focus of the report next week.

Telstra (TLS) – reports 16th August

·         We remain keen on Telstra at current levels targeting a move to ~$3.50

Telstra (TLS) Chart

Conclusion (s)

CBA’s result was broadly inline, and the stock is trading higher  

ECX delivered a poor update yesterday, however we will hold the position, and may consider adding to it

We remain positive on TLS at current levels

Have a great day

James / Harry &  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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