Views at a Glance / Income Report; Keeping our finger on the pulse for opportunities (FMG, PPT, HVN, NCK)

By Market Matters 24 January 18

Income Report; Keeping our finger on the pulse for opportunities (FMG, PPT, HVN, NCK)

Market Matters Income Update 24th January 2018

The market has pulled back over the past week by -0.20% with the move sugar coated somewhat by the strong advance from the weekly lows yesterday as the ASX pushed up +45pts with all sectors doing well. Overnight we saw overseas markets tick higher, however the commodity markets were less optimistic leading to some weakness in that area today – something we’ve been patiently waiting for using the weakness to BUY Fortescue Metals (FMG) in the Income Portfolio below $5.00 this morning.

Yesterday we locked in a ~13% profit in Harvey Norman (HVN) once again reducing our exposure to retail stocks at a time when the market is being more optimistic (or at least less negative) on the sector, however HVN has traded from below 10x to above 12x on that sentiment shift. Although more expensive, we’ve retained a position in Nick Scali (NCK) for now, simply given it’s a higher quality, more specialised retail operator with a stronger moat guarding it against competitive threats.

ASX 200 Daily Chart

In terms of the MM Income Portfolio over the week, not much movement overall with the portfolio flat versus the market which was down. Since inception (5th July 2017), the portfolio is up by ~7.825% versus the ASX 200 which has added 3.43%, while it’s strongly  outpacing the benchmark of the portfolio which is the RBA Cash rate +4%, which equates to 3.06% over the period since inception (equating to outperformance of 4.76%).  Just a quick word on benchmarks, we use them as a guide and as these portfolios morph into investible funds they become more relevant. The use of a cash rate + a margin is more relevant for this portfolio given it’s a combination of equities, hybrids and fixed interest. Therefore an equity only benchmark such as the ASX 200 is less relevant given the portfolio only has around ~55% exposure to equities. 

As always, we’re hunting around for income opportunities with a current focus on 3 areas;

1.    Resources – We own FMG and WPL in the Income Portfolio & have started to accumulate BHP in the Platinum Portfolio

We’ve bought into Fortescue this morning below $5.00. Not your traditional ‘yield play’ however a combination of an aggressive cost strategy, massive amounts of free cash flow, a much lower debt burden and a buoyant Iron Ore price, the metrics of this stock are sound. Firstly, we obviously acknowledge that underlying earnings are dictated heavily by what commodity prices do, and as such, volatility in earnings will play out and will feed some volatility in dividends. If we buy resource stocks solely for dividends, then this reality must be acknowledged.

The miners dividend policies revolve around a payout of earnings with varying ranges. This might seem simple however cast your mind back to the ‘progressive’ policies of the past, which in hindsight seem ludicrous. Because they pay a percentage of earnings, we should simply focus more on earnings, the outlook for those earnings and the dividends will look after themselves. At this stage, the market’s expectations for Iron Ore is still a lot lower than the current spot price, and therefore the longer the price stays elevated, the more earnings upgrades FMG will receive. On the revised dividend guidance (50-80% of NPAT), Fortescue is likely to yield somewhere between 4.5-7% fully franked – which is HUGE for a resource stock (at this point in time).

Fortescue – price versus earnings

Also worth revisiting the work of Peter O’Connor, Shaw’s very good resource analyst around valuations relative to the sector and relative to its asset base. Below is price relative to Net Present Value (NPV).  

Any then applying spot commodity prices, FMG looks cheaper. As it stands now analysts are more bearish Iron Ore prices over the next 12 months than the current spot price so forecasted earnings are lower than if we apply spot  - which is very relevant for FMG.

Importantly, we’ve allocated 3% into FMG and will look to go to 5% should further weakness unfold

2.    Fund Managers / Diversified Financials – we own PPT in the Income Portfolio while we have JHG and IFL in the Platinum Portfolio

Looking at the stocks below on simplistic measures of PE and yield (there is certainly more to it), JHG, MQG and to a lesser degree, PPT stand out. We don’t own MQG and probably should at the right price. MQG is a mix of Fund Manager & Bank, so is discounted on that basis but too aggressively in our view, however if we think the US mkt is overcooked and due a pullback, buying MQG into weakness rather than prevailing strength should be the play – MQG has broken out today trading at new all-time highs.

In terms of our 4% holding in PPT, this still looks attractive, and we remain on the buy side into any weakness despite the +8% rally in share price since our purchase, with an eventual target of $55.

Perpetual Daily Chart

3.    Retail – we sold HVN yesterday at $4.44, we still own NCK from $6.12 in the Income Portfolio, while we hold WEB in the Platinum Portfolio

Harvey Noman still appeals from a valuation / yield perspective however the stock is clearly losing momentum, so we exited yesterday at $4.44. Our overarching view that the fear of Amazon was bigger than the near term reality proved accurate, however the market has now cottoned onto this and retail has become a more crowded trade. While we’ll retain NCK for now (and WEB in the Platinum Portfolio) , the sector has lost its overall appeal in the short term.

Harvey Norman Daily Chart

Conclusion (s)

We added Fortescue to the portfolio this morning at $4.99
We sold Harvey Norman yesterday at $4.44
We are keen to add further to our resources exposure in time

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 Wednesday, or after the session when positions are traded.

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