Income Report / Income Report: Screening for Income Opportunities (FMG, NEC, SFR, NHC)

By Market Matters 23 October 19

Income Report: Screening for Income Opportunities (FMG, NEC, SFR, NHC)

Market Matters Income Report 23rd October 2019

The market has opened lower this morning after a late sell-off in the US overnight with BREXIT uncertainty weighing on sentiment. Banks are dragging financials today while Fortescue and Rio Tinto are doing a good job of supporting an otherwise weaker materials sector. Tech has been on a wild ride this morning as Wisetec (WTC) trades again. WTC traded as low as -7.5% below the last close before bouncing strongly to trade as high as 11.7% in the black. Western Areas (WSA) delivered a slightly better than expected quarterly update, while Vicinity Centres (VCX) and Dexus (DXS) are both higher after their September quarter update – property stocks doing well in their updates this week.

Overall, the ASX 200 is currently trading down -18pts or -0.28% to 6653.

ASX 200 Chart

The Income Portfolio was higher during the week, up 0.60% in the week against the backdrop of the ASX200 Accumulation index which traded around +0.3% higher. The portfolio outperformed thanks to a decent 7% jump in CSR, as well as a 5% rebound from Perpetual (PPT) which recovered some of the previous fortnight’s decline. The portfolio is tracking well above the benchmarks, currently up +2.69% financial year to date, versus its absolute return benchmark of +1.53%. Since inception the portfolio is up +19.65% vs the benchmark of +12.46%

For those interested in investing for income in a low rate environment, Market Matters manages the investments for the Market Matters Active Income portfolio offered under Praemium SMA. The portfolio is based on the MM Income Portfolio. The SMA has now passed its first anniversary and performance has remained sound, the September update can be viewed - HERE

Screening For Income Opportunities

Investing is all about having a big toolbox of information and ideas to draw from, and knowing how and when to use them. Just as tools are useless without knowhow, information is irrelevant without context. At MM, we try to distil our views down as much as possible, provide context on the information given and attach an action, even if that action is do nothing. Investing is all about probabilities rather than certainties , and skewing those probabilities  into our favour, one way we do that is by screening markets for investment opportunities, whether that be technical or fundamental screens, simply to get ideas. Today’s income note will look at the results from a very simple screen we run looking for income stocks as we move to skew the MM income portfolio further away from traditional yield, into more cyclically orientated companies that still offer reasonable income potential.

We often include the simple price to earnings (P/E) ratio as a measure of value, the basic definition being the stock price divided by earnings per share (EPS). Higher P/E’s mean a more expensive stock, lower P/E’s mean a cheaper stock. While this is useful at a glance, anchoring this to earnings growth is more relevant when we think about growth orientated investments. A high P/E today can be justified if those earnings are 1. Growing strongly and / or 2. Highly predictable.

However, when thinking about income I find it more useful to think about earnings yield rather than the price over the earnings. Earnings yield is essentially the inverse of a P/E, it means the earnings (EPS) divided by the share price – it’s known as the E/P ratio. Why do I like it? Simply, because it gives a direct look into the level of return a stock can generate. For example, if a stock is valued at $100 and it has EPS of $5, the stock generates at earnings yield of 5%, if it pays a 6% dividend, then quiet clearly, the sustainability of that dividend is questionable.

Earnings yield is more of a return metric than a valuation metric and as with anything, having a handle on earnings, and the trajectory of those earnings remains very important, however screening for earnings yield is useful.  

Below screens the ASX 200 for an earnings yield greater than 10% and a forecast dividend yield greater than 4%.

Source: Bloomberg

This spits out an interesting list of stocks. We already hold Rio Tinto (RIO) in the portfolio, we recently cut Alumina (AWC) for a profit and  Whitehaven Coal (WHC) for a loss – both due to commodity price headwinds with the Alumina market oversupplied while Coal prices were weak, although yesterday’s update from WHC was more upbeat about the outlook for thermal prices with some of the high cost supply coming out of the market  - that said, we’ll leave the 3 stocks to one side.

We’re comfortable with our current skew towards property, holding Stockland (SGP) and Abacus (ABP), while Genworth (GMA) also has a property tilt. We have no interest in increasing that exposure which rules out  Growthpoint (GOZ), National Storage REIT (NSR) and Dexus (DXS).

Chicken producer Inghams (ING) has had a tough 12 months with high input costs, water / feed etc and production issues weighing earnings. Agricultural stocks are very uncertain at the moment and while we think buying at cyclical lows is the way to go, we’ve been burnt on Costa (CGC) in the Platinum Portfolio,  hence I’m gun shy right now to step up and buy ING. Some brokers have turned more positive ING in recent times however I think we’ll leave it on the wait and see pile for now.

…and then there were 4

1 Fortescue Metals (FMG) $8.77

We traded FMG in the Income Portfolio at the end of 2018 early 2019, taking the most unsatisfying 20% profit on the position in the process – just as the Iron Ore market was heating up. We now hold the stock in the Platinum Portfolio however the above metrics imply we should look at this position for income.

On the face of it, FMG is on an earnings yield of 17% and forecast to pay 11% of that out in dividends over the coming year while being on a P/E of just 5x. Fairly compelling. The issue for income investors is around assessing the sustainability of that yield.  Commodity stocks notoriously volatile from an earnings perspective, and therefore dividends and shares prices are very volatile.

Also worth considering the gap which has opened up between the FMG share price and the current price of Iron Ore.

Fortescue Metals (FMG) v Iron Ore

We are bullish FMG, targeting new highs above $9.50 although concede it’s a higher risk income opportunity with a more volatile earnings profile.

Fortescue Metals (FMG) Chart

2 Nine Entertainment (NEC) $1.82

NEC is a stock we’ve looked at a number of times for the income portfolio, although we’ve never pulled the trigger. Trading on an earnings yield of 11% while paying a 5.61% fully franked yield with some growth potential through their digital channels, and now a footprint in radio through the acquisition of Macquarie Media, NEC is certainly a cyclical business that should do well if the government loosens the purse strings.

We are neutral / bullish NEC at current levels

Nine Entertainment (NEC) Chart

3 Sandfire (SFR) $6.25

A tough period from an operational perspective for Sandfire (SFR) in the last 12 months or so, putting the stock clearly in the naughty corner, however given our bullish view on Copper its worth revisiting SFR for any obvious value.

On an earnings yield of 10.5% and a dividend yield of 4.48% fully franked, the stock simply needs a Copper price tailwind from here, and we’ll see it closer to the $8 target Shaw’s Peter O’Connor has a buy on the stock. As a side, note I’ll interview Peter on Monday and we’ll discuss Sandfire(SFR)

We are bullish SFR from current levels

Sandfire Resources (SFR) Chart

4 Newhope (NHC) $2.20

This is a stock that tends to always look cheap however as was the case with Whitehaven (WHC) the coal price headwind has continued to blow. WHC did talk about an improving met coal market, or at least tightening of supply however that’s not happening in Thermal Coal which is a negative for NHC.

Overall, NHC continues to look too hard.

We have no interest in NHC

Newhope (NHC) Chart


We are looking to skew the equity positions in the MM Income Portfolio away from defensive yield and more towards cheaper, cyclical exposures
We are bullish FMG & SFR from the stocks above

Have a great day 

James & 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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