Income Report / Income Report; Searching for income opportunities in recent results (BHP, FMG, COL, WES, WOW, MTS, SGP, NEC, BOQ)

The market is trading flat into lunchtime after an initial burst higher out of the blocks. Some weaker than expected wage growth figures putting the cap on buying. While there is a lot happening under the hood, at the index level, the market is now tired and as suggested this morning, a short term pullback from current levels remains our preferred scenario. That  implies we should remain patient adding any index influenced stocks to the portfolio. In today’s note we’ll look at recent results of income stocks we don’t own – but could be interested in.

ASX 200 Chart

Over the past week, the Income Portfolio added +0.61% while in the current financial year to date, it is up 2.25% vs the benchmark (RBA + 4%) of 3.51% while the ASX 200 accumulation (including dividends) is +1.08%.  Since inception, the portfolio is tracking at +5.36% p.a. vs the 6.5% p.a. benchmark, or +8.87% in total vs the benchmark tracking at 8.95%. In the past week we saw reasonable performances out of AWC and PPT (both up around 3%), collected a dividend from CBA while there were no major detractors.

We subscribed to the recent NAB hybrid (NABPF) and this will be added to the portfolio with a 5% weighting.

Searching for income opportunities in recent results

BHP (ASX:BHP) reported after market yesterday and the result was a miss in terms of earnings, about 4% at the profit line while the dividend was a slight beat. Last year the company had a weak 1H followed by and a strong 2H and the market is now factoring that in. While income investors have had a cracking year in FY19, from FY20 onwards, dividends are expected to come back to more normal levels, around the 3.5% mark plus franking. We are not buyers of BHP at current levels.  

Fortescue Metals (ASX:FMG) was out this morning and the conference call is on shortly, however  they’ve delivered a great set of numbers. While its very disappointing that the income portfolio no longer holds the position (sold too early) for a 20% profit,  recognising FMG as an income opportunity early on has been validated. Today they reported a big earnings beat (about 15%) however the main initiative was around capital management. They announced a dividend of A19c (~65% payout ratio – midpoint of 50-80% guidance range) and a special dividend of A11c. That largely takes care of their franking credit balance and provides Twiggy a big income injection. FMG had the 3rd largest franking balance of the top 25 Australian miners (Rio and BHP are larger) which was sitting around US$800m. The total dividend outlay today of  ~$650m  clears out a large part of the balance. Simply a huge turnaround from the miner, buoyed in part by a big turnaround in the underlying  Iron Ore price, but more importantly, a significant reduction in the discount applied to their lower quality Ore, which peaked at ~40% and now sits around ~13%. The stock remains on our radar, however into weakness, not strength. If we still held, we would sell todays strength.

Fortescue Metals (ASX:FMG)

Coles (ASX:COL) & Wesfarmers (ASX:WES); Typical income orientated stocks, Coles out with results yesterday and Wesfarmers due out tomorrow. The Coles result was a weak one as discussed in the afternoon report. They missed in terms of earnings while the outlook for growth to us seems muted. In terms of the dividend, they guided for a dividend based on an 80-90% payout of earnings starting in September which on the current run rate they’d pay 2.4% fully franked  jumping to a full year yield of 5.4% in FY20. It was an uninspiring result and we have no interest in the stock as we discussed at the time of listing – click here

Wesfarmers will release results tomorrow with expectations for half year profit of ~$1.1bn and a dividend of $1.06

Woolworths (ASX:WOW) reported this morning and it was below market expectations (about 5% at the earnings line) while guidance was hardly inspiring. They discussed the potential for an ‘off market buy back’ similar to BHP & RIO assuming they get regulatory approval for the sale of their service stations for around ~$1.7bn – this would likely be a small capital component and large fully franked dividend to release franking credits from their balance sheet which could be a good exit for long term holders with capital gain issues.

Thinking purely about the stock on a current P/E of 21.2x  and a yield of 3.11%. why does the market pay such a premium for this stock?  Granted, it’s a superior business to Coles which is shown through better margins across the operation - a result largely of better distribution and logistics, however that is something now being addressed by Coles i.e Coles will continue to get better, not worse. That implies to us the valuation gap between Coles on 15x and WOW on 21x will close. Over the past 5 years, WOW has traded between 13.6x and a high of 21.5x. On today’s multiple of 21.2x WOW is trading just 0.3 P/E points below its highest point in 5 years.  We have no interest in WOW even with the 5% decline in SP today.

Woolworths (ASX:WOW) Chart

The often overlooked Metcash (ASX:MTS) which powers a suite of independent brands like IGA, Home Timber & Hardware, Foodland, Mitre 10 and others is interesting from a valuation perspective. While they report out of cycle with their next update in June 2018, MTS is seen as the illegitimate child amongst the cosy duopoly. They’ve had a tough time with the loss of a large contract while supermarket conditions generally remain tough, on a PE of 10 and a yield of 6% plus franking, this is looking interesting. Technically the stock appears destined for $3.00

Metcash (ASX:MTS) Chart

In the property space, Stockland (ASX:SGP) reported a 6% decline in earnings this morning while they guided to full year growth of +5% - which is the lower end of their prior expectations of +5-7% and they are relying on a big second half skew. More interesting in the result was a revaluation lower of their retail assets, however that was more than offset by a revaluation higher in their office and logistics holdings. The residential business is going okay and they reiterated their 6,000 residential lot settlement target for F19. They spoke of weak retail conditions and soft housing however weakness in some areas offset by strength in others means that NTA remained flat. We would only have interest in SGP into new lows, below $3.40

Stockland (ASX:SGP) Chart 

We have highlighted a couple of ‘dogs’ in morning reports of late and we bought the first of them yesterday in Bingo (ASX:BIN) within the Growth Portfolio. We use the term ‘dogs loosely’ and view these more as good companies that have had a difficult period and present value.  Nine Entertainment (ASX:NEC) fits that bill trading on around 10x earnings while yielding around 8%. They report tomorrow and this is one we have on the radar.   

Nine Entertainment (ASX:NEC) Chart

We touched on the regional banks this morning with a focus on Bank of QLD (ASX:BOQ) for the income portfolio (not the Growth Portfolio as some have queried). The regionals have been sold down following their results, and rightly so – however the elastic band has now stretched too far in our opinion.  Bank of QLD trades on a P/E of 10x while yield 8.5% plus franking.

BOQ looks interesting below $9.00 however given cash levels, we would not trim NAB to buy BOQ. We are interested in BOQ for the income portfolio below $9.00

Conclusion (s)

We are looking to buy Bank of QLD (ASX:BOQ) for income
We are negative Coles & Woolies however we see value in Metcash
BHP & FMG have now run too hot for consideration
NEC reports tomorrow and is on our radar

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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