Views at a Glance / Income Report; Should we cut FMG on their dividend miss? (FMG, BHP, WES)

By Market Matters 21 February 18

Income Report; Should we cut FMG on their dividend miss? (FMG, BHP, WES)

Market Matters Income Update 21st February 2018

We’re now in the vortex of reporting season with around ~30 companies reporting results today alone – a lot to get ones head around in a short space of time. BHP reported yesterday (stock down ~4.5% today) while we’ve seen Fortescue out this morning (stock down ~4%) with their result – both of which we’ll provide colour on below. Wesfarmers is another on our radar that reported today (we were trying to buy below $40 for the Income Portfolio) however ‘frustratingly’ that stock has bounced despite missing consensus earnings and dividend but their underlying metrics were better than the mkt had feared. Not an income stock, however A2 Milk (A2M)  has set the mkt alight with a result this morning that blew expectations out of the water – about a 20% beat on the earnings line and the stock is on fire today...we ll cover in the afternoon report.

In terms of the MM Income Portfolio over the week,  the portfolio was up by  0.71% in a market that was strong. Since inception (5/7/17) the portfolio has gained 6.36% tracking nicely above the market and above its benchmark.   

1.      FMG – should we cut it on lower than expected dividend?

We added Fortescue to the Income Portfolio about a month ago below $5.00 and the stock has done well, adding around 7% to yesterdays close. They reported first half  results this morning that were a beat on most metrics, but they paid a smaller dividend than we/the market thought they would – we therefore need to ask the question, should we hold or cut and run?

Firstly, their 1H18 scorecard was better than expected with about a 3% earnings beat but more importantly, not as bad as some had feared over the past month or so  - given the price discount trends on their lower quality Iron Ore.

Revenue was a tad light on and the dividend was a big miss which is worth some attention while the other metrics were all sound. The earnings are obviously the key here, and the trend has actually turned up (see chart below) – from late January 2018 in fact - so the downward leg from April 2017 appears to have run its course. This is important because the share price and EPS trend are closely correlated. Unwinding, or reduction in the price received discount (32% in 1H vs 25-30% for FY est.) would see this earnings trend continue, with or without a move in the underlying iron ore price…

Fortescue – Share price in black – Earnings in Orange

Source; Shaw and Partners

So we think earnings are okay, however clearly the dividend was a bit underwhelming. The 1H payout ratio at 40% is below the company guidance range of 50-80% for the FY  suggesting there is a very high chance that the dividend will have a big second half skew. On 11cps for the half, a 22cps for the full year equates to 4.4% fully franked on our buy price, however, what’s more likely is a bigger second half dividend. The market currently expects 18cps which if delivered would equate to 29cps for the full year or 5.8% fully franked.

So although the dividend missed, the weakness today looks like an opportunity to buy rather than sell. We’re comfortable with FMG in the Income Portfolio.

Fortescue Metals (FMG) Daily Chart

2.    BHP – was the result ‘that’ bad?

BHP reported yesterday after market and our comments in the afternoon report still hold true –  a weak result however the underlying trends in the business remain intact. In summary …it was a miss in terms of earnings, a beat in terms dividend, revenue was okay – but a miss overall. 

That said, BHP’s 1H18 NPAT was up a whopping 26% YoY and 15% HoH which is a big result  and highlights how well the underlying business is tracking, it’s just the markets expectations leading in to the result were high. The dividend was a BIG positive surprise  at  US55c ahead of consensus at 49c (12%) taking  the full payout ratio for ordinary shares to ~72% - which is a big result. In terms of the full year dividend, Bloomberg consensus sits at US45c, so if achieved the full year dividend will be $US1 per share or $1.27 based on spot currency. That equates to 4.25% plus franking or 6% grossed for franking.

BHP currently resides in the Income Portfolio with a buy price of $29.30, slightly below the prevailing mkt price.  We remain comfortable with that holding

BHP Daily Chart

3.    Wesfarmers  – why did the market like it?  **We have removed our buy alert below $40.00**

I was on Sky Business this morning when the WES result dropped and on first blush, it looked like a miss. Consensus was at  $1.6bn in terms of underlying profit and it printed an underlying result of $1.535b – a clear miss + they also missed in terms of the dividend – although only by a whisker. Two real gems in the result today that the mkt clearly liked and that sent the stock up ~3% at time of writing – and frustratingly, well above our trigger point to buy on a move below $40 – sometimes the mkt is cruel.

Bunnings; What a cracking business!  like for like sales growth of +9.0% a (vs. 6.5% in pcp), and (b) EBIT margins +30bp from 12.9% to 13.2%. Well run and should continue to do well – evidenced by the bumper 47.0% return on capital (vs. Coles paltry 9.0%)! Up there as being one of the best businesses in Australia!

Coles; Better than the market feared  with like for like sales growth of 1.3% which was up from the paltry 0.4% we saw in Q1 taking the average to 0.9% which is at the top end of mkt expectations 0.5% to 1%. The issue though is with margins and that has been a common theme amongst the retailers (Nick Scali excluded) this reporting season.  Coles are expected to do EBIT margins of 3.9% down from 4.6% just 12 months ago. Comparing that to Bunnings which are at 13% shows why Bunnings is such a superior business!

So all up, the result was a miss, but the underlying metrics in the two biggest divisions were stronger than the market thought – offset by weakness in some other areas.  Officeworks was good, the industrial side was mixed, strong free cash flow shone through, balance sheet is good and guidance was typically vague and non-committal. Issue comes down to what multiple should we apply to earnings. Right now on 16x forward its about fair value – a move under $40 would prompt us to step up and buy the stock.

Wesfarmers Daily Chart

Conclusion (s)

At this stage, we like FMG and BHP at current levels, but will not be adding to our existing positions
We seem to have missed the boat on Wesfarmers and will remove that alert to buy below $40


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