Views at a Glance / Income Report; We add another ‘controversial’ stock to the portfolio

By Market Matters 02 August 17

Income Report; We add another ‘controversial’ stock to the portfolio

Income portfolio update 2/08/17

The Income Portfolio added +0.42% over the course of the week versus the ASX 200 which was up by +0.30% / +17pts. A fairly frustrating market overall with the current tight range between 5629 and 5836 continuing to hold with sentiment swinging from bullish to bearish almost daily. Our preference is for a correction as we enter the seasonally weak August / September but no sell triggers have surfaced to-date. Our cash position in the Market Matters Income portfolio remains high (18%) and we continue to look for opportunities into market weakness – although we have spent 4% of that today.

Our most recent addition to the portfolio – Harvey Norman (HVN) has done well over the week with the stock adding +7.62%. The market is clearly negative the retailers and if we a see a hint of optimism – of better sales momentum – of a less dire situation than the one being portrayed in the media and priced by the market,  there remains a very high chance the sector will rally strongly from clear oversold levels. Important to note though, that although we see an opportunity here given current market positioning, and the nearer term sustainability of dividends, the longer term trends are a concern, particularly from rising interest rates, reduced purchasing power at a time when competition will become more of a threat.

ASX 200 Weekly Chart

At this stage we remain comfortable with the portfolio positioning with the mindset that we’ll pounce on opportunities thrown up during reporting season. Our weighting towards Hybrids could increase by another 5-8% however that would be it, with the optimum skew being 65% equities / 35% Hybrid’s or other listed income securities.

For those new to the service, it may be worthwhile revisiting our initial Income Report – available here

Australian Reporting Season

Always a busy time on the desk during reporting season as we attempt to decipher the good from the bad and more importantly to find market over / or under reactions to specific results. Collectively, analysts are optimistic on this reporting season factoring in earnings growth of around 18%, which seems impressive however if we strip out the resources, we get something closer to 6%. The resources are the big variable – they clearly benefit from higher commodity prices – which can change in a heartbeat.

UBS gave a good earnings preview recently and included the below table to use as a yardstick when thinking about Australia relative to other markets. On a 1 year forward P/E of 15.6 times the market looks reasonable to peers, particularly considering earnings growth in FY17 of 18%, however the market prices future earnings and the profile in 2018 is not as rosy – largely because analysts have lower assumptions for commodity prices. If commodity prices stay firm, then the Australian market looks good and we’ll likely see analysts revise earnings expectations higher.

In terms of specific stocks, UBS reckon potential upside surprises in AGL Energy, Flight Centre, Harvey Norman, JB Hi-Fi, Janus Henderson Group, Mirvac Group, Qantas Airways, Resmed and Woolworths. Resmed has already reported and the stock has been clobbered (down 5% today) even though the result was OK. That reaction though is not a surprise given the high valuation RMD trades on. This is a clearly a lesson that we should take into this reporting season. Well owned stocks, on high multiples should be avoided this reporting season – simply the bar is too high for these type of companies, particularly those that operate overseas given the impact of the higher currency,  which will impact outlook statements. Instead, look for cheaper stocks that the mkt dislikes, potentially stocks with high short positions that the market is underweight – the retailers spring to mind here – as does one other stock we’ve added to the portfolio today!  

On the downside, UBS flag  Coca Cola Amatil, Crown Limited, CSL, Seek and Wesfarmers as those that may disappoint.

Two stocks worth a mention at this juncture, Telstra & Genworth. The market hates Telco’s given the changing landscape (NBN) and increasing competition in the network space (TPG) while there is growing concern around the Telstra dividend. The market is also negative on property with the obvious concern that rising interest rates will cause delinquencies, and a company like Genworth (which provides mortgage insurance to highly geared borrowers) will suffer as a consequence. As it stands, Telstra pays a dividend of ~7.50% plus franking which equates to 10.71%, while Genworth is paying ~8.5% plus franking which equates to 12.14% - clearly 2 high income stocks that are worth consideration for the MM Income Portfolio.

Telstra (TLS)  $4.11 P/E of 12.6x – yield of 7.50% FF (however at risk)

Trades on a forward P/E of 12.64 times which is clearly cheap however the dividend of 31cps is unsustainable – and will be cut at some stage. On our earnings numbers, a sustainable dividend is around 25cps which puts it on a 6% yield based on current prices. It seems the market is factoring in a dividend cut – the timing of which is the issue. We think they’ll cut sooner rather than later, get the monkey off their back then look at refocussing the business into future growth. The market dislikes the stock, and a lot of selling has been obvious over the past year, however the earnings profile over the next five years is weak unless they can make a string of good acquisitions. We think Telstra goes under $4.00 which will wash out a lot of the ‘concerned longs’ and that’s the time we’ll consider it for the Income Portfolio.

Telstra Weekly Chart

Genworth (GMA) $3.16 P/E of 10x – yield of 8.50% FF **BUY**

GMA provides mortgage insurance to borrowers on highly geared properties and has enjoyed a strong run in property over the past few years. Delinquencies have been low and therefore earnings have been strong, however the real story here is around excess capital on their balance sheet, and importantly their ability to return excess capital to shareholders. As it stands, GMA is holding around $1 per share excess capital plus today they announced an on market share buyback, of up to $100m of stock. The buyback will take place on market at prices below book value which currently sits at $3.89.

They also announced today that profit fell which on face value seems weak, however in our view, this is now priced into the stock. Earnings are under some pressure given banks are less inclined to consider high LVR loans, however given excess capital, high yield, low multiple and strong balance sheet, we think GMA is a good addition to the MM Income Portfolio around current levels – with a 4% weighting

Genworth (GMA) Weekly Chart

Conclusion (s)

Stocks trading on high valuations that the mkt is ‘already long’ present the biggest risk this reporting season

Telstra is cheap however they will cut their dividend. We think we’ll be able to buy stock in the high $3’s

We are adding Genworth to the MM Income Portfolio today

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.

Disclaimer

All figures contained from sources believed to be accurate.  Market Matters does not make any representation of warranty as to the accuracy of the figures and disclaims any liability resulting from any inaccuracy.  Prices as at 02/08/2017.  12.47PM.

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