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Paul Rickard
+ About Paul Rickard

Paul Rickard has more than 25 years’ experience in financial services and banking, including 20 years with the Commonwealth Bank Group in senior leadership roles. Paul was the founding Managing Director and CEO of CommSec, and was named Australian ‘Stockbroker of the Year’ in 2005.

In 2012, Paul teamed up with Peter Switzer to launch the Switzer Super Report, a newsletter and website for the trustees of SMSFs. A regular commentator in the media, investment advisor and company director, he is also a Non-Executive Director of Tyro Payments Ltd and Property Exchange Australia Ltd.

Follow Paul on Twitter @PaulRickard17

Shorten’s super slugs to hit more than 1,000,000 Australians

Thursday, April 18, 2019

Bill Shorten hasn’t been caught out after all about his super slugs. He didn’t “mis-speak”, he just “misheard”. Maybe? Let’s give him the benefit of the doubt on this occasion.

What he can’t hide from, however, is that these slugs are another attack on the superannuation system and the attractiveness of it relative to the Government providing for your retirement. The $34 billion it will raise over the next decade through higher taxes and reduced tax concessions will come from more than a million Australians.

Take the change to the non-concessional contribution cap to just $75,000. Twelve years after it was established at $150,000, Shorten will slash it to half  its original amount. Adjusting for inflation, it’s less than one quarter.

Super was designed to reduce people’s dependence on the government aged pension. Rather than the taxpayer, get the individual to prepare, plan and save for their retirement. But almost every change made to super recently is making it less attractive as a savings vehicle. Now Shorten is planning to add to this by introducing five further changes. Each change makes super less attractive in its own right, and will cause many savers to question why they should tie their money up in the super system for the next decade, or two or three.

Here’s a simpler “no super” strategy for savers: spend the money on your family and have some fun yourselves, invest in the tax-free family home, “gift” surplus assets to your kids five years before you retire,  go on the government aged pension, and, if needed in your old age, seek some “reverse gifts” from your family to supplement your government pension.

Here’s a run-down on Shorten’s super slugs and who’s impacted:

1. Non-concessional contribution cap slashed to $75,000

Originally set at $150,000 12 years’ ago for the 2007/08 financial year, increased to $180,000 for 2014/15, reduced back to $100,000 for 2017/18 and 2018/19, the annual cap on non-concessional contributions will be cut back to just $75,000.

Non-concessional contributions are, of course, personal contributions to super from your own resources and are made from your “after tax” monies.

The cut in the cap will reduce the ability to make a large “one-off” contribution to super, which may come from the proceeds of selling an asset, an inheritance, a termination payment or some other means. By using the ‘bring-forward’ rule, a person under 65 can make 3 years’ worth of non-concessional contributions in one year. This means that under current policy, a person can get $300,000 into super in one hit while a couple can potentially contribute up to $600,000. Under the ALP, this will fall to $225,000 or $450,000 for a couple.

While only impacting 20,000 superannuants in its first year, the change potentially impacts all superannuants because this will set the standard for decades to come. It reduces the utility of super as a savings vehicle

2. Abolish catch-up concessional contributions

Probably the dumbest of Shorten’s super slugs, he plans to abolish ‘catch-up’ concessional contributions. According to Treasurer Josh Frydenberg, this will impact about 230,000 workers.

An initiative of the current Government, the ability to make ‘catch-up’ contributions only came into effect last July. It is designed to allow people with interrupted work patterns, such as a mother who goes on maternity leave, to make additional super contributions when they return to work and still receive the same tax concessions.

The unused portion of the annual concessional cap of $25,000 can be carried forward for up to 5 years. Concessional contributions are primarily your employer’s compulsory 9.5% plus salary sacrifice contributions. If you don’t make any concessional contributions for four years, you could potentially make a concessional contribution of up to $125,000 in the fifth year. Or if you made a concessional contribution of $5,000 in the first year, you could make a concessional contribution of $45,000 in the second year. 

Eligibility is restricted to those with a total superannuation balance under $500,000 (as at 30 June of the previous year).

Shorten says that he will announce policies that deal with some of the perceived inequities of the super system (such as the materially lower balances women have when they retire), but for some reason, ‘catch-up’ contributions doesn’t appear to pass the test. Hard not to think that this isn’t a case of the “not invented here” syndrome at work.

3. End deductibility of personal contributions within the concessional cap

Concessional contributions include your employer’s compulsory super guarantee contribution of 9.5%, salary sacrifice contributions and personal  contributions you make and claim a tax deduction for. They are capped at $25,000 in total.

Until recently, the third category was only available to “self-employed” persons who satisfied the “10% rule”, that is, they received less than 10% of their income in wages or salary (ie genuinely self-employed). Last year, the Government scrapped the 10% rule so that anyone who was eligible to contribute to super could claim a tax deduction for personal super contributions (within the overall concessional cap of $25,000). This was designed to assist, amongst others, employees whose employer didn’t offer salary sacrifice facilities.

Shorten says that an ALP Government will reverse the change and scrap the widespread deductibility of personal super contributions.(It is not clear whether this means the re-instatement of the 10% rule.) According to Frydenberg, this could impact up to 800,000 workers who are working part-time at the same time as running a small business. Many are using the salary from their part-time job as the cash flow to make their business grow. He says that “the concession (tax deduction) specifically encourages the dual objective of entrepreneurship and savings for retirement, and helps strengthen the small business sector – the backbone of the economy”.

4. Higher income super tax lowered to $200,000

Persons on incomes from $200,000 to $250,000 will have their concessional super contributions taxed at 30% (rather than 15%). Known as Division 293 tax, a higher tax rate (effectively 30%) applies to concessional super contributions made by higher income earners. Originally introduced to apply to persons on incomes of $300,000 or more, the threshold was reduced last year to $250,000. Now, Shorten proposes to lower it to $200,000.

130,000 additional people will pay 30% tax on their super contributions. And if you are wondering why the threshold is $200,000 rather than the $180,000 threshold for the 47% marginal tax rate , the income definition for Division 293 tax includes super contributions (which is approximately $180,000 plus the 9.5%).

5. SMSFs won’t be allowed to borrow  

David Murray’s Financial System Inquiry recommended that SMSFs be prohibited from borrowing to purchase investment assets such as property. The current Government chose not to adopt this recommendation.

Shorten’s Treasury Spokesman Chris Bowen has stated that an incoming ALP Government would adopt this recommendation and change the law to prohibit SMSFs from borrowing.  Presumably, this will apply prospectively, with some form of grandfathering or transitional “wind-down” period applying to SMSFs with existing loans.

 

More super changes but will they ever see the light of day?

Thursday, April 11, 2019

The recent budget contained two more changes to super.

The first will get rid of the ‘work test’ for people aged 65 and 66 wishing to make super contributions. To align with an eventual increase in the pension age to 67, from 1/7/20, people aged 65 and 66 will be able to make personal after-tax (non-concessional) super contributions, salary-sacrifice contributions and have spouse contributions made on their behalf without needing to satisfy the ‘work test’ (defined as working 40 hours over any 30 day consecutive period). They can be fully retired and still make super contributions.

They will also be able to access the ‘bring-forward’ rule, which allows a person to make up to three years’ worth of non-concessional contributions in one hit. Potentially, a way to get $300,000 into super, or for a couple, up to $600,000. Currently, you need to be under age 65 during the financial year to trigger this. It will  be extended to under age 67 from 1/7/20.

The second change will make it easier for spouse contributions to be made, by extending the age of the receiving spouse from under age 70 to under age 75. The receiving spouse will no longer need to meet the ‘work test’ if aged 65 or 66 (but will need to meet the work test if aged from 67 to 74 years). Potentially, this means that more spouses can claim the tax offset for making a spouse contribution(up to $540), and extends the opportunity by another 5 years to equalise superannuation balances between spouses.

Both changes are sensible and arguably overdue, and on paper, should be supported when they finally make there way through the legislative processes.

However, the day after the Budget was delivered, the Government quietly dumped one of its headline super changes from the 2018 Budget – a plan to increase the maximum number of members in a Self-Managed Super Fund (SMSF) from 4 to 6. Originally the centrepiece of an omnibus bill covering changes to superannuation, craft brewing and global infrastructure and imaginatively entitled Treasury Laws Amendment (2019 Measures No. 1) Bill 2019, all references to the SMSF change had gone when the Senate finally gave it the nod. Presumably, some pesky cross-bench Senators had concerns (or were lobbied by other interest groups), and in the wrap up of Parliament, the Government took what was on offer. Craft-brewers were celebrating the excise relief, while SMSF members were left stranded.

This is a reminder that changes to superannuation requires changes to the law, which means running the gauntlet of the Senate cross-bench. If there is a change of Government at the May election, there is no guarantee that the super changes announced by Josh Frydenberg in the Budget will make their way back into Parliament.

This is because all bills lapse when the Parliament is dissolved (as happens at a General Election). Moreover, the ALP has its own set of priorities for the super systems and has already announced 5 changes. The “not invented here” syndrome possibly also comes into play. Here is a re-cap on the ALP’s proposed changes.

1. Non-concessional contribution cap slashed to $75,000

Originally set at $150,000 12 years’ ago for the 2007/08 financial year, increased to $180,000 for 2014/15, reduced back to $100,000 for 2017/18 and 2018/19, the annual cap on non-concessional contributions is set to be cut back to just $75,000.

Non-concessional contributions are of course personal contributions to super from your own resources and are made from your “after tax” monies.

The cut in the cap will reduce the ability to make a large “one-off” contribution to super  which may come from the proceeds of selling an asset, an inheritance, a termination payment or some other means. Under the ALP’s plan, if you access the ‘bring forward rule’, the maximum contribution will fall from $300,000 to $225,000, or for a couple, from $600,000 to $450,000.

2. Catch-up concessional contributions abolished

An initiative of the current Government, the ability to make ‘catch-up’ contributions came into effect last July. It is designed to allow people with interrupted work patterns, such as a mother who goes on maternity leave, to make additional super contributions when they return to work and still receive the same tax concessions.

The unused portion of the annual concessional cap of $25,000 can be carried forward for up to 5 years. Concessional contributions are primarily your employer’s compulsory 9.5% plus salary sacrifice contributions. If you don’t make any concessional contributions for four years, you could potentially make a concessional contribution of up to $125,000 in the fifth year. Or if you made a concessional contribution of $5,000 in the first year, you could make a concessional contribution of $45,000 in the second year. 

Eligibility is restricted to those with a total superannuation balance under $500,000 (as at 30 June of the previous year).

3. End deductibility of personal contributions within the concessional cap

Concessional contributions include your employer’s compulsory super contribution of 9.5%, salary sacrifice contributions and personal  contributions you make and claim a tax deduction for. They are capped at $25,000 in total.

Until recently, the third category was only available to “self-employed” persons who satisfied the “10% rule”, that is, they received less than 10% of their income in wages or salary (i.e. genuinely self-employed). Last year, the Government scrapped the 10% rule so that anyone who was eligible to contribute to super could claim a tax deduction for personal super contributions (within the overall concessional cap of $25,000). This was designed to assist, amongst others, employees whose employer didn’t offer salary sacrifice facilities.

4. Higher income super tax lowered to $200,000

Persons on incomes from $200,000 to $250,000 will have their concessional super contributions taxed at 30% (rather than 15%). Known as Division 293 tax, a higher tax rate (effectively 30%) applies to concessional super contributions made by higher income earners. Originally introduced to apply to persons on incomes of $300,000 or more, the threshold was reduced last year to $250,000. Now, the ALP proposes to lower it to $200,000.

5. SMSFs won’t be allowed to borrow

David Murray’s Financial System Inquiry recommended that SMSFs be prohibited from borrowing to purchase investment assets such as property. The current Government chose not to adopt this recommendation.

Shadow Treasurer Chris Bowen says that an incoming ALP Government would adopt this recommendation and change the law. Presumably, this will apply prospectively, with some form of grandfathering or transitional “wind-down” period applying to SMSFs with existing loans. If it doesn’t, then we will all be screaming.

 

Stop the press: Property prices set to rise

Thursday, April 04, 2019

Surely not. The ABC, and their friends in the Channel 9 newspapers (The Age and The Sydney Morning Herald), keep telling us that we are in the middle of a massive property market slump. Predictions of a price “crash” of 40% to 50% abound. Auction clearance rates are down, days on market (the time it takes to sell a property) are up and there are anecdotes of job losses in the real estate industry as agents and back office staff are laid off.

Hard data from Core Logic supports the assertion that times are tough. Sydney house prices are down 10.9% in the year to March, and 13.9% since peaking in late 2017. Melbourne prices fell by 9.8% on average and are 10.3% lower than their peak. Of the capital cities, only Hobart, Canberra and Adelaide recorded a rise in the year to March.

So, what’s the basis of my “courageous” call (as Sir Humphrey Appleby might have described it to Minister Jim Hacker) that house prices could rise?

Well, it is not Josh Frydenberg’s Budget, where almost everyone gets a tax cut. It is not going to hurt, however, and will certainly provide stimulus to the economy and boost confidence.

The thing that is really going to support the property market is the announcement from Chris Bowen last Friday that the start date for the ALP’s changes to negative gearing and capital gains tax is 1 January 2020. For investors, this provides a huge incentive to invest prior to this date, and conversely, not invest after this date. It is also being accompanied by some other supporting factors.

Here are 5 reasons why the property market might rise in 2019.

Firstly, the banking regulator, APRA, is relaxing the home lending controls it applied a few years’ back, making it easier for borrowers to get a loan. At the time, APRA was very worried about the systemic risk of an overheating property market and introduced controls on how many loans banks could make available to investors and how many loans could be serviced on an ‘interest only’ basis. They also tightened loan servicing models and estimates of household expenditure. Together, these controls acted to restrict the supply of credit, making it very hard for investors and some others to obtain finance.

APRA has eased up on the investor and ‘interest only’ rules, and while getting credit today is still harder than it was 18 months’ ago, the banks are “warming up” to home lending and credit growth is increasing.

The outlook for interest rates has also changed. Six months ago, almost every market commentator was saying that the next move in interest rates was “up”. Now, most agree that the next move is “down”, or if not down, sideways for an awful long time. Further, the spread between the benchmark 90-day bank bill rate and the RBA cash rate has narrowed. This means that an “out of cycle” cut to the home loan rate is a possibility, and if competition heats up a little, don’t be surprised to see some very competitive offers being made available to new borrowers.

While markets don’t always repeat previous behaviour and history is only a guide, it is worth noting that the fall in prices from the peak experienced by the Sydney market of 13.9% and Melbourne of 10.3% is about the same as that experienced in the last two big housing market downturns - the GFC of 2008/2009 and Paul Keating’s “the recession we had to have” of 1990/1991. Both these downturns occurred at times of high unemployment and higher interest rates, neither of which are in play today.

But the biggest single factor is 1 January 2020. From this date, investors won’t be able to negatively gear newly acquired investment properties. While all existing negatively geared properties will be “grandfathered” and interest on loans will still be an allowable deduction against rental income, any net rental loss won’t be deductible against other income such as salaries or wages. Of course, this assumes that Bill Shorten becomes Prime Minister on May 11 or May 18, but the market thinks this is a forgone conclusion and accordingly, canny investors will be considering property options ahead of this “drop-dead” date.

Even more important is the change to the discount applied to capital gains. Presently, an individual investor who has held an asset for more than 12 months is eligible for a 50% discount and only pays tax on half the gain. For assets acquired on or after 1 January 2020, the discount will be cut to 25%, meaning that an investor will pay tax on 75% of the gain.

This doesn’t necessarily sound like a big change, but depending on your marginal tax rate, can have a huge impact on the investment return from the asset. Take the example of a taxpayer whose marginal tax rate is 47% (the highest). Under the current rules, the investor pays an effective tax rate of 23.5% on the capital gain (half of 47%). Under the ALP plan, their tax rate rises to 35.25%.

Suppose an investor makes a capital gain of $100,000. With the current rule, they would pay tax of $23,500 and be left with $76,500. When the change is applied to assets acquired on or after 1 January 2020, they would get to keep $64,750. To be in the same post tax position of $76,500, that investor would need to see a pre-tax capital gain of $118,147, an effective increase of over 18%.

Bottom line – for investors paying tax at the highest marginal rate of tax, assets need to grow in value by 18% more than they otherwise would have done for them to be in the same after tax position.

Buy an investment property on 31 December 2019 and assuming things go to plan, investors paying tax at the highest marginal rate will be roughly 18% better off than if they buy the same property on 1 January 2020.

This is why I think many investors will look very closely at the property market in 2019. And while 2019 could be okay, if I am right, there could be a bit of a cliff in early 2020. As always, time will tell.

 

Is Wesfarmers a buy or has its MD had a brain explosion?

Thursday, March 28, 2019

It was a case of “sell first, ask questions later” when the market saw Wesfarmers staggering announcement that it was proposing to acquire rare earth minerals producer Lynas Corporation (ASX: LYC). Wesfarmers share dropped 3.5% on Tuesday, before recovering 0.7% on Wednesday after the Lynas Board ruled out any further engagement.

Summing up the mood of the market, The Australian quoted an unnamed fund manager who said: “if you gave 200 fund managers 200 guesses about what Wesfarmers would buy next, not one of them would have said Lynas”.

And it’s not because Wesfarmers all cash bid of $2.25 per share was pitched at a 44.7% premium to the last closing price of Lynas on the ASX. Most analysts thought this was pretty cheap and a relatively opportunistic bid. But rather, Wesfarmers taking on a business that involves so much political and environmental risk seems like an anathema to a conglomerate that largely operates in relatively defensive sectors. Further, it comes after Wesfarmers has just exited all its mining businesses.

Since taking over 18 months ago, Managing Director Rob Scott has been re-positioning the conglomerate. He has divested Homebase, the chain of UK home improvement stores that Wesfarmers tried to “Bunningise”. He has set the Coles supermarket, convenience store and liquor business free by creating a separately listed ASX entity. For some bizarre reason, Wesfarmers decided to keep a 15% stake in Coles.

Other sales have included:

·      Wesfarmers 40% interest in the Bengalla JV thermal coal mine in the Hunter Valley for $860m. This completed Wesfarmers exit from coal mining (the sale of the Curragh mine was finalised in March 2018);

·      The Kmart Tyre and Autoservice business for $350m; and

·      A 13.2% indirect interest in Quadrant Energy for US$170m.

But as if wanting to lend support to the adage that it is “harder to acquire a business than sell a business”, Scott’s potential foray into rare earth mining is high risk. He has been under pressure to roll out a revenue growth strategy, and it looks like he has succumbed to the pressure to get something moving. Calling it a “brain explosion”, while a little harsh, is not too far off the mark.

On paper at least, Lynas does have the makings of a fantastic business. It is the largest rare earth oxide producer outside of China, sourcing its ore from Mount Weld in Western Australia. From the oxides, Lynas produces neodymium, praseodymium and other heavy minerals that are key ingredients in the permanent magnets used in electric vehicles, energy efficient consumer devices and in the aerospace and defence industries.

After treatment at Mount Weld, the oxides are shipped to the Lynas Advanced Material Plant at Kuantan in Malaysia. And this is where the problem lies, following a ruling by the Malaysian authorities that the company must remove 450 million tonnes of low-level radioactive waste generated by its processing plant. In December, Lynas was forced to temporarily shut down processing at the Kuantan plant after failing to win government approval to increase output. This September, its operating licence is up for renewal.

Wesfarmers says that it can help Lynas as it has “a track record of working well with diverse  Government and other stakeholders to deliver sustainable, positive outcomes for local communities.” And it argues that Lynas could leverage Wesfarmers capabilities in chemical processing.

But in regard to relations with the Malaysian authorities, it is hard to think of too many countries that has been as obstructive to Australian interests as Malaysia has over the last couple of decades.

What do the brokers say?

The brokers see Wesfarmers shares as being marginally overvalued. According to FN Arena, the consensus target price is $32.17, 5.5% lower than yesterday’s closing price of $34.04. Of the major brokers, Citi and Morgan Stanley are the most bearish, with a target price of $29.00, while Macquarie has the highest target price of $37.13. There  are 3 neutral recommendations and 4 sell recommendations, with just one buy recommendation.

None of the major brokers are particularly supportive of the acquisition proposal. While they can see the attraction of a business exposed to the tail winds of electric vehicles and renewable applications, Malaysian political risk is major factor and the acquisition would result in a step-up in the risk profile of Wesfarmers. Following the announcement, Morgans downgraded its recommendation from add to hold.

Bottom line 

Not a buy. If the acquisition goes ahead, which is somewhat unlikely given that the bid is highly conditional and Lynas is refusing to play ball, expect more selling pressure.

 

Aussie Super’s super fee gouge

Thursday, March 21, 2019

Australia’s biggest superannuation fund, Aussie Super, is set to increase its administration fee from $1.50 per week per member to $2.25 per week, an increase of 50%. From 30 March, 2.2 million Australians will pay higher fees, netting Aussie Super an extra $86m each year.

That’s $86 million to spend on more TV advertising, Qantas Frequent Flyer points for new members (currently 20,000 on sign up) and other “useful” member benefits.

To be fair to Aussie Super, this is their first fee increase in almost a decade. They say that the monies will also go to “provide better products and services for you”, which will include upgrading digital technology and improving cyber security, developing new products and services, and briefings, seminars and on-line tools.

And of course, it is only $39 a year per member. But for a member with a balance of $2,000, that’s an extra fee of almost 2%.

It’s not the only admin fee. Retirees drawing a pension or income stream, through Aussie Super’s Choice Income or TTR Income (transition to retirement) products, pay a fee of 0.11% pa on their account balance. This is on top of the investment management fee of around 0.66% pa for the balanced option, indirect transactional costs of another 0.05% pa and potentially, an exit fee on any lump sum withdrawals.

The interesting point about this fee increase is that if it was a Bank owned retail super fund increasing a fee by 50%, Bill Shorten, the media and other bank bashers would be calling for a Royal Commission. But because it is an industry super fund which has made a virtue of being a low fee, top performance fund  that is “run for you”, there is absolute silence. Not a word.

Fortunately, Bill Shorten, who was a Director of Australian Super when he ran the AWU, has had the sense to slap down the trade union bosses who think that they can use the industry super funds to pressure big companies to pay higher wages and offer better working conditions (see Peter Switzer’s article at http://www.switzer.com.au/the-experts/peter-switzer-expert/shorten-super-kicks-trade-union-butts/). Michele O’Neil, an alternate Director of Australian Super and President of the ACTU, was one of the chief cheer leaders.

Peter pointed out that under law (s62 of the Superannuation Industry Supervision Act), the sole purpose of a super fund is to “provide benefits to its members upon their retirement (or attainment of a certain age), or for beneficiaries if a member dies”. Running industrial campaigns is wholly inconsistent with this sole purpose.

While on the subject of industry super funds, one of pieces of market “scuttlebutt” doing the rounds is that retirees running their own SMSF and potentially impacted by Bill Shorten’s ban on excess franking credit cash refunds should consider moving their super monies to an industry super fund. This is flawed thinking.

Firstly, it is highly unlikely that Bill’s proposed ban will be legislated as it currently stands. Very few commentators expect that the ALP and the Greens combined will have a majority in the Senate, meaning that Bill will have to deal with the crossbench to legislate. The current crossbench has said that they are opposed to the change, so Bill will need to offer some form of “sweetener” to get the legislation through. The most likely outcome is a cap that allows cash refunds up to a maximum of (say) $10,000 per annum.

Further, while most industry super funds are net tax payers and potentially in a better position to utilise franking credits, it is very unclear that they have the capacity (under their trust deed) or accounting technology to pass on “pseudo” cash refunds to a member in pension phase. The industry super fund won’t be receiving a cash refund, but rather, just paying less tax. As members in the pension phase don’t pay tax, it would have to work out a way to pass on the reduction in its tax bill as a credit to members in the pension phase.

I am not aware of any industry super fund that has come out in writing and said that it can do this. I am ready to be proven wrong.

And even if I am wrong, it is very unlikely that any fund can guarantee to do this over the long term. As more monies move into the 0% pension phase (which is happening  now anyhow as the super system matures), the super funds proportionally pay less tax and are less able to utilise franking credits as tax offsets.

Beware market scuttlebutt.

 

Are the shorters getting bullish on retail?

Thursday, March 14, 2019

If you have been reading the mainstream press, retail looks like a disaster area. Retail turnover rose in January by a tiny 0.1% following a very ordinary Christmas; consumers are feeling the “inverse wealth” effect of tumbling home prices and delaying discretionary purchases; consumer confidence is on the ropes; the Amazon juggernaut is going to destroy local retailers; and high street shops stand empty as consumers move their buying online and landlords refuse to budge on rents.

Supporting these stories has been the recent collapse of high profile retailers, including Roger David, Toys R Us, Max Brenner and Laura Ashley.

But the share market is telling a slightly different story, particularly from those who stand to make money from the retail sector falling into a hole. These are the professional investors who “bet” against the fortunes of a company by selling the shares short. That is, they sell a company’s shares with the aim of buying them back at a lower price and making a profit.

According to the latest figures from ASIC, which publishes data every day on the number and value of short positions, these are falling when it comes to Australia’s major discretionary retailers. Leading retailer JB Hi-Fi has seen its short position close from 17.77% of the total shares outstanding 3 months’ ago to 13.15% today.

While this is still a big short position, the reduction by more than a quarter represents the net purchase of 5.3 million JB Hi-Fi shares – worth about $125m. And as the table below shows, positions in Myer have closed from 11.75% to 10.07%, while Harvey Norman has reduced to 8.69%.

Major retailers - % of shares short sold  

 

* ASIC short position reports for trade dates 7 March 19 and 7 March 18

Looking at the share prices, the major retailers have bounced hard. Harvey Norman is up almost 28% from its low in November 2018 of $2.99, JB Hi-Fi is up 16.7% from its low on 4 January, while Super Retail Group (which owns the Rebel Sports, BCF, Supercheap Auto and Macpac brands) is up 23% from its low on 14 January.

Harvey Norman (HVN) – 3/14 to 3/19

JB Hi-Fi (JBH) – 3/14 to 3/19

Super Retail Group (SUL) – 3/14 to 3/19

So, what’s behind the short covering and recent share price surge? No doubt part of the answer is that retail stocks got “too cheap” and moved into “value” territory, encouraging some of the short sellers to cash in on their profits. But there are also two other key factors.

Firstly, the realization that the “Amazon juggernaut” hasn’t made that much headway. While it is not quite stalled, it isn’t getting much traction with Australian consumers. Logistics is proving to be more challenging than expected, the range of goods is narrower and Australian retailers are fighting hard on-line with price.

Next, the half year profit reports weren’t too bad. JB Hi-Fi reported a profit for the December half of $160.1m, up 5.5% on the corresponding period in FY18. The company re-affirmed guidance for full year profit of $237m to $245m, up by 1.6% to 5.1% on the 2018 result. In its key Australian JB Hi-Fi retail business, it grew both comparable store sales and margin. The recently acquired Good Guys business, which had been struggling, showed a small re-bound in sales.

Harvey Norman also posted an improved profit result for the December half, up 7.3% to $222.7m, but removing some one-offs, the underlying profit result was flat. While there was some weakness with the Australian business (comparable store sales growth fell by 0.6% in the half, and for the first 7 weeks of 2019, was down 2.2% on the same period last year), the market liked the improved contribution from Harvey Norman’s offshore businesses. In fact, 25.4% of group profit now comes from Harvey Norman’s stores offshore, in New Zealand, Singapore, Malaysia, Ireland, Northern Ireland, Slovenia and Croatia.

More upside to come?

Retail stocks remain cheap, trading in the main on multiples of around 11.0 to 12.0 times forecast FY19 earnings (fast fashion jewellery chain Lovisa is an exception, trading on a multiple of almost 28 times). And yields are attractive, with Harvey Norman (according to FN Arena) forecast to yield 6.7% fully franked (based on a current share price of $3.84), and JB Hi-Fi 5.9% (current share price $23.36).

While the calling of the federal election will help, it is unlikely to prompt a big rebound in consumer confidence and translate into a lift in retail turnover. Amazon may not prove to be the threat that some expected, but the shift online will continue and in this environment, margins will remain under pressure. The negative macro factors aren’t going away in the short term.

Hence, I am approaching the sector using a “buy in weakness”/”buy in dips” style strategy. JB Hi-Fi, Australia’s premiere retailer, is my pick. The major broker analysts are marginally positive on the stock (3 buy, 3 neutral, 2 sell recommendations) and have a target price of $24.74. At lower prices, nearer to $3.00 than $4.00, Harvey Norman also has appeal. Being more exposed to the state of the Australian housing market, I view it as higher risk than JB Hi-Fi. The broker analysts  agree, with a target price of just $3.72 (below the current market price) and 2 buy, 2 hold and 2 sell recommendations. Myer is in another category all together- forget.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.

 

These stocks could be winners under Bill Shorten!

Thursday, March 07, 2019

If the polls and the bookmakers are right, Bill Shorten will become Australia’s 31st Prime Minister and could be sworn in by the Governor General as early as Monday 20 May. Sportsbet is, for a $1 bet, paying $1.20 for an ALP win. It is paying $4.20 for a win by the Coalition.

After six years of Coalition government, an incoming ALP government is sure to throw out some existing policies, refresh the Government’s investment priorities and implement several new spending initiatives. Typically, higher taxing and higher spending than their Coalition counterparts, government monies will flow to the private sector and many companies will see their revenues go up.

While a lot has been written about who may “lose” under the election of an ALP Government, there hasn’t been as much discussion about potential “winners”, particularly companies listed on the ASX. Let’s look at this by considering the industries that may benefit from any government largesse.

1.     Healthcare

The opinion polls say that the ALP rates higher than the Coalition when it comes to the question of “who is most trusted to deliver improved health care services”, so it is not unreasonable to expect that an ALP government will spend more in this portfolio. While State Governments are key players, the bulk of services are delivered by the private sector.

Possible winners include Healius (ASX: HLS), formerly known as Primary Health Care, and Sonic Healthcare (SHL). Healius is involved in delivering GP services, pathology and imaging. While Sonic is more internationally focussed, 39% of revenue still comes from Australian pathology, imaging and clinical services. Both could benefit, if the ALP “unfreezes” the Medicare rebate or implements other initiatives to trigger patient demand.

Although short term “losers”, health insurance companies Medibank Private (ASX: MPL) and NIB Holdings (ASX: NHF) may prove to be long-term winners, if the ALP implements its pledge to cap the rise in health insurance premiums to no more than 2% pa. While no company welcomes price controls, it will give them increased negotiating power with the private hospital operators Ramsay (ASX:RHC) and Healthscope (ASX: HSO), as well as helping to address their long-term Achilles heel relating to the affordability of private health insurance.

2.     Energy

The ALP proposes to achieve 50% renewable energy by 2030 as a way to combat climate change. This means more support for the renewable energy industry and potentially government investment and/or incentives.

A clear winner could be Infigen Energy (ASX: IFN), Australia’s largest listed wind power generator by installed capacity. It has several wind and solar projects currently under development.

Less clear is the position of traditional big energy companies AGL (ASX: AGL) and Origin Energy (ASX:ORG). While both are investing in “clean energy” and related energy services, they have legacy wholesale coal/gas generating businesses and their behaviour as producers and retailers has come under fire from all sides of politics and the ACCC.

3.     Housing

The ALP says that it is going to can negative gearing, except where it relates to investment in new housing. Existing negative gearing arrangements will be “grandfathered”.

Although no date has been announced for the “commencement date” (the date it is canned from), most commentators agree that it will be a net negative for the property market. This may lead to an adjustment in rents (higher), and over the medium term, more investment in new housing. If this happens, major developers and builders, such as Stockland (ASX: SGP) and Mirvac (ASX: MGR) could benefit. Residential development accounts for approximately 35% and 15% respectively of their earnings.

The ALP also has policies promoting the development of affordable housing. Innovative companies that are able to respond to stimulus here could be big winners.

4.     Education

Like health, education is another key focus area for the ALP, which almost invariably means higher spending. Because services are essentially delivered by Government (government run schools and universities), the private sector is less involved.

Two listed companies involved in the tertiary sector (international students, online learning,  training etc) are Navitas (ASX:NVT) and IDP Education (ASX:IEL), although the latter is very focussed on Asia.

Short-term winners

And while the election period is usually bad for consumer facing firms, as consumers tend to defer major purchases, there are some short term winners. The TV companies, Nine Entertainment (ASX: NEC), Seven West Media (ASX: SWM) and Prime Media (PRT) will get a sugar hit from the political advertising. They will be offering a “special” thank you to Clive Palmer.

 

Shorten’s franking credit changes contribute to dividend bonanza for Rio!

Thursday, February 28, 2019

The announcement last night that Rio would return to shareholders a special dividend of US$4 billion caps off a remarkable company reporting season. While company profits and outlook statements have in the main been a touch disappointing, shareholders have been flooded with cash returns.

Increased ordinary dividends, special dividends, and share buybacks are the go as companies react to Bill Shorten’s proposed change to franking credits and generally favourable economic conditions. There is not a company board in Australia that isn’t looking at its franking credit balance and reviewing its capital needs to see whether it can increase short term returns to shareholders.

Franking credits are of no value to the company. Representing the tax the company has already paid, they are only valuable in the hands of shareholders. So with Bill Shorten looking like a shoo in come May, companies are acting before his 30 June deadline. This is why we have seen special dividends from BHP, Rio and Wesfarmers (amongst others), an “extraordinary” ordinary dividend from Woodside, and off-market share buybacks from Caltex and Woolworths. Next cab off the rank will be the three major banks (ANZ, NAB and Westpac) who will look at accelerating the payment of their interim dividend. These have typically been paid in early July, but watch for the dates to be moved to June or earlier.

All this money has to go somewhere and with the RBA now sounding “dovish” on the cash rate and some economists even predicting that the cash rate will be cut, income stocks are back in vogue. This is why the market has remained well supported above 6000, notwithstanding a fairly uninspiring company results season.

Back to Rio, it will pay a special dividend of US 243c per share or approximately A$3.39 per share. This is on top of a final dividend of US 180c per share (A$2.51), unchanged from 2017. The stock will trade ex-dividend on 7 March, with the dividend payment to be made on 18 April.

As good as it gets for Rio?

Rio’s underlying EBITDA for the full year of US$18.14bn was down US$0.44bn on 2017, a fall of 2.4%. This was a little short of broker forecasts. Improvements in the realised price of the commodities, a more favourable exchange rate and production increases added a combined US$1.4bn to earnings, while higher energy costs, raw material cost headwinds, inflation and other costs and one offs subtracted US$1.6bn from the result.

While cost pressures particularly impacted aluminium, Rio is struggling to make further  headway in reducing costs with its Pilbara iron ore. Cash costs were US$13.30 per tonne, down very marginally from US$13.40 in 2017.

Since the end of the commodity boom in 2014, the major miners have been very focussed on improving shareholder returns. They have strengthened their balance sheets by selling underperforming assets, repaid debt, been very disciplined about capital investment and focussed on increasing productivity and efficiency, thereby lowering per unit production costs.

But the news from this report (and competitor BHP’s report) is that it is getting harder and harder to lower per unit costs. In fact, both miners reported “negative” productivity improvements.

Rio’s balance sheet is in fine form with adjusted net debt (after paying the special dividend  and previously announced share buybacks) down to a proforma US$8.0b. This gives it a gearing ratio of less than 10%.

And while there is a development pipeline and a ramp-up of projects, with capital expenditure forecast to rise from US$5.4bn in FY18 to US$6.0bn in FY19,  earnings growth is going to be largely dependent on higher commodity prices. There aren’t further assets to sell, and productivity and production increases will be challenging.

Interestingly, Rio began its investor presentation with a couple of slides describing 100 tailings storage facilities they operate, and their assurance processes for managing tailings and water storage. The fallout from Vale’s Brazilian mine tragedy is ringing alarm bells with investors and analysts.

What do the brokers say?

Going into the result, the major brokers were moderately positive on Rio with 3 buy recommendations and 4 neutral recommendations. The consensus target price (according to FN Arena) was $89.94, 5.5% below Wednesday’s pre-result closing price on the ASX of $95.12.

Broker target prices for resource companies are hugely dependent on forecasts for commodity prices, so a small uplift or downgrade to their commodity outlook can have quite a big impact on the target price. The company doesn’t have to do anything. But the history of broker forecasts shows that in the main, they aren’t any better than anyone else at forecasting commodity prices, so the target price is only of limited use. This all said, I expect that the brokers will be a tad disappointed with the result and over the next few days, there will minor downgrades to target prices.

The bottom line

If commodity prices  continue to head higher, Rio’s share price will be well supported. The  run up in the iron ore price following competitor Vale’s dam collapse could have further to go. But in terms of what the company can control, I reckon that this is as close to “as good as it gets”. Too late to buy. Use rallies to reduce weighting..

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.

 

Will a new era dawn for Coles?

Friday, February 22, 2019

“It’s time for a new era at Coles”. That was the promise made by Coles CEO Stephen Cain as he delivered an uninspiring first half profit result for Coles on Tuesday.

Using the following chart, he pointed to Coles success in lifting earnings by 125% between 2009 and 2016.  Investment in management, stores and brand drove sales growth (red line) and with it, earnings growth. Since 2016, earnings growth has been in decline, mainly due to intense industry competition, but also because Coles sales performance has been ordinary (red line for comparable store sales growth).

Cain wants to turn Coles around and drive sales growth.

He says he will do this through a “strategic refresh”, which includes a “fresh tomorrow” strategy for supermarkets, making life easier for customers, executing faster, efficiency programs to simplify the business and offset inflation, investment in automation and digital, and “winning together” sustainably with supplier and communities.

But the market didn’t buy this (which to be honest, could have been a strategy for almost any company), and Coles shares have fallen by 9% from $12.59 to $11.37 since the result was announced.

The market didn’t like that earnings continued to fall in the half, down by 5.8% to $733m. Adding to this was news that Coles was beaten in the sales war by competitor Woolworths, reporting same store sales growth in the December quarter of 1.5% compared to Woolworth’s 2.7%. While Coles can boast that it has delivered 45 consecutive quarters of comparable sales growth, the only quarter it has beaten Woolworths was the September quarter this year when Woolworths got badly caught up in the plastic bag fiasco and Coles ran its “little creatures” promotion.

In supermarkets, the EBIT margin (earnings as a percentage of gross sales) declined by 0.12% from 3.8% to 3.7% as expense headwinds grew. The cost of doing business rose by 0.27% to 20.4%. Demonstrating that Woolworths has the lead not just in sales but how it manages its business and supply chain, it reported an EBIT margin for Australian food of 4.7%, an increase of 0.08%.

On the back of an improved margin and product mix, Coles liquor division grew EBIT by 7.0% to $85m. An upside for Coles going forward will be the new alliance agreement with Viva Energy (who supply petrol to the Coles branded service stations and Coles Express). Coles will no longer have direct exposure to retail fuel price movements but rather receive a commission on fuel volumes achieved. Coles is positioning Express to be Australia’s leading convenience retailer.

What do the brokers say

The major brokers had been a touch bullish on Coles, seeing it as undervalued compared to rival Woolworths. Following the somewhat disappointing result, most cut their target price and lowered their earnings forecasts for FY19 and FY20. The consensus target price slipped to $11.92, a 4.9% premium to Wednesday’s closing price of $11.37. Ord Minnett downgraded its rating from “hold” to “lighten”.

The following table from FN Arena show individual recommendations and target prices, with the latter ranging from a high of $13.40 (Citi) to a low of $10.84 (Credit Suisse).

The brokers have Coles trading on a multiple of 19.4 times FY19 earnings and 17.4 times FY20 earnings. Coles won’t be paying its maiden dividend until September 19, which will cover the period after the Wesfarmers demerger from 28 November 18 to 30 June 19. It is targeting a payout ratio of 80-90%. For the next full year (FY 20), the brokers forecast total dividends of 55.6c which puts Coles on a forecast yield of 4.9%.

Bottom line

I haven’t bought the story that Coles is the classic demerger story and that set free of “big brother” Wesfarmers, Stephen Cain and his team will magically work wonders (see http://www.switzer.com.au/the-experts/paul-rickard/would-you-buy-or-sell-coles-right-now/) . And I also can’t see a “new era dawning for Coles”. This is a super competitive industry, and with the discount supermarket operators (Aldi, Costco and Kaufland) aggressively expanding, life is going to remain pretty tough for both Woolworths and Coles. Growing sales, margin and earnings will be challenging.

But every stock has its price and Coles, at the right price, offers investors a high dividend yield with a relatively high degree of earnings certainty. Not quite an annuity, but close.

Buy at $11.00. Sell around $13.00. 

 

Shorten screwing brokers is a big bank bonanza

Thursday, February 14, 2019

Australia’s 31st Prime Minister, Bill Shorten, is set to hand the big banks a fee and revenue bonanza. He says that an incoming ALP Government will implement in full all the 76 recommendations from the Royal Commission. This includes Commissioner Hayne’s ideas about the mortgage broking industry.

Hayne and his team of lawyers have made 5 recommendations about “intermediated home lending” or mortgage broking. The first, that the law should be amended such that mortgage brokers must act in the best interests of the intending borrower is sound and arguably, should already have been in place. Strengthening reporting about misconduct and regulating mortgage brokers under the same laws that govern the conduct of financial advisers also makes sense.

But the big recommendation, and the one that will make the big banks richer, is to eliminate all commissions. The consumer, not the lender, should pay the fee to the mortgage broker.

A user pays system, free of conflicts.

Hayne sees this fundamental change to the industry happening over two to three years, first by prohibiting lenders from paying trail commissions on new loans, and then prohibiting lenders from paying other commissions.

This has the major banks licking their lips because it will lead to the demise of the mortgage broking industry. With mortgage brokers out of the way, the major banks will save around $2,400 per loan in upfront commission and then the same again in ongoing trail commissions (on an average loan of $400,000, banks typically pay upfront commission of 0.60% and then a trail commission of 0.20% pa.) They will also increase market share, as mortgage brokers won’t be around to promote the loans of the pesky minor banks and smaller credit providers, who don’t have large branch or proprietary distribution networks.

Why will it lead to the demise of the mortgage broking industry? Simply, Australian consumers won’t pay directly for the service, or if they do, not enough to make it profitable to run a mortgage broking service.

All the evidence, be it in financial advice, superannuation, insurance, real estate, the travel industry etc. is that Australian consumers are very reluctant to pay directly for “intangible” services. That’s why so few Australians have a financial adviser, there are so many self-managed superannuation funds, insurance brokers are paid by the insurer, real estate agents are paid by the seller out of the sale proceeds and travel agents are paid by the airline or travel provider.

Australians are tight and don’t like paying. They certainly won’t want to fork out around $5,000 for a loan.

Hayne acknowledges this problem. Firstly, he suggests that the brokerage service fee could be capitalised in the loan amount and repaid by the consumer over the life of the loan. In other words, consumers would take out bigger loans so they could pay the mortgage broker.

And then his craziest idea – that banks charge an additional fee to consumers who deal with them directly. That’s right, another bank fee! An establishment fee by any other name, but only paid by borrowers dealing directly with the bank.

As I have indicated, it may be that to create a level playing field between banks and brokers, banks should be required to charge a fee to direct customers based on the costs that are incurred by the bank when there is no broker”.

He then goes on to suggest that the ACCC should be responsible for monitoring the fee.

For those with short memories, establishment fees were charged on most home loans up until a decade ago. As competition in the industry picked up, banks realised that  establishment fees were a big turn-off for consumers and eliminating them was an easy market differentiator that led to an immediate boost in share. A thing of the past, it has now turned the full circle with some banks paying customers an upfront bonus to take out a loan. A “negative” establishment fee. This experience is further testament to the fact that consumers don’t like paying

Commissioner Hayne’s recommendation is wrong, not theoretically, but practically. His  ideas to address this (capitalisation and an establishment fee) aren’t going to be welcomed by consumers. And the big banks won’t say too much because it is in their collective interests to see the mortgage broking industry suffer and dwindle.

Bill Shorten needs to pause and reflect very carefully on the Royal Commission’s recommendations. A well-regulated mortgage broking industry is important to competition and helping to ensure that the consumers gets a good deal. He doesn’t want to hand the big banks a revenue bonanza.

 

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