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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

How can I get my super but not retire?

Thursday, October 11, 2018

I am surprised at how often I get asked this question, which I guess is a sign of the times with an ageing workforce and many mature age workers expressing a clear preference to keep working. 

There are three key ages when it comes to accessing your super. 65 years old, 60 years old and your “preservation age”. I  won’t dwell too much on the “preservation age” because for most people it is also 60 years. If you were born before 1 July 1960, it is only 55 years. There is a transitional scale from 56 years to 59 years for those born on or after 1 July 1960 up to 30 June 1964, and after that, it is 60 years.  

65 years is “magic” because this the age when there are absolutely no restrictions about accessing your super. You can withdraw by lump sum as much or as little as you want, or commence a regular pension, even if you are working full-time.

60 years is “special” because this is the age when withdrawals from super by lump sum or regular pension will generally be tax free. If you are in an older style defined benefit scheme, you may have some tax to pay, but for most of us, withdrawals will be tax free.

Turning 60 also opens up the opportunity to access your super without retiring. There are two ways.

Firstly, you can commence a transition to retirement pension and access part of your super. (It is also available if you reach your preservation age at an earlier age). Introduced by the Howard government some years ago with the aim of allowing people to scale back on their work commitments and ease into retirement without too much financial pain, it comes with several rules.

You can’t take a lump sum withdrawal and you must open an account-based pension. You are then required to take a minimum of 4% of your account balance as a pension each year, and a maximum of 10%. For example, if your super balance is $500,000 and you start a transition to retirement pension, you must take at least $20,000 as a pension payment each year and you can’t take more than $50,000.

Pension payments can be made as often as you want (fortnightly, monthly, quarterly or just once a year etc), and if you commence a pension during the financial year, the minimum and maximum amounts are prorated (for example, if you start a pension midway through the financial year on 1 January, the minimum and maximum amounts are half the full year amounts).

You can continue to work full or part time and make super contributions as normal. These contributions will  be kept separately from the balance you used to start the transition to retirement pension.  

When you turn 65, you can either take the monies out as a lump sum, or just keep it as a normal account-based pension. One important change at that time is that the investment earnings on the assets supporting the payment of the pension will become tax free (inside a transition to retirement pension, they are taxed at 15%).

The other way to access your super when you turn 60 is to cease an employment arrangement (e.g. quit your job). Potentially, you can access all your accumulated super benefits to that point of time, either as a lump sum or use to start an account-based pension. If you continue in another employment arrangement, or start a new job, the contributions that you or your employer make will be kept separately in the accumulation part of the super system.

The point to note here is that there is no need to retire – simply the act of ceasing an employment arrangement after reaching age 60 allows you to access your accumulated super.

If you do decide to retire, it doesn’t mean that you can’t work at all. The super laws define “retirement” for a person over 60 as having no intention again to be “gainfully employed”, either on a full-time or part-time basis. Part-time means working up to 30 hours a week and a minimum of 10 hours per week. So, potentially you can retire and start a new position provided you work just short of 10 hours per week. And if you retire and decide that you’re not cut out for retirement or your financial circumstances change, you are not locked out of the super system for ever. It’s an “intention”, rather than a permanent  commitment.

Finally, for completeness, you can also access your super early in the event of a terminal medical condition, severe financial hardship and on compassionate grounds, but hopefully, these won’t apply to you. 

 

Would I buy the banks right now?

Friday, September 14, 2018

I am going to stick my neck out and say that the banks are a buy! Given that there is so much negativity about the major banks, this feels like something Sir Humphrey Appleby of Yes Minister fame would have labelled a “courageous call”.

Before mounting the case for the major banks, I will start with why they have been poor performers in 2018.

The backdrop

Firstly, the Royal Commission, which by revealing some dreadful practices and systematic bad behaviour, has shocked the community. I, like some others in the financial community, underestimated the extent of the practices and the impact the Commission would have on public opinion and also bank share prices.

The penultimate round of public hearings gets under way today. Scheduled to appear over the next fortnight include representatives from AMP, Suncorp and CommInsure (owned by the CBA). The final round of hearings (if the Commission is not extended) is scheduled for late November, when it will examine policy questions.

Putting the “shock value” to one side, the key issue to consider about the Royal Commission is the likely nature of the recommendations it will make to the Government, and the impacts these could have on the banking industry in the medium term. The areas the Commission may seek to address include: an end to the vertical integration of wealth management business (product manufacturing, investment management, distribution and advice); expansion of “responsible lending” rules to small business, as well as toughening these provisions for consumers; the end of conflicted remuneration arrangements; and changing the commission arrangements on home loans.

But these moves have been widely telegraphed and the banks are already taking action. For example, each of the majors has made moves to exit some, or all, of their wealth management businesses. Westpac possibly sees this as a differentiator, but it has sold off its investment management business (Pendal) and is rumoured to be considering an exit of its financial planning arms.

If the Commission recommends criminal charges against banks or bank executives, or widespread civil actions to penalise and compensate, this could unsettle markets.

However, it is difficult to see what the Commission could recommend that would fundamentally diminish the competitive position of the major banks. While all the bad news may not be out yet, my sense is that “Royal Commission risk” has bottomed.

Other factors

The other factors that have impacted the performance of the banks in 2018 are:

  • Revenue growth is anaemic – at best low single digits. Overall credit growth has slipped below 5%, with housing credit growth down to 5.5%. Further, the major banks are losing share to non-bank participants, as APRA’s toughened regulatory stance (particularly in regard to investor lending and interest only loans) bites;
  • Interest margins are under pressure as the cost of short-term funds in the wholesale markets (in particular, the relationship between the 90-day bank bill rate and the overnight cash rate) moves higher;
  • Fears that a major downturn in the housing market could pressure bank balance sheets and increase losses;
  • Increasing compliance costs;
  • Suggestions that the investment into Fintech style initiatives, supported by reforms such as Open Banking (the exchange of customer data between banks), will, in the medium term, materially disrupt the competitive position of the major banks; and
  • Selling by SMSFs and others as fears widen that Bill Shorten will be Australia’s 31st Prime Minister, and the ALP will proceed with its plan to abolish the refunding in cash of excess imputation credits.

The case for

The case for is relatively straightforward. Firstly, the major banks still enjoy a fantastic oligopoly with immense pricing power (witness the “out of cycle” rate increase to home loan rates by CBA, ANZ and Westpac over the last two weeks).

While there is a slow drift in customers from the major banks to the minor banks/“non-banks”, it is tiny. Despite consumers saying that “they want to change banks”, their actions don’t match. All the evidence points to an incredible degree of inertia.

Capital ratios are sound. With the possible exception of the NAB, the majors are on track to reach APRA’s new definition of “unquestionably strong”. This means no dilutive capital raisings, and again with the possible exception of the NAB, dividends are secure.

Banks are cheap. They are trading on a forecast multiple of FY19 earnings of between 11.7 and 12.9 times (see table below based on broker consensus estimates, source FN Arena).  And notwithstanding the challenges about growing revenue and funding pressures, earnings per share growth is occurring.

Forecast Multiples, EPS Growth and Dividend Yields

Source: FN Arena 7/9/18

Bad debts remain low, and the two most likely triggers, higher interest rates or higher unemployment, aren’t on the cards. The opportunity to radically take out cost by cutting branch networks, digitising processes and reducing head office bureaucracies remains, although each of the major banks is now acting to cut costs.

Finally, dividend yields are super attractive (forecast 5.8% for the ANZ to 6.8% for Westpac). And even in a Bill Shorten world, where excess franking credits are not refundable, a 6.8% yield for an SMSF in pension phase is still a lot more attractive than a term deposit rate of 2.5%!

Which bank?

The obvious question then becomes “which bank?” The answer is that it probably doesn’t matter that much as they are essentially pursuing the same strategies and the differences from one bank to the next are at the margin.

But before coming back to this question, let’s look at how they have done this year and what the major brokers have to say.

The table below shows the performances of the major banks in 2018. Only ANZ has delivered a positive return to shareholders of 1.6%. I put this down to two factors – it is the most focussed (and advanced) in its cost out initiatives, and possibly, carries the least “Royal Commission” risk.

Major Banks Performance in 2018

Westpac is the weakest performer (loss of 8.3%), with much of the downside coming recently following the revelation of funding pressures. It is also the “most exposed” in terms of the changes with “interest only” home loans.

Looking ahead, the major brokers are largely neutral about the prospects of the major banks. The following table shows the major brokers recommendations and target prices for the banks.

In summary:

  • There is no standout “preferred” bank;
  • They see upside (limited) for each of the major banks. Westpac has the most upside of 10.1% (trading at $27.80 versus a consensus target price of $30.60), ANZ has the least upside of 4.2%;
  • NAB has the most “buy” recommendations (four “buy”, two “neutral”, and two “sell”).

Broker Ratings – Major Banks (Recommendation and Target Price)

Source: FN Arena 7/9/18

I have been on the ANZ bandwagon this year and in this respect, been proven to be right. However, it is now the second most expensive on forward multiple, and Westpac is (unusually) the cheapest. As the differences between the banks are so small, on value grounds, my vote goes to Westpac.

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C’mon ASIC, do your job. Get tough on these short sellers

Thursday, September 13, 2018

Retail doyen, Gerry Harvey of Harvey Norman fame, is really annoyed with short sellers. In fact, he is more than just annoyed, he is downright angry. In an exclusive TV interview with Peter Switzer, he labels their activities as “criminal”  (you can watch it here).

Gerry is angry because 116 million Harvey Norman shares, worth around $400m, are presently short sold. This represents more than 10% of the total number of Harvey Norman (HVN) shares on issue, or a more alarming 20% of the “free float”, when you take out Gerry and his family’s 50% stake in the business. 

Short selling, that is selling a stock that you don’t own and hoping to buy it back at a lower price, keeps downward pressure on the share price. But it also has a purpose in that it can aid the efficiency of the market by reducing wild swings in prices, particularly on the downside, and work to eliminate stock pricing anomalies.

If a professional trader wants to say that Wesfarmers is going to outperform Woolworths, and then buys Wesfarmers shares and short sells Woolworths shares (to effectively mitigate the overall market risk from the trade), and if a super fund wants to lend the short seller the Woolworths shares and be paid by the short seller to do so, thereby enhancing the return for the fund’s members, I have no problem with this. Or if an option market maker wants to short sell the underlying shares against a put option he writes, I have no problem with this either.

And if a punter wants to take a view on a company and short sell the shares because he or she thinks that they are a dog, I have no problem with this, provided it is done within reason.

What I do have a problem with is the extent of the short positions being taken, the lack of timely reporting on short positions, and regrettably, the increasing practice by some short sellers to “misspeak” about a company after taking a short position. Actively talk it down. Gerry goes further than this, calling some of them “liars”, and doing it from outside Australia, away from the eyes of ASIC and the Corporations Law section that deals with the act of disseminating “misleading information”.  

Let’s look at the extent of the short positions being taken.

The biggest short positions

Listed below are the top 10 companies by the size of the short position. Topping the list is would be graphite producer, Syrah Resources, which has 20.3% of its ordinary shares (60 million shares) sold short. This is based on the latest data from ASIC (released Wednesday) and covers position as at the close of business last Thursday, 6 September.

Retailer JB Hi-Fi comes in second with 19.5%, while Lithium hopeful Orocobre ranks fourth at 16.3%. In the case of JB Hi-Fi, the 22.3m shares sold short are worth around $520m. Big bets are being taken on some of these companies.  

Source: ASIC

Looking through the top short positions, three industries dominate the short sellers’ interest. Retailers, who may be impacted by the Amazon threat (and don’t we just keep hearing about how much damage Amazon will do to the industry) and the changing nature of the competitive landscape are a clear favourite, as are the minerals companies getting ready to produce “next generation” minerals such as lithium, graphite and nickel. Financial service companies also feature prominently due to concerns about “Royal Commission risk” and a possible downturn in the housing market. Some of the mid cap growth “darlings”, such as Seek, Dominos and Flight Centre, also have major short positions.

The following tables show the overall short position rankings of the most shorted retail, financial services and mineral stocks.

The short sellers don’t always get it right, and in fact, there have been some spectacular failures. But in the main, these professionals get it right more often than they get it wrong, they have very deep pockets and can hang on to their positions for many months, sometimes years. Investors betting against the short sellers are making a “courageous” call.

ASIC needs to act

As I said at the outset, I am not against short selling per se. However, it is time to put some controls on it and improve transparency.

The first thing ASIC should do is to up the ante about the reporting of short sales. The data ASIC will publish on its website today around midday reflects positions taken three and a half business days’ ago. This is despite the market having moved to a T+2 settlement basis 30 months ago in March 2016. At the very least, the data should be no more than two and a half days’ old.

However, with modern technology, there is no reason why we shouldn’t be able to see same day reporting, or even better still, real time reporting of short sales. 

Next, ASIC needs to clamp down on short sellers “talking their book" and filling the media with “bad news”. Regrettably, our media (particularly the ABC and Fairfax) love bad news when it comes to finance, and seem only too happy to run unsourced stories pointing to investor or analyst concerns about a company’s prospects, industry threats, or other financial risks. This may require changes to the law because while spreading “misleading or false” information is illegal under the Corporations Law, it is no doubt very hard to prove. The bar may need to be lowered. And ASIC needs to consider how to work with overseas regulators to cut off this route.  

Finally, I think it is time for an outright cap on short selling. Many companies have core strategic shareholders or shares under an escrow arrangement, and the free float of shares is often very small. Short sellers selling up to 20% of the ordinary shares on issue can represent a huge expansion in the free float, thereby placing enormous downward pressure on the share price. While any cap should arguably be assessed on a company by company basis, a blanket across the board 5% cap would be a good place to start and even out the playing field for the average “long only” investor.

Time to act. ASIC, do your job.

 

Labor’s changing the rules for super

Thursday, September 06, 2018

If PM Scott Morrison has his way, he will govern until Saturday 18 May, the last day that a half Senate election can be held in conjunction with an election for the House of Representatives. If the voters of Wentworth have their way and seek retribution by electing an ALP candidate in the forthcoming by-election, and a couple of Scomo’s National colleagues move to the cross-bench, there could be a general election before Christmas. In any event, it is becoming increasingly likely that Bill Shorten will become Australia’s 31st Prime Minister.

And that will mean further changes to the super system. Just after many superannuants are coming to terms with the very material changes that started in July last year, the ALP proposes six further changes. Here is a run-down of their (so-far) announced 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 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. By using the ‘bring-forward’ rule, a person under 65 can make three 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 up to $450,000 for a couple.

Clearly, the ALP doesn’t see the super system as a place for the “comfortably off” to invest their surplus funds.

2. Abolish catch-up concessional contributions

An initiative of the current Government and having just come into effect on 1 July, the ALP plans to abolish ‘catch-up’ concessional contributions. 

Persons with low super balances can carry forward the unused portion of their concessional contributions cap. Potentially, someone who leaves the workforce for a period of time (such as maternity leave) can carry forward their cap and upon return to work, make higher contributions to “catch-up” for their absence.

The unused portion of the annual concessional cap of $25,000 can be carried forward for up to five years. 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).

The ALP says that it will abolish the scheme. It hasn’t announced any alternative plan to assist in this area.

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 you elect to make 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

The ALP says that it will reverse this change and scrap the widespread deductibility of personal super contributions. It is not clear whether this means the re-instatement of the 10% rule.   

4. 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.

Recently, ALP Shadow Treasurer Chris Bowen said that the ALP would adopt this recommendation and change the law to prohibit SMSFs from borrowing. 

5. 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. 

6. Employer super contributions will go up to 12%   

A long-standing ALP policy is to raise the compulsory super contribution made by employers from 9.5% to 12% of ordinary earnings. No timetable has been announced as yet, but expect this to be an early priority of an incoming ALP Government. The only certainty is that employers should expect to pay more, and while the transition from 9.5% to 12% is likely to be phased, there will be considerable pressure from the ACTU and others to do it over a shorter period.

The only thing that is constant with super is change.

One last thing, if you want to improve your knowledge about money come along to our Listed Investment Conference next week in Brisbane, Melbourne or Sydney. Switzer has brought together a collection of Australia’s best money managers to find out how they’re investing and where they see value in the current global environment. You can access a complimentary ticket (or two!) to come join us. There’s only one week remaining – so make sure you don’t miss out! To access your free ticket/s, click here, choose the event you’d like to attend in your State and enter the promotional code ‘SD’ on checkout. Peter and I hope to meet you there so come up and say “hello”.

 

Is 7000 on the ASX a real chance?

Thursday, August 30, 2018

In November 2007, the Australian share market hit a high of 6828.7. Yesterday, almost 11 years on, the S&P/ASX 200 closed at 6352.  

A key characteristic of a bull market is that it takes out the previous high to make a new high. More than nine years past its GFC lows and despite fantastic leads from Wall Street, the Australian share market still languishes. Stuck in a seamless grind higher, the question remains as to what will power the local market to make a fresh high? Has the company profit reporting season, which wraps up tomorrow, been “good enough” to give the market the momentum it needs? And if it won’t come from accelerating company earnings, what could take the market to 7000 by year’s end?

Let’s review the strength of the August company reporting season, the time companies report full year or half year profits and provide guidance about their prospects for the next 6-12 months.

It has been good, but not brilliant.

According to AMP Capital’s Shane Oliver, who has analysed the data with 85% of companies reporting, 47% have “beaten” market expectations (blue bar below). This compares to a “norm” of around 44%. Misses, companies reporting worse than expected, is only 22% (red bar below).

Breadth of profit increases is high, with 79% of companies reporting higher profits than a year ago (blue line below), compared to a norm of 66%.  Most companies (86%) have increased or maintained their dividend (red line).

Overall, earnings growth for 2017/18 is on track to come in around 9%, with resources earnings up 25%, thanks to the increase in commodity prices and the rest of the market seeing growth of around 5%. While the overall 9% growth rate is better than expected, it is a long way short of the 24% growth US companies achieved on average in the last quarter.

A highlight of the season is that the so-called “growth” companies, those trading on high price earnings multiples and expected to grow earnings more rapidly, have on the whole delivered on pre-result expectations. This includes highflyers in the IT sector, such as Altium, Afterpay, Carsales, REA and WiseTech Global; healthcare leaders such as CSL, Cochlear and  Resmed; and consumer goods leaders such as a2 Milk, Bellamy’s and Blackmores.

Other key themes to emerge are consumer discretionary stocks are benefiting from a stronger domestic economy and performing satisfactorily; resources companies are being  challenged by rising costs (energy, raw materials and labour) and that profit growth in the future will be dependent on commodity price increases rather than productivity and production gains; and revenue growth in the financials sector is anaemic.

Electoral risk rises

In the midst of reporting season, the Liberal Party chose to dump Malcolm Turnbull as Prime Minister and give Scott Morrison the gig. If ScoMo can successfully smoke the peace pipe with the conservative right, the Government might survive to fight an election on Saturday 18 May 2019, the last possible day that a half Senate election can be held in conjunction with the House of Representatives. And if he can re-invigorate the Government, he might even beat Bill Shorten at the election.

But he first needs to win a by-election in Wentworth, win over at least one National MP who has threatened to sit on the cross-bench, and mend fences with independents Cathy McGowan and Bob Katter, who have previously agreed to vote with the Government on supply and confidence motions. The prospect that ScoMo will lose a no-confidence motion and be forced to call a pre-Christmas election is real.

Electoral risk is now very “front of mind” with investors. Federal elections are typically a negative for markets due to the uncertainty around policy, and the impact on consumer facing businesses where purchase decisions are sometimes deferred.

Exacerbating the concern over the election is the suite of “investor unfriendly” policies that Bill Shorten and his ALP team have already announced. To recap, these include:

·         Reducing the discount on capital gains from 50% to 25%. Taxpayers on the top marginal tax rate of 47% will see their effective tax rate on a capital gain on an asset (property, shares, managed funds, collectables etc) owned for more than 12 months increase from 23.5% to 35.25%;

·         Abolition of negative gearing, except for new housing;

·         Eliminating cash refunds of excess franking (imputation)  credits (except for those in receipt of a government benefit);

·         Capping premium increases on private health insurance to 2% pa; and

·         Reducing the cap on non-concessional super contributions to $75,000 pa, abolishing catch-up concessional contributions and lowering the threshold to $200,000 for Division 293 tax (the extra tax high income earners pay on concessional super contributions).

7000 by Christmas?

I can’t readily see 7000 by Christmas. Reporting season was good, but not brilliant and the events of last week with Scomo and Turnbull mean that the markets will be keeping one eye firmly glued on Canberra.

If the US market continues to power ahead, then the Aussie market will be dragged higher. The former seems only to be held back by trade tensions and the fear of higher interest rates. News that the US and Mexico have come to an agreement to replace NAFTA and that Canada is due to resume talks has eased short term market concerns. Europe is said to be getting ready to do a deal, meaning that the big one, the $200bn spat between the US and China, could be the next area to be resolved. If China and the US call a truce, Wall Street will go nuts – a 500 point rally could be on the cards, with our market to follow.

In President Trump’s hands we lie?

 

Link – positioned for long-term growth

Friday, August 24, 2018

The “hiccup” that beset growth stock Link (LNK) appears to be over. Following the release of its profit report on Friday, Link rose 48c to close at $8.07, well above the post “Budget blues” low of $6.73.

Link Administration Holdings (LNK) – August 17 to August 18

Source: nabtrade

The low came after a surprise announcement in the Federal Budget to cap administrative fees on low balance super accounts at 3% and sponsor the consolidation of inactive super accounts. Link, which is Australia’s largest provider of back office services to super funds, including Australian Super and REST, earns revenue largely based on the number of super accounts it services. To come into effect from 1 July 2019, Link has estimated that it will take a hit to revenue of $55 million.

On a total revenue base of just on $1.2 billion and EBITDA of $335 million, a $55 million hit is still material. But the market seems to have put this “hiccup” behind because it buys Link’s long-term growth story, backs management, and perversely, the Government’s changes and other regulatory pressures could act as tailwinds for Link’s super fund administration business unit.

As the industry’s least cost provider, Link says its administrative platform will assist super funds deal with the pressures to provide improved services and reporting to their members, and lower overall fees.

The Link business

Link has three Australasian domiciled businesses and the UK/Ireland based Link Asset Services (formerly Capita Asset Services), which was acquired in November 2017.

The Fund Administration business contributed almost one-third of group EBITDA with $123.1 million in FY18, up 4.2% on FY17. By the number of super members, it has a 35% share of the market for back office super administration services. Its nearest competitor is Mercer with 7%, while super funds providing their own “in-house” services (a key target growth area for Link) account for 52% share. Clients include Australian Super, REST, HESTA and Cbus.

Average super account admin fee

Source: Link

Corporate Markets, the traditional share registry business, grew revenue by 8.2% and EBITDA by 8.3% to $51 million. Net client growth of 226 clients and increased capital markets activity (largely outside ANZ) drove the revenue growth. Recurring revenue, which accounts for 81% of the division’s total, grew by 1.6%.

Technology & Innovation, the third division, grew revenue by 6.8% and EBITDA by 32.5% to $72.9 million. The improvement in EBITDA arose mainly from IT cost and integration efficiencies. Services are provided to Link’s other divisions and external clients, with the latter now responsible for 33% of revenue.

Finally, the European based Link Asset Services (acquired in November 17). On a full year basis, this will be Link’s biggest division generating around 37% of group EBITDA. For the eight months of FY18 it earned $93.8 million. Link Asset Services operates in 10 European markets, providing back office services to fund managers, asset managers, corporate borrowers and investors.

Link has demonstrated consistent “through the cycle” growth in earnings over the last decade, from $89 million in 2009 to $335 million in 2018. It boasts a highly experienced management team, has a sound record of business acquisitions and integration, has invested in proprietary technology and is positioned to benefit from opportunities in existing and adjacent markets. Just on 80% of revenue is “recurring”.

Link Group – EBITA 2009 to 2018

Source: Link

The Group’s growth strategy revolves around: investing in predictable markets with tailwinds such as superannuation; leveraging scale and proprietary technology to drive efficiency and lower cost; product and service innovations for customers; regional expansion; and investing in adjacent market opportunities (for example, its shareholding in PEXA, the company processing and settling property transactions).

What do the brokers say?

The brokers like the stock, noting the prospect of moderate earnings growth, margin expansion, strong cash flow generation and an undemanding pricing multiple.

According the FN Arena, Link is trading on multiple of 18 times FY19 forecast earnings and 17 times FY20 earnings.

Dividends are forecast to rise from a total of 20.5c in FY18 (100% franked) to 24c in FY19 (yield 3.0%).

Four out of the eight major brokers have buy recommendations, with the others sitting at neutral. The consensus target price is now $8.56, up 37c on the pre-result target of $8.19. Individual recommendations and targets are set out below.

Source: FNArena

Risks include driving integration benefits from the acquisition of Link Asset Services and revenue growth in the domestic business.

Bottom line

Back in April, and before the Government’s announcement, Link raised $300 million in an oversubscribed institutional placement at $8.50 per share. This was achieved at just a 2.4% discount to the then share price of $8.71.

The stated purpose was to provide Link with “flexibility to pursue strategic opportunities”. One of these opportunities might be PEXA, which is currently undertaking a dual track trade sale/IPO process. At the analysts’ briefing, MD John McMurtrie said that Link, which owns just under 20% of PEXA, was examining all options, including being a buyer or seller into the process.

Putting the PEXA process to one side, the success of the institutional raising demonstrated the very high esteem that the market has for Link. Friday’s profit result will add to this, and notwithstanding the “hiccup” from the Government, I think Link will re-test the previous high of $9.05 in due course. For the portfolio – this is a long-term growth stock.

 

Is this supermarket business a super share?

Thursday, August 23, 2018

It comes as no real surprise that Woolworth’s shares have dropped by 3.6% (or $1.08) since announcing its full year profit report on Monday. Although the results came in pretty much as expected, they didn’t allude to too many upsides as sales momentum in the business slows. Further, the stock remains expensive, trading on a multiple of 20.6 times FY19 earnings.

Woolworths has been a great recovery stock. From a low of $20.30 in June 2016, it hit a high of $31.48 in mid-July, as the market bought the transformation story. This saw the closure of the Masters homeware business, the hiring of Brad Banducci as CEO, a refresh of Australian supermarkets such that they are competing vigorously with Coles and Aldi, the pursuit of an IPO or sale of the petrol business and progress (albeit slow) to turnaround the disastrous BigW division.

Woolworths Share Price – August 2013 to August 2018

Source: Nabtrade

But the transformation is nearing completion and shareholders are increasingly asking “what’s next?”. The answer they are seeing is a business competing in a mature, low growth market with little on the horizon to excite.

Net profit after tax in FY18 grew by 12.5% to $1.72bn on top line sales growth of 3.4% to $56.7bn. The Australian supermarket business starred, growing EBIT by 9.6% to $1.75bn or 64% of the whole group. This came on the back of an increase in its key EBIT to sales ratio by  0.23% to 4.7% (for every dollar spent at a Woolworths supermarket, the company makes 4.7 cents), with improvements in stock loss, meat operating model, product mix, and promotional effectiveness offsetting higher operating costs.

However, sales momentum in Australian supermarkets slowed. In the key metric that measures sales growth across comparable stores, 4th quarter sales increased by 3.1%, compared to the 4th quarter in FY17. This was down from the full-year growth rate of 4.3% and suggest that Woolworth’s recent lead over Coles is narrowing.

Comparable Stores Sales Growth Food (Easter Adjusted) – 17/18

Moreover, Woolworths warned that for the first seven trading weeks of FY19, comparable store sales growth had slipped to 1.3%. It blamed the impact of the plastic bag fiasco, the success of the Coles “miniatures” initiative, fresh food deflation and the cycling of a prior year initiative for the performance.

The Endeavour Drinks business, which includes Dan Murphy’s and BWS, grew EBIT by 2.8% to $516m (19% of the group total). Sales growth of 4.5% was held back by a reduced EBIT to sales ratio (down 11bp) as the costs of doing business increased.

The contribution from the NZ division (Countdown) fell by 8.2% to 284m, while losses continued with BigW ( a loss of $110m). On a brighter note, comparable store sales for BigW recorded an increase in the final quarter, up 2.0%.

Shareholders will receive a final dividend of 60c per share (50c ordinary and 10c special), taking the total to 103c for FY18, up 22.6% on the 84c paid for FY17.

What do the brokers say?

The brokers are largely neutral on Woolworths, seeing it as fairly but fully valued. There are no buy recommendations. According to FN Arena, the 8 major brokers have a consensus target price of $28.47, fractionally below yesterday’s closing price of $28.54. Citi is the most bullish with a target price of $32.00, while Morgan Stanley is at the other extreme with a target of $23.00. (see table below).

They forecast earnings per share rising moderately to 138.4c per share in FY19 and then 149.9c per share in FY20. This puts Woolworths on a multiple of 20.6 times FY19 and 19.0 times FY20 earnings. The forecast dividend yield is a relatively unattractive 3.5% for FY19.

Bottom line

Shareholders can look forward to some capital management initiatives this year when the sale of the petrol business is completed. The company is also fairly bullish about WooliesX, its investment in digital, data, loyalty and the customer experience to drive sales, in particular on-line sales. It is rolling the model out to New Zealand (CountdownX).

However, it is still fundamentally a low growth business, and unless inflation picks up or competition cools off in the supermarket business, it will be challenged to lift earning.

I can’t get excited by Woolworths trading on a multiple of over 20 times. Not a buy. If you are looking to create room in your portfolio or need the cash, this is a stock to put on the sell list.

 

CSL delivers another stunner!

Thursday, August 16, 2018

Oh, to go back to 1994 and have the opportunity to invest $1,000 in the privatisation of  Commonwealth Serum Laboratories, today called CSL Limited. 

Investors paid the sum of $2.30 per share, which was subsequently split into three giving an effective entry cost of just $0.77 per share. Yesterday, CSL’s shares closed on the ASX at a record high of $214.58. That same $1,000 invested in 1994 is today worth $279,875. Over the 24 years since privatisation, this is equivalent to a compound annual return (CAGR) of 26.4%!

CSL is now Australia’s fourth largest company by market capitalization at $97bn – bigger than the ANZ Bank, National Australia Bank, Wesfarmers and Woolworths. Only the Commonwealth Bank, BHP and Westpac are bigger.

To say that CSL is Australia’s “best company” is a huge call, but it is an accolade that is not out of place from a shareholder’s perspective. No other company on the ASX comes close to CSL’s record for profit growth over a sustained period. And as Australians, we should be celebrating CSL’s success because it is the global leader in its field of blood plasma products. It earns more than 90% of its revenue offshore.

Yesterday’s profit result was another stunner. 

Result highlights

CSL reported a full year profit of US$1,729m, up 28% on a constant currency basis on 2017.This was at the higher end of market forecasts, and above CSL’s recently revised upward guidance range of US$1,680m to US$1,710m.

Revenue grew by 11% to US$7,915m, with immunoglobulin sales up 11% to US$3,145m, haemophilia sales up 5% to US$1,113m, specialty product sales up 24% to US$1,490m and revenue from the Seqirus influenza vaccines surging by 16% to US$1,088m. Acquired back in 2016, earnings (EBIT) from the Seqirus division improved from a loss of US$179m in FY17 to a profit of US$52m in FY18.   

Shareholders were rewarded with a full year dividend of US$1.72 per share  (all unfranked, final dividend US$0.93), up 26% on the FY17 full year dividend of US$1.36. The dividend represents a payout ratio of 45%. 

Looking ahead, CSL forecast strong demand for plasma and recombinant products and guided to revenue growth in FY19 of around 9% in constant currency terms. On the back of expected margin growth from plasma product mix shift, specialty and recombinant products growth and further improvement with Seqirus, the company has guided to a NPAT in FY19 of between US$1,880m to $1,950m. This represents an underlying growth of between 10% and 14%., matching (already elevated) market expectations.

Capital expenditure in FY19 is expected to rise to US$1.2 bn to US$1.3bn (up from US$1.0bn in FY18), with investment in new products, growth in existing products, and new facilities and modernisation. The company plans to open between 30 and 35 new plasma collection centres, adding to the 206 centres that CSL operates worldwide. 

The only obvious cloud on the horizon is increasing US labour costs in connection with the collection of plasma.

What do the brokers say?

Going into the result, the brokers were bullish but wary on CSL. The wariness coming from the elevated pricing, with CSL trading on pre-result forecast multiple of 38.6 times FY18 earnings and 34.5 times FY19 earnings. According to FN Arena, of the 8 major brokers, there were 4 buy recommendations and 4 neutral recommendation. Target prices varied from  a low of $168.50 (Morgans) to a high of $232.00 (Citi), with a consensus price of $192.38.

CSL has “form” in guiding conservatively, so with guidance for FY19 of 10% to 14% meeting pre-result broker expectations and an overall upbeat tone to the outlook statement, it is likely that target  prices and earnings forecasts will be raised. While this may not lead to upgrades, it shouldn’t lead to any downgrades, notwithstanding the shares finishing up 6.4% on the day at $214.58. 

Bottom line

If you own CSL, hang on. There is no sign of the CSL train running out of steam. While you “can never go wrong taking a profit”, the adage “let your profits run” seems to trump the former more often than not. Particularly when you are backing a company on fire.

If you don’t own CSL, it should be on your shopping list. As the fourth largest company by market capitalisation, it is just too big to ignore. On a multiple of 36 times FY19 earnings, it is pretty expensive. So, while the strategy might be to buy in weakness, you need to have the discipline to buy when the market looks gloomy and the other indicators are telling you not to . Don’t be too greedy. 

 

 

Why I prefer other banks to CBA

Thursday, August 09, 2018

New CommBank CEO Matt Comyn rolled out his strategy yesterday to “become a simpler, better bank for our customers,” which prioritises simplification of CommBank’s operating model and processes, leading in retail and commercial banking and being the best in digital.

“Banking 101” some might call it.

Apart from digital, where CommBank clearly has the lead, the strategy could have been developed for almost any bank in Australia. It is almost identical to the ANZ and NAB strategies. Westpac, which is hanging onto its wealth management businesses and is a stronger proponent of a multi-brand model in retail, is looking somewhat distinctive.

Gone or going at the CBA are wealth management (Colonial First State and CFS Global Asset Management), most financial planning channels, life insurance in Australia and New Zealand, mortgage broking and TymeDigital in South Africa. Under review are general insurance and CBA’s banking businesses in Indonesia and Vietnam. 

The challenge for Comyn and his leadership team with this strategy is where does the growth come from? When the area of operation is just Australasia, the focus is traditional  banking, this market is an oligopoly where market share gains between the major players occur at the margin, and the Government is supporting new entrants through Fintech and open banking initiatives, it is hard to grow revenue. In fact, maintaining revenue will be challenging.

To grow earnings, outright cost reduction becomes increasingly important, and interestingly, Commbank specifically identified this as a key goal. It also called out ‘data and analytics’ and ‘innovation’ as supporting capabilities.

So, how much progress is CommBank making with cost reduction?

Looking at yesterday’s full year profit result, the answer to this question is “a work in progress.” Operating expenses in the shorter second half were up 2% on the first half from $5.74bn to $5.86bn, and for the full year excluding one-off costs such as the $700m AUSTRAC penalty, up 3.1% on 2017.

A fair chunk of the increase in operating expenses was due to elevated risk and compliance costs, a software impairment in the Institutional Bank and software amortisation, but offsets also occurred because bonuses and staff incentives were slashed. In fact, total staff numbers increased across the year from 45,614 FTE (full time equivalent) to 45,753 FTE in 2018.

Fully implementing the recommendations of APRA’s Governance Review and others expected to arise from the Royal Commission means that CBA will have its work cut out to obtain meaningful cost reduction in the near term. Hence, it is viewing cost reduction as a medium-term priority.

But it starts behind the ANZ and NAB who are both making cost reduction their number one goal, and shareholders will be expecting CBA to do more on this front, faster.

Overall, CBA’s profit result for the year of a cash NPAT of $9.23bn, up 3.7% when “one-offs” are excluded, was a little better than expected (or not as bad as the market had feared) and CBA shares rose on the day by 2.6% to $74.81.

Positives included:

·      Transaction account balances up 10.6% on the prior year, and customer deposits now contributing 68% of total group funding;

·      The net interest margin in the second half of 2.14% was only down 0.02% on the first half, notwithstanding the pressure in the short-term funding markets;

·      Most business units increased cash NPAT, with the Retail  Bank up 5%, the Business Bank by 4%, Bank West by 18% and ASB by 12%.

·      An increase in the final dividend from $2.30 to $2.31 per share. Small, but an important “statement” by the Board.

On the negative side:

·      A half-on-half profit decrease (second half vs first half) of 6.8% or $330m. Now, there are three fewer calendar days in the second half (which reduces revenue by about $150m), but this is only part of the explanation;

·      Market share in home loans fell from 24.8% to 24.4%, with home loan lending growth of 3.7% below the market (‘system’) growth of 5.6%. Business lending market share fell from 18.6% to 17.8%;

·      Home loans in arrears (over 90 days due) rose from 0.60%  of the total loan amount  to 0.70%, and;

·      The disappointing performance of the Institutional Banking & Markets division, with profit down 14% due to lower trading revenue and the write-off of a lending system.

Bottom Line

A workmanlike result, but rather because expectations had been hosed down. CBA had been sold down on the ASX ahead of the result, so its performance yesterday was more about “reversion to the mean” than “a huge vote of confidence.”

As the bank trading at a premium to the other banks (highest multiple of earnings and lowest dividend yield), hard to recommend in the absence of demonstrable evidence that its strategy can grow earnings by cutting costs and/or increasing revenue. For the time being, I prefer others such as the ANZ.

 

Rio results a tad disappointing

Wednesday, August 01, 2018

Reporting season kicked off yesterday with Rio’s first half result (Rio has a 31 December balance date). Over the next 30 days, about 80% of Australia’s ASX listed companies will update the market with their half year or full year profit results.

With the Australian share market perched near 10 year highs, a good earnings season will be critical to sustaining upward momentum.

The first major company to report, Rio, delivered its results after the close of trading. Expectations were high, and while there was some further positive news about shareholder returns, it was a tad disappointing. Overall, a little mixed.

Rio reported underlying EBITDA of US$9.2bn, up 1.7% on the corresponding half last year, but down 3.6% on the second half of FY17. Underlying earnings for the half came in at US$4.4bn, lower than some broker forecasts of up to US$4.8bn.

                                    Rio by the Half Year (US$)

Although net debt rose to US$5.2bn, Rio maintained a very strong balance sheet with gearing at just 10%. Free cash flow fell to US$2.8bn, in part due to higher capital expenditure and payment of tax for FY17. Shareholders will receive a higher interim dividend of US 127.0 cents, up 15.4% on last year’s 110.0 US cents.

Higher commodity prices, in particular aluminium and copper, and increased volumes drove the small increase in EBITDA, but this was offset by cost headwinds. Rio said that higher energy cost knocked US$0.2bn off the result, while the cost of raw material inputs reduced earnings by US$0.3bn.

The cash unit cost of production in the Pilbara for a tonne of iron ore rose from US$13.00 in the last half of FY17 to US$13.40 in this half.

Rio’s productivity programme also met the cost headwinds, but Rio said that it delivered a net benefit in mine-to-market free cash flow of US$0.3bn in H!1 2018 and was on track to deliver a further SUS0.4bn in the second half.  

Earnings from aluminium and copper benefited from both higher prices and volumes, while iron ore earnings were barely changed as higher volumes were offset by the impact of lower prices. Rio’s average realised price was US$57.90 per wet metric tonne of iron ore compared to US$63.00 in the corresponding half last calendar year.  

Underlying EBITDA by Product


But when compared to the second half of FY17, first half EBITDA from iron ore decreased by 4.5%. On a positive note, Rio said that 2018 shipments of iron ore are expected to be at the upper end of the existing guidance range of 330-340 million tonnes.

Buyback increased

Rio announced that it would undertake a further US$1.0bn on-market buyback of Rio Tinto plc shares by the end of February. This is in addition to the US$1.4bn remaining from an existing on-market buyback programme.

It has also promised to return the post-tax proceeds of its recent asset disposals to shareholders. This is approximately US$4.0bn and includes US$4.15bn from the sale of coking coal assets, US$0.8bn from the sale of European aluminium smelters (Dunkerque and ISAL), less tax of US$1.0bn.

Some of that US$4.0bn might find its way back directly to Australian shareholders through an off-market buyback. This will prove to be very popular for self-funded retires and their super funds and other low rate taxpayers.

Bottom line

Going into the result announcement, the brokers (on consensus) had a target price of $89.44 on Rio, a 9.5% premium to yesterday’s closing price of $81.65. Ord Minnett topped the list at $96.00, with Macquarie at $94.00 and UBS at $93.00.

With costs rising and productivity gains becoming harder to achieve, some downward revision to earnings forecasts and target prices is likely. The prospect of ongoing shareholder returns will provide support and limit any pullback.

 

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