The Experts

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

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.


Cutting fees will boost investment returns

Thursday, July 26, 2018

The inescapable conclusion is that fees matter when it comes to your super, so if you want your Self Managed Super Fund (SMSF) to do better, cut the fees it pays or make it bigger. If your super is invested through a public fund, choose a lower fee industry super fund over a higher fee (largely bank owned) retail fund.

The importance of fees is driving a new debate in the SMSF world, with some arguing that SMSFs should have a least a million dollars in assets. Respected journalist Adele Ferguson (or Saint Adele as  Peter Switzer calls her) kicked off the debate on Monday in a piece in the Australian Financial Review.

Ferguson based her argument on a report from Industry Super Australia (ISA), the lobby group for the Industry Super Funds, that argues that SMSFs on average underperform industry super funds and this underperformance is more pronounced with smaller funds. ISA had analysed a report from the Australian Taxation Office, ‘ATO Self-Managed Superannuation Funds: A Statistical Overview 2015-2016’.

The ATO’s report compared average returns for SMSFs and all APRA funds, which includes industry, corporate and retail funds, over the five years from 2012 to 2016. The graph below (Graph 17) is from the ATO’s report.   

This shows that on average, SMSFs performed the same as APRA funds in 2016, and underperformed in 2012, 2013, 2014 and 2015. The ATO cautioned that it was not an “apples and apples” comparison.

The same data (and longer-term data) was considered by the Productivity Commission in their recent report into Superannuation: Efficiency and Competitiveness. The Productivity Commission says: ”Over the period 2006 to 2015, SMSFs, on average, performed favourably against APRA regulated funds and a listed benchmark portfolio before and during the GFC, but less favourably since”. It cautioned about the direct comparison, noting the differences in methods used to estimate rates of return in each segment and the incorporation of set up costs in the returns of newly established SMSFs.

It made the following (draft) finding.

The SMSF segment has broadly tracked the long term investment performance of the APRA-regulated segment on average, but many smaller SMSFs (those with balances under $1 million) have delivered materially lower returns on average than larger SMSFs.

And that’s the rub. Fund size really matters as the following chart from the ATO (Graph 19) so graphically demonstrates. Whereas SMSFs with assets of more than $500K had on average positive net investment returns in each of 2012, 2103, 2014, 2015 and 2016, SMSFs with funds under $200K largely had negative returns in those same years.

The ATO says that in 2016, the average fee paid by an SMSF with a balance of between $100K and $200K worked out to be 6.41% pa compared to the 0.69% pa paid on average by funds over $2m. This is because a number of the fees are fixed so that when they are apportioned over a small balance, they have a devastating impact on investment performance. Conversely, when those fees are applied over a large balance, the impact is relatively modest.  

While being “better investors” will obviously improve performance, the data says that SMSFs should also work on reducing the impact of fees. To improve performance, SMSFs can cut the fees they are paying, or get bigger (by adding balances or more members).   

How to cut fees in a SMSF

The first thing is to identify the fees you can’t avoid. These include the ATO’s Annual SMSF Supervisory Levy of $259, an external auditor’s fee (the latest ATO data says that the median audit fee was $550 although some administrators offer an audit service in the low $200s), the ASIC annual fee for a special purpose trustee company of $53, and for some funds, the actuary’s fee for providing an actuarial certificate, typically around $250.

Next is your accountant’s or administrator’s fee. This is where it pays to shop around because fees are coming down. Scale players such as the AMP owned Super Concepts, Super Guardian and BT are investing in technology and taking market share at the expense of local accountants and other niche operators.

Administration fees range from about $1,000 (for standard services from companies such as eSuperfund and Xpress Super) to around $3,000 for more comprehensive services from players such as BT, Super Concepts or Super Guardian. BT, for example, offers three packages – ‘core’ at $1,900 pa, ‘connect’ at $2,500 pa and ‘custom’ from $3,500 pa. An annual audit fee of $286 is also payable.

Like most services, you pay for what you get. If you have very standard investments (shares, retail managed funds, term deposits), then you can probably make do with a more basic administration service. If you have unlisted investments, including property, unlisted managed funds or collectables, then you will require a more customised (expensive) service. Administrators make their money if they can automate and standardise their processes. This includes getting access to readily available market data, so servicing unlisted investments, where the market price is not always known, will always be more expensive. Again, don’t pay for what you don’t need, so if an administrator has a package that allows you to include one residential property and you have no intention of ever owning one, this is probably the package you don’t need.

Shop around, considering carefully all the additional fees that could be charged. If your accountant is providing the service, make sure that you are getting “value for money”. If he/she is just processing your “shoebox” at the end of the year and charging you several thousands of dollars, you are probably not.

Finally, there are the platform, transaction and investment management fees. While platform fees are coming down (BT is now charging 0.15% pa capped at $1m plus $540 pa), if you don’t need to be on a platform or get little utility out of using it, get off it. Don’t pay just because it suits your adviser.  With investment management, whether it be an indirect fee via a managed product or a direct fee with an adviser, these need to be evaluated in terms of performance and service. Paying big fees for outstanding performance or superior service is fine – paying big fees for below average performance or indifferent service is robbery.

Don’t rob your super nest egg – fees matter!


AGL’s Vessey needs to fall on his sword

Thursday, July 19, 2018

AGL shareholders should be demanding that the Board sack CEO Andy Vessey. And if the Board doesn’t act, then shareholders should be lining up to change the Directors at the AGM later this year.

Vessey’s intransigence over the Liddell coal fired power stations has cost shareholders billions of dollars. This year, AGL shares are down by 11.5%. Since reaching a high of $26.52 on 8 December, they are down by 18.7%. And $3bn has been wiped from AGL’s market capitalisation.

AGL Share Price July 17 to July 18

AGL’s nearest listed competitor, Origin Energy, which owns the Eraring coal fired generator and has a similar retail energy business, has seen its share price rise over the same period. It closed yesterday at $9.38 compared to $9.13 on 8 December.

While there is a little bit of “apples and oranges” in comparing AGL and Origin and there are also other factors at play in the fall in AGL’s share price, an inescapable conclusion is that AGL’s position on the closure of Liddell has hurt it. AGL has no friends in Government, few friends in the public and the regulators are gunning for it.

AGL’s posture on Liddell, initially insisting that it had to be closed, then refusing to consider a sale of the plant, and then glibly dismissing an offer from competitor Alinta Energy and Chow Tai Fook Enterprises with “AGL has determined that the offer is not in the best interests of AGL or shareholders” has infuriated the Government, sections of the media, the public and the regulators. The charge that AGL was closing Liddell to protect its generating margins on its Bayswater and Loy Yang A power stations was widely levelled.

Some went further, accusing AGL of price gouging. Former Prime Minister Tony Abbott labelled AGL’s decision not to sell the Liddell coal-fired power station a “strike against the national interest”.

So is it any wonder that the ACCC’s final report on its inquiry into Electricity Supply and Prices went a lot further than expected? Its recommendation to prohibit acquisitions or other arrangements (other than investment in new capacity) that would limit market shares to 20% per cent in any region or across the national energy market as a whole to prevent further “harmful concentration” will be known as the “AGL clause”. AGL’s national market share at 21% (29% in NSW, 30% in VIC and 39% in SA) means that it will be locked out of any acquisition opportunities.

Vessey’s strategy that the company needs to move to lower emissions generation technology and that there is no future in coal fired power generation might well prove to be right. However, he has overplayed his hand and shareholders are paying the cost. AGL needs to get in sync with the community and bury the hatchet with the Government. This will be easier if Vessey goes.

Do the brokers see any value in AGL?

The major brokers who have assessed AGL following the release of the ACCC report have a marginally positive view on its outlook. According to FN Arena, there is 1 buy recommendation and 4 neutral recommendations (no sell recommendations).

The consensus target price is $22.90, a 6.2% premium to yesterday’s closing price of $21.56. While acknowledging that AGL is relatively cheap trading on a PE (price earnings) ratio of 14.0 x forecast FY18 earnings and 13.1 x forecast FY19 earnings, the brokers note the heightened regulatory environment and the risk this poses. They expect to see further downward pressure on wholesale energy prices and compression in the retail distribution margin. Individual recommendations and price targets are shown in the table below.

Bottom Line

I would be much more comfortable buying AGL if it was smoking a peace pipe with the Government. It is not, and probably won’t, until Vessey goes.

Further actions by Government, the regulators or as a result of public/media pressure can’t be ruled put. Energy is a “red hot issue”, particularly in the lead up to a federal election. The public want lower energy prices and are not going to shed any tears if AGL gets hurt (many would say gets what is due to it).,

In the absence of any change in Management or strategy, avoid in the short term.


BHP’s capital challenge

Thursday, July 12, 2018

A Reuters report that oil giant BP is set to pay more than US$10 billion for BHP’s US onshore oil and gas assets has led market analysts to start pondering what BHP might do with this somewhat unexpected “pot of gold”.

The onshore shale assets in the Eagle Ford, Permian, Haynesville and Fayetteville basins were acquired by BHP at the height of the oil boom in 2011. Largely written off in 2016, they are now being sold primarily in response to pressure from activist shareholder Elliott & Associates. In plans tagged “Value Unlock Plan for BHP” and “Fixing BHP,” Elliott argued that out of a total investment of US$29.2bn, US$19.9bn in acquisition costs and US$9.4bn of negative cash flow, BHP had “destroyed” US$22.7bn of shareholder wealth.

According to Elliott, BHP was not the right custodian of the US onshore assets, as there were no real operational synergies or risk diversification, and BHP didn’t have the cultural mindset or nimbleness to operate in shale oil where rigs are quickly commissioned and often drill for less than two years.

BHP hasn’t confirmed the sale to BP. Its last update to the market said that the process was tracking to plan, with bids due by the end of June and the “potential” for a deal announced by the end of calendar 2018. It also hadn’t ruled out a demerger or IPO of the business.

In the resources business, timing is everything, and BHP seems set to benefit from some “luck” in the sale process. A steady rise in the oil price to US$74 a barrel, President Trump’s corporate tax cut and some successful well trials are helping to lift interest in the sale and raise expectations about the proceeds. So, with BHP set to receive a small windfall, what will it do with the funds?

Capital options

BHP has three broad options for the funds - capital expenditure on new projects or buying assets, to pay down debt, or return the funds to the shareholders.

Under Andrew Mackenzie’s reign as CEO, BHP has been very disciplined with capital expenditure, particularly when it comes to new projects. It currently has four major projects underway with a combined capital expenditure of US$7.5bn over the life of the projects. There are two petroleum/LNG projects (Mad Dog Phase 2 in the Gulf of Mexico and North West Shelf Greater Western Flank-B in WA), the Spence Growth Option in Chile to expand copper production and the excavation, lining and building of infrastructure for the Jansen potash project in Canada. BHP recently announced a fifth project, the US$2.9bn South Flank iron ore project in the Pilbara.

Future growth options include offshore oil in the Gulf of Mexico with Atlantis, copper at Olympic Dam in SA, metallurgical coal at Wards Well in the Bowen Basin in Queensland, copper at Resolution in Arizona and after almost a decade, possibly the production of potash at Jansen. BHP says that “any investment decisions will be made in accordance with our capital allocation framework and fully consider the broader market impact”.

According to Mackenzie, BHP’s return on capital employed (ROCE) which was just 10% in FY17, is forecast to rise to around 14% in FY18 and the company is targeting 20% by FY22. 

BHP has also been working hard to drive cost efficiencies, for example, lowering the production cost of iron ore to US$13 per tonne, and is targeting further productivity gains of US$2bn by end FY19. Debt has been reduced, down to US$15.4bn as at 31 December, with BHP now targeting ongoing net debt in a range of US$10– $15bn. It has guided to capital and exploration spending of US$8bn pa to FY20.

The BHP story is “capital discipline, debt reduction and shareholder returns.”

Unless BHP has a major change in strategy, this means that a fair chunk of the proceeds from selling the US onshore oil assets will be earmarked for shareholder returns. This will most likely translate into an on-market buyback of shares in the UK listed entity (to reduce the discount with the Australian listed entity), and an off-market buyback (at a discount) of shares in the Australian listed entity.

The latter will allow BHP to distribute excess franking credits to Australian shareholders and will prove to be very popular with shareholders, assuming that they can get it done before a Bill Shorten ALP Government changes the rules.  

Do the brokers see any value in BHP?

In a commodity up cycle, the major brokers are supportive of BHP with 7 buy recommendations and 1 neutral recommendation (no sell recommendations). That said, they don’t see a lot of upside with a consensus target price $34.48, just 2.1% higher than last night’s closing price.

Individual broker recommendations and target prices (source: FN Arena) are set out below. Because resource company profits are highly dependent on commodity prices, broker forecasts should be treated with an extra degree of caution because a key input is the broker’s forecast for commodity prices.

In a commodity up cycle, the major brokers are supportive of BHP with 7 buy recommendations and 1 neutral recommendation (no sell recommendations). That said, they don’t see a lot of upside with a consensus target price $34.48, just 2.1% higher than last night’s closing price.

Individual broker recommendations and target prices (source: FN Arena) are set out below. Because resource company profits are highly dependent on commodity prices, broker forecasts should be treated with an extra degree of caution because a key input is the broker’s forecast for commodity prices.

                                                Broker Recommendations

Bottom line

Commodity prices are still in uptrend and if you are long BHP, I think you stick around for the ride. With BHP maintaining a high degree of discipline over its capital expenditure and balance sheet, shareholders will be rewarded with higher dividends and capital returns.

Can share investors seeking exposure to resources find better value elsewhere? Probably. If you place faith in the broker forecasts, the same analysts see 11.4% upside potential with Rio and 24.4% upside potential for Fortescue. The latter is much higher risk, given that it is virtually a pure play iron ore miner.

But the sale of the US onshore oil assets should allow BHP to further reward investors, and while it is probably too late to buy, there is no reason to bail out yet. Hold.




Super changes for the new year

Thursday, July 05, 2018

The start of a new financial year invariably means changes to the super system. This year, the changes are all positive and will potentially assist people at opposite ends of the age spectrum, as well as those that might be temporarily out of the workforce. Here is the rundown.

1. Downsizers can contribute to super 

If you are 65 years or older, you can choose to make a downsizer contribution into your super of up to $300,000 from the proceeds of selling your home. A couple could effectively get up to $600,000 into super.

The main qualification is that your home, which was your primary residence, was owned by you or your spouse 10 years or more prior to the sale. Contracts must have been exchanged on or after 1 July, the home can’t be a caravan, houseboat or other mobile home, and you must make the downsizer contribution within 90 days of settlement. You can’t access the scheme more than once. 

Technically speaking, you don’t actually need to buy another home!

It is very unlikely that this scheme will drive the decision to downsize, but if for lifestyle or other reasons you are thinking about downsizing, it could be an added incentive. Super is of course a very tax effective way to invest, with a maximum tax rate of 15% and the magical tax rate of 0% available to retirees who are eligible to access their super through an account based pension. 

The main disadvantage is that if you receive a government pension, funds in super will count against the assets test limit. This happens because you sell an asset that is exempt from the assets tests, so it’s not a drawback of the scheme per se but rather a financial disincentive from the act of downsizing.

The downsizer contribution won’t count against your non-concessional contribution cap and can be made even if your total super balance is more than $1.6 million. It will then be included when this is next re-calculated at the end of the financial year.

2. A no-brainer for first home buyers

The First Home Owner Super Saver scheme is up and running and is a “no brainer” for first home owners. It is essentially an accelerated savings scheme where you make additional voluntary contributions into super and take out later for your deposit or down payment on that first home.

In this scheme, you will save about 30% more than if you save by putting the money in a bank account or term deposit. This could be worth up to $6,000.

The only reason a young adult who has never owned a property wouldn’t access it is because if they never end up buying that first home, the funds will be stuck in the super system until age 60.

The scheme is, of course, subject to caps and rules. The main one is that you can only deposit $30,000 in total and a maximum of $15,000 in any one year. While the contribution can be a non-concessional contribution from your own monies, most participants will choose to make a concessional contribution out of pre-tax monies via the salary sacrifice system. 

In both cases, the contributions will count against the respective caps.

In terms of eligibility, you can’t access the scheme if you have owned property before. This includes an investment property. A couple could potentially deposit $60,000 and as it is assessed on an individual basis, if one partner has owned property and the other hasn’t, the latter can still deposit up to $30,000. There is no age limit.

When you take the funds out, you must sign a contract to purchase or build a home within twelve months. While the funds can’t be used to purchase vacant land, they can be used to construct a home on vacant land.

3. Catch up concessional contributions 

Announced back in the 2017 Federal Budget, the ability to carry forward unused concessional contributions commenced from 1 July. This may suit someone with a low superannuation balance who leaves the workforce for a period of time (such as maternity leave), or who for other reasons is unable to utilise their full concessional cap. 

The unused portion of the concessional cap of $25,000 per annum can now be carried forward for up to 5 years. This means that if you didn’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.  

To be eligible, your total superannuation balance must be under $500,000 as at 30 June of the previous year.

Contributions are measured over a rolling five- year period and unused portions expire if not used. As the scheme only started this year, the first year that you can access it to make a higher concessional contribution is next financial year (2019/2020) and the carry forward will only relate to 2018/19. The following example from the ATO shows how this works.  




5 last minute super actions to take before the end of the financial year

Thursday, June 28, 2018

With only a couple more sleeps to go until the end of the financial year, here are five last minute super actions to take. But you will need to act straight away because contributions must be receipted and banked by your super fund or your SMSF before the close of business on Friday.

1.    Can you claim a tax deduction by making additional contributions to super?

There are two caps that limit how much money you can contribute into super. A cap on concessional (or pre-tax) contributions of $25,000, and a cap on non-concessional (or post tax) contributions of $100,000.

Concessional contributions include your employer’s compulsory super guarantee contribution of 9.5% and any salary sacrifice contributions you elect to make. They are called “concessional” contributions because they are a tax deductible expense for your employer.

There is also a third form of concessional contribution which is a personal contribution you make and claim a tax deduction for. Until this financial year, the ‘10% rule’ meant that only self-employed persons who received less than 10% of their income in wages or salary could claim this deduction. This rule has now been scrapped so that anyone can claim this tax deduction.

There are two important caveats. Firstly, you must be eligible to make a super contribution. If you are under 65, or aged between 65 and 74 and pass the work test, you will qualify (there are some particular rules for the under 18s). Secondly, you aren’t allowed to exceed the $25,000 cap on concessional contributions.

Let’s take an example. Tom is 45 and earning a gross salary of $100,000. His employer contributes $9,500 to his super, and he has elected to salary sacrifice a further $5,000. Potentially, prior to 30 June, Tom can contribute a further $10,500 to super and claim this amount as a tax deduction. He will do this when he completes his 17/18 tax return.

Tom will need to notify his super fund that this is a contribution he is claiming a tax deduction for. He does this by using a standard ATO form or online with his super fund. Technically, he will have until the earlier of when he lodges his tax return or 30 June 2019 to do this.

2.    Can you make additional post-tax contributions to super?

Non-concessional contributions are personal super contributions made from your own after-tax monies. You don’t claim a tax deduction for these contributions and they are capped at $100,000 each year. You must be under 65, or if aged between 65 and 74, meet the work test to qualify. And your total super balance (as at 1 July 2017) must also be less than $1,600,000.

If you are under age 65 (technically aged 64 or less at 1 July 2017), then you can access the “bring-forward rule” which allows you to make up to three-years’ worth of contributions, or $300,000, in one go. A couple could potentially get $600,000 into super. Ability to access this is further limited by your total super balance (under $1.4 million full amount; $1.4 million to $1.5 million $200,000; $1.5 million to $1.6 million $100,000).

3.    Can you or a family member access the Government Co-Contribution?

There aren’t too many free handouts from Government. The government super co-contribution remains one of the few that is available – so it seems silly not to try to access it. If eligible, the Government will contribute up to $500 if a personal (non-concessional) super contribution of $1,000 is made.

The Government matches a personal contribution on a 50% basis. This means that for each dollar of personal contribution made, the Government makes a co-contribution of $0.50, up to an overall maximum contribution by the Government of $500.

To be eligible, there are three tests. The person’s taxable income must be under $36,813 (it starts to phase out from this level, cutting out completely at $51,813), they must be under 71 at the end of the year, and critically, at least 10% of this income must be earned from an employment source. Also, they can’t have exceeded the non-concessional cap or have a total super balance over $1.6 million.

While you may not qualify for the co-contribution, this can be a great way to boost a spouse’s super, or even an adult child. For example, if your kids are university students and doing some part time work, you could potentially make a personal contribution of $1,000 on their behalf – and the Government will chip in $500!

4.    Can you claim a tax offset for super contributions on behalf of your spouse?

While this tax offset (rebate) has been around for years, the Government decided in last year’s budget to make it a whole lot more accessible by raising the income test threshold to $37,000 (it was previously $10,800). So, if you have a spouse who earns less than $37,000 and you make a spouse super contribution of $3,000, you can claim a personal tax offset of 18% of the contribution, up to a maximum of $540.

The tax offset phases out when your spouse earns $40,000 or more. Effectively, your maximum rebatable contribution of $3,000 is reduced on a dollar for dollar basis for each dollar of income that your spouse earns over $37,000. The offset is then 18% of the lesser of the actual super contribution or the reduced maximum rebatable contribution.

Your spouse’s income includes their assessable income, reportable fringe benefits and any reportable employer super contributions such as salary sacrifice. Similar to the rules for the co-contribution, you cannot claim the offset if your spouse exceeded their non-concessional cap or their total super balance was more than $1.6 million. 

5.    Pensions – have you paid enough?

If you are taking an account based pension, then you must take at least the minimum payment. If you don’t, then your fund will potentially be taxed at 15% on its investment earnings, rather than the special rate of 0% that applies to assets that are supporting the payment of a super pension.

The minimum payment is based on your age and calculated on the balance of your super assets at the start of the financial year (1 July). The age based factors are shown below.

Minimum Pension Factors

For example, if you were aged 66 on 1 July 2017 and had a balance of $500,000, your minimum payment is 5% of $500,000 or $25,000. You can take your pension at any time or in any amount(s), but your aggregate drawdown must exceed the minimum amount and be taken by 30 June 2018.

If you commenced a pension mid-year, the minimum amount is pro-rated according to the number of days remaining until the end of the financial year, and calculated on your balance when you commenced the pension.


Telstra’s profit downgrade overshadows attempts to create "new Telstra"

Thursday, June 21, 2018


Telstra CEO Andy Penn’s attempt yesterday to drum up support for the company at its Strategy Day fell on deaf ears. Penn’s strategy, somewhat unimaginatively titled ‘Telstra2022’, was overshadowed by a larger than anticipated profit downgrade for FY19 and a refusal to provide guidance on the FY19 dividend.

As might be expected, some broker analysts cut their dividend forecast for Telstra from 22c in FY18 down to a range of 15c to 19c in FY19.

Telstra shares fell 4.8% on the day. After trading as low as $2.69, they finished at $2.77, down 14c. In part, this was a retracement of the run up in the share price ahead of the Strategy Day, but also reflected underlying disappointment about Management’s ability to right “the Telstra ship”.

The market is desperate for an excuse to buy Telstra but is not convinced that Penn and his team are the right people to lead it. Yesterday’s downgrade, coming just 5 weeks after the last downgrade, shook confidence again.

Telstra has guided for FY19 EBITDA of $8.7bn to $9.4bn. Using the midpoint of $9.05bn, earnings have been slashed by more than $1.0bn compared to the revised (lower) FY18 forecast provided on May 14. And this excludes restructuring costs of $0.6bn.

Telstra has been hit by intense competition in the mobiles market. It expects overall FY19 market mobile and fixed revenue to be down by 2-3% on FY18, and mobile EBITDA to decline given trends in revenue per user and the impact of new entrant TPG on the market. Excess data fees are expected to decline as consumers switch to unlimited data plans, while headwinds from the NBN rollout will continue to impact the fixed line business.

Partially offsetting this is Telstra’s cost productivity target of $1.5bn, which is now expected to be met by the end of FY20.

But this downgrade was worse than expected, and with a dividend cut in FY19 more than a possibility, the market was in no mood to be too forgiving. And what of ‘Telstra2022’, Telstra’s new strategic plan?

‘Telstra2022’ has four strategic pillars:

  • Radically simplifying product offerings, eliminating customer paint points and creating all digital experiences;
  • Establishing a standalone infrastructure business;
  • Simplified structure and agile work environment; and
  • Cost reduction and portfolio management.

The first pillar will see, amongst other things, Telstra reduce the number of customer plans from 1800 to just 20 by June 2021, the end of excess data charges, and a much improved digital experience. Telstra expects that $500m of “historic” revenue will be eliminated from the business over the next 3 years as products and plans are simplified.

The second pillar involves establishing a wholly owned standalone infrastructure business unit. It will comprise Telstra’s fixed network infrastructure assets including data centres, domestic fibre, international subsea cables, exchanges, poles, ducts and pipes. It will provide access to these assets to other Telstra business units on commercial terms, as well as services to nbnco . It is expected to have an initial workforce of 3,000, assets with a book value of $11bn, revenues of approximately $5.5bn and EBITDA of $3.0bn.

The infrastructure business will not include mobile assets including spectrum, radio access equipment, towers and some elements of backhaul fibre. Telstra sees these as being crucial to its 5G strategy and allowing it to maintain a competitive differentiation around the capability of its mobile network.

It is expected to be fully segregated by 30 June 2019. When the nbn rollout is complete, Telstra could potentially sell or spin out the infrastructure business.  

In regards to organisation, Telstra plans to create an agile work environment and simplify its structure by flattening the organisation and reducing 2 to 4 layers of management. It will create a Telstra Global Business Services division for its large “back of house” processes (shared services division) and eliminate a net 8,000 jobs over the next 3 years. Overall, Telstra is targeting a reduction in labour costs of 30%.

Telstra is upping by $1bn the target for its previously announced productivity programme from $1.5bn to $2.5bn by FY22. It is targeting total costs to be flat or decline each year. It also plans to monetise $2bn of assets by the end of FY20 with the proceeds used to strengthen the balance sheet.

Bottom Line

Telstra needed to deliver a strategy aimed at slashing costs, and in this regard, it has. Reducing headcount by a net 8,000 positions to cut payroll costs by 30% and hold overall costs for the next four years at or below FY18 levels will be no mean feat, particularly in an environment where it needs to improve the customer experience to compete. These are ambitious, but commendable targets.

The questions the market has are twofold. Firstly, can Telstra actually do it, and secondly, why has it taken so long for Management to come up with the plan? Telstra fessed up to the NBN earnings hole of more than $3.0bn over 12 months ago and intense competition in the mobiles market is not new news.

At the moment, the jury is out on whether Andy Penn and Co are the right team to lead Telstra. A market re-rating is still some way off.




Takeover bid for APA fuels infrastructure stocks

Thursday, June 14, 2018


Yesterday’s $13bn bid for energy infrastructure provider APA by Hong Kong based CK Infrastructure (CKI) saw gains across the board for infrastructure stocks. In an otherwise down day on the ASX, Spark Infrastructure added 2.8%, Ausnet Services 1.0%, AGL 2.5% and toll road operator and owner Transurban 1.4%.

APA’s securities finished trading at $10.00, up 20.9% on Tuesday’s closing price of $8.27, but still a full dollar short of the indicative bid price of $11.00. The wide discount reflects the market saying that this bid is by no means a “done deal”.

And it is not just that the bid is indicative and conditional. It has the usual conditions around being subject to satisfactory due diligence, implementation through a scheme of arrangement and APA Directors indicating that they will support the offer and vote in favour.

The big condition relates to regulatory approvals from the Foreign Investment Review Board (FIRB) and the Australian Competition and Consumer Commission (ACCC).  

APA is one pf Australia’s leading energy businesses, owning and/or operating in excess of $20 billion of energy infrastructure assets. Its 15,148km gas transmission pipelines span every state and territory on mainland Australia, delivering approximately half of the nation’s gas usage. It also distributes gas to 1.4m consumers through 28,600km of gas mains and pipelines, owns wind and solar farms producing 585MW of power, gas processing plants and 244km of high voltage electricity transmission.

CKI and its associated consortium partner Power Assets own a majority stake in SA Power Networks, the primary electricity distribution network in South Australia; Citipower, which supplies electricity to 310,000 customers in Melbourne's CBD and inner suburbs; and Powercor, Victoria's largest electricity distributor which supplies electricity to 700,000 regional, rural and outer Melbourne customers. It also owns Australian Gas Infrastructure Assets. The latter supplies gas to 2 million customers through 34,000km of mains and pipelines, and owns 3,500km of gas transmission pipelines.

The CKI consortium revealed that it had already had discussions with and provided information to both FIRB and the ACCC. In respect of the ACCC, it has proposed a divestment package which would include APA’s interests in the Goldfields Gas Pipeline, Parmelia Gas Pipeline, Mondarra Gas Storage Facility and a standalone management team.

Whether these divestments will be sufficient for the ACCC is hard to say, but clearly the market thinks that competition concerns are going to come to the fore. FIRB’s position is unclear, but with more and more energy infrastructure assets coming under foreign control, a recommendation to the Treasurer to block the takeover can’t be ruled out.

One aspect that can be ruled out is a competing offer. The bid price of $11.00 is full, representing a 33% premium to APA’s last traded price and a 26% premium to the broker consensus target price of $8.73. Further, this is a company that is sitting on $9.3bn of net debt in an environment of rising bond yields, geared at 67%, with limited revenue or earnings growth. The company has guided to EBITDA of $1,475m to $1,510m in FY18 compared to $1,470m in FY17. Best case, 2.7% growth.

A forecast distribution of 45c in FY18, largely unfranked, puts it on a yield of 4.1% based on an offer price of $11.00. Broker consensus, according to FN Arena, has the distribution rising by 3.5% to 46.6c in FY19, a prospective distribution yield of 4.2%.

Shareholders, particularly those who took part in a $500m capital raising just a few months’ ago at $7.70 per security, will be hoping that FIRB and the ACCC let the bid through. Those worried about the “national interest” might have a different view.



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