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

Does AGL’s Andy Vesey need to fall on his sword?

Thursday, October 19, 2017

By Paul Rickard

While it is not exactly unusual for a stock to trade at a 11% discount to the broker target price, it is getting on the high side and shareholders (and Boards) should ask questions as to why. In this category is energy generator and retailer AGL.

AGL’s share price closed yesterday at $24.20. According to FN Arena, this represents a 10.7% discount to the consensus broker target price of $27.10. It is also a 14.8% retreat from the share price high of $28.42 achieved in April this year.

And although utility stocks have eased in general, I think one of the key reasons for its underperformance is that CEO Andy Vesey overplayed his hand with the Federal Government over negotiations for the Liddell power station. AGL’s refusal to consider selling Liddell was one of the factors that drove the Government to adopt its National Energy Guarantee (announced on Tuesday), which is the long run, will hurt electricity retailers such as AGL.

Vesey argued that it would cost AGL hundreds of millions of dollars to keep the fifty year old Liddell power station operating past its targeted shut down date of 2022, and that producing electricity from coal was not part of AGL’s go forward plan. Further, AGL could make up the shortfall through other sources including green energy.

He may be right about the cost of keeping the ageing Liddell operating, but it was his refusal to consider putting it up for sale and testing whether another operator wanted to try their hand that really got up the Government’s nose. After all, AGL effectively bought Liddell for just $1 (plus the cost of remediating the site) when it purchased Macquarie Generation from the NSW Government in 2014.

If AGL doesn’t want to run Liddell, why not see whether there is a willing buyer who might pay $1 or more for it?

Of course, Liddell is not AGL’s only fossil fuel power station. There’s the main asset of Macquarie Generation, black coal Mt Piper in NSW, the brown coal Loy Yang in Victoria, and the gas fired Torrens in SA. AGL doesn’t want a competitor undermining its position as an integral supplier of base load power to the grid.

Vesey has painted a wholly different picture for AGL as it exits the generation of electricity from fossil fuels by 2050. In the future, AGL will not only be producing and distributing green energy, but it plans to be a service provider to its customers, helping them to store and produce their own roof top solar, use smart meters in the household to optimise demand and manage devices, and potentially, operate charging stations for battery operated vehicles. So called “new energy”.

But the reality is that AGL earns most of its profit from the generation of electricity from coal and gas fired power stations. It is arguably Australia’s largest “big polluter” (to quote a phrase loved by the Greens), and this isn’t going to change in the medium term. The “new energy” business touted by Vesey lost $3 million in FY17, admittedly an improvement on the loss of $12 million the year before.

The market has decided that the Government’s intervention in the gas market and the establishment of the National Energy Guarantee, which will require retailers to contract to purchase dispatchable power plus the end the subsidy to green energy from 2020, will put downward pressure on wholesale energy prices. This will be a headwind for AGL.

What do the brokers say

The broker analysts are reasonably positive on AGL.  Of the seven major brokers tracked by FN Arena, there are four buy recommendations and three neutral recommendations. The consensus target price is $27.10, with Morgans the lowest at $25.10 and UBS the highest at $29.20.

The brokers see AGL earning 153.7c per share in FY18, rising to 177.8c per share in FY18 (a growth rate of 15.6%). This has AGL trading on a multiple of 15.7 times forecast FY18 earnings and 13.6 times FY19 earnings. The forecast dividend yield is 4.8%.

AGL has recently reconfirmed profit guidance for FY18 of an underlying profit in the range of $940 million to $1,040 million - an increase of 17% to 30% over FY17’s profit of $802 million.

Bottom line

I think that there will be consistent pressure on AGL by Government, Australian Energy Market Operator (AEMO) and the Australian Competition and Consumer Commission (ACCC) to reduce wholesale power prices, and that the best days of AGL extracting monopoly style rents are behind it. AGL will find it harder to grow revenue than some broker analysts are forecasting. Reduce.

On the question of Andy Vesey’s tenure, I think the jury is still out. AGL shareholders will be better served if the company is seen to be working with the Government and community, rather than being accused of executing a plan to boost profits.


Is your business ready for the elderly Asian consumer?

Thursday, October 12, 2017

By Paul Rickard

Many Australian businesses are highly geared to the affluent middle class consumer in Asia. High profile stocks such as ASX-listed Blackmores and Bellamy’s readily come to mind, with their sales of vitamins and organic food products to Chinese consumers.

But there are also hundreds of others, usually privately-owned, Australian businesses providing products and services to the booming consumer market in Asia. The Asian century is finally upon us!

And while this is the “now”, companies (and investors) will need to re-think how they approach Asia because the demographics are changing. According to Deloitte, the balance of power in Asia is shifting.

In its Voice of Asia (third edition) report, Deloitte says Asia will be home to 60% of the world’s over 65s by 2030. Asia’s over 65s will be the largest and fastest growing market in the world, growing from 365 million people in 2017 to 520 million people by 2027. By 2042, just a quarter of a century away, the over 65s in Asia will exceed the entire population of the Eurozone and North America combined, and number 1 billion shortly after the middle of the century.

While the ageing population will create challenges for growth in some nations, it will also generate a growth cluster of new business opportunities, with the potential to produce some very large winners at an industry level.

Country winners and losers

According to Deloitte, the median age in Japan is now over 47 years. It is the oldest country in the world, and the average resident in Japan today is 25 years older than was the case in 1950. Hong Kong, Korea and Singapore all sit well above the median age for Asia at a whole of 31.0 years. Even China at 37.6 years is on the high side, and interestingly, is the same as Australia.
At the other end of the scale, The Philippines at 24.6 years is the youngest, followed by India and then Indonesia (see table below).

Median Age by Country in 2017 (yrs)

Projecting ahead and looking at the impact of both an ageing population (in some countries) and the “demographic dividend” of an increasing workforce in others, Deloitte calculates that the biggest losers from demographic change over the next decade will be Hong Kong, Taiwan and Korea. China will also be a loser, with demographic changes reducing the Chinese economy by 4.2%.

Demographic addition/subtraction to size of economies over next decade

Winners will be India, The Philippines and Indonesia. Following the rise of Japan and China in decades past, Deloitte predicts that India will drive the third great wave of Asian growth, with its potential workforce set to rise from 885 million people today to 1.08 billion in twenty years’ time. And like Japan and China before them, it won’t only be more workers, but better trained and educated workers with rising economic potential.

Cynics will say that they have heard this before about the potential for India and that it has consistently failed to deliver. The gap between China and India has increased, not decreased, no doubt in part due to the “price” India pays for being the world’s largest federated democracy. Time will tell, but on paper at least, you can’t argue with the demographic factors at play.

Industry winners and losers

An ageing population will create huge tailwinds for some industries, and headwinds for others. In the former, health, medical and pharmaceuticals; financial services such as asset  management, wealth advisory, insurance and the management of retirement savings; travel, particularly airlines and luxury accommodation; luxury goods; age appropriate housing and consumer goods purchased by the elderly.

Headwinds will be slower to develop because the Asian population is increasing in aggregate. Long run losers are likely to include goods consumed by babies, kids and young adults; childcare services; educational services; cafes/takeaway food and the entertainment industry.

Minimising the impact of ageing

Deloitte suggests that Asian countries can act to minimize the impact of an ageing population and declining workforce on economic growth. Strategies include raising the retirement age; encouraging a higher level of participation by women in the workforce; welcoming working age migrants; re-skilling the workforce to be more productive and increasing birth rates.

Act sooner rather than later

Like all megatrends, the business winners will be those who identify the trend early and act appropriately. Markets and investors position for tailwinds, and prefer to exit positions facing headwinds when the wind is more like a breeze rather than a gale. Be prepared to act sooner rather than later.
If you would like to see my interview with Chris Richardson from Deloitte Access Economics, you can view it here.  The full Deloitte paper can be downloaded here.


Australia for income, the rest of the world for growth?

Thursday, October 05, 2017

By Paul Rickard

Australia for income, the rest of the world for growth, is an investment thesis that is growing in popularity. Firstly, because it is borne out by the simple fact that the Australian share market is small on a global scale, concentrated, and heavily skewed in terms of companies represented.

At less than 2% of global stock market capitalisation, the Australian market is just a minnow. This also means that 98% of investment opportunities lie outside Australia. And because the top 10 companies in Australia make up 45% of the local market capitalization, our market is heavily concentrated.

However, it is on an industry sector basis that our market stands out. The two largest sectors, financials and materials, account for 54.3% of the total market, with the other 9 sectors making up the balance. In the USA, these two sectors make up just 17.6% by market capitalization.

Moreover, it is the under representation in growth sectors like information technology and consumer discretionary that really highlights the differences. In IT for example, the Aussie market comes in at a paltry 1.4% compared to the USA’s 23.2%. We simply don’t have the Facebooks, Googles, Alphabets or Amazons.

The following pie charts show the composition of the Australian and US stock markets at 30 September by the 11 industry sectors (same colours).

Australia for income, the rest of the world for growth as a thesis is also supported by the long term data. The following chart from the RBA compares Australian and world share prices over a 23 year period since 1994 using a common base and logarithmic scale. Australia has underperformed quite considerably compared to the USA.

On the income side, Australian dividends over this period have typically been around 2% higher than overseas markets - producing an average dividend yield of around 4% for the Australian sharemarket compared to 2% offshore.

And that’s before the impact of franking credits is taken into account. The dividend imputation system, which is unique to Australia, effectively incentivises companies to pay high dividends and maintain high payout ratios as undistributed franking credits aren’t of any value in the hands of the company, but are of value to Australian resident shareholders. It therefore shouldn’t come as any surprise to learn that Australian companies pay higher dividends than their offshore counterparts.

To be fair to Australian companies, there are some terrific growth companies. Companies such as CSL, Ramsay, Seek, Cochlear and Dominos are world class companies with consistent records of growth over many years. The problem is that they are in the minority - too many companies are growth challenged, with Directors feeling obliged to favour paying dividends over potentially re-investing profits back into the business.

The question investors need to consider is whether this thesis Australia for income, the rest of the world for growth is likely continue in the short to medium term.

2017 so far

Before I address this, let’s have a quick look at how 2017 is shaping up. As the table below shows, it is the same old story.

To the end of September, the US market is up by 12.5% compared to a dismal 0.3% for Australia. For the September quarter, the US market rose by 4.0% compared to a fall locally of 0.7%, and for the month, the US added 1.9% while Australia lost 0.6%.

The picture if dividends are included (total return) is a little better, but directionally the same. For the year, Australia has returned 3.9% compared to a total return of 14.2% in the US.

Can Australia get a growth spurt

The Australian market’s lack of recent performance is due to several factors. Chief amongst these is the perceived “high” aussie dollar up near 80 US cents, which is stopping foreign investors from getting their cheque books out and also undermines the earnings outlook for companies such as CSL, Macquarie and James Hardie. Other factors include the wash up from of an underwhelming profit reporting season in August, anemic top line revenue growth at many major companies (banks, grocery retailers, telcos etc) and a lack of confidence amongst institutional fund managers.

Then there is also the September/October effect, traditionally interesting months and often turning points in the stockmarket calendar. While it is true that October can often be a good month for stocks, memories of October 1987, October 1997 and October 2007 have some investors worrying about the next October ending in a ‘7’ - October 2017 .

Can the Australian share market get a growth spurt? I think that the weight of money looking to invest will eventually be that catalyst, but it will require a positive lead from US markets, strong local employment growth and some of our company CEOs being a little more upbeat on their prospects. This may come in the Company AGM season which kicks off later this month.

That said, I am still betting on Australia for income, rest of the world for growth over the medium term.


ASIC needs to get tough on short sellers

Thursday, September 14, 2017

By Paul Rickard

Short selling of Australian shares is getting dangerously out of control and ASIC needs to act. Sixty companies listed on the ASX now have more than 5% of their ordinary shares sold short. This includes names such as Rio, Seek, Healthscope, Dominos, JB Hi-Fi, Harvey Norman, Oil Search, Flight Centre, Bendigo & Adelaide Bank, Tabcorp and Woolworths.

Short selling, that is selling a stock that you don’t own and hoping to buy it back at a lower price, has a purpose. It can aid the efficiency of the market by reducing wild swings in prices, particularly on the downside, and it can help 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 remove 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.

Let’s look at the extent of the 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 19.7% of its ordinary shares (55 million shares) that have been sold short. This is based on the latest data from ASIC (released Wednesday), and covers position as at the close of business last Thursday, 7 September.

Lithium hopeful Orocobre comes in second with 17.4% of its shares sold short, while major retailer JB Hi-Fi ranks seventh overall with 12.8% of its shares sold short. In the case of JB Hi-Fi, the 14.65 million shares sold short are worth around $340 million. Big bets are being taken on some of these companies.

Highest Short Positions
Looking through the top short positions, three industries dominate the short sellers’ interest. The discretionary retailers, whoich may be impacted by the Amazon threat (and don’t we just keep hearing about how much damage Amazon will do to the industry) are a clear favourite, as are the minerals companies getting ready to produce “next generation” minerals such as lithium, graphite and nickel. Healthcare companies also feature prominently because of elevated earnings multiples. Some of the so-called 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, healthcare and mineral stocks. 
Retailer Short Positions

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 onto their positions for many months. 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 18 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.

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.


CommBank is in the doghouse. Is it a buy yet?

Thursday, September 07, 2017

By Paul Rickard

News that litigation funder IMF Bentham has agreed to fund a shareholder class action against the Commonwealth Bank relating to alleged breaches of the anti-money laundering and counter terrorism financing laws is the latest development to hit the bank. This is one group of CBA shareholders, those who purchased shares between 1 August 2015 and 3 August 2017, effectively suing every other CBA shareholder. Just think of the money and CBA management time that will go into defending this action as CBA shareholders battle it out with each other.

What has been an eye opener in this whole messy saga has been the ferocity with which the public, politicians, media, commentators and CBA’s own shareholders have leapt on to the bandwagon to attack the bank. I am not saying that it is not deserved, but it really does look like a case of the tall poppy syndrome at work. Everything bar the kitchen sink has been dredged up from the past - the financial planning scandal, life insurance definitions with CommInsure, the Storm Financial debacle of 2007, aggrieved BankWest borrowers, leaked internal risk management papers savage CBA’s reputation. Only in Australia.

Since AUSTRAC announced its intention to seek civil penalties for the 53,500 alleged breaches of the Act, CBA shares have shed 9.5% (adjusting for the dividend of $2.30). Compared to its major bank competitors, it has underperformed on a relative basis by between 7.1% against Westpac up to 10.4% against the National Australia Bank.

Major Bank Returns post AUSTRAC

The questions for investors are: is the fall in share price, which has reduced CBA’s market capitalisation by a staggering $13.8 billion, enough and if so, is CBA now a buy?

Relative pricing

One of the methods used to compare the value of different banks is earnings multiples. Others include price/book ratios and the discount or premium to the assessed target price. On an earnings multiple basis, CBA has traded at a premium to the other major banks at times as high as 35% and rarely below 15% over the last five to seven years.

CBA attracted a premium price because it is the market leader or number two player in almost all of the major banking categories (home loans, retail deposits, credit cards, and wealth management); it has the strongest balance sheet; it is the clear leader in technology, having invested in both customer applications and its core banking platform; and arguably, it had the best management team. For shareholders, it delivered the highest return on equity.

However, this premium has now evaporated. As the following table of major broker forecasts shows, CBA is trading on a multiple of 12.8 times FY18 earnings, almost the same as the other major banks.

Major Banks - Forecast Earnings and Dividend Yields (source FN Arena)

On a prospective yield basis, CBA is now up near 6%, higher than the ANZ.

What do the brokers say

The major brokers remain unenthusiastic about the Commonwealth Bank. While most see moderate upside potential in the share price, with the consensus target price of $79.47 a 7.8% premium to yesterday’s closing price, there are no buy recommendations. Of the eight major brokers sampled by FN Arena, there are five neutral recommendations and three sell recommendations. Morgan Stanley currently has the lowest target price of $72.00. 

CBA - Broker Recommendations (source FN Arena)

My view

While I would like to think that CBA at the same multiple as its peers looks very attractive, because this saga is going to drag on for such a long time, thereby distracting management and creating uncertainty, CBA might have to trade at a discount first to attract buyers. APRA is yet to name the panel members for its independent prudential enquiry, which is expected to take six months from commencement. In relation to AUSTRAC, after CBA lodges a defence in December and AUSTRAC responds in March, a directions hearing has been set for 2 April 2018. It may be a year or more before the size of the fine is announced, and some years before the proceedings of shareholder class actions wind up.

In this environment, it is going to be very hard for CBA to get clear air.

Perhaps the appointment of a new CEO, which is now almost certainly going to be an external candidate, could be the catalyst for the public (and the market) to move on and allow CBA to focus on growing revenues and profits.

Until this happens, the risk is that CBA is going to underperform its peers. Buyers can be a little patient.


Ramsay Health Care is still a 'must have'

Thursday, August 31, 2017

By Paul Rickard

Ramsay Health Care, one of Australia’s best companies, delivered a credible full year financial report yesterday. As befits a market leader that trades at premium to its peers, it met its own forecast with core NPAT (net profit after tax) up 12.7% to $542.7 million and core EPS (earnings per share) up 13.0% to 261.4c per share. In February, Ramsay upgraded guidance for both to be in the range of 12% to 14% growth.  

While the full year result was on target, Ramsay’s guidance for FY18 of core NPAT and EPS growth of 8% to 10% was less than some analysts had anticipated, and the market sold the shares down 5.3% to close at $68.10. On the long-term chart (see below), this will only appear as a small blip.

Only two months into the new financial year, it is probably understandable for Ramsay to be a little cautious on the numbers, particularly as it has a history of upgrading guidance as the year progresses. While noting the challenges with the operating environment in Europe, the company expects “strong growth” with the mainstay Australian hospitals business.

Let’s take a closer look at the numbers and see if there are any concerns.

Full year result

Group revenue grew by 0.2% to $8.7 billion over the full year, or 4.1% in constant currency terms. With tight cost control, core NPAT grew by 12.7% over the year to $542.7 million. While the second half’s core NPAT of $274.9 million was only up 2.7% on the first half, it was still up 12.7% on the corresponding half in FY16.

The second half (January to June) is only 181 days, and in Australia at least, surgical procedures in the January holiday period are light and hospital admissions fall. That said, the performance of the key Australian hospitals division, which generates 50% of Group EBITDAR (earnings before interest, tax, depreciation, amortization and rent/restructuring costs) , wasn’t as strong in the second half. While revenue was up 5.1% compared to the corresponding half in FY16, it was down on the first half with a fall of 1.8%.
Group and Segment Financial Metrics

Ramsay noted that operational efficiencies with its Australian hospitals led to an improvement in its EBIT margin of 80bp for the full year - from 13.0% in FY16 to 13.8% in FY17.

With regard to its outlook for Australian hospitals, Ramsay says that operations and admissions continue to trend up as expected with an ageing and growing population, and points to opportunities for out-of-hospital growth opportunities in adjacent businesses including retail pharmacy.

In France, Ramsay Generale de Sante grew revenue by 0.3% over the year and EBITDAR by 0.6%. This was achieved despite the pressure on tariffs by volume growth and strong cost control. Although down on the corresponding period in FY16, EBITDAR in the second half of €242.2 million was up 17.5% on the first half. Looking ahead, Ramsay says that “the election of the new government has seen an uplift in business and consumer sentiment, which bodes well for the future in that country”.

The UK, which is the smallest of Ramsay’s three operating segments, grew EBITDAR by 1.8% on revenue growth of 4.6%. Second half EBITDAR was up 20.3% on the first half. Ramsay says that its cost restructure program carried out in 2017 is delivering operational efficiencies. While the UK remains a challenging environment, the tariff increase scheduled for April 2018 will assist.

Ramsay’s growth strategy

Ramsay continues to execute its four-pronged growth strategy. Firstly, organic growth underpinned by the demographics of an ageing population and increased demand for services from quality operators, and secondly, brownfield capacity expansion to cater for unmet demand. In FY17, Ramsay completed, or commenced, projects worth $500 million that will add 500 beds, 27 operating theatres and 3 private emergency centres. It opened two brand new facilities: The Border Cancer Hospital in Albury Wodonga and the Southport Private Hospital, and completed several brownfields projects.

The development pipeline for FY18, which is worth $385 million, includes the Northside Clinic at St Leonards in NSW, Albert Road Clinic, Lake Macquarie, St Andrew’s Private Hospital at Ipswich as well as Croydon Day Surgery in London and Tees Valley Private hospital in Middlesbrough.

The third prong involves public/private collaborations, as governments look for private operators to provide services to public patients. The fourth prong is acquisitions and strategic opportunities. The Ramsay Retail Pharmacy franchise network, which is on track to total 55 retail pharmacies in sites close to hospitals so that Ramsay can extend both medication and other services to patients beyond the hospital walls is an example of a strategic opportunity.
What do the brokers’ say?

Prior to the result, the brokers were marginally positive on the stock. According to FN Arena, of the 6 major brokers who follow the stock, there were 2 buys and 4 neutrals. The consensus target price was $74.99. This is likely to be downgraded a touch in the coming days, as the consensus forecast was for EPS growth in FY18 of 11.1% rather than Ramsay’s guidance of 8% to 10%.

On a multiple basis, Ramsay is trading at yesterday’s closing price of $68.10 at 26.1 times trailing core EPS, and on a forecast basis, 23.9 times FY18 earnings. The yield is 2.0%.

Bottom line

History says to pay a premium for companies that can consistently deliver profit growth. Since 2014, Ramsay has grown profit at CAGR (compound annual growth rate) of 16.2% and EPS growth of 16.9%. Next year’s guidance of 8% to 10% shows that the market is getting a little tougher, but my guess is that this is the board being a little conservative rather than any new industry headwinds coming their way. They can’t control the strength of the Aussie dollar, which shows few signs of wanting to head south. And while Europe might remain challenging, management seems remarkably confident about the growth opportunities in Australia.

On a multiple basis, there is no doubt that Ramsay is an expensive stock. But with premium companies, you need to buy when others want to sell, and I reckon this might be a bit of a buying opportunity.

I am an investor in Ramsay and it will remain a core stock in my portfolio.


Can Woolworths WOW the market next year?

Thursday, August 24, 2017

By Paul Rickard

Woolworths' CEO Brad Banducci delivered a very impressive full-year profit result yesterday. But the good news was already in the price. After opening almost 2% higher, Woolworths shares faded during the day to close (in a weaker market) at $26.94, down 12c or 0.44%.

As the chart below shows, Woolworths shares have risen by more than 20% over the last 12 months, and some 32.7% from the low of $20.30 in early July 2016. The market has well and truly telegraphed the recovery in the underlying business. Moreover, this has occurred in a hyper-competitive environment (Coles, IGA, Aldi, Costco), with the impact of Amazon and German retailer Kaufland still to come.

Woolworths - Aug 12 to Aug 17

Source: ASX

So, what was impressive about the Woolworths result?

Well, it wasn’t the headline number of NPAT from continuing operations of $1,422.1m. While this was better than analysts had forecast, it was still down 3.6% on the result for FY16.

The real highlight was the performance of the Australian supermarkets division. In particular:

  • It smashed Coles in the sales war. In the final quarter of FY17, comparable store sales growth in food was 6.4% (adjusted for the timing of Easter). Coles, on the other hand, only achieved sales growth of 0.6%;
  • The net margin in the supermarket business (EBIT to Sales %) improved in the second half to 4.48%, from 4.34% in the first half;
  • Second half EBIT of $791.5m was up by 13.2% on the corresponding half in FY16 of $699.4m. And although second half EBIT was down 2.5% on the first half, the former  had 25 trading weeks compared to the 27 weeks for the first half; and
  • Pointing to ongoing momentum, comparable store sales for the first eight weeks of FY18 are up by around 5.4%.

 Comparable Store Sales Growth

Other highlights included the performance of Endeavour Drinks, which in a very competitive market, achieved sales and EBIT growth, the latter by 3.9%. Financially, Woolworths strengthened its balance sheet by reducing net debt by $1.2bn, improved free cash flow, and lifted the return on funds employed from 21.7% to 22.3%. Shareholders were rewarded with a total dividend of 84c per share - up 7c on FY16, and about 9c higher than analysts had forecast.

Divisional EBIT

Big W continues to be the problem child for the group, although there were signs that sales are starting to stabilise. Final quarter comparable store sales growth, though still negative, improved to be down by 3.9%, better than the full-year slippage of 5.7% and the performance of competitor Target.  

EBIT for Big W slipped to a loss $150.3m for the full year ($123.3m for the second half). Looking ahead to FY18, Woolworths warned that the turnaround would be a multi-year journey, and while they hope to stabilise sales in FY18, underlying trading performance was not expected to improve due to the investment in product range, price and customer shopping experience.  

What do the brokers’ say?

Going into yesterday’s result, the brokers’ viewed Woolworths as fully priced. According to FNArena’s data on the major brokers, there were three buy, one neutral and four sell recommendations, with a consensus target price of $26.41, a 2.0% discount to the current share price. Although the FY17 result came in better than expected, the subdued outlook for Big W will temper upward revisions to earnings forecasts, and it is unlikely that there will be material changes to the target prices or recommendations.

Woolworths is trading at pretty hefty multiples, 24.3 times on a trailing basis to FY17 earnings, and 21.4 times on forecast FY18 earnings. This compares to Wesfarmers, which is trading on a multiple of 16.4 times FY18 earnings.

Trading Multiples (Woolworths and Wesfarmers)

Bottom Line

The turnaround that Woolworths has achieved with the Australian supermarkets business has been impressive, and they clearly have sales momentum over arch rival Coles. But this is an industry facing significant competitive headwinds. Further, Big W will be a drag on earnings for some time.

Low-growth industry, increasing competition, low dividend yield and a heady pricing multiple don’t add up to a buy in my book. I am not sure that Woolworths is a sell (yet), but it is not a buy. 

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


CSL’s 'exceptional' result fails to inspire market

Thursday, August 17, 2017

By Paul Rickard

CSL must be close to, if not the best, Australian listed company. Shareholders who were lucky enough to participate in the privatisation of the old Commonwealth Serum Laboratories in 1994 paid $2.30 for their CSL shares. Twenty three years later, and following a 3 for 1 share split in 2007, those shares are now worth a touch over $125. A capital return of 16,300%.

CSL Share Price - 1994 to 2017

Source: CommSec

And while CSL chooses to largely re-invest and doesn’t pay high dividends, on a per share basis, dividends have also grown very impressively. In its first full year as a private company in 1995, it paid 12c in dividends. This year, shareholders will receive 175.6c - a factor increase of almost 15 times. A great example of “dividend growth”.

Yesterday, CSL announced its full-year profit result. While CSL exceeded its own profit guidance, it didn’t quite live up to some of the analysts’ expectations about growth going forward, and eased on the market, slipping 1.5% to close at $125.27. That’s what happens sometimes - let’s take a closer look.

The CSL Result

The result was headlined as “CSL delivers exceptional performance”, with net profit of US$1,337m, up 16% on FY16. On a constant currency basis (CSL’s preferred measure), NPAT grew by 24% to US$1,427m, higher than CSL’s guidance in February for profit growth in the range of 18% to 20%.

Total revenue for the group increased on a constant currency basis by 15% to US$7,002m. The CSL Behring business, which contributes the lion’s share of the revenue at US$5,891, grew revenue by 12% on a constant currency basis. Immunoglobulins, where CSL is the global leader, saw revenue growth of 14%.

Revenue from the recently acquired loss making Seqirus influenza business increased by 23%. CSL says that this business is tracking to plan and it should break-even in FY18.

Other highlights included:

  • Strong early demand for CSL’s new haemophilia product, IDELVION;
  • The company is very excited about its specialty product HAEGARDA, which was launched in July. This product prevents HAE (Hereditary Angioedema) attacks, a very rare and potentially life threatening condition; and 
  • The acquisition of a majority stake in Chinese plasma manufacturer Ruide closed on 2 August. CSL expects the plasma market in China to grow over the next 5 years at circa 15% pa, with demand forecasted to outstrip supply.

Looking ahead, CSL has guided to revenue growth in FY18 of 8% on a constant currency basis, and underlying NPAT in the range of $1,480m to $1,550m - an increase of 10.6% to 16% on a constant currency basis. The broker analysts were a little underwhelmed by this guidance, in part because a return to profitability for the Seqirus business implies a slower rate of growth in profit by the CSL Behring business, and some of the bullish discussion on the new products.

CSL says that it is investing to support sales growth, and that capex in FY18 will be US$900m to US$1bn. With this level of capex and net debt to EBITDA at 1.5 times, the higher end of CSL’s target range of 1.0 to 1.5, CSL won’t conduct a further share buyback in FY18 when the current on-market buyback completes.

CSL also pointed to FX headwinds, particularly with the sharp appreciation of the Euro and Swiss Franc against most currencies in the last six weeks of the financial year. While CSL sells in 60 countries, the bulk of its manufacturing is located in Switzerland and Germany. 

The Brokers

Going into yesterday’s financial report, the six major brokers who cover the stock were fairly positive on CSL. According to FNArena, there were 4 buys and 2 neutral recommendations on the stock. The consensus target price was $137.87, a 10.1% upside to the current price. Analysts were forecasting FY18 earnings per share to grow by 18.5%.

With CSL now guiding to a lower rate of profit growth, forecasts are likely to be revised down a touch, although there was a sense at the briefing that Management was being somewhat conservative. This may also lead to a small reduction in the consensus target price.

Bottom Line

CSL is trading on a multiple of around 29 times FY18 earnings, which is not cheap by any standards. That said, there aren’t too many companies that have been able to consistently grow earnings at double digit rates of growth. And arguably, it is Australia’s best company and should be a core stock in growth portfolios. 

Around $125, CSL is no bargain buy, and if the Aussie dollar tracks higher, this will hurt the share price. But don’t expect too much of a sell-off - dips will be keenly bought. If you don’t own any CSL shares, put it on the shopping list.  

Disclosure: The author and his SMSF own shares in CSL.


Forget AUSTRAC, CBA result is good news for bank shareholders

Thursday, August 10, 2017

By Paul Rickard

Commonwealth Bank’s AUSTRAC fiasco has become a classic media beat-up. Led by the anti-business ABC, supported by some Fairfax cheerleaders, and then the usual cabal of Canberra politicians, this story has been done to death. CBA has been tried, found guilty, and hung by the media before it is yet to even file a defence. This is not the making or breaking of the Australian banking industry.

Sure, CBA deserves a material fine, some Executive heads need to roll, and it is quite proper that the CBA Board has slashed bonuses and set up an independent Board Committee to oversee the remediation programme. Further, the Bank hasn’t handled the incident well, starting from a fumbled response last Friday when the story broke, selective media interviews on Sunday (rather than a full press conference), and the lack of contrition in its response.

It is this lack of contrition that really gets the public mad, and comes after earlier failings with life insurance, financial planning and Storm Financial. Facts such as the CBA making 4,000,000 suspicious transaction reports each year to AUSTRAC -  12,000,000 over the period in question - fail to get a mention because the public is so annoyed with the banks inna general, and CBA in particular. Instead, the media multiply the number of offences (circa 53,000) by the maximum fine to beat the story up and come up with an absurd statement that the fine could be in the “trillions of dollars”. Even claims of “billions” are arrant nonsense.

As an ex CBAer, I am going to be accused of being “part of the family” and having lost perspective on this issue. But unless there has been a cover-up by management or they negligently dismissed advice to fix the problem, I don’t think so. It is possible that overseas regulators such as the US Federal Reserve might show an interest and conduct their own investigations, which may lead to other fines, however I think this is unlikely.

Investors should keep perspective and focus on CBA’s bottom line. Yesterday’s full-year profit result ticked most of the boxes.

CBA’s Profit Result

CBA reported a cash profit of $9.88bn for the full year, up 4.6% on the prior year and about $100m better than market forecasts. For the June half year, the cash profit was $4.97bn, up 7.1% on the corresponding period in 2016.

Highlights of the result included:

  • Stable Net Interest Margin (NIM) in the second half of 2.11% (same as first half);
  • Improved Return on Equity for the half year of 16.1% (16.0% in the first half);
  • Higher than expected final dividend of $2.30 per share (compared with $2.22 in FY16). For the year, total dividend of $4.29 compared with analysts’ forecasts of $4.25;
  • Positive jaws - for the year, operating income grew by 3.8%, while operating expenses grew by 2.4%, for an increase in underlying operating performance of 4.8%;
  • Group’s capital ratio (CET1) rose, largely due to organic growth, to 10.1%;
  • In the Retail Bank, a cost to income ratio of 30.8%;
  • Home loans distributed through proprietary channels rose to 57% (broker channel down to 43%); and
  • Impairment expense remains low at 15bp. For the half year, $496m compared with $599m in the first half.

On the other side of the ledger, weaker parts of the result included:

  • An underwhelming performance from Bank West. Negative jaws and an increase in loan impairment losses led to a fall in cash profit of 9.8%;
  • Disappointing performance from the Wealth Division, although the second half was an improvement on the first half. Increased income protection claims led to a fall in insurance income;
  • Market share falls in most products, although home loans grew a little faster than system; and
  • Interest only loans represent 39% of the home loan book, well above APRA’s target of 30%.

The Bank also announced that it is in discussions with third parties about its life insurance businesses in Australia and New Zealand (operated by CommInsure and Sovereign respectively), which may lead to divestment in due course.

Bottom Line

Looking ahead to the next financial year, CBA faces some financial headwinds:

  • The Federal Government banking levy, which CBA says will cost the bank $369m pre tax, or $258m post tax;
  • The crazy South Australian banking levy. At 6% of the national total, this could be another $22m pre tax ($15m after tax). If WA or other states choose to follow suit, this could yet become material;
  • A fine from AUSTRAC. I reckon that this will be closer to $100m than $1,000m - time will tell. The real cost for the CBA will come in the extra ongoing compliance costs as it beefs up resourcing and systems to prevent breaches happening again.

However, the capital cloud has been lifted, the net interest margin has stabilized (showing the pricing power of the banking majors), interest rates will head higher, which will be a positive for margin, bad debts remain under control, and there is still an enormous opportunity to take out cost.

At $81.11, CBA is not cheap and is trading at a premium to its rivals. However, with the earnings and dividend clouds removed and a reasonable expectation that they can be maintained if not increased in the years’ ahead, a 5.3% fully franked dividend yield (7.5% grossed up) looks tempting. CBA is in buy territory.

CBA trades ex the $2.29 dividend on Wednesday 16 August. A 1.5% discount will apply to shares issued under the dividend re-investment plan. Shareholders can elect to participate in the scheme if they notify the Registry by Friday 18 August.


Do you want to own a second-tier UK bank?

Thursday, August 03, 2017

By Paul Rickard

Do you want to own a second-tier UK bank? National Australia Bank (NAB) shareholders who were “gifted” shares in CYBG Plc, the holding company for the Clydesdale and Yorkshire Banks, should periodically ask themselves this question for two reasons. Firstly, because the shares are often in the “nuisance” category, and secondly, CYBG is really just a minnow in the UK banking market.

Back in February 2016, NAB decided to exit UK banking and their ownership of the Clydesdale and Yorkshire Banks. NAB shareholders were given one share in CYBG (quoted on the ASX under code: CYB) for every four shares they owned in NAB. For example, if you owned 1,000 shares in NAB which were then worth around $30,000, you received 250 CYB shares worth $1,000 (the exact cost price for each CYB share for CGT purposes was $4.01). In relative terms, the CYB shares were about 3% of their NAB investment - nuisance value for many shareholders.

Despite a share sale facility that saw 140,000 CYB shareholders with less than 100 shares exit in early July and receive $4.76 per CYB share, there are still some 240,000 Australian shareholders who have a holding of less than 5,000 CYB shares. Based on yesterday’s closing price of $4.72, shares worth less than $23,600.

They will be pleased to see that CYB has released an encouraging third-quarter trading update that shows it is on target to meet its FY17 fiscal and strategic objectives. However, the question remains that as CYB is a second-tier player in a foreign banking market, is there any strong reason for Australian shareholders to continue with their investment?

Image: Cash machine at a Clydesdale Bank's Piccadilly branch, London. Source: AAP.

CYB’s targets

CYB is a northern English and Scottish retail and small business bank, with 2.8m customers and £30.7bn in loans. Its strategy is to offer a differentiated customer experience delivered brilliantly through an omni-channel mix (digital, branches, contact centres and third party). Financially, this translates to the following medium term metrics:

By Australian standards, these aren’t particularly exciting or challenging targets. Australian Banks have ROEs (return on equity ratios) of around 14% (CBA is the highest at 16%, ANZ the lowest at 12.5%), while cost to income ratios for our majors are in the low 40’s (CBA’s retail bank is nearing 35%). For CYB, however, these targets are a long way off. In the first half of FY17, CYB had a cost to income ratio of 70% and the RoTE was just 6.3%!

The third-quarter update showed that CYB is nevertheless making solid progress. Mortgage growth of 5.8% with record application volumes in the third quarter, loans to small business up by 4.7%, a small increase in net interest margin (NIM), a CET1 capital ratio of 12.4%, and an efficiency program running ahead of guidance that should see operating costs for the full year of less than £680m compared to previous guidance of £690 - £700m. 

In the medium term, CYB’s strategy to improve shareholder returns involves an aggressive cost out plan which includes branch closures, head count reduction, business simplification, process re-design and organisational design, and digital transformation by leveraging their “market leading banking platform”. In regard to the former, they are running marginally ahead of schedule.

CYB’s “market leading banking platform” is known as iB, a set of microservices and APIs sitting over a core banking platform to manage interactions with customers and staff, and provide access to real time data and insights. While this digitization strategy should be an important enabler to positioning the Bank for future growth, caution is required as residual legacy issues from the core banking platform (which is not being changed) may limit the capability of what is offered. 

In the first half, the Bank reported an underlying profit of £123m, up 15% on the corresponding half in FY16. With the third-quarter results pointing to an improved cost outcome, broadly stable NIM and asset growth in line with the target, the Bank is on track to record an underlying profit of £250-£255m this year. The payment of an inaugural dividend has also been telegraphed.

What do the brokers say?

The major brokers who cover CYB are largely neutral on the stock, with one buy, two neutrals, and two sells. According to FNArena, the consensus target price for the stock is $4.93, a 4.4% premium to the last price. Individual recommendations are as follows:

On a multiple basis, the analysts have CYB earning 19 pence or 32.0 Aussie cents in FY17. This puts it on a multiple of 14.7 times FY17 earnings. Earnings for FY18 are forecast to rise to 37.6c, giving it a multiple of 12.5 times.

Bottom Line

The multiples aren’t cheap, but when a Bank has a RoTE of just 6.3% and a cost to income ratio of 70%, there has to be considerable upside opportunity. Then again, it is a second-tier bank operating largely in regional markets, and it is going to remain a second-tier bank.

If you don’t mind the nuisance value of the investment, hang on for the ride. Otherwise, look at one of the Australian majors.



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