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

Coles demerger is no silver bullet

Thursday, March 22, 2018

It always pays to be wary when the price of a stock jumps suddenly following 'news'. Particularly when that news has absolutely nothing to do with value creation. This is exactly what happened to Wesfarmers last Friday.

On the back of an announcement that Wesfarmers is set to demerge the Coles business (supermarkets, liquor stores and convenience stores), its shares jumped by 6.3% from $41.20 to $43.80. In market capitalisation terms, it added (“wiped on”) a staggering $3bn.

But no new value has been created. Not a single dollar of earnings has been made. All that has happened is the development of a plan for Wesfarmers shareholders to exchange a share in the current business for a share in Coles and a share in a new Wesfarmers (ex Coles). Purely a paper transaction.

And because there will be costs to implement this plan (stamp duty, legal fees, advisers fees etc), Wesfarmers shareholders in aggregate will be poorer initially.

That doesn’t mean that the plan isn’t without merit, and that it won’t ultimately be a positive in the long run for shareholders. Recent demergers, such as S32 and CYBG, have done reasonably well once the initial overhang of stock has been cleared (typically, this takes about 6 months). However, the proof will ultimately be in the delivery, rather than the expectation. This is one of the reasons that Wesfarmers shares have eased this week, pulling back to $43.05 yesterday as saner heads prevailed.

Rationale for the demerger

Wesfarmers rationale for the demerger is pretty straightforward. It reckons that Coles is impacting its return on capital. Coles contributes 34% of the conglomerate’s EBIT, but employs 61% of the capital. By getting rid of Coles, the return on capital employed for the new Wesfarmers will be a lot higher.

Wesfarmers will also be in a position to focus on organic growth opportunities with the remainder of its portfolio (Bunnings, Kmart, Target, Office Works and Industrials), and acquire new businesses.

Further, a newly established company comprising supermarkets, liquor and convenience stores will prove attractive to investors who want predictable and resilient earnings. Investors will pay for the defensive characteristics of the Coles business.

The sum of the parts will be greater than the whole.

As one of Australia’s last real conglomerates, Wesfarmers has a multi-decade history of active portfolio management – acquiring and disposing of businesses – and so a rationale based on improving its return on capital employed is credible. This is also borne out by the history of demergers in Australia, which in the main, have been largely successful. In addition to CYBG and S32, names such Treasury Wine Estates, Bluescope, Dulux, Orora and BT Investment Management come to mind. Maybe it is a result of “freed up/refreshed” management making the difference – big isn’t always better.

But the surviving company doesn’t always fare so well, and the Wesfarmers mergers and acquisitions team will need to take a cold shower and be careful about blowing money on new acquisitions.  Their recent track record on this front is pretty poor. The disaster of the Homebase stores acquisition in the UK, which within two years of announcement has been written down to zero, comes to mind. And if you care to go back a little further, a case can be made that the acquisition of the whole Coles group in 2007 has delivered less than stellar results for shareholders.

What do the brokers say

According to FN Arena, the major brokers are largely positive on the proposal. That said, only one of the brokers upped their target price, with Morgans arguing that “a greater focus on existing businesses should lead to improved growth prospects” and raising their target from $41.18 to $44.65.

Morgan Stanley, which has an underweight call on the stock, maintained its target price of $40.00. It said that “it does not believe a separate Coles will drive accountability or performance, and incremental costs of $10-$20m should be expected as Coles operates as a separate entity”.

The consensus target price is currently $43.06, fractionally above yesterday’s closing price of $43.05. There are 2 buy, 5 neutral and 1 sell recommendation as shown in the following table.


My view

Wesfarmers has traded in an incredibly narrow trading range over the last five years (see chart below). Essentially, it has been a buy around $37 and a sell around $44. Time spent below or above these levels has been fleeting.


While I think the demerger should be good for the company, Wesfarmers has blotted its copy book over the last few years. It allowed Woolworths to crawl back and take the lead in the super-market wars, and its foray into the UK hardware/homewares market through Homebase has been a disaster. Although Rob Scott has recently come on board as CEO and is a “cleanskin”, I get nervous when he starts talking about “value accretive transactions”.

I have been a supporter of Wesfarmers on grounds that it is better value than Woolworths (it is g on a multiple of 18.5 times forecast earnings compared to Woolworths 21.5 times), it has the powerhouse of Bunnings Australia and I think there is value in the conglomerate moderate. However, the market looks to me that it has been a little premature in subscribing value to the proposed transaction. Wesfarmers is more of a sell than a buy at these levels.


Shorten’s naked tax grab may lead to more buybacks

Thursday, March 15, 2018

Bill Shorten’s proposed changes to the dividend imputation system are a naked tax grab. They are not about making the system more equitable, and they are not closing a “tax loophole”.

The changes, which would see an end to the Australian Taxation Office paying cash refunds to taxpayers who have excess imputation credits, is set to raise $59bn over 10 years.  To start from 1 July 2019, it will raise more than $5bn in its first year.

Self-funded retires and pensioners will be particularly hard hit, as will non-working spouses and part time workers who have share investments. In fact, anyone whose marginal tax rate is less than 30%, which includes all superannuation funds and persons with incomes under $37,000, could be impacted. At least 1.12m taxpayers will be worse off – and potentially a lot more if some public offer super schemes are also caught.

And because Bill and his team have a realistic chance at winning the next election, companies will act by bringing forward the payment of special dividends and off-market buybacks.

More on this later. First, let me explain why Shorten is not “closing a tax loophole” and why this is a naked tax grab.


Dividend imputation exists to eliminate the double taxation of company profits. If a company makes a profit, it pays tax on that profit at 30%. If the company then pays a dividend out of its after-tax profit, that dividend is taxed in the hands of the shareholders at their marginal tax rate, which could be as high as 47%. The original profit has been taxed twice – once in the hands of the company, and once in the hands of the shareholders.

Paul Keating recognized that company profits were, through double taxation, effectively being taxed at punitive rates and introduced the system of dividend imputation in 1987. The system effectively rebates through imputation credits (also called franking credits) the tax that the company has already paid, so the profit is only taxed in the hands of the shareholder.

Critically, the system only recognizes company tax that has been paid to the Australian Taxation Office, so if companies aren’t paying tax in Australia, they can’t frank their dividends. This is why companies such as CSL, which earns more than 90% of its revenue outside Australia and pays tax to foreign governments, can’t frank its dividends. It simply doesn’t pay enough company tax to the ATO.

In 2000, an enhancement to the scheme was made by Peter Costello to refund excess imputation credits in cash. The purpose was simple – to make sure that every shareholder (taxpayer) gets the same benefit. This is what Shorten now proposes to axe.

Let’s take an example to demonstrate the point. Suppose that a company makes a profit of $100, pays tax of $30, and then distributes a dividend of $70 to its shareholders. Because it has paid the full amount of company tax, it can fully frank the dividend. Consider five shareholders – with respective marginal tax rates of 47% (the highest), 30% (potentially another company), 19%, 15% (a super fund in accumulation phase) and 0% (a super fund in pension phase or an individual earning less than $18,200).

Dividend Imputation by Shareholder Tax Rate

For a shareholder paying tax at rate of 47%, both the dividend of $70 and the imputation credits of $30 are included in their taxable income. Tax of $47 is assessed, and then the imputation credits act like a tax rebate, meaning that the net tax payable is $17. On the profit of $100, the company has paid $30 in tax, and the shareholder $17 (total $47).

In the case of a shareholder paying tax at 30%, such as another company, the gross tax payable on the taxable income of $100 is $30. After deducting the imputation credits, the net tax paid is $0.

For shareholders paying tax at 19% or 15%, the imputation credits more than offset the gross tax payable. The excess imputation credits are then refunded in cash, meaning that the shareholder has in addition to the dividend, received a cash payment from the ATO.  Finally, for a shareholder with the best marginal tax rate of 0%, they pay no tax and get the imputation credits refunded in full.

This table highlights two important points. Firstly, the total amount of tax paid to the ATO on company profits depends on the tax rate of the shareholder. If the shareholder is a low rate or 0% rate taxpayer, the Government’s take is small. Conversely, if the shareholder is paying tax at the top rate, company profits are effectively taxed at 47%.  Whether this is right or wrong is arguable, but it is totally consistent with a progressive taxation system.

Secondly, it is utter nonsense by Shorten and his cronies to say that denying the refundability of excess imputation credits is closing a “tax loophole”. There is no loophole, but rather a system where every taxpayer gets the same benefit – their tax is reduced by the same $30 (reflecting the tax the company has paid). What could be more equitable than this?


Clearly, some of the strong dividend paying stocks will look less attractive to investors. Telstra, which pays a fully franked dividend of 22c per share, is probably the best example. For a shareholder with a tax rate of 0% (such as a SMSF in pension phase or retiree with limited income investing outside super), on a purchase price of $3.40 per share, this translates to a yield of 9.2%. Take away the refunding of the franking credits, the yield is crunched to 6.5%. Still interesting, but a lot less exciting. Impact – the share price will fall.

The banks and other high paying dividend stocks could also be impacted.

But there will also be offsetting actions that some companies will take. Because the change won’t come into effect until the start of the 2019 tax year, some Boards will “read the tea leaves” and accelerate the payment of special dividends. Companies with strong capital positions and healthy franking account balances will undertake off-market buybacks. These allow companies to buy their shares back at a discount to the then market price, and are particularly attractive to zero rate taxpayers who can get their excess imputation credits refunded in cash. Take way this aspect, as Shorten proposes, and off-market buybacks as we know them could well be a thing of the past.

One thing we can be certain of is that Shorten’s proposal will become a hot political issue. And in due course, will be seen for what it is - a naked tax grab.


Ramsay feels some pain

Thursday, March 01, 2018

It’s hard work being a “market darling”, particularly when you have a track record of surpassing market expectations. When you then miss – even if it is only a small miss – the market can be pretty punishing.

That’s what happened yesterday to Australia’s largest private hospital operator, Ramsay Health Care, when it reported that its core earnings for the first half had grown by 7.5% to $288.0m and core EPS (earnings per share) by 7.8%. This was below Ramsay’s guidance range for the full year of an increase of 8.0% to 10.0%, and its shares were sold off, losing 5.75% on the day or $3.90 to close at $63.90.

Analysts had been expecting Ramsay to do better, with consensus forecasts for the full year dividend to grow by 14.3% (Ramsay lifted its interim dividend by 8.5% to 57.5 cents per share), and top line revenue growth of almost 7% for the Australian hospital division (Ramsay achieved top line growth of 4.3%).

But it did reaffirm full year guidance of cores EPS growth of 8.0% to 10.0%.

So, how should you play Ramsay? Firstly, let’s take a closer look at the results.


For Ramsay, the result is a tale of two continents. A strong performance in Australia due to cost efficiency programmes, and a weak performance from France and the UK where revenue fell.

Overall, Group revenue grew by 3.0% to $4.4bn, EBIT by 1.5% to $470.4m and Core NPAT by 7.5% to $288.0m.

Australian hospitals, which contribute 55% of Group EBITDAR, lifted earnings by 9.1%. Although revenue only grew by 4.3%, Ramsay was able to improve its EBIT margin from 14.6% to 15.3%, mainly due to operational efficiencies and a cost restructuring programme implemented over the last 2 years. By way of comparison, Ramsay’s main competitor, Healthscope, saw its margin get crunched from14.3% to 11.6% in the December half.

Looking ahead, Ramsay expects continued volume growth, and says that the recent focus on improving the value and affordability of private health insurance will be a positive for the sector. It says that the reimbursement environment with the private health funds is stable, with most arrangements negotiated in FY17 with multi-year terms. It is also sees opportunities with non-hospital earnings – pharmacy being an example, where it now has 54 pharmacies.

Brownfield developments to hospitals and clinics (beds, theatres, suites) remain a key part of the growth strategy, with $57m of work completed in the first half, $147m set to open in the second half, and $156m in the first half of FY19. The company is currently considering expansion business cases worth over $500m, including a major expansion of the Joondalup Health Campus in Perth.

The French hospitals’ business, which accounts for 35% of Group EBITDAR, saw revenue decline by 1.1% to 1,066m. EBITDAR fell by 5.8% from 206.1m to 194.1m. According to Ramsay, overall admission growth and strong cost management mitigated the negative tariff setting.

In a slightly more upbeat assessment, Ramsay says that the tariff decrease slated for March 2018 is a little lower than anticipated. They are progressing a centralisation programme in France, which will see functions such as finance, admin and HR removed from hospitals and located in a separate shared service centre. When implemented, this is expected to save £5m pa.

UK hospitals were impacted by NHS (National Health Service) demand management strategies, with revenue falling by 4.8% to £206.2m. EBITDAR fell by 4.6% to £49.4m – about 10% of the Group. A positive tariff adjustment will take affect from 1 April. On the volume front, Ramsay expects normal volume growth to return in the short to medium term.


Going into the results, the Brokers saw upside in Ramsay. According to FN Arena, there were 2 buy recommendations and 5 neutral recommendations, and a consensus target price of $73.26 (see table below – data sourced from FN Arena).

Broker Recommendations (prior to result)

Brokers were also forecasting earnings per share growth of 9.8% in FY18, and a further 9.5% in FY19.

With the December half result a little less than anticipated, and ongoing challenges in Ramsay’s European business, the coming days will probably see brokers make some minor downgrades to earnings forecasts and target prices.


With attractive demographic sector fundamentals, combined with their very strong record of execution, I have long argued that Ramsay Health Care should be a core stock in your portfolio. While the December result was a little disappointing, Ramsay’s reaffirmation of full year guidance is important, and I can’t see cause to change my view.

On last night’s close at $63.90, Ramsay is trading on a multiple of 22.2 times FY18 earnings and 20.4 times forecast FY19 earnings. It is not that cheap, and with earnings growth slowing (from the low teens to high single digit over the next few years), the risk is that there may be a further PE de-rating.

I think that this is unlikely, with fund managers looking at any price weakness as an opportunity to top up. A hold for me at these levels – buy in market weakness. 


Hard work ahead for Wesfarmers

Thursday, February 22, 2018

New Wesfarmers boss Rob Scott has a big job in front of him. Yesterday, Wesfarmers released its first half profit results, which showed that Group EBIT (excluding significant items) fell by 3.3% to $2.35bn and NPAT (excluding significant items) by 2.7% to $1.54bn. The star performer was the local Bunnings Warehouse business, which grew EBIT by 12.2% to $864m and topped (for the first time) the Wesfarmers divisional league table. It also reported comparable store sales growth for the second quarter of 7.5%.

At the other end of the league table was Bunnings United Kingdom and Ireland. Less than two years after acquiring the Homebase stores franchise and attempting to “bunningise” the UK, Wesfarmers has written off the whole investment of $777m, booked an inventory write-down of a further $66m, and set up a provision of $70m for store closures. To add salt to the wounds, the division reported an operating loss for the half of $165m.

Such are the challenges of running Australia’s largest conglomerate. One division firing, another in the doldrums.

And that was the common theme. Strong performances from Officeworks, Kmart and Resources, were offset by weaker earnings from the all-powerful Coles supermarket division, Target, Fertilisers and Industrial & Safety.

The following table shows high level segment performance. Due to the ongoing supermarket war and lower fuel volumes in convenience stores, earnings from Coles fell by 14.1% to $790m. Highlighting the competitive environment, the net margin fell from 4.6% of sales to 4.0% during the half year. On the other hand, the resources division benefitted from higher coal prices and stronger production, with EBIT increasing 51.4% to $209m.

Divisional EBIT


Encouragingly, Coles reported second quarter comparable store sales growth of 1.3%, up from the 0.3% in the first quarter and better than most analysts had forecast. This is still likely to be smashed by competitor Woolworths, who reported growth of 4.9% in the first quarter and are due to report their second quarter sales figures tomorrow. Coles also reported transaction growth, units per basket growth and customer satisfaction improvements.

Comparable Store Sales Growth


While noting the momentum with the supermarket business, Management said that it expects price deflation to remain at elevated levels and divisional earnings in the second half will be affected by increased staff costs and lower earnings from the convenience stores.

Problem child Target continued its horror run, with sales falling by 6.5% compared to the corresponding quarter 12 months earlier. Wesfarmers didn’t disclose Target’s loss for the period, but said that trading margins had improved, it is working hard to reduce costs and the re-set of product, price and range continues.

For shareholders, Wesfarmers maintained its interim dividend of $1.03 (fully franked) per share. Cash generation was strong due to improvements in operating cash flow and working capital inflow, allowing Wesfarmers to increase net capital expenditure while reducing net debt by $0.4bn to $3.9bn. Wesfarmers will also neutralize its dividend re-investment plan by buying back on market the shares it issues.


Going into the result, the major brokers saw Wesfarmers as fully valued and were not that positive on the stock. According to FN Arena, of the 8 major brokers that analyze the stock, there was only 1 buy recommendation (from Macquarie). There were 4 neutral recommendations and 3 sell recommendations., with a consensus target price of $40.20 (a 4.3% discount to yesterday’s closing price).

Of the two brokers who had published their analysis of the result (Citi and UBS), both saw it as marginally positive. While neither broker changed their target price, the UBS analysts said that they expected to see “modest upgrades to consensus forecasts post the release.”    

Broker Recommendations*



Wesfarmers shares have traded in a very tight range over the last 12 months, from a high of $45.60 to a low of $39.52. Following a rise yesterday of 3.0% to $41.99, it currently sits mid- range.  


Wesfarmers (WES) – Feb17 – Feb18 (source CommSec)

Whilst there are some encouraging signs in the result (sales momentum with Coles, the power of the Australasian Bunnings business and strengthened balance sheet), the ongoing supermarket war between Woolworths, IGA, Aldi, Coles, Costco and potentially others will pressure Coles earnings. Target remains a challenge, and losses will continue from Bunnings UK. The outlook for the broader industrials division (which includes resources) is mixed.

The dividend yield is attractive, meaning that income investors will provide a solid level of support if the stock is marked down. Assuming it can maintain a second half dividend of $1.20 per share, Wesfarmers is yielding 5.31% pa fully franked. Grossed up, this is 7.44% pa.

For the time being, I can’t see Wesfarmers breaking the trading range. Buy in the high thirties, sell in the mid forties.


Transurban – “a buy in weakness” stock

Thursday, February 15, 2018

On Tuesday, toll road operator Transurban delivered another set of credible results. Guidance was re-affirmed for a full year distribution of 56c per unit – up 8.7% on FY17, with an interim distribution of 28c per unit – up from the 25c on the first half of FY17.

If Transurban (TCL) meets full year guidance, then unitholders will have witnessed their distribution grow from 29.5c in 2012 to 56c in 2018, a compound annual growth rate (CAGR) of 13.6%.

This is why some analysts consider Transurban to be a “growth” stock. Others look at its high nominal debt and the fact that each toll road is a leveraged proposition. The free cash flow it generates from tolls, after paying maintenance and interest expenses, is largely returned to unit-holders as a distribution.

So, if interest expenses increase, then Transurban won’t have the same free cash flow to pay distributions. Many characterize the stock as a “quasi” bond – and when bond yields rise, bond prices fall. With the recent increase in yields, Transurban units have pulled back from a high of $13.11 just prior to Christmas to yesterday’s $11.58.

But Transurban’s debt is fully hedged. It has an average tenor of 9.3 years and there are no maturities to be refinanced in FY18. Transurban’s current development pipeline is fully funded.

Ultimately, it is a refinancing risk. If bond yields continue to rise, then as current loans mature, they will be refinanced at higher interest rates. To meet this cost and continue to grow unitholder distributions, Transurban has an increasing revenue stream from higher tolls, and a very healthy development pipeline.

Transurban’s $11bn development pipeline

Transurban has a committed $11.0bn development pipeline. In Sydney, this includes the NorthConnex (the freeway linking the M1 Pacific Motorway to the M2); in Brisbane an inner-city bypass and enhancements to the Logan Motorway; in Washington DC express lanes to the 395 freeway; and in Melbourne the Monash Freeway upgrade.

The biggest project is the $5.5bn West Gate Tunnel Project in Melbourne (Transurban’s share is $4.0bn). It is aimed at relieving congestion in Melbourne, reducing reliance on the West Gate Bridge, providing a direct freight link to the Port of Melbourne and removing trucks from residential areas in the inner west. It is expected to complete in 2022.

The project comprises the following core components:

  • Upgrade and widening of the West Gate Freeway from four lanes to six lanes in each direction;
  • New tunnels under Yarraville, connecting the West Gate Freeway to the Port of Melbourne precinct and western edge of the city. The twin tunnels will be three lanes each; and
  • Port of Melbourne, City Link and city connections, including a new bridge over the Maribyrnong River.

In addition to its committed pipeline, Transurban has identified many other development opportunities. These include “missing links” such as the north-east link in Melbourne and   network enhancements such as the widening of the M7 is Sydney. In the USA, significant opportunities in public/private partnerships are expected if President Trump’s plan to re-build American infrastructure is funded.

The most immediate opportunity for Transurban is the massive West Connex project in Sydney and the sale of a 51% equity interest by the NSW Government. Transurban says that while it has registered an interest to submit a bid, no asset is a “must win” and that it will maintain a disciplined investment process. The West Connex sale process will play out over the next few months.

What Do the Brokers Say

The major brokers are positive on Transurban with 6 buys and 2 neutrals. Following the results announcement, brokers made minor revisions to their target prices. Deutsche Bank upped its rating from neutral to buy. According to FN Arena, the consensus target price is now $12.92, an 11.6% premium to yesterday’s closing market price of $11.58.

The brokers have Transurban trading on a forecast yield of 4.9% for FY18 and 5.3% for FY19.

How to play

If bond yields rise quickly, Transurban shares will come under further pressure. But the market is also aware that it made the mistake of too readily labelling Transurban a “bond proxy” last May/June, and then watching the shares bounce as bond yields stabilized.

Many investors see Transurban as a core portfolio stock, with monopoly assets, a guaranteed increasing revenue stream, and genuine growth opportunities. The company’s performance continues to support this view.

Buy in market weakness. If you don’t own any, today’s market is an opportunity to start building a position.


CommBank gets reporting season off to a solid start

Wednesday, February 07, 2018

In all the commotion about Wall Street, reporting season for Australia’s listed companies got underway in earnest yesterday. Commonwealth Bank, CIMIC Group (formerly Leighton Holdings), furniture retailer Nick Scali and Carsales each reported soundly.

CommBank’s result highlighted two important trends. First, the on-going pricing power that the major banks have, with CBA able to increase its overall net interest margin by 6bp to 216bp thanks largely to re-pricing its home loan book.

Secondly, the cost of compliance and regulation. While a provision of $375m for the AUSTRAC money-laundering fine will get most of the headlines (this is CBA’s best guess - it could potentially be as low as $50m and as high as $1,000m), CBA also disclosed that it booked an additional provision of $200m for an expected compliance program spend. Further, the cumulative spend on compliance programs across the Group  over the last 5.5yrs was just under $4.0bn and had grown at a staggering compound annual growth rate of 33%.


Adjusting for the AUSTRAC fine and discontinued business lines, CBA’s underlying cash profit for the first half was $5.11bn, up 5.8% on the $4.83bn for the corresponding half in FY17. Underlying operating income grew by 4.9% mainly due to higher net interest income, while operating expenses grew by 4.7%. This led to “positive jaws”, with operating performance up by 5.1%. Eliminating the $200m provision for compliance program costs, “business as usual” expenses grew by 2.0%.

Loan impairment expenses were flat at $596m or just 16 basis point (0.16%) of gross loans and advances.

On the capital front, CBA’s CET1 (Common Equity Tier 1) ratio rose to 10.4%. On a pro-forma basis, this will reduce to around 10.15% on 1 July 18 when CBA adopts a new “forward looking” provisioning standard. The leverage ratio increased to 5.4%.

For shareholders, CBA increased the interim dividend by 1c to $2.00 per share.


The main positive was the increase in interest income from the home loan book. Together with a moderate increase in volumes and tight cost control, this helped the all-powerful Retail Bank grow NPAT by 7.7% to $2.65bn. Its cost to income ratio fell to a remarkable 30.1%.

In fact, most divisions recorded healthy profit rises. Business & Private Bank grew cash NPAT by 9.3%, BankWest by 16.9%, New Zealand by 14.1% and Wealth Management by 33%. The exception was Institutional Banking & Markets, where NPAT decreased by 13.2% due to lower income in financial markets, subdued lending volumes and higher provisions.


Underlying volume growth was disappointing and remains a key challenge for the Bank. Average interest earnings assets grew by 3.4% over the 12 months to $851bn, and by a dismal 0.6% over the last six months.

On a product basis, this translated to growth in home loans of 2.9% in the six months ending 31 December compared to system growth of 4.2%. With business loans, CBA grew balances by 0.1% compared to system growth of 1.9%.  Accordingly, CBA went backwards in market share in home loans and business lending - down to a share of 24.6% with the former compared to 25.0% 12 months earlier.

Another negative was the dividend of $2.00, slightly less than the $2.06 forecast by some analysts.


The brokers were marginally negative on Commonwealth Bank going into the result, with 1 buy, 5 neutral and 2 sell recommendations. According to FN Arena, the consensus target price was $78.13, compared to last night’s closing price of $76.79.

Their main concerns were those echoed in CBA’s results - lack of momentum in balance sheet growth, and the ongoing cost of the compliance and regulatory obligations, including the “Royal Commission” risk.

Following the result, UBS and Citi confirmed their respective targets and recommendations. In the next couple of days, the other major brokers will update their forecasts, and while it was a result that met expectations, there was little “new news” and changes should be limited.


CBA’s result was sound without being spectacular. It supports why I remain bullish (and overweight) the major banks. Interest margins are holding up, there is no uptick in bad debts, the pressures on capital have subsided and cost pressures are modest.

Downside risks include the compliance and regulatory burden, and the biggest challenge of all - volume growth.

However, price/earnings multiples are reasonable by historical standards, dividend payouts are high, and there is still an enormous opportunity to go really hard on the costs.

My view is somewhat at odds with many in the market, who are down on the major banks because of the lack of revenue growth and potential “Royal Commission” risk. I have argued that the market will get bored with this in due course and come to recognize the major banks as low risk, annuity style investments paying high fully franked dividends. Stay long the banks. 



JB Hi-Fi slams the short sellers

Thursday, February 01, 2018

A few months back, JB Hi-Fi was the most shorted stock on the Australian share market with more than 17% of its ordinary shares sold short. Professional investors had taken the view that the profits of Australia’s specialty retailers such as JB Hi-Fi, Harvey Norman and Super Retail Group were going to be decimated by the arrival of Amazon and its category killing offers and logistics knowhow. While market share loss would be small in the short term, the profit impact would come as the retailers responded to the competition by slashing prices, thereby crushing margins.

To add to this bearish flavour, the Australian Bureau of Statistics was reporting that retail was on the skids. A horror first quarter of the financial year saw total retail turnover in Australia fall by 0.2% in July, fall again in August by 0.6%, before a small rise of 0.2% in September.

JB Hi-Fi shares were smashed, falling to a low of $21.64 on 24 November.

                                    JB Hi-Fi - 1/17-1/18 (source: CommSec)

But Amazon finally launched on December 5, didn’t conquer but instead underwhelmed……..and the ABS discovered that retail trade was growing! The first quarter’s weak performance was followed by a rise of 0.5% in October and a staggering increase of 1.2% in November. Accompanying this news were big increases in both consumer and business confidence.

The shorters started to cover, a couple of the broker analysts turned more bullish, and the rest is history. One of the best performing stocks on the market in January, JB Hi-Fi closed last night at $29.23.

While the shorters have been stung badly, they haven’t entirely given up the ghost. The latest figures from ASIC yesterday showed that there were still some 16.65 million JB Hi-Fi shares short sold, 14.5% of the total number of ordinary shares.

First half profit

JB Hi-Fi is due to report its first half profit on Monday week, 12 February. It hasn’t provided a profit forecast per se, but has forecast total group  sales to be circa $6.8bn for the full year, with $4.65bn coming from the JB Hi-Fi chain and $2.15bn from The Good Guys. For the JB Hi-Fi branded stores, this translates into sales growth of 6.4% pa.

At its AGM in October, the company reported that year to date sales growth for the JB Hi-Fi business was 6.2%, and for Good Guys 3.1%. Management reaffirmed full year guidance.

In terms of profitability, the market is forecasting that JB Hi-Fi will earn around $145m for the first half, compared with $125.4m in the first half of FY17. The increase is in part due to a full six month contribution from The Good Guys business (the acquisition was completed in November 2016). On an earnings per share basis, the market is forecasting that JB Hi-Fi will lift this on a full year basis from an underlying 186.0 cents per share in FY17 to 208.2 cents per share in FY18, a growth rate of 11.9%.

While EPS growth is well above the sales growth rate, JB Hi-Fi has a strong track record of reducing its cost of doing business. It is also leveraging synergy benefits from the Good Guys acquisition. Provided that the gross margin holds up, profit growth in the order of 12% is achievable.

What do the brokers say

The major brokers are in two camps. There is the camp led by Citi and Credit Suisse who think that Amazon is going to have a very material impact on profitability and accordingly, have low stock price targets and sell recommendations.

The second camp says that JB Hi-Fi is responding very credibly to the Amazon threat, that JB Hi-Fi is an exceptionally well run retailer and that the stock is cheap. Four brokers have raised their price targets in January.

Overall, the consensus price target is now $27.33, 6.5% below last night’s market close. Individual broker recommendations and targets are detailed in the table below.

            Broker Price Targets & Recommendations (source: FN Arena)

In terms of multiples, the brokers have JB Hi-Fi trading on a forecast multiple 14.0 times FY18 earnings, and 13.5 times FY19 earnings. The yield is an attractive 4.6% (plus 100% franking).

Bottom Line

While I am a huge JB Hi-Fi fan (it is unquestionably the best run retailer in Australia) and the stock it is still cheap on the multiples, every stock has its price. If JB Hi-Fi gets into the thirties, I am going to taking some profits.

Amazon hasn’t gone away and over the medium term, its presence in Australia will put pressure on the margins existing retailers can earn.  The short sellers might be in retreat at the moment, but they will look to re-set their positions because their fundamental view on retailing hasn’t changed.



Why can’t the Aussie sharemarket go up?

Thursday, January 25, 2018

It seems that almost every morning, we wake to the news that the US stock market has reached another record high. With these leads, you would think that local Aussie investors would be rocking and rolling, but the opposite has been the case. Our market has been in the doldrums, massively underperforming compared to Wall Street.

Prior to last night’s trade, Wall Street is up around 6% this month. The Dow Jones by 6.03%, the S&P 500 by 6.19% and the NASDAQ by 8.07%. But the poor Aussie market is down, yes down, by 0.17%.

So, why has the Aussie market de-hitched from the US stock market and underperformed so badly?

Here are my 4 reasons.


Firstly, the Aussie dollar is too high at around 80 US cents. Aussie dollar strength (up from around 75.5c in mid-December) is partly a function of a globally weaker US dollar, but also a function of strengthening commodity prices.

A high Aussie dollar impacts the earnings of key growth companies such as CSL, Amcor, Cochlear, Macquarie, Boral, Brambles, Treasury Wine Estates and Aristocrat Leisure. Moreover, it deters foreign investors from putting new cash into the Australian market, who in the main have accepted the conventional wisdom that the long-term value of the Australian dollar should be closer to 70 US cents. At 80 cents, this is around the top of the range.


The next problem is market composition. As the following table shows, the Australian share market is massively overweight in financial and material stocks, with the former representing 35.6% of the entire market, when weighted by market capitalization. Materials in Australia weigh in at 17.9%, compared to just 3.0% in the USA.

On the other side of the ledger, Information Technology (IT) is the largest sector in the USA accounting for 23.8% by market capitalization. In Australia, it makes up a paltry 1.9%. The Aussie market is also underweight in healthcare, consumer discretionary and industrials. 

This year, the biggest sectors in the US market are among the best performing sectors. IT comes in second place in performance, being up 8.4%; healthcare is fourth, being up 7.2%; and consumer discretionary is the best performing sector, up 9.2%. Financials comes in fifth place, up 6.7%.

While materials has been one of the better performing sectors in Australia (up 1.4%), the largest sector, financials, is down 0.6%, held back by bearish sentiment relating to the Royal Commission.


Some years back, local fund managers were typically bullish when asked about the stock market. They “talked their book”, knowing that retail investors (who drove new investment flows) responded to positive outlook statements.

Today, the flows are largely institutional super monies, with the asset allocation already determined. Also, with boutique managers needing to differentiate their expertise, it seems to have become fashionable to be bearish, or at the very least, being able to point to how much cash is being held so as to demonstrate how actively the money is being managed.

Whatever the reasons, all the data says that local fundies are overweight cash. They have a vested interest to “talk the market” down.


Most importantly, many of Australia’s largest companies are “growthless”. Earnings growth at the banks are low single digits as APRA’s clampdown on home lending impacts volumes and business credit growth remains weak; Telstra is challenged to replace revenue lost to the advancement of the NBN rollout; Woolworths and Wesfarmers are locked into the supermarket wars battling Aldi and others; discretionary retailers are being impacted by the arrival of Amazon; and weak wages growth is impacting other consumer facing stocks. There are bright spots with some of the resource companies, but the bottom line is that overall earnings growth is moderate at best.

Compare this to the USA, where earnings growth in 2017 has been strong, and the current quarterly earnings season has gotten off to a really good start. And this is before the impact of President Trump’s tax cuts.

Ultimately, a share price is today’s valuation of a company’s future earnings, and if earnings aren’t growing, it’s hard for the price to go that much higher.


Of course it can. While the composition of the market is not going to change, the Aussie dollar could easily pull back (particularly if US interest rates move higher) and if the economic data continues to show an improving trend, our local fundies could get bullish.

In the short term, company earnings are the key. Reporting season in Australia gets underway in a little over a week, which will see around 75% of our companies report either full year or half year earnings for the period to 31 December. If the reports are ok, and the outlook statements for the next period positive, our market could easily get a push along and “close the gap” on the US market.


Sydney Airport flying into headwinds

Thursday, December 21, 2017

By Paul Rickard

Yesterday, Sydney Airport (SYD) released its traffic performance for November. This showed that November was a strong month for the Airport, with domestic passengers 3.1% higher than in November 2016 and international passengers growing by a pleasing 7.1%.

Year-to-date, domestic passengers have grown by 1.5% compared to 2016. With international passengers, which drive 70% of the airport’s revenue but only represent 37% of the traffic, the growth rate is 7.4%.

Passenger growth, particularly with higher yielding international passengers, and the development of retail, property, parking and ground transportation services, has allowed Sydney Airport to increase its distribution to 34.5c per unit for FY17. Since 2012, distributions have increased at an impressive compound annual growth rate (CAGR) of 10.4%.

Looking forward, Sydney Airport sees continuing opportunities to grow passenger numbers, particularly with international passengers from Asia due to Sydney’s status as the main gateway to Australia and an Asia/Pacific business hub, and the growth in the outbound Chinese tourist. It says that 35% of landing/departure slots remain available at Kingsford Smith, while the introduction of larger aircraft by airlines will contribute to increased revenue per slot. 

However, with Western Sydney Airport moving from the concept stage into construction, Sydney Airport faces the threat of competition when the new airport opens in 2026. A wholly Government owned company chaired by Mr Paul O’Sullivan, WSA Co, has been established to deliver the project, with $5.3bn of government equity available. Last week, expressions of interest were being sought for early stage earthworks.

What do the brokers say

The major brokers are, according to FN Arena, largely neutral on Sydney Airport, with 2 buy recommendations, 3 neutral recommendations and 1 sell recommendation.  They see the stock as a little overvalued, with a target price of $7.23, 2.0% lower than the current share price of $7.38.

Following a distribution of 34.5c for FY17, they forecast a distribution of 37.8c for FY18, a growth rate of 9.6%. For investors, this translates to a forecast yield of 5.1% for FY18 (unfranked). Individual broker recommendations and target prices are as follows:

My view

In the medium term, Sydney Airport should be able to grow passengers, increase revenue and most importantly, increase distributions. Its monopoly as Sydney’s only commercial airport won’t be under any attack until at least 2026.

However, markets like to anticipate events well before they actually occur. The chances are that as development on the second airport ramps up, markets will fret about the competitive risk and factor this into the share price. And it won’t just be investors who worry about competition. 

Sydney Airport has net debt of $7.9bn. While this has an average maturity stretching into 2024, as the debt comes up for renegotiation, banks, bond holders and rating agencies will increasingly consider whether a competitive threat could arise. It just takes one bank or rating agency to believe that the threat is credible and possibly material, and Sydney Airport will find that it is paying higher interest charges.

And if bond yields start to rise again, which seems inevitable as the growth momentum in the US continues and the Federal Reserve tightens monetary policy in response, Sydney Airport and other “bond proxy” stocks will come under pressure.

Sydney Airport is not a buy. For holders, don’t wait too long to sell.



Downsizers and first home buyers get a leg-up

Thursday, December 14, 2017

By Paul Rickard

On the same night that the eyes of the nation were fixed on Canberra with the vote on the legislation to allow marriage by same-sex couples, the Government had another win as the Senate passed two measures to improve housing affordability. Announced back in the May Budget, the measures involve the superannuation system and were opposed by many in the “rent seeking” superannuation industry and on the floor of the parliament by the ALP. The changes will provide a small incentive for some older Australians to downsize, and assist first home buyers to save a deposit faster and help to overcome one of the barriers for getting into the housing market.

Neither measure is a silver bullet for the housing affordability problem, but they are a step in the right direction. They don’t come at a huge cost to Government revenue (foregone tax), and won’t have any long term impact on prices in the housing market. If anything, by making the super system a little more aligned with that other primary retirement objective, home ownership, they will actually be a boost to the super system in the long term.

Here’s a run-down on the two changes and who they might suit.

  1. 1. Downsizing 

Persons aged 65 or over who downsize by selling the family home will be able to make a non-concessional contribution to super of up to $300,000 from the proceeds. These contributions won’t be subject to meeting any work test, will be in addition to the current non-concessional cap and won’t be subject to the $1.6m balance test for making non-concessional contributions. If a couple, then potentially $600,000 could be contributed to super.

The only qualification is that it must be from the sale of your principle residence owned for the past 10 or more years.

Downsizing is rarely driven by just financial reasons, with lifestyle, health and family reasons more often cited as the main factors. For those who are receiving the age pension, there  remains a financial disincentive to downsize as the family home is exempt from the pensioner assets test and the net proceeds from the downsizing (whether invested in cash or back into the super system)  is included in the assets test. And this measure won’t do anything to improve the availability of suitable properties. But, it should prove popular with self-funded retirees who can then invest their savings in a 0% or worst case 15% taxing environment, and free up homes that no longer meet their needs for younger growing families.

  1. 2. First Home Super Saver Scheme

At the other end of the housing market, first home buyers will be able to make voluntary salary sacrifice contributions into super, and withdraw these together with associated earnings for a deposit for their first home. 

The Government says that first home buyers will accelerate their savings by at least 30% using the First Home Super Saver Scheme (FHSSS). For example, an individual earning $70,000 pa who makes annual salary sacrifice contributions of $10,000 for 3 years will be able to withdraw (after all taxes - see below) $25,892 for a deposit. This is $6,210 more than the $19,681 they would have saved if investing after tax dollars ($10,000 less $3,450 tax) for 3 years in a bank account earning 2% pa. (You can access a calculator here )

The Scheme allows up to $15,000 per year and $30,000 in total to be contributed. While it will count within the individual’s concessional super cap of $25,000 per annum, both members of a couple can take advantage of the measure, meaning that potentially $60,000 can be contributed.

Special taxing arrangements will apply to these super contributions. Like other salary sacrifice contributions, they will come out of a person’s pre-tax income and then be taxed at 15% when the contributions hit the super fund. Inside the fund, the contributions will earn a deemed rate of interest (currently around 4.78% pa), with the interest amount then taxed at 15% pa.  On withdrawal, the whole amount will be taxed at the individual’s marginal tax rate, less a 30% tax offset. This means that the maximum tax rate on withdrawal will be 17%.

From a home saver’s point of view, participation in this Scheme should be really easy. No new super account required, just instruct your employer to salary sacrifice and pay this amount to your super fund marked as a FHSSS contribution. 

Individuals who are self-employed or whose employers don’t offer salary sacrifice can still make voluntary contributions to the FHSSS, and then claim the contributions as a tax deduction (subject to the $25,000 cap on concessional contributions). This means that savings effectively come out of pre-tax income. 

Non concessional contributions (from after tax monies) can also be made, subject to the overall limit of $30,000 and $15,000 in any one year. These won’t be taxed on entry or exit, but could benefit (marginally) from the higher deemed rate of interest.

To qualify, you must be over 18 and have never owned ‘real property’ in Australia before. If you have owned or own an investment property or vacant land, you will not be eligible to use the FHSSS. But you won’t be ineligible if your partner has owned a property before, and you haven’t. To access the savings, you will need to purchase a residential property (including vacant land to be built on), sign a contract to do so within 12 months, and occupy the premises for at least 6 months of the first 12 months after it is practicable to do so.

Despite comments that “$30,000 doesn’t really give you much of a deposit for the Sydney or Melbourne markets”, this measure will prove to be popular when first home-owners realise that it is a “no-brainer”.



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