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Latte with Ray – China and Russia get closer

Thursday, November 02, 2017

By Raymond Chan
After spending a week in Moscow, I observed Chinese tourists were everywhere in the city while it is also very common for Russians to take Mandarin lessons at universities. Since the dissolution of territorial disputes between China and Russia during Jiang Zemin’s era, the relations between the two countries have been developing remarkably rapidly. Undoubtedly, rich resources from Russia are beneficial to China while high productivity and sufficient capital from China are beneficial to Russia.
China remains the largest trading partner of Russia

“China is Russia's largest trading partner,” indicated Kirill Dmitriev, head of the Russian Direct Investment Fund (RDIF), at the latest BRICS Summit held in Xiamen. Last year saw a 12 percent growth in Chinese direct investment in Russia. Kirill Dmitriev considers the Chinese-Russian tie greatly positive. The RDIF recently has announced a partnership with the China Development Bank (CDB) and is expected to provide an opportunity for Chinese investors to directly invest with settlements in yuan (RMB).
Although the total trade volume between China and Russia was once affected by the collapse of commodity prices, China remains the largest trading partner of Russia, reflecting a good foundation of the bilateral trade. The bilateral trade volume is expected to exceed 80 billion US dollars. This is not only limited to minerals, and a significant amount of agricultural products are also being exported from Russia to China.
With the painful experience of the global financial crisis in 2008, economists generally agree that development in a multipolar global economy is more desirable than merely relying on America’s “unipolar”.
China’s high productivity is unquestionable. So, the question is, “does Russia deserve Chinese investment?”
A mutually beneficial relationship is built between the nations

A few years ago, Russia implemented an integrated Arctic strategy. The country ambitiously extracted natural gas from the Arctic and constructed an airport and a military base in Alexandra Land. 100,000 tons of building materials and 140,000 tons of equipment were delivered to the area. Forecasting China's demand and funding would continue to grow, Russia had already realised that the commitment to the mining development in the Arctic could be of mutual interest to the nation and China. Russia is benefiting from the infrastructure brought by China’s One Belt One Road (OBOR) strategy, while China can enjoy the low cost of the natural mineral and gas resources from Russia – but the real mutual benefits are that no aggression nor hegemony is called for.
China’s OBOR strategy has a positive role in promoting economic and trade cooperation with Russia; the amount of human resources and funds investing in the collaboration between the two countries for the mining development in the Arctic is unprecedented. The dissolution of territorial disputes between China and Russia gives a way for better China-Russia trade relations.
Political issues do matter

In Australia, analysts do not put much emphasis on the economic and trade cooperation among BRICS countries, that is, Russia, India, China, Brazil and South Africa. In fact, analysts should not only pay attention to stock markets or statistics but also to political issues.
The Russian Far East strategy is not simply about the relation with China, but with North Korea and Japan as well. North Korea is facing United Nations sanctions for its escalating nuclear and missile programs; local resources are in short supply, not to mention funds for overseas investments. As for Japan, right-wing populism has put the plan for systematic cooperation with Russia to death. The nation tried to create a comprehensive logistic chain between the two countries, but to no avail. Therefore, politics always decides the prospects for economic and trade relations between nations.
The China-Russia trade relationship is essential for the world

Moreover, the Chinese-Russian tie has often been overlooked in multinational trade. Research scholars in China believe enhancing the economic and trade relations with Russia will help revitalise the old industrial bases in the northeast.
Australian media hardly mentioned the fact that the RDIF and the CDB have agreed to establish a Russian-Chinese investment fund worth 68 billion RMB. The funding from the 15-year-agreement will be spent on development of the Far East and Siberia for energy, transportation, industry, power facilities and cross-border projects.
At the moment, Russia has stepped out of the financial crisis and entered a period of economic growth. China and Russia do not purely care about whether the trades are settled in yuan or ruble; according to the officials, the two nations are doing their best to prevent the negative impact of trade activities by fluctuations in foreign exchange markets. In other words, to exclude the US dollar factor and prevent the problematic impacts of hedge funds on financial markets again.
The aftermath of the world economic crisis is not scattered and the global economic growth recovery is slow and weak, it is necessary to put the old rules aside and seek new directions.
In 2016, China's total crude oil imports from Russia reached 52.3 million tons. Russia overtook Saudi Arabia to become China's biggest crude oil supplier for the first year ever. In the first five months of this year, bilateral trade between China and Russia has skyrocketed with an increase of over 33%. A close China-Russia trade relationship is essential for us, and for the world!


Latte with Ray: Value in resources?

Thursday, October 12, 2017

By Raymond Chan

In September, we exercised our caution in short term stock market performance. It’s proven to be right with the ASX 200 (XJO) down 0.58% for the month of September. We’re now expecting a better October in the lead-up to the AGM season.

This month, Latte with Ray would like to draw your attention to the Resource Sector. Our analyst Adrian Prendergast has been accurate in calling the resource sector and here are our latest thoughts.

Is there value in resources after peak cost-out?

There is still value on offer in resources, but it is harder to find now that: 1) the majority of resource industries have reached peak cost-out levels (with only incremental gains or cost inflation on offer from here), and 2) after the large ‘relief rally’ from recovering commodity prices that has carried sector valuations to multi-year highs. With the easy gains in the sector now made, we still see value in two areas: 1) those companies already holding value-accretive volume growth options (OSH, BHP, RIO), and 2) resource companies with earnings in an upgrade cycle (where spot prices are above current consensus forecasts – i.e. raw materials, base metals and now oil).

Time to take a breather

Even though we see the recovery cycle as remaining on track, we also see potential for the sector to take a short ‘breather’ in some areas in the fourth quarter after posting strong gains during 2017. Short-term demand conditions, particularly for raw materials like iron ore, look significantly weaker heading into the December quarter. We see aggregate consumption of the important steel additive as likely to be impacted by Beijing’s efforts to suppress pollution ahead of China’s 19th National Congress in mid-October. We also see some fresh tightening of liquidity in China also likely to hurt short-term demand for metals.

Changes to commodity forecasts

We have marked-to-market our CY18 forecasts, which continue to see an upgrade trend remain on outperforming metal prices. Post the northern hemisphere winter (where we expect volatility), we believe positive demand fundamentals across key manufacturing and construction regions will support metal prices at healthy levels. The pace and focus of China’s industry reforms also remains an area of focus for us that could further impact our forecasts (although in the case of aluminium this appears to be already factored in). In the oil and gas sector, we have trimmed our CY17-19 oil price forecasts to factor in a longer range-bound period before recovery (which we expect to be dictated by the duration of tier 1 shale reserves that remain an important contributor to marginal cost). We forecast the oil price to improve as the low-cost shale reserves are drilled out.

How to play the sector

Share prices of our large-cap miners have (so far) proved resilient against some pull back in metal prices. However, our expectation for weaker fourth quarter conditions could see selling pressure increase over the coming months. Given our forecasts for a continuation of the recovery cycle for metals (beyond Q4), we would view any sell-off as having potential to create a buying opportunity in our preferred sector exposures. Meanwhile the quality of earnings/management/assets in oil & gas remain much more varied and a case-by-case proposition.


Reporting season: Volatility breeds opportunity

Tuesday, August 08, 2017

By Raymond Chan

Welcome to the Australian reporting season! 

Below is an update from our strategy team on the first full week of reporting season.

It's difficult to read a lot into last week’s results, with only 13 out of 250 odd stocks of interest having reported so far. However, it's been disconcerting to see the market's reaction to profit warnings and poor results (and even some flat results) which has driven localised volatility in various names, both small and big. 

Navitas, Freelancer, iSentia and Select Harvests are all either high-PE or highly-cyclical growth stocks, which all issued either disappointing results or downgrades last week and were subsequently sold off by 12-18%. 

ASX 100 stock ResMed reported strong underlying revenues but higher-than-expected costs and was sold down 6% on the day, which the Healthcare team thought excessive. ASX 50 stock Suncorp fell 6% after slightly disappointing earnings (claims and costs).

As we flagged in our reporting season preview, it is proving difficult for corporate results to not disappoint a market trading on fair-to-fully priced valuations. However, volatility breeds opportunities and we expect more over-selling situations in quality names like ResMed to unfold during reporting season.

Looking to key results in the coming days:

Tuesday - Transurban

Wednesday - CBA, Carsales, Seven Group (tbc)

Thursday - Orora, AMP, AGL 

Friday - REA Group, NAB (Quarterly) 

Transurban: The focus will be on costs, FY18 DPS guidance and FY18-20 LTI targets. 

CBA: Expect result to be broadly in line with consensus. Focus will fall on the AUSTRAC civil case and possible implications for the other majors.

Carsales: We're looking for more colour on recent price rises and the new competitor. Trading on 22x FY18.

Orora: Australasia is subdued, while North American momentum should continue. Key will be impact of energy cost headwinds in Australasia from FY18. 

AMP: We expect a relatively stable result, given AUS/NZ equity markets are slightly up for the half (NZ+8%).

REA Group: Commentary on volume growth is the key to holding recent price gains. Trading on 32x FY18.


Latte with Ray: National Broadband Network

Tuesday, May 23, 2017

By Raymond Chan

There has been a lot of talk about the National Broadband Network (NBN) and its potential impact on Australian Telco companies.

Our analyst, Nick Harris, provides us with a great update on the progress of the NBN.

NBN market share trends

Looking at Fixed Line NBN connections for the March 2017 quarter, Telstra (TLS) tracked at 53% of NBN net adds from December 2016 to March 2017. This was down ~200bps on the Dec-16 quarter, but still above their legacy market share of ~48% (albeit below their regional market share).

TPG Telecom (TPM) tracked at 21% (up 25bps on Dec 16, but still down on their legacy market share of ~27%). Optus tracked at 13%, which was down 20bps on the Dec 16 quarter and still below their legacy market share of ~15%. Vocus Group (VOC) tracked at 9.4%, which was up 110bps on the Dec 16 quarter and above their legacy market share of ~7%. Market share from others (not the big four Telcos) continues to expand slowly.

Telco shopper: Plan pricing continues to decline

The average NBN Fixed Line pricing for both entry level (25mbps) and premium connections (100mbps) continues to decline, with the average plan pricing falling 13% since Aug-16. Premium plan pricing has fallen more severely (-20% in the same timeframe), showing that customers are not willing to pay more for higher speeds.

Belong (Telstra’s challenger brand) and Optus have the cheapest plans in the market. They aggressively dropped prices over the last six months, and raised them in May, but still offer the cheapest 25mbps plans in the market. We continue to take a view that until the NBN rollout is completed (and the once-in-a-lifetime forced churn event finalised), Telcos will compete aggressively on headline prices.

Overall, we think investors should underweight stocks with “legacy Fixed Line” business. 

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.


Latte with Ray: Agriculture Investments

Wednesday, April 19, 2017

By Raymond Chan

Latte with Ray would like to talk about agriculture investments this month.

In late March, we attended the Global Food Forum in Melbourne. It’s a conference where everyone in the Agricultural and Food industry gets together to hear from high-quality speakers including Andrew Pratt and Gina Rinehart.

The listed companies which spoke included Woolworths (WOW), a2 Milk Company (A2M), Blackmores (BKL), Ingham’s Group (ING), Bega Cheese (BGA), Fonterra Shareholders' Fund (FSF) and Costa Group (CGC).

This year, there was record attendance with 421 participants. The mood of the event was one of excitement and confidence in the industry’s future.

The conference reinforced to us that the sector is in good shape and investment demand has never been stronger.

Our analyst Belinda Moore summarised the key themes and issues presented at the conference:

  • Golden era for agriculture and the Dining Boom.
  • The important role Australian agriculture plays in our economy.
  • Benefits of the Free Trade Agreements (FTA) that will reduce tariffs overtime, and increase Australia’s competitive position.
  • China’s commitment to e-commerce and the Free Trade Zones (FTZ).
  • Australia’s position as a clean, green, quality and importantly, safe producer.
  • The issue of provenance – consumers are questioning - more than ever - where their food comes from.
  • Animal welfare is also a key consumer concern – e.g. demand for free range.
  • Need to reduce food waste.
  • Food producers need a strong brand so they aren’t competing at the commodity end, and the need for differentiation is extremely important.
  • Strong demand for health foods and organics – the supermarkets are increasingly looking to expand in this area to achieve sales growth.
  • Producers and food companies are a beneficiary of Amazon Fresh coming to Australia as a new customer. It will reduce the power of the major supermarkets or pharmacy chains.
  • Farming smarter – The Ag-Tech Revolution. Farmers need to apply technology to improve yields and productivity and to make Australian agriculture more competitive.
  • Tax cuts are required to make Australia more globally competitive, however, they need to be reinvested back into growth.
  • More foreign investment is required, but don’t be scared of Chinese investment.
  • Dairy industry will survive and prosper in the future, despite last year’s events.
  • Negative implications of rising gas and energy prices will eventually need to be passed onto the consumer, as efficiency initiatives won’t fully offset them.


Latte with Ray: US equities vs Trump's rhetoric

Thursday, March 02, 2017

By Raymond Chan

Our Chief Economist Michael Knox, and our Strategy Team, came up with an excellent piece of research on Trump's speech. Latte with Ray thinks it will be beneficial to share this with our Switzer readers. 

Donald Trump delivers his first speech to Congress

The content of yesterday's speech will be pored over by financial journalists in the coming days, and is an important marker in the context of the S&P500's record run. We thought it was timely to circulate Michael Knox's views on Trump's agenda and the enthusiasm already built into US equities, arguably with flow on effects to Australian shares.

Our strategist Michael Knox's view in a nutshell

The outlook for the US economy is good and the outlook for US earnings is even better. However, the US equities market is now pricing itself very fully on the prospect of better earnings in the future. Part of the reason for that optimism is the prospect of much lower corporate tax rates. We think that these tax reforms are guaranteed to have a noisy passage through the US Senate and that this could easily give inflated equity markets a scare.

Michael's views in more detail: "Too much good news"

Since the US presidential election in November, the US stock market has been rising strongly. This rise has been followed by a similar rise in Australian equities. This partly reflects better fundamentals, but much more of this rise simply reflects better sentiment. 

A stronger US economy 

In 2016, the US economy was relatively soft. GDP grew at only 1.6% for the full year. The reason for the weakness was a slowdown in non-residential construction. Very low oil prices in the beginning of 2016 meant a much lower level of investment in oil drilling, gas drilling, and energy infrastructure such as gas pipelines. Improving energy prices in the second half of 2016 caused the beginning of a recovery in the same non-residential construction. In 2017, the US economy should accelerate to 2.3%. In 2018, growth should pick up further to 2.7%. This improving economic outlook has generated a remarkable scenario for operating earnings per share of US corporations. 

However, US stocks look to have overshot our model of the S&P500 

With stronger growth and the prospect of much better earnings, it's not surprising that the US stock market has risen. The question is, has it risen too much? We model the S&P500 based on the level of operating earnings per share and US 10-year bond yields. This gives us a pretty good model explaining more than 80% of monthly variations. 

S&P 500 Operating Earnings

The problem is what the model now tells us. Based on the current level of earnings per share and bond yields, our fair value for the S&P500 in February 2017 is only 1916 points. At the time of writing, the market was way above that, at 2351 points. In the future, earnings will justify such a level of the S&P500, at a level of bond yields around where they are now. The problem is how far in the future it will be before earnings provides that justification. 

Our model tells us that, even with the much better earnings expected in the future, fair value of the S&P500 does not reach a fair value of 2338 until the third quarter of 2018 and 2394 until the fourth quarter of 2018. That means that the S&P500 is currently trading at fair value based on earnings that do not arrive until the third and the fourth quarter of 2018. 

Rotation from debt to equity has been driving equity prices

Why is this happening? We think that the US market is receiving a flood of liquidity from the US corporate debt market. The difference between US corporate yields and US sovereign yields has fallen dramatically since February 2016. Where previously investors might have bought corporate debt, the decline in the yield on that debt is now leading investors to switch from corporate debt to corporate equity. The money from the corporate debt market is flooding into equity prices and driving equities to a level that the market does not yet justify.

And, of course, euphoria around promised tax rate cuts

In addition to liquidity, the market is being supported by sentiment. Much of this sentiment is driven by the prospect that the new Republican administration will cut corporate tax rates. We have written before about the proposal to cut US corporate tax rates from 35% to 20% and maybe even to 15%. These corporate tax cuts are possible through the elimination of most of the corporate tax deductions that currently exist in the tax code. In addition, revenue is raised through a border adjustment tax. The elimination of tax deductions for corporate imports provides an effective revenue tariff of 20%, assuming a corporate tax rate of 20%. 

The problem is that even though those proposals have the support of the House of Representatives and the American President, they have yet to gain the support of the American Senate. US elections are much more open to the operation of lobbyists than is the case in Australia. This is primarily because of the very large cost of running elections in the US. This, in turn, is due partly to the high cost of advertising to very large populations.

There is no doubt that some Republican donors currently feel that the businesses that they are engaged in will lose out through the introduction of the Border Adjustment Tax. Our understanding is that this has resulted in heavy lobbying against the Border Adjustment Tax in the US Senate.

The problem is that without the Border Adjustment Tax, there is not enough revenue to support a cut in the corporate tax rate. Without the Border Adjustment Tax, a cut in the corporate tax rate will result in a large budget deficit. 

The stock market is banking on a cut in the corporate tax rate. Unfortunately, the passage of the corporate tax cut through the US senate is likely to be achieved only after much public argument. As the market sees those corporate tax cuts at risk, it is possible that its reaction could be both volatile and negative. 


Australian reporting season preview

Thursday, February 02, 2017

By Raymond Chan

Happy Lunar New Year to all! We wish all readers a happy, healthy and prosperous Year of the Rooster. 

Since the beginning of the year, we have seen mixed performances from global markets:

ASX 200: -0.8% 5,620 points,

Dow Jones: +0.5%

S&P 500: +1.8%

NASDAQ: +4.3%

Nikkei 225: -0.4%,

Hang Seng: +6.2%

Shanghai: +1.8%

FTSE: -0.6%

AUD/USD: +5.3% at 0.7586

Iron Ore: +4.4%

Gold: +5.2%

Brent: -2%

Copper: +8.7% 

The Australian reporting season will kick start with market heavyweights Macquarie (MQG) and Transurban (TCL) early next week.

Based on consensus estimates, the EPS growth for the ASX 200 is expected to be 12% for FY17. This is important as after two conservative years of earnings FALLS (led by resources and energy), we’re likely to have one year of earnings GROWTH! 

It's no doubt the ASX 200 is trading on an expensive PE - over 16 times on FY17 estimates - and as such, investors will be looking for clues from reporting seasons on the sustainability of earnings growth (not only for FY17, but also for FY18). 

The key things to watch will be management commentary on:

(a) sustainability of payout ratio,
(b) planned capital spending,
(c) commodity prices (for miners),
(b) housing (for REITs and construction companies),
(c) interest rate (especially important on banks and infrastructure stocks) and;
(d) AUD/USD (for offshore earners)

Our strategy team wrote: “The diminishing risk of global deflation has prompted a revaluation of the outlook for growth among investors. Against an expensive market (>16x 12-month forward PE), the prospects for improved pricing power and demand have increased the appeal for the overlooked ‘value’ segment of the market (low price-to-earnings and price-to-book).

We think that ‘value’ [segment] (stocks with low expectations) has a higher propensity to surprise and therefore attract buyers this reporting season, while expensive stocks will be punished if elevated expectations are missed - Brambles is a timely reminder against complacency.” 

Further, mining stocks will also be the bright spot of this reporting season: both BHP and RIO may surprise on capital management after spending considerable time in cutting down costs and dividends during tough times.


Latte with Ray: Trump and stocks in the buy zone

Monday, November 14, 2016

By Raymond Chan

What has happened?

Latte with Ray first heard of Donald Trump from Anthony Robbins’ “Unleash The Power Within”: how the real estate mogul almost went broke, owed several billions in debts from the 1990 US recession and made a comeback in his own biography book “Art of the Comeback” in 1997 – well before his famous appearance on “The Apprentice” in 2004. 

On November 8, the underdog Donald Trump defeated Hillary Clinton in the US presidential election and will become the 45th President of United State of Amercia. His second major comeback. 

What are Trump’s policies?

Our economist Michael Knox suggested Trump’s current policies show the significant influence of Speaker of the House, Paul Ryan. Paul Ryan is known as “a policy wonk”. In Australian English, we might say he is a policy “nerd”. Ryan rose to prominence as Chairman of the Budget Committee of the House of Representatives. Economic management is his specialist area. The central part of Paul Ryan’s program is to reduce corporate taxation from 35% to 15% and to eliminate most tax breaks. The purpose of this reduction is to make sure that US multinational companies bring their funds back to the US and reinvest it domestically in the US economy. He will also cut individual tax rates.

Last but not least, he also proposed a number of tax reforms for manufacturers, and increased military spending. If they proceed, the total program would cost $4.55 “trillion” and push the US federal budget deficit to 4.5% of GDP. The US corporate tax rates proposed within the Trump program would also increase US private fixed capital investment in the Australian economy. This would also be enormously beneficial for the Australian economy.

Having said that, in near term, Latte with Ray can’t rule out that the US ecomomy will still go into a soft growth period, given Trump’s policy uncertainties and geo-political risks. 

How does Trump impact our stock market?

Over the week, the ASX 200 gained +3.7% to 5,370 points, the Dow Jones rose +5.4%, the S&P500 rose +3.8% and the NASDAQ rose +3.8%.

  • Nikkei +2.8%
  • Hang Seng -0.5%
  • Shanghai +2.3%
  • FTSE +0.6%
  • TSE +0.3%
  • AUD/USD -1.7% to $0.7546
  • Brent -2.2% to $44.5
  • Iron Ore +15% to $74
  • Gold -6% to $1227
  • Coal +4.6% to $111
  • US 10-year bond yield +21% at 2.2%
  • Australian 10-year bond yield +10% at 2.6% 

You could imagine how defensive the fund managers were positioning prior to election day, and the “unexpected” stock market “V-sharp” rally meant violent shorting covering and portfolio re-balancing. The only market that didn’t go up last week was Hang Seng, which was down -0.5% on concerns over US/China trade relationships in the Trump era. RMB hit a 6-year low. 

The bottom line

The stock market may not be completely out of the woods yet. The key risk will be the upcoming FOMC meeting in early December. Technically speaking, the ASX 200 making a new low (5,052 points) could mean we’ve not seen the bottom of recent correction yet. The ASX 200 will remain volatile and this is still a stock-pickers market.

We need to watch the global bond market closely given the bond selloff (i.e. bond prices going down, bond yields going up). 

A rotation of fund flows from bonds into equities has commenced. Fund manager cash position are likely to fall from their highest levels since 2001. 

The Federal Reserve will now hike rate in Decembers with the USD to strengthen. 

US reporting season has been well received, (71% exceeded market expectation according to FactSet) favouring companies with offshore earnings. 

The bond selloff triggered the selldown in infrastructure/yield Stocks. This may present us with buying opportunities.

Infrastructure Stocks - APA Group (APA), AusNet Sevices (AST), Duet Group (DUE), Macquarie Atlas Roads (MQA), Transurban Group (TCL), Sydney Airport (SYD) - all got smashed over the week. Last month, we suggested:

  • “In this low interest rate and low growth environment, we think infrastructure assets are “core portfolio holdings”. Having said that, while we like the infrastructure stocks as an asset class, we don’t agree on the current pricings. Even after recent price correction, the PE on infrastructure stocks remains elevated. Among the infrastructure stocks, Latte with Ray prefers TCL (already a Core Portfolio holdings), SYD (we see the second Sydney airport announcement as an upcoming catalyst). We would love to top up TCL below $10.00 and buy into SYD below $6.00.”

One month on, both TCL and SYD have NOW fallen within our accumulation zone, at $9.58 and $5.95 respectively.

Disclaimer: Morgans Financial Limited (Morgans)

This report is provided for general information purposes only and is not intended as an offer to enter into any transaction.  This information contained in it is not necessarily complete and its accuracy cannot be guaranteed. We have prepared this presentation without consideration of the investment objectives, financial situation or particular needs of any individual investor.


Latte with Ray: Europe's big challenges and buying opportunities

Thursday, October 13, 2016

By Raymond Chan

Latte with Ray wrote this article at Heathrow Airport, awaiting a flight back to Sydney. 

Our thoughts on Europe's financial markets

The European economy remains weak. The financial markets here are having ongoing issues. Over past two weeks, we had Deutsche Bank's stock price reaching a record low, Commerzbank (the second largest German bank) cutting 9,600 jobs (or 20% of the workforce) and ING trimming another 5,000 jobs. When we talked to our contacts over here, they were all looking for job opportunities either in Asia or Australia. 

It's not just Deutsche Bank

On Deutsche Bank, an institutional client commented that the situation is definitely much worse than what the market is pricing in right now.

Everybody is relying on State support for a rescue plan, but the German government is bounded by the EU's bail-in law which restricts direct intervention. [EU regulations prevent European bank bailouts by the ECB and other central banks, unless a risk of “very extraordinary” systemic stress.] The announcement by Commerzbank last week highlighted that it may not be a Deutsche Bank specific problem. Most likely, will see more asset sales, and even deep discount rights issue. But UK banks taking over the iconic German bank seems quite far-fetched at this moment given Brexit and national pride. Like all previous bailouts, we need to see much worse market movement before a solution would come up. Expect more volatility over the next few months. 


As you know, Brexit introduces uncertainty to the UK economy. This week, the GBP reached new 31-year low against the USD. Well, it’s definitely great for inbound tourists and overseas property buyers here, given the 20% “currency” discount. However, this does not help business confidence. We think the Henderson takeover of Janus Capital is interesting. Henderson was a spin off from AMP Capital - now dual-listed in the UK and Australia. Under the proposed takeover, if successful, we will see Henderson to de-list from UK and move its primary listing to the US. We can’t help but feel that the Brexit may have something to do with the proposal. 

What does it mean for our Australian portfolio?

Europe is a significant economy and one of biggest trading partners to China. In turn, China is Australia’s biggest trading partner. With the economy going soft, Latte with Ray maintains that the ECB will have no choice but to maintain its easing bias (despite some “European experts” here calling for ECB QE tapering). In the US, it’s without doubt the Fed is now pushing back the tightening timetable. Our new RBA governor Philip Lowe held rates at 1.5%.

In this low interest rate and low growth environment, we think infrastructure assets are “core portfolio holdings”. Having said that, while we like the infrastructure stocks as an asset class, we don’t agree on the current pricings. Even after recent price correction, the PE on infrastructure stocks remains elevated. 

Among the infrastructure stocks, Latte with Ray prefers TCL (already a core portfolio holdings), SYD (we see second Sydney airport announcement as an upcoming catalyst) and Magellan Infrastructure Fund MICH (ETF-listed on the ASX). We would love to top up TCL below $10.00, and buy into SYD below $6.00. We expect that both TCL and SYD can generate growing dividend returns over next few years. On the Magellan Infrastructure Fund, the ETF offers us global diversification in infrastructure assets, and more importantly, “AUD hedged” returns. 

When to buy?

We don’t think we have seen the bottom of the infrastructure stock correction yet. It’s likely to see further selling pressure when the market starts talking up the prospect of a Fed rate December hike.

As you know, the performance of infrastructure stocks are negatively correlated with 10-year US and Aussie bond yields. The higher the bond yields, the less attractive the infrastructure stocks are going to be. However, in our opinion, price weakness will present us with the opportunity to buy. We expect both TCL and SYD to generate growing dividend returns for long term investors. 

Disclaimer – Morgans Financial Limited (Morgans)

This report is provided for general information purposes only and is not intended as an offer to enter into any transaction.  This information contained in it is not necessarily complete and its accuracy cannot be guaranteed.  We have prepared this presentation without consideration of the investment objectives, financial situation or particular needs of any individual investor.



Latte with Ray: Market curve-balls and buying opportunities

Thursday, September 15, 2016

By Raymond Chan

Market Conditions

The ASX 200 has corrected -7% since its recent peak of 5,600 points on August 1. We think it makes sense to re-visit the market fundamentals.

To better understand the fundamental value of our stock market, we need to review the Australian reporting season just passed. Our strategy team made the following comments on the reporting season:

Evidence of a softening domestic economy

Economic bellwether CBA noted the slow ongoing transition of the Australian economy. It sees stable (albeit weak) underlying GDP growth and stable employment, but notes that households and business are hesitant to respond to monetary stimulus. CBA expects ‘more of the same’ as the most likely scenario, but with risks skewed to the downside.

Fewer large cap hits

Far fewer large-cap companies beat market expectations compared with recent reporting periods, with only 11% of ASX50 Industrials stocks surprising the market to the upside. This reflects deflationary economic forces and sector specific issues (e.g. intensifying supermarket competition) making it harder for Australia’s largest corporates to grow.

But fewer misses

Conversely, the proportion of disappointing results was significantly lower for both large and small caps. This isn’t too surprising as:

1) Expectations had been progressively lowered heading into August;

2) Consensus expectations were more tightly dispersed than usual; and

3) Corporates are cycling flatter (more predictable) outlook guidance.

Tepid profit growth

Results met expectations overall, however, industrials companies will only record profit growth of around 5% in FY16, which looks uninspiring when measured against a forward price-to-earnings multiple of over 16 times.

Corporate confidence eroding

The quality of company outlook statements and earnings guidance continues to deteriorate. We reported a sharp step-up in companies now either not quantifying or not offering forward guidance. Again this reflects higher economic fragility/uncertainty.

Given current high PE’s on the ASX 200, it’s reasonable to see a bit of breather on stock markets in September ahead of two key macro events - the FOMC meeting on 20-21 September, and the US presidential election in 60 days.

These two events are related. Let me explain.

The market is currently pricing in just 20% chance of FOMC rate hike. It’s basically telling me that if the Federal Reserve goes for a rate hike next week, it will be a big surprise to the stock market (and the Fed will get cursed like the RBA did when it hiked rates before 2007 Federal Election). The US stock market could then get sold off more heavily, given its high PE. The panic could create market volatility to our Australian Stock Market.

However, this market volatility does not really change the fundamental value of our ASX 200. Based on reported earnings, the fair value of ASX 200 is valued at 5,460 points and as such, the selloff could be seen as buying opportunities. When to buy? I will be adding to equity positions once the index falls below 5,200.

NextDC Limited (NXT)

NEXTDC Limited (NXT) is a Data-Centre-as-a-Service (DCaaS) provider offering a range of services to corporate, government and IT services companies.

We first discussed NXT as a BUY on Switzer back on 16th March 2016. Since then, NXT stock price has rallied over +60% from $2.40 to $4.00 and easily outperformed the volatile ASX 200 during the same period.

We’re still seeing NXT as one of our core portfolio holdings.

NXT has signed a large-scale 1.5MW contract with a "major international customer", which takes S1 (the company’s first Sydney Data Centre) to 82% utilised on a contracted basis. Strong Channel Partner sales in Sydney and 12- to 18-month lead times on new builds mean NXT has announced it will build S2.

To fund this expansion, NXT has announced a $150m underwritten capital raising (39.2m new shares). NXT has announced, and more importantly funded, the initial builds for its secondary data centres in the three key locations (Brisbane, Melbourne and Sydney).

This take NXT’s facilities to eight in total, with over 100MW of total capacity and the potential to generate over A$200m of EBITDA. The capital intensity of data centre builds is very high and with the initial builds of phase two now funded, and supply versus demand in check, we see limited operational risk for NXT.

The key share price risk (upside and downside) relates to the rate of sales and whether it plateaus, slows, or accelerates. Faster customer demand (in the form of racks and/or whitespace) would lead to share price appreciation due to a higher fill rate (and within reason NXT now being able to fund this). Conversely, slower demand may disappoint relative to market expectations.


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.



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