by Raymond Chan

What happened last month?

Latte with Ray wrote this article at Hong Kong International Airport, after spending the week here visiting clients and family. Over the month, NASDAQ +5%, Hang Seng +5%, Nikkei 225 +4%, S&P500 +3.9%, Dow Jones +3%, TSE +1.3%, Shanghai +0.6%, Iron Ore -12%, Oil (WTI) +3%, AUD/USD flat

Two thoughts for the month

Thought #1 - Why did Chinese stocks underperform both S&P 500 & ASX 200 over the past year?

Chart 1 – Major Indices: One Year Performance

Source: IRESS

During our visit, we gathered further feedback on the Chinese stock market, which lagged both the US and our market by a big margin over the past year. There’s no secret that the Chinese economy is not growing as fast as before however one sector still showing signs of strong growth is the TMT (Telecom, Media and Technology) sector, especially the Internet / Social Media space. Unfortunately, the best Chinese internet companies have chosen the NASDAQ over the Hang Seng and Shanghai stock markets for better liquidity and valuation. What got left behind in the Shanghai and Hong Kong stock markets were those big Chinese financial institutions and Property Developers. As we speak, Chinese Financial Institutions are trading below book value on bad debt concerns while Investors are selling out of Listed Property Developers on Chinese property price weakness.
Back in 2007, the Shanghai Index traded as high as 5,900 points. 7 years on, it last closed at 2040 points.

Thought #2 – Two investor days that caught our eyes (WES & SUN)

WES - Latte with Ray attended a charity gala dinner in JW Marriott Hong Kong, with Wesfarmers as the major sponsor. It’s interesting to note WES also held its Investor Strategy Day this week.

We hold WES in our Core Portfolio and the Key highlights from the day are:

  • Coles and Kmart - both very solid but with further room for growth (volume and store rollout).
  • Target - worse than feared and the customer simply hasn't returned. Very large turnaround required and will take years. There is a large amount of goodwill associated with this business which may have to be impaired. Richard Goyder is also throwing a lot of experienced resources at this project.
  • Bunnings - the star performing division and this is set to continue. Rollout and sale/leasebacks will continue.
  • Chemicals/energy/fertilisers and Industrial/Safety - good businesses but the macro remains difficult.
  • Resources - pricing outlook remains negative, earnings set to bottom potentially in FY15. Limited further cost out opportunity from here.
  • Balance sheet - there is no doubt they are assessing counter-cyclical opportunities across the industrial businesses, but it was also clear that return-enhancing opportunities aren't that easy to find. In the absence of an acquisition, capital will be returned to shareholders.
  • WES appears to be fairly valued at 20x, while offering <5% EPS growth in FY15. The upside potential really lies in a successful Target turnaround and resource market turnaround - timing of both of these is difficult. We have a little less confidence in the growth coming out of Coles/Kmart/Bunnings  being able to offset the deterioration in Resources and Target. What was abundantly clear from yesterday's strategy briefing is that the quality of this management team is second to none. WES remains a core portfolio holding and we certainly don't see material downside risk....especially while the group boasts such a robust balance sheet. We recommend clients HOLD their positions with a view to assessing acquisitions and/or capital management if/when they arise.

SUN - Opportunities worth considering

SUN, one of ASX Top 20 stocks, held an investor day during the week and the company noted that growth in the general insurance market will likely slow. At the current price, we think SUN is fully valued but the stock has the highest grossed up yield of the top 20 ASX stocks. We believe there is the potential for SUN to pay further special dividends over the next two years.

  • The key message from SUN's investor day "efficiency led growth from price led growth" - which entails a huge focus on technology.
  • A takeaway on the General Insurance outlook: SUN's message of efficiency led growth emphasises the pricing/revenue outlook in General Insurance is going to be a lot tougher over the next few years as pricing competition continues to heat up. SUN's GI margins are tracking well above its targeted 12% ('through the cycle') - however we feel SUN is sticking to this target to give a cushion to protect market share. The IT transformation and procurement programs give SUN a competitive advantage - however we think SUN will be using these benefits, or giving them up, to maintain its strong market share.  
  • Our View: Buy for yield, however capital growth could be muted from here With SUN now trading close to valuation and given the point in the insurance cycle, SUN's share price growth could stagnate here. However, SUN remains a genuine yield stock for portfolio clients.  
  • We think it’s best to BUY SUN on any price weakness.

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.