Monday 20 February 2016 Contrarian plays

A contrarian play on CSL or BHP last year would have paid off for investors. As Warren Buffett’s advice goes: “be greedy when others are fearful”. The direction of the dollar is difficult to predict, but if the Aussie heads lower, there could be a few stocks that will benefit. I discuss this in my article today.

Sincerely,

Peter Switzer

Inside this Issue 02 The money-making contrarian plays for 2017 Lower Aussie dollar? by Peter Switzer 04 CBA’s dividend increase is big news What it means by Paul Rickard 07 Earnings season continues – BHP and Woolworths Out this week by James Dunn CBA’s dividend 11 Lessons from the Trump Presidency What to watch increase is big news by Barrie Dunstan by Paul Rickard 13 Buy, Sell, Hold – what the brokers say 04 Upgrades and downgrades by Rudi Filapek-Vandyck 16 3 miners and how to play them Three major miners by Roger Montgomery

Important information: 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. For this reason, any individual should, before Switzer Super Report is published by Switzer Financial Group Pty Ltd AFSL No. 286 531 acting, consider the appropriateness of the information, having regard to the 36-40 Queen Street, Woollahra, 2025 individual's objectives, financial situation and needs and, if necessary, seek T: 1300 SWITZER (1300 794 8937) F: (02) 9327 4366 appropriate professional advice. The money-making contrarian plays for 2017 by Peter Switzer

One of the curious findings from our years of publishing the Switzer Super Report is that subscriber interest always peaks when the ‘you know what’ hits the fan! A rising market brings complacency and I guess happiness as set investments bring the returns hoped for when they were placed.

However, when a market is rising, we all know certain sectors or companies can be copping a caning. If you need reminding, just go back to late last year when the big fund managers got caught short of banks and Source: Yahoo!7 the big miners — BHP, Rio and Fortescue — so we saw good companies such as CSL dumped. As you can see, CSL’s share price started falling around August and that’s when BHP broke $20 and That was a classic contrarian time to buy a good the experts realised that they had got the big miners quality company and it reminds you of the Warren wrong! The likes of CSL had already been on a slide Buffett advice to be “greedy when others are fearful”. because of a few reasons but profit-taking in the face of great price rises and a high P/E were amongst At that time, the question that I asked most of my TV them. experts was whether these dumped companies were buys at that time. Only a few would sign up for the So what’s next? contrarian play. Already the smarties are looking at other companies The same happened when I pondered whether BHP that might have been dumped because of the chase at $14 was a good buy for an investor who could wait for miners. Last Tuesday, Bell Direct’s Julia Lee said two to three years for his or her pay-off? she liked some specific mining services companies and Monadelphous was her number one pick. It was I must admit I used the Gary Stone method of the best performer last week on the S&P/ASX 200 investing and waited for the turnaround and index. establishment of a believable trend before I jumped in at around $16. However, it proved to be a good bet, It could still be too early for mining services but especially it’s quick rebound way before I expected! contrarians are into them already and doing work on these will be a goal for this Report in coming weeks. Here’s the CSL one-year chart to show what a contrarian play with a quality company looks like: One play I like for a few reasons is investing in companies that benefit from a lower dollar but my only concern is that the dollar might not go lower! It is one of the hardest commodities to forecast.

AMP’s Shane Oliver thinks it will go higher to around

Monday 20 February 2017 02 78 US cents but as the Yanks raise interest rates — possibly four this year! — then the greenback will rise and the Oz dollar will fall below 70 US cents!

That’s his best guess and others agree but it’s still guessing.

The team at www.dailyfx.com thinks recent economic data was better than expected and has kept the dollar up at 76-77 US cents levels, but they expect things to change but not necessarily that our economy will worsen but it won’t surge. Here’s their summary:

“The upshot of all this is that the prognosis for Australian interest rates has not changed. They are low. They are likely to remain so until the RBA is convinced that the economy is revving durably. And it isn’t.”

They could get a surprise here but I won’t argue too much about this now but I think the following view is pretty well right: “It is going to take either the dialing back of US rate-rise expectations or the emergence of a more stridently hawkish RBA to really give AUD/USD bulls room to charge. Neither seems at all likely this week, so a neutral call it must be.”

So, what stocks are beneficiaries of a lower dollar? Macquarie (MQG), CSL (CSL), (AMC), Ramsay (RHC), the miners, (ANN), Resmed (RMD), Westfield (WFD) and others, which I will try and pry out of my experts on my TV show this week and share with you on Saturday’s Report.

Of course, some of these might not be ripe for a price surge from a currency drop right now, for specific company reasons, and the dollar might not follow the script and fall. Even still, however, you end up with pretty good companies.

This is always my ultimate approach to investing because time usually gets the best out of great business outfits.

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.

Monday 20 February 2017 03 CBA’s dividend increase is big news by Paul Rickard

The most important news last week was the ’s move to increase its interim dividend by 1c to 199c per share. While the increase in itself was immaterial, it signaled that the Bank believes that it has enough capital and won’t need to undertake a further dilutive capital raising.

Of course, the Bank said it was all about maintaining a dividend payout ratio at 70%, but in an environment where most analysts have been forecasting reducing dividends, any action to increase the dividend, however small, was a big statement.

And it came less than a week after APRA Chairman, Source: CBA Investor Briefing Wayne Byres, said in a prepared speech that “the main policy item on our agenda in 2017…is to set There is little doubt that the banks will work to further capital standards so that the capital ratios of our improve their capital ratios, but they won’t be deposit-takers are ‘unquestionably strong’…We will undertaking dilutive issues and dividend cuts are now have more to say in the coming months about how largely off the agenda. This is what the market we propose to give effect to the concept of celebrated, with CBA and the other major banks unquestionably strong”. He went on to say that “The rising strongly. Since CBA’s announcement on major banks have added in the order of 150 basis Wednesday, it has put on $2.76 or 3.34%, closing points to their CET1 ratios over the past couple of Friday at $85.39. years. Assuming the industry continues to steadily build its capital, we expect it will be well placed to A strong half year respond to future policy changes in an orderly manner.” CBA’s cash profit of $4.91bn was up 2% on the corresponding half of 2016. Most importantly, it was Commonwealth Bank produced the following chart to able to demonstrate revenue growth of 3%, while show that on an internationally comparable basis, it operating expenses grew by only 1%. This gave it has the second highest CET1 (Common Equity Tier “positive jaws” (income growing faster than 1) ratio of any major global bank at 15.4%. This expenses), with operating performance up by 4%. places it in the top quartile of the top quartile. Revenue growth was achieved in an environment where margins continued to come under pressure, with group NIM (net interest margin) down by 4bp to 211bp, or down by 3bp, when compared to the half year ending 30 June 16. Although pressure on NIM is moderating, CBA said that it expects it to keep trending down.

Monday 20 February 2017 04 Loan impairment expense remains low at 0.17% of the premium bank with the best technology and group assets (17 basis points). The forward indicators leading market shares, it also trades at a premium on consumer arrears are at historically low levels, price, and the differences are not that material. despite some elevation in WA. Accordingly, they see CBA as being marginally over-valued and ascribe a neutral rating on the stock.

Individual broker recommendations are shown in the following table.

* Source FN Arena. Based on highest recommendation Highlights of the result included: According to FN Arena, CBA is trading on a multiple of 15.4 times FY17 earnings and 15.0 times FY18 Market leading return on equity (ROE) of earnings. The forecast dividend yield is 5.0%. 16.0%, up from the June half of 15.6%; Capital ratio (CET1) of 9.9%; What I say A group cost to income ratio of 41.5%, with the retail bank at a staggering 30.8%; I draw two main conclusions. Firstly and most Market share gains in home loans and in NZ; importantly, I think that the banks are getting close to Very strong profit performance by the retail “unquestionably strong” and fears about capital bank, contributing 50% of group profit; and raisings/dividend cuts are likely to recede. While there An improved performance from the will be ongoing pressure on NIM and revenue growth institutional bank, mainly due to trading will remain challenging, there are no signs to suggest income and continued restraint in corporate that the credit cycle is deteriorating and banks still lending. have enormous opportunities through productivity initiatives and branch closures to attack their cost The wealth management division saw cash profit fall bases. by 34% to $249m. While this was an improvement on the June half, the cost of advice remediation, margin If the stock market is to power through 6000, it will be pressure in funds management and insurance claims driven by the leading stocks – so it will need the in wealth protection weighed on this division. major miners and the major banks to fire. I am not sure that I want to be overweight the major banks, but What the brokers say I can’t see any real reasons to be underweight. When I add in the security of the dividend yield and The Bank’s result beat broker consensus and was the prospect of higher interest rates later this year seen as reasonably strong, with few faults. Most of (which in the short term will boost margin), I am more the brokers raised their price target, but there were no inclined to be positive on the sector. upgrades. Secondly, CBA should be a core stock in your Overall, the broker’s acknowledge that while CBA is portfolio. Although it is the most expensive bank

Monday 20 February 2017 05 (based on forward earnings multiples, it is trading at a premium of 15% to the ANZ and NAB and approximately 7% to ), this is not out of the ordinary compared to the last five years.

* Source FN Arena, using closing price on 17 February 2017

Over this period, the premium has ranged from around 8% to as high as 35%. While there is no doubt that the competitive differences between the banks have narrowed and that they are largely pursuing the same strategy, CBA still comfortably leads in technology, product market shares and balance sheet strength and has been able to translate this into the leading ROE.

I am not making the case that CBA is necessarily the best bank to own. But with an index weight of 9.5%, it is too big to ignore, and if you own two or three major banks, then CBA has to be in the mix.

For dividend chasers, CBA goes ex-dividend on Wednesday (so you can purchase CBA up to the close of business on Tuesday and still get the dividend).

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.

Monday 20 February 2017 06 Earnings season continues – BHP and Woolworths by James Dunn

The December half-year profit reporting season lines Oliver says this anticipation means that only 44% of up for a big week, with BHP Billiton (BHP) reporting reporting companies have seen their share price interim numbers on Tuesday, outperform the market on the day they reported. (WPL) showing its full-year result on Wednesday, Fortescue Metals (FMG) and Woolworths (WOW) Broking firm Citi says of the stocks that it covers, 23% reporting interim results on the same day, and have beaten estimates for earnings per share (EPS), (RHC) (interim) and Westfield and 15% have exceeded dividend forecasts. But 26% Corporation (WFD) (full-year) stepping up to the plate of stocks have fallen short on EPS and 13% have not on Thursday, as well as (QAN) Airways matched up to dividend expectations. (interim result). This has seen Citi make slightly more EPS Other companies reporting full-year 2016 results downgrades than upgrades: results have influenced include Caltex Australia (CTX), (SCG), Citi to upgrade 4% of companies reporting from (OSH) and Greencross (GXL) (Tuesday); ‘neutral’ to ‘buy,’ but the firm has also downgraded APN News & Media (APO), Coca-Cola Amatil (CCL) 6% in the other direction. and IRESS (IRE) (Wednesday); Adelaide Brighton (ABC), Asaleo Care (AHY), Alumina (AWC), At the top line, broker Credit Suisse says companies Macquarie Atlas Roads (MQA), MYOB (MYO), Iluka reporting so far have delivered average revenue Resources (ILU), InvoCare (IVC), OZ Minerals (OZL) growth of 3.2%. Credit Suisse also sees earnings up and Estia Health (EHE) (Thursday). by 6.8%, helped by cost management, and dividends up 6.8%. The reporting season is about 40% complete entering this week, and generally the results so far have been The results flow has seen broker UBS lift its market good. According to Shane Oliver, head of investment EPS growth expectation for FY17 to 19.4% from strategy and chief economist at AMP Capital, more 19.2%, with resources driving the charge, up 152%. than half (53%) of companies to report so far have beaten the market’s earnings expectations, The broking house has lifted its EPS expectations for compared to a norm of 44%. A further 22% of the finance stocks, from 6.5% to 6.9%, but companies have matched expectations but still, on downgraded projections for industrials, from 5.1% Oliver’s numbers one-quarter of companies are EPS growth to 4.7%. UBS still expects REITs to lift bringing out profit results that do not meet profits by 1%. expectations. But while company downgrades have been Oliver says 70% of companies have lifted their profits surprisingly – and reassuringly – few, there have from a year ago, while 69% have boosted their been some disappointments, as some companies dividends. Some 17% of companies have kept the come up short against high earnings growth same dividend, but a problem-child minority – 14% of expectations and sky-high valuations. This is companies – have cut their dividends. particularly the case for market-favourite stocks: Domino’s Pizza (DMP) plunged 14% last week on its The market had priced in much of the good news: interim report, even though it boasted a record interim

Monday 20 February 2017 07 profit and record sales. instead committing to a payout ratio of 50% of underlying earnings over the longer term. ( The market was concerned that the crucial did much the same thing, switching to an intention to same-store sales figure was losing growth return between 40%–60% of underlying earnings.) momentum, and that the net profit was less than half of the $124.8 million full-year profit expected by BHP is expected to boost dividend payments by more analysts’ consensus. Add to that, revelations that the than 60% this year on the back of higher coal and pizza chain had experienced wider issues with wages iron ore prices: the company expects to generate free underpayment and franchisee disputes than cash flow of $US7 billion ($9.1 billion) during the previously known, and you had a seriously current year. The interim dividend will be a sign of disappointed stock market. how this expectation is tracking. On consensus, analysts expect about 42 US cents (54.5 cents), (TLS) also underwhelmed the market with its although it could come in lower if the company opts to interim result, which showed a 3.6% drop in total use its cash flow boost to reduce debt. Analysts still revenue, to $12.8 billion, and a 14.4% drop in interim see BHP as showing some upside, with a 4% gap net profit, to $1.8 billion. While Telstra maintained the between the current price and the consensus target interim dividend at 15.5 cents, the longer-term risk to price, according to FN Arena. the dividend is worrying the market, with analysts starting to cut their forecasts. The NBN will bring a $2 Fortescue is expected to triple its underlying first-half billion–$3 billion hit to Telstra’s earnings and the profit to about $US950 million ($1.2 billion) and lift its market is concerned at what will fill the hole: analysts interim dividend significantly. Analysts see the stock expect Telstra to lose market share in mobile, and the paying a full-year dividend of about 25 US cents a company is also facing heightened competition in share: an interim dividend of about 16.8 US cents corporate fixed-line, with TPG Telecom (TPM) and (25.7 cents) is expected. Analysts see Fortescue as Vocus (VOC) increasingly aggressive competitors. trading 5% above the consensus target price, however. Private (MPL) also disappointed last week, reporting a 1.9% rise in net profit, but that was driven On Tuesday, Oil Search is expected to post by higher income from investments: operating profit underlying earnings of about $US100 million ($130 from the health insurance business actually fell by million), down significantly on the $US360 million 8%, as a net 41,000 policies lapsed: membership ($470 million) figure of 2015. But in headline terms, numbers fell by 2.3%. the net profit of $US165 million ($214 million) will be a major improvement on the previous $US39 million Turning to this week, analysts expect big things from loss ($50 million). Oil Search looks to be showing BHP Billiton and Fortescue, who are riding better better comparative value than Woodside, with the FN commodity prices (especially iron ore, the latter’s Arena analysts’ consensus price seen as more than sole focus). BHP will report after the market closes 13% above the current share price. tomorrow: according to Bloomberg estimates, analysts expect BHP to report underlying first-half On Wednesday, Woolworths’ (WOW) half-year profit of $US3.4 billion–US$3.6 billion ($4.4 earnings will be most notable for the second-quarter billion–$4.7 billion), up more than eightfold on the sales numbers, which analysts expect will show figure reported a year ago. like-for-like supermarket sales growth of 1.5%–1.7%. Given that ’ Coles reported BHP’s interim dividend will also be of great interest: second-quarter sales growth of 1% last week, that last year BHP slashed its interim dividend by 75% – would mean the long-awaited move by Woolworths to the first dividend cut since 1988 – to 16 US cents, sales growth ascendancy has arrived: Woollies has about half of what the market expected, after not beaten its arch-rival on like-for-like (same-store, reporting its first loss in more than 16 years. The that is, with store openings and closing stripped out) mining giant also ditched its “progressive dividend” sales growth in a quarter for 30 quarters, or more policy, which guaranteed that dividends never fell, than seven years. But FN Arena reckons Woolworths

Monday 20 February 2017 08 to be trading about 5% above the analysts’ Coca-Cola Amatil – full-year consensus target price. FY16 EPS change: +5.1% to 54.1 cents FY16 Dividend per share (DPS) change: Woodside’s full-year result on Wednesday is +3.8% to 45.2 cents, 75% franked expected to show a profit of about US$850 Fairfax Media (FXJ) – interim million–US$900 million ($1.1 billion–1.17 billion), but (FBU) – interim a 23% fall in the dividend, to 84 US cents ($1.09) a Infigen Energy (IFN) – interim share, fully franked. On analysts’ consensus price IRESS (IRE) – full-year target, Woodside is trading with upside of 2.4%, FY16 EPS change: +25.8% to 44.3 cents according to FN Arena. FY16 Dividend per share (DPS) change: +6.3% to 45.4 cents, 60% franked This week’s reports McMillan Shakespeare (MMS) – interim Pact Group (PGH) – interim Tuesday APA Group (APA) – interim (QUB) – interim Aconex (ACX) – interim Resolute Mining (RSG) – interim BHP Billiton – interim Woodside Petroleum – full-year (reports in Caltex Australia – full-year US$) FY16 EPS change: –12.6% to 203.6 cents FY16 EPS change: +3,380% to 104.4 US FY16 Dividend per share (DPS) change: cents –12.4% to 102.5 cents, fully franked FY16 Dividend per share (DPS) change: Flexigroup (FXL) – interim –22.8% to 84.1 US cents, fully franked Growthpoint Properties Australia (GOZ) – Sky Network Television (SKT) – interim interim (reports in NZ$) Monadelphous Group (MND) – interim Property Group (SGP) – interim REIT (NSR) – interim Medical (SRX) – interim Independence Group (IGO) – interim Steadfast Group (SDF) – interim Scentre Group (SCG) – full-year Group (TGR) – interim FY16 EPS change: +3.1% to 23.3 cents Woolworths – interim FY16 Dividend per share (DPS) change: Fortescue Metals – interim +1.2% to 21.2 cents, unfranked Insurance Australia Group (IAG) – interim Sandfire Resources (SFR) – interim Vocus Communications (VOC) – interim SEEK (SEK) – interim (HSO) – interim (SBM) – interim Virtus Health (VRT) – interim Thursday PropertyLink (PLG) – interim Senex Energy (SXY) – interim Adelaide Brighton (ABC) – full-year Greencross – full-year FY16 EPS change: –7.8% to 29.5 cents FY16 EPS change: +27.2% to 38.7 cents FY16 Dividend per share (DPS) change: FY16 Dividend per share (DPS) change: +74.2% to 26.1 cents, fully franked +8.1% to 20 cents, fully franked (AAD) – interim Asaleo Care (AHY) – full-year Wednesday FY16 EPS change: –18.6% to 10.9 cents FY16 Dividend per share (DPS) change: APN News & Media (APN) – full-year –8.3% to 9.2 cents, 20% franked FY16 EPS change: from –1 cent to 23.5 cents Alumina (AWC) – full-year (reports in US$) FY16 Dividend per share (DPS) change: from FY16 EPS change: +10.6% to 3.4 US cents nil to 4.2 cents, unfranked FY16 Dividend per share (DPS) change: Bluescope Steel (TES) – interim +15.4% to 7.3 US cents, fully franked (BKL) – interim (CWN) – interim

Monday 20 February 2017 09 Ramsay Health Care – interim Monday 27 February (NEC) – interim Qantas Airways (QAN) – interim QBE Insurance Group (QBE) – full-year Travel (FLT) – interim (reports in $US) Macquarie Atlas Roads – full-year FY16 EPS change: +5.9% to 53.3 US cents FY16 EPS change: +55.2% to 17.7 cents FY16 Dividend per share (DPS) change: FY16 Dividend per share (DPS) change: –8.1% to 46 US cents, fully franked +14.6% to 18.3 cents, unfranked Amaysim Australia (AYS) – interim MYOB Group – full-year Bellamy’s Australia (BAL) – interim FY16 EPS change: +38.3% to 15.1 cents Gateway Lifestyle (GTY) – interim FY16 Dividend per share (DPS) change: Lend Lease (LLC) – interim +5.1% to 11 cents, unfranked iSentia Group (ISD) – interim (CGC) – interim Group (ASX) – full-year Waste Management (CWY) – FY16 EPS change: +60.3% to 9.5 cents interim FY16 Dividend per share (DPS) change: (ILU) – full-year +18.8% to 14.3 cents, unfranked FY16 EPS change: from 12.8 cents in FY15 to Adairs (ADH) – interim –7.6 cents Spotless Group (SPO) – interim FY16 Dividend per share (DPS) change: –59.5% to 10.1 cents, fully franked Important: This content has been prepared without Investa Office Fund (IOF) – interim taking account of the objectives, financial situation or InvoCare (IVC) – full-year needs of any particular individual. It does not FY16 EPS change: –1.2% to 49.5 cents constitute formal advice. Consider the FY16 Dividend per share (DPS) change: appropriateness of the information in regards to your +7.5% to 40.9 cents, fully franked circumstances. Oz Minerals – full-year FY16 EPS change: –11.9% to 37.8 cents FY16 Dividend per share (DPS) change: –34.4% to 13.1 cents, unfranked Perpetual (PPT) – interim Platinum Asset Management (PTM) – interim TradeMe Group (TME) – interim (reports in $NZ) Southern Cross Media (SXL) – interim Estia Health (EHE) – full-year FY16 EPS change: +44.4% to 21.8 cents FY16 Dividend per share (DPS) change: –53.1% to 12 cents, fully franked (WEB) – interim

Friday

Automotive Holdings (AHG) – interim Charter Hall Group (CHC) – interim (CMW) – interim Mayne Pharma (MYX) – interim NEXT DC (NXT) – interim Regis Healthcare (REG) – interim (SUL) – interim

Monday 20 February 2017 10 Lessons from the Trump Presidency by Barrie Dunstan

In November, investors were fearful about the effects commodity prices all seem to favour the stock market of a Donald Trump presidency. Then, almost from the bulls – for the moment. day he became president, the stock market took off and, with a few pauses, the Wall Street market has Much will eventually hinge on the bullish impact of been flirting with new highs. President Trump’s stimulatory fiscal measures including his ambitious promise of lower taxes. There This is despite erratic behaviour from the new still are some inevitable doubts on delivering this and President on his twitter account; one high level other policies, but the new President does appear to casualty from his cabinet and a general consensus be mellowing a few of his more extreme foreign policy that investors may need strong nerves to survive stances. Still it’s probably fair to say that a majority of Trump’s effect on equity markets. investors and economists still fear Trump’s economic policies could blow up. But, while people continue to shake their heads about the new President, the US stock market still thinks he For instance, widely-followed New York University can do no wrong. Last week, despite foreshadowing economist Nouriel Roubini recently wrote that loose news of his “phenomenal” tax plan, Trump instead fiscal policy and tight monetary policy could hit did a 75-minute press conference, notable for workers and require more protectionist measures, boastful and rambling attacks on “fake media” – but which would hamper economic growth and flirt with with not a word on his tax policy. The Dow Jones and the possibility of a global trade war. For the stock S&P indices were left unruffled at near peak levels. market, there is also danger from Trump’s habit of directly interfering in corporate matters. Which seems to continue the lesson of the first weeks of the Trump presidency. Despite unprecedented But, while watching global macroeconomic issues, shocks from the Oval Office, the stock market seems SMSF investors here might usefully concentrate on to be adjusting to Donald Trump. Remember, the local factors, especially ominous rumbles in the market is always looking ahead and the current level banking and housing sector. There also have been of share prices may, in fact, be factoring in the likely some volatile market reactions to disappointing inflation from the new President’s proposed policies. interim reports.

If there is a lesson for investors from the first weeks The biggest worry could come in the over-heated of the Trump presidency, it may be that, in worrying property investment market. Barely a day goes by about the all too obvious dangers, they should not without another warning about lending for property overlook the plus factors – or other unknown investments – and increasingly these are from the unknowns. authorities and not from market commentators. Most recently, it was the International Monetary Fund and But, for the moment despite their doubts, investors the banking regulator, APRA. As a result, several are still believers in the Trump rally. The buoyant banks have announced they are pulling back from mood on Wall Street, forecasts of higher world some lending for property investment. economic growth (plus the cautious agreement from our Reserve Bank) and the continued run in Now, there also have been scares – so far

Monday 20 February 2017 11 downplayed, but persisting – that the government might be looking at changing the capital gains discount for property investments and even fiddling with negative gearing. There are growing signs that the banking authorities are keeping a very close watch on lending and the system now seems to be in for a slow squeeze.

Even as the government continues to deny that any changes are in the wind, there is more overt support for adjustments and for some inquiry in the banking system. In short, the climate is changing in ways that no one can predict.

Cynics might suspect the government could be thinking, at the very least, of jawboning the property bubble. While this approach may be an effective intervention in a fevered residential property market, it risks triggering unforeseen reactions – which, for local investors, could be worse than Donald Trump spooking the stock market.

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.

Monday 20 February 2017 12 Buy, Sell, Hold – what the brokers say by Rudi Filapek-Vandyck

In the good books The broker upgrades the stock to Outperform from Neutral and raises the target price to $2.95 from CSL LIMITED (CSL) Upgrade to Buy from Neutral $2.80. by Citi B/H/S: 6/1/0 LIMITED (SGM) Post the formal release of CSL’s interim financials, Upgrade to Outperform from Underperform by Citi analysts have become a lot more comfortable Macquarie B/H/S: 4/2/1 with the growth outlook. Their projections now imply 21% EPS CAGR for FY16-FY19. First half results were in the middle of the guidance range. Macquarie finds the market environment far Citi believes this outlook, in combination with the from clear but believes the company has done well to reliability that continues to be on display, warrants a mitigate downside risks. premium valuation. The analysts have increased their price target to $136.40 (was $113.75). Upgrade to The company believes further self-help could add Buy from Neutral. more than 50% to EBIT. On the strength of such potential, Macquarie upgrades to Outperform from Underperform. Target is raised to $13.60 from $11.20.

VICINITY CENTRES (VCX) Upgrade to Buy from Neutral by Citi B/H/S: 3/0/2

At face value, the H1 financial performance was in-line, but Citi analysts highlight the result also put the limelight on the broader benefits of capital recycling. LIMITED (S32) Upgrade to Outperform from Neutral by Credit Suisse B/H/S: 5/2/0 Upgrade to Buy from Neutral. Target price loses 2c to $3.22. The analysts point out the shares are now First half results were slightly better than the broker’s offering circa 6% yield plus 10% upside to the price estimates, FY17 guidance for D&A has been revised target for the year ahead. upward by $40m to $$760m. Estimates have changed little. Citi analysts FY17 production guidance remains unchanged, but encourage investors to look through the earnings cost guidance has been increased across most impact of asset sales. They expect growth to divisions, reflecting FX moves and price linked royalty accelerate from FY18. payments. The broker forecasts cash of $1.6bn at the end of FY17 and assumes $800m of buy-backs in In the not-so-good books each of FY18 and FY19. LIMITED (CPU) Downgrade to

Monday 20 February 2017 13 Neutral from Buy by Citi B/H/S: 4/3/1 Outperform and reduced the target price to $8.60 from $9.50. Computershare’s growth outlook has changed dramatically, and for the better, comment analysts at IPH LIMITED (IPH) Downgrade to Hold from Buy Citi. They have made only small positive adjustments by Deutsche Bank B/H/S: 1/2/0 to estimates. Adjusting for unrealised FX gains, first half results However, the analysts also note the share price has were broadly in line with Deutsche Bank forecasts. rallied hard. On this basis, they downgrade to Neutral The broker downgrades to Hold from Buy on from Buy. Target jumps to $13.80 from $11. valuation grounds.

Medium-term earnings estimates are reduced to better capture the risks around national phase entries being conducted electronically and potential margin compression from increasing competition.

Target is reduced to $5.40 from $6.60.

TELSTRA CORPORATION LIMITED (TLS) Downgrade to Hold from Accumulate by Ord Minnett B/H/S: 0/5/3

Ord Minnett has downgraded to Hold from Accumulate upon Telstra’s release of what turned out a weak interim report. The analysts highlight both IOOF HOLDINGS LIMITED (IFL) Downgrade to top line and bottom line were well off what the market Neutral from Outperform by Macquarie and was expecting. Downgrade to Neutral from Outperform by Credit Suisse B/H/S: 0/4/1 There’s sector dominance and an attractive looking yield, but Ord Minnett is taking a medium-term view First half underlying profit missed Macquarie’s and sees potential structural changes and downward expectations. Gross margin pressure flowed through pressure. Target falls to $5.35 from $5.45. to net margins. The dividend payout of 98% was ahead of forecasts, backed by strong cash flow, but the broker expects this to return to 90%.

Macquarie downgrades to Neutral from Outperform as operating headwinds are expected to remain despite the prospect of some moderation in the second half. Target is reduced to $8.50 from $9.60.

First half earnings were disappointing for the broker, despite a small increase in net profit. Credit Suisse has downgraded FY17 forecasts by -6%, primarily driven by business divestments.

The broker notes cost savings have largely come through, but the unexpected divestments raise questions around the earnings outlook. The broker has downgraded the stock to Neutral from

Monday 20 February 2017 14 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.

Monday 20 February 2017 15 3 miners and how to play them by Roger Montgomery

Putting aside any societal benefits, the objective of many years to respond to higher prices by developing starting a business is usually to generate a profit for new mines to take advantage of the buoyant prices. its owners. Shareholders are owners of a business Of course, higher prices also mean that previously and so presumably they are interested in receiving marginal ventures can be profitable and so the their proportion of the profits. response to rising prices is often oversupply, which pushes prices back down and send marginal Thanks to the stock market however, the nexus operators out of business and the share prices of between a business and its owners can often be lost even the most profitable operators crashing. or forgotten. Instead of seeking to profit from the long-term ownership of a business, ‘investors’ – I It is interesting to note, in particular, that the iron ore use that term loosely – often use shares as gambling price is 57% higher than the margin cost of the 90th chips, betting on nothing more than the ups and percentile producer, suggesting a significant return to downs of prices. The emergence of this approach to supply will soon get underway at precisely the same the stock market has rendered many good intentions time Iron Ore stockpiles on China’s major ports are nothing more than speculation, and akin to betting on at decade highs and they arguably don’t need any black or red at the roulette wheel. more fixed asset investment.

One of the biggest recipients of this style of The best time to buy commodity business assets is ‘investing’ is shares representing companies when they priced at scrap or as if they are going out operating in the mining, materials and resources of business. This rarely happens, so generally sector. investors will find investing in more stable and predictable businesses less anxious and more Suppose for a moment I offered you an opportunity to rewarding. invest in a new business venture through an Information Memorandum (IM). Reading this IM, you BHP (BHP) discovered that the asset of the enterprise was a licence to explore, and later mine, a vast tract of land BHP Billiton is the world’s largest mining company situated between four white pegs. The operators are but imagine I ran a business to which you extended not sure how much valuable ‘stuff’ is underground, an additional $38 billion and injected an additional nor how long it will take to extract. The operators also $51.5 billion of equity over the last 10 years. You don’t know how much it will cost to extract, and once would expect profits to have risen materially. Yet, extracted, there is no certainty about the price they despite all those additional resources, profits have will receive for the product nor to whom they will sell declined by nearly 90% from $13.6 billion in 2006 to the product. an expected $1.5 billion in 2016 and about $5 billion in 2017. In various forms, this is the basic story of the hopeful mining and exploration business and despite all of the The shares remain significantly higher than our uncertainties, investors pour hundreds of millions if estimate of their intrinsic value. SELL not billions into these speculative endeavours. Santos (STO) The resource sector is highly cyclical because it takes

Monday 20 February 2017 16 With one of the largest exploration and production acreages in Australia (including oil in the Carnarvon Basin, LNG in Gladstone and Darwin and exploration in the Browse and Bonaparte basins), Santos is the Asia-Pacific’s leading independent oil and gas producer.

The owners of the business have tripled their equity investment to $10 billion over the last decade and lenders have lent five times more debt than the company had in 2006. Despite this, the 2016 profit is expected to be less than 10% of those reported in 2006. Analysts then expect a ten-fold increase by 2018. The bullish forecast for intrinsic value in 2018 is today’s share price. HOLD

Newcrest (NCM)

Newcrest is the world’s sixth largest gold producer. Gold produces no income for its owners and has few industrial uses. Buying gold is a bet on the increasing fear of others. Gold prices tend to rise when speculators believe the prospects of a financial crisis and associated uncertainty has increased. In 1915 the inflation-adjusted gold price was $400 per ounce. Today it trades at $1350 – a rise of 1.1% per annum over 100 years. Shares in low cost gold producers are leveraged to the gold price and Newcrest’s future is equally tied. SPECULATIVE

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.

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