Investment Outlook In Search of the Equity Peak - FNZC
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August 2017
Investment Outlook
In Search of the Equity Peak
NZ Equities Australian Equities Global Equities
BUY Contact Energy, Metlifecare and BUY CSR, Iluka Resources and
BUY exposure to Europe and technology
Kiwi Property Group Scentre Group
- page 14 - page 18 - page 22
Interested in economic and financial market developments, then follow us on LinkedIn
-INFINZ Sharebroker of the Year (2017) for the eighth time in ten years
Overview August 2017 Current conditions are supportive for equities. In particular it is positive seeing earnings driven by revenue growth, rather than from share buybacks, lower tax and reduced interest costs. However, a number of the equity market’s supporting factors are stretched, while others are starting to fray around the edges. In particular we note statements from five central banks, not including the Reserve Bank of NZ, that all indicate a desire for less monetary policy stimulus and higher interest rates. We take heart from the lack of evidence for a recession, but continue to believe an equity market correction (down 5-7%) is a possibility and that regular portfolio reviews focusing on investment portfolio risk and return are warranted. From the list of current global risks, we believe China represents the biggest. The outlook for the Chinese economy beyond the Communist Party Congress later this year is unclear and is further complicated by China’s longer term ambitions with respect to its global influence. An important part of this global influence is China’s One Belt One Road plan. To get a better understanding of why interest rates are at current levels, we go through a process of interest rate deconstruction. Through exposing the components of interest rates, we provide an insight into what drives each component and thus the whole. Unsurprisingly, we find that current interest rates are unusually low relative to what would ordinarily be expected. In line with our belief that financial markets are all about people, we are fortunate to profile The Deloitte Top 200 Chief Executive of the Year in 2016, Mike Bennetts of Z Energy. Retaining the focus on high achievers, we also profile FNZC’s Head of Institutional Research, Arie Dekker, who is INFINZ Analyst of the Year for 2017.
Contents Through the Telescope 4 Asset Allocation 8 Z Energy’s CEO - Mike Bennetts 9 FNZC’s Telecommunications, Media, 11 Dairy and Retirement Village Sector Expert – Arie Dekker New Zealand Equities 14 Australian Equities 18 Information Technology – Still Bullish, But Less So 22 The China Pivot 24 Interest Rates Deconstructed 26 Hybrid Debt Securities – Correctly Priced? 29 Can the Kiwi Keep Flying? 31 FNZC Investment Portfolio Series - Investment Process 33 Calendar of Major Events: August-October 2017 35 Financial Markets – The Last 20 Years 36 If in Doubt Contact Your Adviser 37
Through the
Telescope
Key Takeaways 2019 Recession?
++ Central banks desire A handful of commentators are now suggesting that there may be a recession in
higher interest rates, developed economies in 2019. This seems to reflect there being no sign of one in
but this must be 2018, the current economic expansion rapidly approaching the longest recorded
supported by expansion since 1850 and recent central bank statements.
economic fundamentals A recession is not expected in 2018 as none of the usual indicators are warning of one
++ The vigour with which any time soon. In this regard liquidity is good, the difference between long and short
China pursues reform term interest rates is well away from zero (let alone turning negative), credit spreads
will impact Chinese and (the amount paid by borrowers above reference interest rates) are very low and
Purchasing Manager Indices are relatively high.
global growth
++ Cash allocations trough However, the recent synchronized comments from central banks suggest we are a
as equity markets peak step closer. These include:
++ Current environment is 1. Comments from the US Federal Reserve (Fed) that as well as increasing the
positive for equities, but Fed funds rate, it plans to start reducing the size of its US$4.2 trillion balance
support factors are sheet by not reinvesting in maturing securities. Current indications are that
stretched the balance sheet could reduce to US$3.1 trillion by 2023.
2. An indication from the European Central Bank (ECB) that they will reduce the
amount of debt securities they are purchasing (referred to as tapering).
3. Having introduced macro-prudential tools to ease pressures in the housing
market, similar to what has occurred in NZ, the Bank of Canada increased
interest rates by 0.25%.
4. There was a split vote by the Bank of England’s monetary policy committee
on the need to reverse the post Brexit 0.25% cut in the official bank rate, due
to high inflation caused by currency weakness.
5. The Reserve Bank of Australia (RBA) commented that the neutral interest
rate (the theoretical interest rate at which inflation is stable and the economy
is growing at its trend rate) is around 3.5%. Not only is this much higher than
the current 1.5%, it was higher than expected. Despite this, the RBA is
expected to keep interest rates unchanged, as is the case in NZ.
Despite the desire by central banks to see interest rates higher, they won’t act unless
economic fundamentals, in particular inflation, support an increase. Despite low or
falling levels of unemployment, wage growth is low and inflation is benign.
Watch this space.
First NZ Capital Securities Ltd – NZX Firm | www.fnzc.co.nz 4
Investment Outlook August 2017
Forecasts
Economics As at 24 July 2017
Fiscal Balance % GDP1 GDP Growth % Inflation % 3 month Libor %2 10 Year Government %
2016 A 2017 F 2018 F 2016 A 2017 F 2018 F 2016 A 2017 F 2018 F Spot 3 mth 12 mth Spot 3 mth 12 mth
New Zealand 0.7 0.2 1.2 2.7 2.4 2.9 1.3 1.8 1.9 1.9 2.0 2.0 2.9 3.3 3.5
Australia -1.5 -2.1 -2.1 2.5 2.2 2.5 1.3 1.9 2.0 1.7 1.7 1.7 2.7 2.5 2.9
US -3.1 -3.3 -3.5 1.6 2.0 2.3 1.3 2.0 2.2 1.3 1.5 2.0 2.3 2.5 2.8
Japan -5.7 -4.5 -4.8 1.0 1.2 1.0 -0.1 0.6 0.6 0.0 0.0 0.0 0.1 0.1 0.3
Europe -1.7 -1.7 -1.5 1.8 2.0 1.7 0.2 1.5 1.4 -0.3 -0.3 -0.3 0.5 0.5 0.7
United Kingdom -2.9 -2.9 -2.4 1.8 1.5 1.4 0.7 2.8 2.5 0.3 0.4 0.4 1.2 1.3 1.5
China -3.5 -3.5 -3.5 6.7 6.7 6.4 2.0 2.0 2.2 4.3 n/a n/a 3.6 3.5 3.5
Source: FNZC, Credit Suisse, UBS, Bloomberg
1
New Zealand fiscal balance is 30 June
2
NZ is the 90-day bank bill yield
Equities and Commodities Foreign Exchange
Spot 12 mth forecast Past Month Past Year USD NZD
Australia – ASX 200 5,688 5,560 - 6,140 -0.3% 3.5% Spot 12 mth Spot 12 mth
Emerging Markets – NZD 0.74 0.71 - -
MSCI EMF GEM 1,064 960-1,070 5.5% 22.4%
AUD 0.79 0.76 0.94 0.94
Europe – Stoxx 50 3,453 3,470-3,830 -2.9% 16.2% EUR 1.16 1.05 0.64 0.68
Japan – Nikkei 225 19,976 18,900 - 20,900 -0.7% 20.1% JPY 111 105 82.6 75.0
New Zealand – NZX 50 7,682 7,100 - 7,800 1.6% 6.3% GBP 1.30 1.30 0.57 0.55
UK – FTSE 100 7,378 7,000-7,700 -0.8% 9.6% CNH 6.75 7.20 5.02 5.47
US – S&P 500 2,470 2,420 - 2,680 1.5% 13.6% Source: FNZC, Credit Suisse, UBS, Bloomberg
Oil Brent USD/Bbl 49 50.50 - 55.50 7.5% 6.4%
Gold USD/Oz 1,255 1,090 - 1,210 0.4% -5.1%
Source: FNZC, Credit Suisse, UBS, Bloomberg
Upcoming Events to Monitor
None of these are new, although the lack of concern by financial markets is notable:
1. North Korea – despite recent successful intercontinental ballistic missile
launches, this risk has been ignored.
2. NZ election – too close to call, with NZ First likely to determine which of
National and Labour/Greens will form the next government. Historically, a
change in government has caused the NZ equity market some angst.
3. Italian election – the election must be held by May 2018. With a fall in the
popularity of the Five Star Party following a poor showing in recent local body
elections, the risk of a poll on Italy leaving the euro has diminished.
4. China –arguably the biggest risk to global economic growth, given it
contributes close to 30% of global economic growth. More about this later.
5. The Trump administration – with the failure to get healthcare reform
legislation passed, hopes for tax reform and major infrastructure spending
are receding. In addition, the possibility of Trump eventually being impeached
remains and just around the corner, in October, the US government debt
ceiling will be reached again.
6. Wage growth accelerates, putting pressure on company profits and the need
for higher interest rates.
First NZ Capital Securities Ltd – NZX Firm | www.fnzc.co.nz 5
Post Congress China
China’s 19th Communist Party Congress is rapidly approaching. What happens after
the Congress will be highly dependent on the composition of the 300 member Central
Committee, the all-important Politburo Standing Committee and Xi Jinping’s power
base. Xi’s 2013 plan included rebalancing economic growth to consumer services and
private investors, market deregulation, fiscal reform (including sustainable finances for
local government), stabilizing the business sector through enforcing the rule of law,
injecting private capital and market discipline into state-owned companies and
reducing pollution. However, the plan was compromised due to socio-political issues
which required a boost to economic growth through more infrastructure spending and
higher credit growth. The vigour with which reform is pursued over the next five years
will depend on the leadership’s stomach for unemployment and bankruptcies which
would surely occur, and the extent to which China’s other ambitions; increased military
might and one belt one road, are compromised. In conclusion, it is very difficult at this
stage to forecast how the Chinese economy will unfold.
“It’s Always Darkest Before the Dawn”
The opposite of the quote above is that it must be brightest before dusk. We use this
analogy to highlight human nature which is to be most optimistic after a long positive
period. We see this in investor behaviour over the past twenty years. Based on US
data the following chart shows that investors have the smallest proportion of their
investment portfolios invested in cash at the top of the equity market and the most at
the bottom.
Cash Holdings Fall as the 9 3000
8
Equity Market Rises 7 2500
Source: Bloomberg, FNZC
6 2000
5
4 1500
3 1000
2
500
1
0 0
03/00 03/03 03/06 03/09 03/12 03/15
Cash Proportion of Portfolios % (lhs) S & P 500 (rhs)
The fact that in aggregate, investors have the riskiest portfolios as the equity market
peaks, suggests a desire to chase historical investment returns without giving due
consideration to the risk involved and/or a lack of focus on asset allocation. Whether
the approach taken turns out to be correct will only be truly tested in a financial market
downturn, when investment returns decline and investor’s real risk appetite is put to
the test. Our approach has been to gradually reduce the proportion of our tactical
asset allocation in equities in recent years, as equity markets have risen.
Are Equity Allocations Too High?
Equities, whether NZ, Australian or global, generate not only the largest potential
“ the price of equities returns but also the most uncertain returns. Therefore they tend to have the biggest
impact on investment portfolio returns in any year. We know the price of equities is
is currently very
currently very high, which leaves little room for error. However, so are other assets. In
high, which leaves particular, relative to the interest rates applicable to government debt, equities appear
little room for error.” to offer good value. There are numerous indicators that investment strategists look at
to determine whether the equity market is at a peak. Unfortunately, most of these
First NZ Capital Securities Ltd – NZX Firm | www.fnzc.co.nz 6
Investment Outlook August 2017
coincide with the equity market peak, thus providing no warning. The best we can do
is think about how these factors are likely to change and thus the impact on equities.
So how do things currently stack up for equities:
1. Earnings momentum is currently positive, being supported by sound
economic growth as indicated by positive, although easing, Purchasing
Manager Indices. Importantly, recent growth is coming from revenue growth
rather than lower tax rates, lower interest rates and share buybacks which
have been the key sources of earnings per share growth in recent years. In
particular, share buybacks are becoming more difficult due to high equity
prices, higher interest rates and high company debt levels, all conspiring
against share buyback feasibility.
2. Extraordinarily low equity market volatility is supporting high company
valuation multiples. A reversal is a big risk.
3. Excess global liquidity is supporting all asset prices, including equity prices.
Despite the Fed commencing a reduction in the size of its balance sheet,
aggregate global central bank balance sheets won’t start to decline until the
September 2018 quarter.
Aggregate Central Bank 16000
Aggregate central bank balance sheet (USDm)
Balance Sheet 14000
Declines in 2018 12000
Source: Thomson Reuters, Credit Suisse
10000
8000
6000
4000
2000
0
07 08 09 10 11 12 13 14 15 16 17 18 19 20
Fed ECB BoJ BoE
4. Historically price-to-earnings (PE) ratios haven’t reduced until inflation
exceeded 3%, with a material decline not seen until inflation rises above 4%.
This represents limited risk.
5. As noted previously, we don’t anticipate a recession in the near term.
6. Relative to long term interest rates, equities appear cheap. Other things
being equal, the US 10 year Treasury interest rate can increase to 3.2% (our
forecast is 2.8% by year end) before the balance tips for US equities. This is
a growing risk.
“ corporate share of 7. With wage growth muted, the corporate share of economic output is high as
can be seen in high corporate profit margins.
economic output
is high” 8. Credit spreads are very low, reflecting a solid economy and low levels of
financial market volatility. A rise in credit spreads would be negative for
company interest costs and earnings. However, more importantly, they would
indicate a weaker economy which would be negative for equities.
While the environment is positive for equities some of the supporting factors are at
extreme levels and others are starting to fray around the edges. In aggregate, the
current environment is positive for equities although some of the supporting factors
are at extreme levels and others are starting to fray around the edges. We
recommend a degree of caution. While a correction of 5-7% wouldn’t surprise us, a
bear market (20%+ decline) would.
First NZ Capital Securities Ltd – NZX Firm | www.fnzc.co.nz 7
Asset Allocation – August 2017
Based on the Portfolio Structure discussion (page 6) we have made no changes to the tactical asset allocation. The
strategic asset allocation represents the average weighting over the long term (circa ten years or an entire economic
cycle). The tactical asset allocation represents a deviation from the strategic allocation to take advantage of expected
changes in asset class returns over the short term (say 6 months plus).
% Strategic Allocation Tactical Deviation %
Income Assets Growth Assets
Conservative
Cash 15 +2
NZ Debt Securities 55
Property 4 -1
NZ Equities 8 -1
Australian Equities 3 -1
Global Equities 12 +1
Alternative Strategies 3
Balanced/Conservative
Cash 11 +2
NZ Debt Securities 44
Property 5 -1
NZ Equities 12 -1
Australian Equities 6 -1
Global Equities 18 +1
Alternative Strategies 4
Balanced
Cash 8 +2
NZ Debt Securities 32
Property 6 -1
NZ Equities 16 -1
Australian Equities 8 -1
Global Equities 25 +1
Alternative Strategies 5
Balanced/Aggressive
Cash 7 +2
NZ Debt Securities 23
Property 6 -1
NZ Equities 20 -1
Australian Equities 10 -1
Global Equities 29 +1
Alternative Strategies 5
Aggressive
Cash 5 +2
NZ Debt Securities 15
Property 6 -1
NZ Equities 23 -1
Australian Equities 12 -1
Global Equities 34 +1
Alternative Strategies 5
First NZ Capital Securities Ltd – NZX Firm | www.fnzc.co.nz 8
Investment Outlook August 2017
Z Energy’s CEO – Mike
Bennetts
Against stiff competition, Mike Bennetts was named Deloitte Top 200 Chief Executive
Key Takeaways
of the Year in 2016. While many who know Mike will not be surprised at him receiving
++ 2016 Chief Executive of the this accolade, it is interesting to think whether anyone would have foreseen this in his
year early life.
++ Assessing, managing and
In the Beginning
correctly pricing risk is key
Mike currently resides in Auckland. This is his home town, having been born in Howick
++ The Z story under Mike and and attended school in Manurewa. Despite a passion for learning, the dream of
his team has been one of becoming a defence lawyer ended after one year of law school, when he decided that
material value creation law simply wasn’t for him. A lucrative period of contract cleaning cars and campervans
gave him cash to buy his first house and time to think about what career path to follow.
His criteria was a career that allowed him to work overseas and develop as a person.
The two sectors identified were tourism and energy. He chose the latter and so began
a career which started with Europa, before being absorbed into BP, and took him from
New Zealand, to South Africa, China, United Kingdom and Singapore. Goal 1
achieved. Sixteen jobs over twenty five years gave him broad exposure to life in an
energy business, including time as a sales rep, experience rebranding Europa as BP
and developing a point of sales computer system amongst other things. No doubt this
experience proved valuable in creating Z Energy (ZEL). Early in his time at Europa,
Mike was advised that to really develop he needed tertiary education, which resulted
in him attaining a Bachelor of Business Management through extramural study from
Massey University.
Defining Moments
At the end of 1998, as Mike prepared to leave China, he realised that he was a small
cog in a big machine and that he needed to take greater control of his own
development. No doubt this led to the next two roles which had a profound influence
on Mike’s career.
The first, in the early 2000’s, was as Chief of Staff to Vivienne Cox CBE, a BP
stalwart, who was executive vice-president and chief executive of BP’s gas, power
and renewables arm. As well as seeing first-hand the inner workings of the world’s
second largest oil and gas company, Mike was exposed to renewables. Furthermore,
Cox set up BP’s commodity derivatives business in the early 1990’s which dovetails
into Mike’s second key role.
Based in Singapore, Mike became CEO and Director of the Integrated Supply and
Trading business for BP’s Australasia, Asia, Middle East and sub-Saharan Africa
region. During this time he learned how to assess, manage and correctly price risk.
The end of his time in Singapore the global financial crisis occurred, which directly
impacted this business as counterparty risk exploded and credit dried up.
First NZ Capital Securities Ltd – NZX Firm | www.fnzc.co.nz 9
The ZEL Chapter
2010 saw the start of the ZEL story, through the acquisition of Shell’s NZ fuel
distribution business by Infratil and the NZ Super Fund for $891 million. As well as
having to create systems which were previously part of the Shell behemoth, the ZEL
team had to develop a new brand to replace one of the world’s best known brands
Shell. They have successfully done this with Z being NZ’s top brand for fuel in the
2016 Readers Digest most trusted brand survey. In mid-2016, ZEL bought Caltex for
$758 million. With a current market capitalisation of $3.2 billion, to which must be
added distributions paid to shareholders, the ZEL story under Mike and his team has
been one of material value creation. The acquisition of Caltex was unusual in that the
purchase was uncontested and the business was integrated within ZEL’s business
before the sale was settled, meaning that the Chevron systems on which Caltex ran
were switched off with ZEL’s systems immediately taking over. In both acquisitions
Mike was able to draw on his risk assessment, management and pricing skills.
Taking a closer look at his current role at ZEL, Mike observes that modern companies
have to be able to change shape and respond to the environment they are operating
in. To enable this to happen requires him to spend a significant amount of time
travelling, meeting staff (where he acts as a coach), customers, shareholders,
government officials and other stakeholders in ZEL’s business. A key ethos which
“extraordinary Mike operates by is that “extraordinary performance comes through leadership by
causing something to happen that wouldn’t happen otherwise”, and that a key to
performance comes
success is to “intervene ahead of issues happening”. In terms of building a successful
through leadership team at ZEL he is acutely aware that personal values trump corporate values.
by causing something Therefore, the social and environmental values of ZEL come from within, rather than
being imposed by the company.
to happen that
wouldn’t happen
otherwise” The Future
Seven years is the longest time Mike has ever been in one job. The question is often
asked when might he decide that he has had enough? To this he explains, three
simple questions must each be answered “yes”.
1. Am I enjoying myself?
2. Am I making a difference?
3. To ZEL’s board, am I the best person to lead ZEL?
“fuel distribution With the fuel distribution industry in a state of flux, there should be plenty to keep the
role challenging. ZEL’s challenges include the production of more efficient forms of
industry in a state of
propulsion (cars, trucks, planes and ships), electric vehicles, hybrid vehicles and
flux ” potentially the greatest threat of all, autonomous vehicles (click to link to report).
However, from these challenges also potentially come opportunities to shift into
adjacent services/industries and also potentially use the disruption as an opportunity
rather than treat it as a threat.
In coming up with a plan for the future, ZEL’s stated purpose is “to solve what matters
for a moving world”. And what matters is a low carbon future. While ZEL has a clear
pathway until the end of the decade, the outlook for the 2020’s is far less certain.
In the immediate future investors are focused on the outcome of the NZ petrol market
review, the potential for increased dividends as the debt used to fund the Caltex
acquisition is paid down (we forecast ZEL’s gross dividend yield to increase from 5.6%
in FY18 to 10.6% in FY19) and the extent of efficiency gains from Strategy 3.0.
First NZ Capital Securities Ltd – NZX Firm | www.fnzc.co.nz 10Investment Outlook August 2017
FNZC’s Telecommunications, Media,
Dairy and Retirement Village
Sector Expert – Arie Dekker
As well as being the analyst responsible for researching eight NZ companies, Arie is
also Head of Institutional Research, which makes him responsible for nine other
analysts and analyst assistants. Dutch born, but New Zealand bred, Arie has already
had a distinguished career having being named INFINZ Analyst of the Year for four of
the last five years. Clearly, at least part of his success relates to sheer hard work and
a passion for analytical work. When asked what he would do if he couldn’t be an
analyst, he replied “an investigative journalist” - not surprising given the strong
parallels with being an exceptional analyst. However, Arie also credits the work
opportunities he has had as giving him an edge in his current role. This includes four
years in investment banking at Credit Suisse in Wellington (which has subsequently
become FNZC), eight years at Todd Capital, two years as Chief Financial Officer at
Ara Wines (over which time the newly formed Auckland corporate office grew from
two to twenty staff), before taking up an analyst role at Craig’s Investment Partners. In
2014, Arie returned to his roots taking up his current role at FNZC. Outside the work
environment Arie is a family man, with two children approaching their teenage years,
who enjoys picking a racquet to play a game of tennis or squash.
The Retirement Village Big Boys
Much has been written on the retirement sector recently, in particular Metlifecare
Key Takeaways
(MET), Ryman Healthcare (RYM) and Summerset (SUM). From a long term
++ House price growth is a key perspective the sector is a beneficiary of the steadily growing number of elderly New
driver of retirement village Zealanders. Although as time passes, the level of supply and demand of retirement
value villages needs to be closely monitored, particularly in Auckland. Of potentially even
greater importance in recent years has been house price inflation (which is heavily
++ Future developments are a
influenced by migration), which has left house prices at high levels relative to incomes,
material proportion of the both from historical and global comparative perspectives. Looking forward, lower
RYM and SUM valuations house price growth, or worse still house price declines, creates a more challenging
++ Residential liabilities form a operating environment. Intuitively this makes sense, as the asset base of these
material financial obligation. companies is residential property in the form of accommodation for the elderly.
Furthermore, these companies record profits on the sale of licences to occupy
In addition RYM and SUM
retirement units, the resale of these licences when a resident moves out and the
have significant bank debt
deferred management fee which is typically 20-30% of the sale price. Occupational
licence values typically reflect the value of the houses in the key catchment area for
the village’s residents.
First NZ Capital Securities Ltd – NZX Firm | www.fnzc.co.nz 11House Prices Influence 425 155
Retirement Village 375 145
325
Share Prices 135
Source: Bloomberg, FNZC 275
125
All prices rebased to 100 225
115
175
105
125
95
75
11/12 05/12 11/12 05/13 05/14 11/14 05/15 11/15 05/16 11/16 05/17
Ryman Healthcare Metlifecare Summerset REINZ NZ median house price (lhs)
RYM has a more diverse business due to its substantial care business. Our analysis
suggests that the valuation of RYM’s existing business (excluding development) is
slightly better placed than SUM and MET (refer table) for a shock to house prices.
Qualitative factors such as the overall mix of RYM’s villages being more needs based
than the more lifestyle based villages of MET and SUM, also needs to be taken into
consideration in a housing downturn. However, if there was a moderate to material
downturn in the housing market, the value ascribed to development would be called
into question as the rate of development slowed. In this case, MET is better positioned
than RYM and SUM as it has a smaller development portfolio and significantly less
debt. RYM does have the advantage of some diversification through having
developments in NZ and Melbourne, Australia.
RYM SUM MET
$/share Proportion $/share Proportion $/share Proportion
Value of existing villages 7.99 113% 6.77 138% 9.30 135%
Resident liabilities net of Deferred Management Fee -3.71 -52% -3.68 -75% -3.07 -44%
Development of NZ land bank 1.29 18% 1.66 34% 0.66 10%
Development of Australian land bank 0.51 7% 0.00 0% 0.00 0%
Development land 1.45 20% 1.39 28% 0.22 3%
Net debt -1.68 -24% -1.22 -25% -0.20 -3%
Potential future development in the next 10 years 1.23 17% 0.00 0% 0.00 0%
Valuation 7.09 4.92 6.91
Share price at 25/7/17 9.07 4.89 5.60
Premium/discount to Valuation 28% -1% -19%
Existing village valuation change to a +/-10% shift in house prices +/-9% +/-12% +/-11%
Source: FNZC
From a valuation perspective, we believe that RYM appears expensive even though
we have included $1.23/share for upside from developments where the development
land is yet to be acquired. This appears aggressive, although in part reflects RYM’s
sound management and solid track record. Furthermore, management have a history
and target of 15%pa plus underlying profit growth – a measure that investors are likely
to increasingly turn away from in favour of cash flow metrics. Arguably, the growth
RYM has been achieving becomes more demanding each year as the company gets
larger. Presumably this is why RYM entered the Australian market, where they are yet
to replicate the track record shown in NZ. RYM’s focus on growth has seen a
significant increase in debt to over $1 billion. We believe that RYM’s high share price
relative to our valuation at least partly explains RYM’s flat share price performance
since early 2014, compared to MET’s and SUM’s share prices which have both risen
by around 40%. While SUM has a clear growth strategy, it is not yet fully proven
(hence we include no value for potential developments on land it doesn’t own). SUM
has the advantage of growing off a small base. MET on the other hand, is only in the
First NZ Capital Securities Ltd – NZX Firm | www.fnzc.co.nz 12Investment Outlook August 2017
early stages of implementing a new strategy. Furthermore, it has the oldest assets
with potentially the greatest need for renovation. The cost of renovation should be
allowed for in the value of the existing villages.
Gearing – Metlifecare is Best Placed
If there is a downturn in the retirement village sector, then the level of gearing could
potentially have a material impact on the performance of each company. In the table
above we observe that the level of net debt is typically similar to the value of
development land. Attention should also be given to the value of residential liabilities
net of deferred management fees, which reflects the amount owed to residents in
relation to occupational licences (which are effectively interest free loans to retirement
village operators and must be repaid). We make three observations:
“The amount of 1. The amount of resident liabilities is material. It amplifies the impact on each
companies’ share valuation of any change in the value of existing villages.
resident liabilities is
material” 2. SUM has the highest relative level of debt (including residents’ liabilities), and
is thus most at risk should the value of retirement villages decline.
Conversely, MET has the least debt.
3. In an extreme scenario where retirement villages find themselves repaying
occupational licences before they are resold (even though there is no
statutory requirement for them to do this in NZ), SUM is in the weakest
financial position to do this and MET the strongest position. While each
company would wind back new development and use the sale proceeds from
completed units to reduce debt in this situation, companies with large
development land banks would still need to pay the interest costs on this
land.
Revenue Mix Favours Ryman Healthcare
“Based on our Based on our forecast cash flow, RYM has the strongest position with fees from
serviced apartments and care facilities and the realised deferred management charge
forecast cash flow
comfortably covering overheads and interest payments. While MET lacks any material
RYM is in the contribution from serviced apartments and care facilities, the level of realised deferred
strongest position” management fees adequately covers overheads and MET’s small interest cost. Only
SUM has a deficit and relies on resale gains to be able to cover its interest payments.
However, under a scenario where there is no future price appreciation of occupational
licences, current occupational licence prices are high enough to ensure that the
deferred management fees yet to be received and future resale gains as occupational
licences are resold, should continue to be realised for some time.
Metlifecare Preferred
While RYM has a very high quality business and enviable track record, we believe that
the current share price is factoring in too much for future growth. Our preference is for
MET, given its defensive attributes in a housing market which appears to be facing
more subdued price growth and which appears to offer good value based on its
existing assets rather than future developments.
First NZ Capital Securities Ltd – NZX Firm | www.fnzc.co.nz 13New Zealand Equities
share prices as at 25 July 2017
Contact Energy (CEN)
Price $5.32 CEN’s soft operating statistics highlight the very low hydro storage levels in the
Target Price $5.85 southern lakes. This has severely eroded CEN’s hydro electricity generation profit by
Rating Outperform
around $30 million in 2H17. While hydro storage levels are mean reverting, the current
low lake levels mean CEN is carrying a 230GWh hydrogenation electricity shortfall
into FY18. In terms of the underlying business, CEN continues to generate attractive
free cash flow. CEN’s gearing is expected to fall within its targeted range this year,
which will trigger a review of distributions to shareholders, with an announcement
likely at its FY17 profit release in late August 2017. The current dividend pay-out
equates to around 60-65% of free cash flow and could be increased to 80%, bringing it
in line with its peers. However, the inability to fully impute dividends suggests that
share buybacks are more likely. Meanwhile, the outlook for the Tiwai smelter appears
secure for the next few years as it benefits from improved aluminium prices, low
alumina cost and relatively flat energy costs. Consequently, it appears unlikely that
the smelter will be shut down.
Fletcher Building (FBU)
Price $7.61 FBU recently revised down FY17 EBIT guidance to $525 million, from $610-$650
Target Price $9.40 million. The revision reflects a further $105 million provision (on top of $110 million in
Rating Outperform
March) for losses incurred in FBU’s Construction Division. We believe the losses
relate largely to the Christchurch Justice Precinct, the Sky City Convention Centre and
$25 million from a range of smaller projects. In aggregate, the losses take $0.15/
share off our valuation. FBU continues to assess the Commercial Bay Project, which
we believe is profitable. Increased labour costs appear to be the main contributor to
the losses. It is difficult to assess whether there might be additional losses until
existing projects approach completion. We believe that two key appointments since
April are positive for the business and should help diminish the appetite to bid on
future marginal contracts. The rest of FBU’s businesses are performing well, with the
exception of Tradelink and Iplex Australia. These two businesses were part of the
Crane Group acquisition and have been written down in value. We have reduced
earnings from these businesses by $14 million which has reduced our FBU valuation
by $0.25/share. As a result of the weak performance, Francisco Irazusta has been
appointed Interim CEO, replacing Mark Adamson. FBU is trading on a 12x forward
price-to-earnings ratio which represents a much larger than normal discount to the
market. Despite some caution around additional possible contract losses, we believe
FBU offers good value.
Kiwi Property Group (KPG)
Price $1.37 KPG is an internally managed property company comprised of 70% retail assets and
Target Price $1.40 30% office assets. KPG has experienced some share price weakness in recent weeks
Rating Neutral
as the global retail property sector has come under renewed pressure from the online
shopping threat and the potential entry of Amazon into the Australasian market. We
First NZ Capital Securities Ltd – NZX Firm | www.fnzc.co.nz 14Investment Outlook August 2017
believe KPG should be relatively insulated from these threats in the medium term due
to the generally high quality of its portfolio –specifically Auckland’s Sylvia Park mall
which makes up 26% of KPG’s portfolio. KPG continues to focus on earnings accretive
development projects at Sylvia Park, Northlands in Christchurch and The Base in
Hamilton. KPG’s recent $161 million capital raising has ensured that it should be able
to comfortably fund its near term development pipeline. After factoring in the $200
million retail expansion at Sylvia Park and the sale of $300 million of lower quality
non-core assets (likely to include The Majestic Centre, North City and Centre Place
North), we expect KPG’s gearing to sit at 30-31%, the mid-point of its 25-35% targeted
gearing range. KPG has a forecast FY18 gross dividend yield of 7.0%.
Oceania Healthcare (OCA)
Price $0.96 Through its retirement villages and aged care facilities, OCA is exposed to the aging
Target Price $1.01 population thematic. OCA’s portfolio mix is quite different from its larger peers
Rating Outperform (Ryman Healthcare, Summerset and Metlifecare) in that 73% of its portfolio is
exposed to aged care. Of those three, Ryman has the highest aged care exposure, at
just 35%. This provides OCA with a more stable earnings profile and less risk, due to
lower exposure to retirement village development at a time when house price inflation
is lower. OCA’s recent FY17 profit result modestly exceeded expectations with lower
net debt of $84.4 million and an adjusted net asset value (NAV) of $0.92/share. With a
share price of $0.96, there is only a modest amount being attributed to its
development pipeline, which includes five large brownfield development projects over
the next three years. Together, these projects are expected to increase the size of
OCA’s retirement unit portfolio by 24% and care by beds by 8%. OCA’s medium to long
term development pipeline offers a further 19% uplift in retirement units/care beds.
However, as they are unconsented, we have not incorporated them into our target
price. While the Government currently supports the private provision of elderly care, a
key risk to OCA’s business model is any change to Government funding levels and
asset test thresholds.
Restaurant Brands (RBD)
Price $6.30 RBD has experienced strong trading across its four NZ brands, while KFC Australia
Target Price $6.18 and its Pacific business are delivering results in line with expectations. RBD reported
Rating Outperform total sales in the first quarter of $161 million, an increase of 67% after it expanded into
Australia, Hawaii, Guam and Saipan. Same store sales for the quarter rose 7.2%, being
dominated by KFC NZ (up 7.1%). Net profit guidance remains “in the vicinity of $40
million”. However, management is typically conservative with early guidance leaving
scope for upward revisions. In terms of further acquisition opportunities, Yum! Brands
have initiated an Australian store divestment programme which could total 110 KFC
restaurants. Recently, 28 restaurants located in Tasmania, South Australia and
Western Australia were sold to RBD’s peer Collins Foods (CKF). Importantly, the sale
price appeared reasonable and no stores where divested in NSW where RBD hopes to
become the dominant operator. Since early May, RBD’s share price has appreciated
by 21% and now appears to factor in potential upside from the acquisition of 10-15
KFC restaurants. Therefore, there is a risk that when an acquisition announcement is
made, it disappoints.
First NZ Capital Securities Ltd – NZX Firm | www.fnzc.co.nz 15Sanford (SAN)
Price $7.31 SAN is a major aquaculture operator and owner of fish quota in NZ. SAN is a
Target Price $6.90 beneficiary of on-going global demand growth for protein and potential increase in
Rating Neutral seafood prices. SAN has a goal to double its earnings (EBIT) to well over $100 million
over a three-to-five year period, from the $65 million achieved in FY16. We believe
management can realistically achieve this goal if it can execute on its strategy to
deliver a more profitable mix by focusing on non-commodity products, development
of new applications such as nutraceuticals (e.g. anti-inflammatory products),
branding of its aquaculture products and pricing discipline for some of its key
products. Despite the long-term prospects appearing favourable, we are wary of the
adverse impact of an elevated NZD/USD exchange rate, and variability in mussel
prices and Northern Hemisphere squid fisheries. While the share price is above our
target price, we observe SAN’s valuation multiples appear to offer good value relative
to the broader equity market.
Synlait Milk (SML)
Price $4.25 SML has enjoyed material success with its nutritionals (infant formula) strategy on
Target Price $4.22 the back of the strong demand for A2 Milk Company’s (ATM) Platinum infant formula
Rating Neutral in China. Demand should drive strong volume growth into FY18. Furthermore, we have
greater confidence in SML’s ability to sustain its current high margins on increased
volume. As has been the case for some years, the key risks remain China’s regulatory
environment, which is somewhat fluid, and the fact SML is reliant on one key
customer, ATM. SML recently moved to de-risk its business by acquiring a second
blending/canning site in Mangere, Auckland. The second site should allow SML to
secure new customers while avoiding capacity issues going into FY19, although there
is uncertainty around whether Chinese regulators will approve product manufactured
across two sites. We are cautiously optimistic on SML’s outlook, but recognise that
the positive leverage currently being experienced with increasing infant formula
production can have the opposite impact if volumes decline.
Tourism Holdings (THL)
Price $4.26 THL’s core business is the rental of motorhomes in NZ (31% of our valuation),
Target Price $4.10 Australia (11%) and the US (40%). In addition, THL earns profits from the sale of its
Rating Neutral fleet, ancillary goods and services, and through its tourism businesses Discover
Waitomo and Kiwi Experience (18%). We believe that THL has a positive near-term
earnings outlook driven by: robust visitor arrivals growth from key markets, continued
structural improvement through flexible capital deployment and a turnaround of the
recently acquired El Monte business. Strong visitor arrival growth in Australasia
reflects both cheaper and more flights to the region. While we believe the airline
industry has reached a cyclical high, the momentum should support FY18 earnings.
However, relative to our valuation, THL’s share price appears to be factoring little
room for error from potential execution slippage or a cyclical downturn which could
prevent management’s $78 million FY20 EBIT target being achieved. This is
important, as THL needs positive free cash flow and the successful rationalisation of
the El Monte fleet to pay down debt (net debt-to-EBITDA is forecast to peak at 2.1x in
FY17).
First NZ Capital Securities Ltd – NZX Firm | www.fnzc.co.nz 16Investment Outlook August 2017
Security Issuer Name
AFT
AIA
AFT Pharamaceuticals
Auckland Airport
NZ Equities Valuation
Metrics and Ratings
AIR Air NZ
ARG Argosy Property
ARV Arvida
ATM A2 Milk Company
AUG Augusta Capital*
AWK Airwork Holdings As at 25 July 2017
BGR Briscoe Group*
CEN Contact Energy Gross Dividend Yield %
CNU Chorus 14%
DGL Delegat Group 12
EBO EBOS Group
ERD EROAD 11
FBU Fletcher Building
FPH Fisher & Paykel Healthcare 9
FRE Freightways
FSF Fonterra Shareholders’ Fund 8
GMT Goodman Property Trust
GNE Genesis Energy 6
HBL Heartland Bank
HLG Hallenstein Glasson* 4
IFT Infratil
IPL Investore Property* 3
KMD Kathmandu
KPG Kiwi Property Group 2
MCY Mercury NZ
MEL Meridian Energy 0
MET Metlifecare
MFT Mainfreight
MHJ Michael Hill International
MPG Metro Performance Glass P/E Ratio x
MVN Methven
50
NZK NZ King Salmon
NZR NZ Refining 45
NZX NZX
OCA Oceania Healthcare 40
OHE Orion Health
35
OIC Opus International
Consultants 30
PCT Precinct Properties
PEB Pacific Edge 25
PFI Property for Industry
20
PGW PGG Wrightson
POT Port of Tauranga 15
RBD Restaurant Brands
RYM Ryman Healthcare 10
SAN Sanford 5
SCL Scales Corporation
SKC SkyCity Entertainment 0
SKL Skellerup
SKT Sky Network TV
SML Synlait Milk Ratings
SPG Stride Property*
SPK Spark NZ Underperform Neutral Overperform
STU Steel & Tube
SUM Summerset POT AIR AIA ARV AWK GMT ARG AFT MET
TGH Tegel Group RYM DGL CNU EBO NZR MVN ATM MPG
THL Tourism Holdings SPK MCY FPH FSF SML PEB CEN
TLT Tilt Renewables P/E Ratio x STU SKC FRE IFT TRA RBD ERD
TME Trade Me
TPW Trustpower TME GNE KMD VGL FBU
TRA Turners HBL KPG ZEL MHJ
VCT Vector MFT MEL NZK
VGL Vista Group International
OIC NZX OCA
VHP Vital Healthcare Property
Trust* PGW OHE SCL
WHS Warehouse Group SKL PCT TGH
XRO Xero THL PFI TLT
ZEL Z Energy
TPW SAN
NZ50 NZ Equity Market
WHS SKT
Source: FNZC, Bloomberg. The P/E
SUM
ratios and Gross Dividend Yield use
VCT
earnings and dividends forecasts for the
next 12 months. *Consensus forecasts XRO
First NZ Capital Securities Ltd – NZX Firm | www.fnzc.co.nz 17Australian Equities
Share prices as at 25 July 2017
Investing Outside the Top 20
The disappointing performance of Australia’s twenty largest companies (ASX20)
highlights the need for investors to look further afield (ASX100 ex top 20) when
investing in Australia (ASX100). This increases the opportunity of finding companies
which can deliver solid investment performance by a factor of five. In Australia, the
100th largest company has a market capitalisation of A$2.7 billion which is
considered large in NZ.
When Investing in Australia, 150
140
Consider Investing 130
based to 100
Outside the Top 20 120
Source: Bloomberg , FNZC 110
100
90
80
09/14 01/15 05/15 09/15 01/16 05/16 09/16 01/17 05/17
asx 100 asx 20 asx 100 ex top 20
Caltex Australia (CTX)
Price $30.38 We expect CTX to announce its ‘Quantum Leap’ review on 29 August. Quantum Leap
Target Price $39.70 suggests something more momentous than just another cost out programme, which
Rating Outperform leads us to believe it will focus on the partial or total break-up of the business. The
release of the Australian Consumer Competition Commission’s draft decision on BP’s
proposed acquisition of Woolworth’s fuel distribution business was expected in July,
but has been delayed pending a new proposal from BP. If as a result of the sale CTX
loses the current contract to supply Woolworths with fuel, it is likely to create a
$100-140 million per year earnings hole. CTX is attempting to fill this hole through the
recent acquisitions of Milemaker in Victoria and Gull in New Zealand, which should
contribute $50 million per year. Further cost reductions and acquisitions are likely to
make up the difference. With gearing expected to fall to 11% in FY19, CTX has
significant balance sheet capacity to undertake another share buyback, pay a special
dividend (thus utilising surplus franking credits) or make a major acquisition. CTX
appears cheap relative to the broader Australian equity market.
Commonwealth Bank of Australia (CBA)
Price $84.28 The banking sector recently benefited from the Australian banking regulator (APRA)
Target Price $89.00 defining ‘unquestionably strong’ as a capital requirement (CET1 ratio) of at least
Rating Neutral 10.5%, which must be in place by January 2020. Both the quantum and timing were
more favourable than expected. The extra capital is likely to be generated organically,
thereby avoiding the need to raise extra equity capital. In response, bank share prices
rallied 4-5%. CBA is our preferred pick in the sector, despite coming from a lower
capital position, as it has a higher return on equity and a less demanding dividend
pay-out ratio. Furthermore, CBA is considering options for its $5 billion Life Insurance
division, which could include sale. Of the other major banks, ANZ also appears well
First NZ Capital Securities Ltd – NZX Firm | www.fnzc.co.nz 18Investment Outlook August 2017
positioned with asset sale proceeds and a lower dividend pay-out ratio than National
Australia Bank (NAB) and Westpac (WBC). We believe NAB and WBC will both
struggle to grow dividends. The outlook for the broader sector remains satisfactory
with sound economic growth. However, bank net interest margins remain under
pressure due to higher wholesale funding costs, increased competition for deposits
and lower commercial lending margins. This has been partially offset by repricing
loans to residential property investors. CBA currently appears to offer good value
relative to the broader equity market, although WBC remains the cheapest in the
sector.
CSR (CSR)
Price $3.95 We believe that CSR offers good value relative to the broader building materials
Target Price $4.90 sector. CSR is trading on a forecast FY19 price-to-earnings ratio of 12.1x, well below
Rating Neutral Australian industrials on 16.0x. With the exception of the struggling Viridian glass
business (15% of CSR’s value), CSR delivered a solid FY17 profit. We expect an even
stronger profit in FY18, before an expected significant decline in FY19, as property
sales normalise and higher electricity prices impact the Tomago aluminium smelter.
CSR should be able to generate profit from property sales for another 10-15 years.
The greatest identifiable risk for CSR is the shape of the expected downturn in
residential construction. We expect reasonable demand to underpin earnings over the
next 12-18 months, which should support sentiment. If residential construction is
worse than expected, high-rise apartment developments are likely to be the most
affected. Apartment construction represents only 12% of CSR’s building materials
revenue. Despite having a $325 million asbestos liability, CSR’s balance sheet is
strong with zero debt. This provides CSR with the opportunity to make acquisitions.
Iluka Resources (ILU)
Price $9.19 ILU produces zircon and rutile. Zircon is used predominantly in tiles to promote
Target Price $9.90 hardness and whiteness. Rutile and synthetic rutile are largely used as the white
Rating Outperform pigment in paint. In the four years up to late 2016, zircon and rutile prices declined.
However, after consecutive quarters of price increases, we believe these commodities
are at the start of a multi-year price upgrade cycle. Our view reflects depleted
inventory levels and strong demand. On the supply side, small producers (which
represent about a third of the market) are running at full capacity. Furthermore,
following years of low prices, there has been little investment in new mine capacity.
Undeveloped deposits are largely controlled by the three big producers: ILU, Rio Tinto
(Richards Bay) and Tronox. ILU recently announced a 9-11% price increase for
uncontracted rutile sold from 1 July. With only 20% of rutile sales contracted, this
should support ILU’s FY17 profit, which has already seen a 46% lift in revenue to $470
million in 1H17. Considering management’s disappointing track record, it was
pleasing to see the stronger cash flow allocated to debt reduction, ahead of
significant forecast capital expenditure. Whilst ILU is no longer very cheap, we believe
the upside opportunity outweighs the downside risks. We note ILU’s share price is
volatile, with earnings highly sensitive to rutile and zircon prices.
First NZ Capital Securities Ltd – NZX Firm | www.fnzc.co.nz 19Lendlease Group (LLC)
Price $17.18 LLC’s share price is up 19.6% year to date as concerns of buyers defaulting on
Target Price $17.50 apartment developments (1H17 defaults were less than 1%) have abated. We believe
Rating Outperform LLC stands to benefit from: 1) an increased win rate for Australian engineering
contracts; 2) successfully diversifying its development business both geographically
and by type; 3) recognising the sale of 50% of its retirement living portfolio for $1
billion, which would represent a $0.85/share value uplift; and 4) apartment settlement
risk remaining under control. In the past, sceptics have pointed to a lack of visibility
around LLC’s ability to replace the Australian apartment earnings which are expected
to peak in FY19, creating a $200 million earnings hole, as a large number of projects
are completed. We remain confident that LLC’s international earnings will comfortably
bridge the gap, as the outlook has improved with a number of projects in delivery or in
the early stages of planning. These projects are forecast to produce circa $300 million
of annual development profits between FY19-23. LLC appears fair value relative to the
broader equity market and has forecast gearing of only 5% at 30 June 2017.
Rio Tinto (RIO)
Price $63.00 With around 62% of earnings exposed to the iron ore price, it is no surprise to see
Target Price $72.00 RIO’s share price follow the iron ore price up. Iron ore has risen from US$54/t in
Rating Outperform mid-June to US$67/t currently. The rally reflects an increased likelihood of Chinese
economic stimulus leading into the 19th Communist Party Congress at the end of the
year, China’s steel capacity closure programme and relatively stable Chinese
economic growth. While steel and iron ore prices remain the key share price driver,
cash flows are also being boosted by aluminium prices (16% of earnings), coal prices
(8% of earnings) and asset sales. We expect the strong cash flow to result, in
increased shareholder returns in the form of incremental share buybacks totalling $9.5
billion over the next 3 years. From a medium term perspective, RIO has a strong
balance sheet (gearing approaching 10%), modest forecast capital expenditure and a
pipeline of growth options driven by exploration/acquisitions/joint ventures. RIO’s
valuation appears fair relative to other Australian resource companies, but is well
below our $72 target price.
Scentre Group (SCG)
Price $4.10 We believe the market has now overplayed the concerns regarding the likely impact
Target Price $5.30 on traditional retailers of rising online sales and the anticipated arrival of Amazon in
Rating Neutral 2018. These concerns have dragged the value of Australian shopping centre property
owners lower, underperforming the Australian equity market by 18.8% over the past 12
months. We believe this has created a value opportunity. SCG, which develops and
operates retail property in Australasia, is our top pick in the property sector. This
reflects our view that SCG has the best quality shopping centre portfolio in Australia
with solid operating metrics, but has seen its price to net tangible assets (P/NTA) fall
to 1.11x, from 1.62x 12 months ago. Furthermore, SCG has a long track record of
creating value through development, yet the share price reflects negligible value for
future development upside. For example, since 2011, SCG has completed $2.8 billion
of developments (at cost) which has created $1.7 billion of valuation upside,
representing a development margin of 62%. Our target price of $5.30 incorporates
$0.52 of development value-add and uses relatively conservative assumptions
compared to the last five years. SCG has a FY18 forecast cash dividend yield of 5.5%.
First NZ Capital Securities Ltd – NZX Firm | www.fnzc.co.nz 20Investment Outlook August 2017
Australian Equities Valuation
Security Issuer Name
AGL AGL Energy
AMC Amcor
AMP AMP
ANZ
APA
ASX
ANZ Banking Group
APA Group
ASX
Metrics and Ratings
AZJ Aurizon
BHP BHP Billiton As at 25 July 2017
BXB Brambles
CBA Commonwealth Bank Cash Dividend Yield %
CCL Coca-Cola Amatil
CPU Computershare
CSL CSL Ltd 7%
CTX Caltex Australia
CWN Crown 6%
DXS Dexus Property Group
GMG Goodman Group
5%
GPT GPT Group
IAG Insurance Australia Group
IPL Incitec Pivot 4%
JHX James Hardie Industries
LLC Lend Lease 3%
MGR Mirvac Group
MPL Medibank Private Limited 2%
MQG Macquarie Group
NAB National Australia Bank 1%
NCM Newcrest Mining
ORG Origin Energy
0%
ORI Orica
OSH Oil Search
QBE QBE Insurance Group
RHC Ramsay Health Care P/E Ratio x
RIO Rio Tinto
S32 South 32
71x
SCG Scentre Group 30x 45x
44x
SEK Seek
SGP Stockland Group
SHL Sonic Healthcare 25x
STO Santos Ltd
SUN Suncorp Group Limited 20x
SYD Sydney Airport
TCL Transurban
TLS Telstra Corporation 15x
VCX Vicinity Centres
WBC Westpac
10x
WES Wesfarmers
WFD Westfield Corporation
WOW Woolworths 5x
WPL Woodside Petroleum
0x
ASX200 Australian Equity Market
Ratings
Underperform Neutral Overperform
P/ENCM
Ratio x APA AZJ AMC AGL AMP CCL CPU CTX
WPL ASX BXB GMG MQG ANZ CSL GPT
SYD DXS ORI ORG BHP NAB IAG
TLS IPL SEK RHC CBA OSH JHX
WOW MPL SHL SGP CWN S32 LLC
QBE WES WFD SUN STO MGR
VCX TCL RIO
SCG
WBC
Source: FNZC, Bloomberg. The P/E
ratios and Gross Dividend Yield use
earnings and dividends forecasts for the
next 12 months. *Consensus forecasts
First NZ Capital Securities Ltd – NZX Firm | www.fnzc.co.nz 21Information Technology
– Still Bullish, But Less So
Key Takeaways Narrow Breadth
++ Strong IT stock performance Information Technology (IT) stocks in the US have outperformed the US equity market
results in a risk - reward (as measured by the S&P 500 Index) by 18.2% over the last year. While the IT sector
re-evaluation has a number of secular themes that should continue to unfold over the next five to ten
years, the strong performance of the sector is leading us to re-evaluate the risk-to-
++ Higher interest rates are a reward opportunity.
potential negative for the IT
sector With a small number of very large stocks accounting for a significant portion of the
outperformance we have become a little more cautious, as history suggests markets
++ Opportunities for IT
are strongest when equity returns are broad and weakest when they are narrow. This
companies abound has also had the effect of driving the US equity market to all-time highs, even though
the average stock is currently 10% off its 52-week high.
Trailing Twelve Month 35
The IT sector has contributed
Returns 30
43% of the US equity market
Source: Bloomberg 25
20 return over the last year. Apple
%15
(AAPL.US), Alphabet
10
5 (GOOGL.US), Microsoft
0 (MSFT.US) and Facebook (FB.
-5
S & P 500 US IT Sector US) have contributed more than
half the gain. If you include
Amazon (AMZN.US), these stocks have collectively contributed 30% of the market’s
return. Ten years ago, only MSFT was in the top ten largest companies in the US.
These days, the top five usually consist of the names above.
A similar story has unfolded outside the US, specifically within emerging markets, as
Chinese internet names Tencent (0700.HK) and Alibaba (BABA.US) as well as
Samsung (SMSN.LN), have contributed around 30% to the emerging markets 25.5%
return over the past year.
If interest rates were to rise, the IT sector is likely to be negatively impacted. Firstly,
cheap debt has allowed these internet giants to snap up rising competition with the
best example being FB’s acquisition of Whatsapp and Instagram. Secondly, higher
interest rates will likely be a headwind for growth stocks, of which technology
companies make up a large proportion. This is due to the time value of money and the
“Better an egg today significant amount of expected earnings yet to be realised. Better an egg today than a
hen tomorrow.
than a hen tomorrow”
As the title suggests, we favour the sector, just less so. This is due to long-term
tailwinds that include: greater connectivity with an increase in internet-enabled
smartphones and other devices; the rise of the sharing economy (e.g. Airbnb and
Uber); an increase in computing power; data growth and cloud computing; the
development of 3D printing; advancement in battery storage; and lastly, an increase in
price visibility. At the same time, even though debt levels in US companies (excluding
financial companies) is close to prior peaks, the IT sector has a net cash position
reflecting the earnings power of IT companies.
First NZ Capital Securities Ltd – NZX Firm | www.fnzc.co.nz 22You can also read
