ORDS MONTHLY NEW YEAR'S RESOLUTION - MIXING PORTFOLIOS - Ord Minnett
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Februar y 2019
ORDS MON T H L Y
NEW YEAR’S RESOLUTION
MIXING PORTFOLIOS
The torrid end to 2018 appears to have
been all but erased from investors’
“We see modest upside and suggest portfolios
collective memory, with equity should be a mix of key cyclicals ...with some
markets racing ahead in the new year.
defensive flavour such as property and
In the February edition of the
Ords Monthly, we examine where
infrastructure trusts.”
markets can go from here against
what can only be described as an
A tough retail banking environment, Going ashore, we reiterate our Buy
unsettled outlook.
and the subsequent pressure on net recommendation on Qube Holdings
Politically, the Brexit debacle, a likely interest margins, was the key driver, after its Patrick stevedoring division
deadlock in Washington between the reinforcing our preference for the joined key rivals in imposing
White House and Congress – and the more business-focused banks. See dramatically higher infrastructure
risk of another extended US page 4 for our review. surcharges on users of its container
government shutdown – and a terminal facilities in the east coast
potential new federal government The December-quarter result from capitals of Sydney, Melbourne
in Australia are the key issues. James Hardie Industries fell short and Brisbane.
of our estimates, principally due to
Economically, US conflicts with China soft trading conditions in its key This move shows the industry is
and the EU over trade, spill-over moving towards a more rational
US market.
effects from Brexit, a slowdown in structure with an eye on stronger
China’s domestic economy and data A modest upgrade to full-year financial returns. We also see upside
showing Australian consumers are guidance, however, along with the for Qube from the continued
keeping their hands firmly in their new CEO’s strategy and the development of the Moorebank
pockets will be at the top of mind. company’s broader prospects, keep logistics hub. See page 7 for our view.
us positive on the building materials
We see modest upside, however, and Alliance Aviation has a new major
maker. Page 5 lays out the
suggest portfolios should be a mix of shareholder, with Qantas Airways
foundations for our view. snatching a 19.9% stake in the contract
key cyclicals – overweight materials,
Shipbuilder Austal, which counts the aviation operator. Alliance Aviation
industrials and energy sectors – with
US Navy and the world’s largest ferry services Virgin Australia, the major
some defensive flavour such as
operators among its clients, raised its domestic rival to Qantas, with a
property and infrastructure trusts.
revenue guidance for fiscal 2019 by a long-term strategic partnership, via a
See our Investment Strategy note
combination of wet leasing and regular
starting on page 2 for our thoughts strong 36%, buoyed by military
passenger services, particularly in
and some suggested stocks for 2019. contract wins in the December quarter.
Queensland. Regulatory obstacles to
Commonwealth Bank leads off our We also highlight the pending any ascent up the share register loom in
corporate coverage in this edition, opportunities from the replacement the form of the competition regulator,
with the nation’s largest bank turning cycle for global high-speed ferries. however, implying there will be no fast
in a soft first-half result. Come aboard on page 6. moves. See page 8.
ords.com.auINVESTMENT STRATEGY
RACING START
Markets have started 2019 at a gallop The most recent data on retail sales,
– the MSCI World Index is up 8.9% and and business and consumer
the S&P/ASX 200 Index has gained confidence, reinforces our view.
7.9% at time of writing. This is despite
The RBA made some concessions to
December’s turbulence and a laundry
recent economic developments in its
list of troubles includes faltering
commentary post the February
economic data, a record-long US
meeting – where it left the cash rate
government shutdown (albeit open at
unchanged at 1.50% for the thirtieth
present) and an unsettled political
situation across much of the globe. straight month.
Even against this uncertain backdrop, On the day after, however, central
Ord Minnett sees some modest room bank governor Philip Lowe made a
for this run to continue and our surprisingly dovish speech, saying
S&P/ASX 200 Index target range of the probabilities of a rise or fall in
5900–6200 still implies potential interest rates now "…appear to be
single-digit upside at the top end. We more evenly balanced" – a significant
suggest portfolio positioning should turn away from long-running
be selectively cyclical – overweight in commentary that the next move in
the materials, industrials and energy rates was likely to be up.
sectors – with a defensive hue – From a corporate earnings
overweight in the property trusts, perspective, our team expects a
and infrastructure trusts such as modest EPS rise of 2.7% in 2019 for
Sydney Airport, along with the S&P/ASX 200 Index, versus a
Newcrest Mining. consensus growth rate of 4.5%.
Meanwhile, the long shadow cast by Global earnings growth looks set to
the Royal Commission, potentially a outpace Australia in 2019, with
new federal government and an
developed markets expected to book
indebted household sector sees us
growth of 7.1%. The consensus
maintain our underweight bias on
forecast for the US is 7.3% earnings
the consumer discretionary and
growth in 2019.
financials sectors.
Looking to stock-specific choices to
Looking at the bigger picture, we
play 2019, we examine our analysts’
expect the domestic economy to
most differentiated ideas – a group
grow at an annualised rate of 2.8% in
of stocks where their views stand
2019. Despite an expected boost
Investment Strategy out from the consensus view. Table 1
from a lower Australian dollar, fiscal
Racing start 2 provides a list of the key metrics for
improvement, and better
Commonwealth Bank these stocks.
transmission of terms-of-trade
At the margin 4 income, we expect the Reserve Bank
of Australia (RBA) to keep its
Aristocrat Leisure
James Hardies Industries
benchmark rate at 1.50% until 2020. This company has strong recurring
Lean gains 5
revenues and has been consistently
Austal The recovery in domestic demand in gaining market share in its key US
Ferry timetable 6 particular has only been visible after gaming operations, growing well in
Qube Holdings
significant upward revisions to a flat market.
consumption, and has required the
Paying the freight 7 Aristocrat has significantly
saving rate to plumb new depths for
Alliance Aviation the cycle. This makes us sceptical. increased its digital exposure (26%
Flying high 8 that momentum can be sustained. of first-half fiscal 2018 earnings, up
ords.com.aufrom 13% in fiscal 2017) and Brambles Reliance Worldwide
continues to develop titles for both
Investor concerns surrounding its The plumbing parts supplier holds
land-based and digital platforms.
CHEP USA business are overdone. leading positions across its key
Further digital growth and capital There was certainly a slowdown in categories and has a proven track
management opportunities are fiscal 2017 revenue growth, which record of delivering revenue
available. extended into fiscal 2018. In our growth, with future earnings set to
view, the factors driving this are be driven by continued penetration
Coupling this with strong execution
largely cyclical, and will revert to a of its disruptive, SharkBite-branded,
skills and the scarcity of earnings
stronger growth rate with the brass push-to-connect (PTC) fittings
growth in the broader market
passage of time. and accessories.
generally, and despite a challenging
and structural slot machine Pallets remain an essential part of We believe Reliance offers an
expenditure decline, we see the the fast-moving consumer goods attractive investment proposition,
risk/reward equation attractive at supply chain and, within that, with high-quality growth
the moment. pooling continues to stack up as underpinned by its PTC products,
the best economic solution for channel expansion strategy and
ANZ Bank Brambles' customers. M&A agenda.
Our Accumulate recommendation
on ANZ reflects an above-peer BlueScope Steel Treasury Wine Estates
earnings growth outlook due to The global steel maker has completed The major wine producer continues
ongoing cost savings and capital a major restructuring over recent to execute extremely well, applying
management. years, including closing half its fast-moving consumer-goods
Australian manufacturing capacity. thinking to the wine industry. It is
We also see ANZ as likely to
also well placed to access the
continue delivering improved BlueScope is a key choice as we see it
structural growth drivers of Asian
returns in its institutional division generating material free cash flow
wine demand, especially China, with
off a low base, reflecting further through the cycle, even at levels that
recent customs issues appearing to
capital efficiency and an improved would be unprofitable for its peers. Its
moderate and the growth in luxury
operating environment for focus on high value-added products –
and so-called masstige wine
institutional businesses in some sold at fixed prices – and US
continuing.
Australia and Asia. spreads that remain unusually high
also underpin our view. These attributes provide very strong
We also expect the bank to adjust
earnings growth on a multi-year
its overly conservative settings in In addition, while lower hot-rolled
basis, despite near-term forecasts
the Australian retail division over coil prices hurt BlueScope’s
assuming some disruption from the
the coming 12 months, implying commodity steelmaking operations,
changes in the US distribution
better revenue momentum relative lower substrate prices could lead to
network, which, once complete, will
to fiscal 2018. margin expansion for its building
provide further growth potential.
products businesses.
Table 1: Six choices for 2019
Market Target Price Implied price Price-earnings Dividend
Company Code Recomm. cap ($bn) price ($) ($) upside (%) ratio (x) yield (%)
Aristocrat Leisure ALL Buy 16 32.45 25.63 21 19.0 2.3
ANZ Bank ANZ Accumulate 77 32.10 26.41 18 11.6 6.1
BlueScope Steel BSL Accumulate 7 19.80 12.46 37 5.8 1.3
Brambles BXB Buy 18 12.55 11.08 12 27.4 1.9
Reliance Worldwide RWC Accumulate 4 5.70 4.89 14 22.4 2.0
Treasury Wine Estates TWE Accumulate 12 20.00 16.25 19 26.6 2.5
Source: OML Research, IRESS, Factset
3COMMONWEALTH BANK OF AUSTRALIA
AT THE MARGIN
Sector: Financials Recomm: Hold Risk rating: Medium Share price: $72.60
Year to June 2018A 2019E 2020E Commonwealth Bank (CBA) share price
Profit after tax ($m) 8,915 9,338 9,706 80
Earnings per share ($) 4.96 5.13 5.44
75
Price/earnings (x) 14.6 14.1 13.3
$
Dividend ($) 4.31 4.31 4.31 70
Dividend yield (%) 5.9 5.9 5.9
65
Franking (%) 100 100 100 Feb 18 Apr 18 Jun 18 Aug 18 Oct 18 Dec 18 Feb 19
Source: Company reports, Ord Minnett Research. Profits are on a normalised basis. Source: IRESS
Commonwealth Bank delivered a was disclosed and the CTI ratio benefits already appear to be in the
slightly weaker-than-expected first- excluding one-offs for the first half of price with the stock trading at a 22%
half fiscal 2019 result due to soft fiscal 2019 was already at 40.4%. P/E premium to the other major banks
revenue trends and an increase in bad versus the five-year average of 14%.
CEO Matt Comyn also flagged an
and doubtful debts. A fully franked
absolute reduction in ‘core’ costs, but We have reduced our cash EPS
interim dividend of $2.00 per share
again no time frame was given and forecasts by 1–2% following this
was declared, the same as a year ago.
there was no firm quantification of report, mostly reflecting the
The result came just days after the
what core costs were in the first half. narrowing of net interest margins.
Royal Commission released its
final report into the financial This commentary is concerning CBA looks expensive versus the other
services industry. given it suggests revenue pressures banks, although we acknowledge its
are unlikely to abate, but also sector-leading deposit position and
Cash net profit from continuing
pleasing in that CBA appears to be capital management potential.
operations of $4.676 billion and
meeting this challenge head-on.
revenue of $12.411 billion both Overall, we prefer banks with a
came in 1% below our forecasts. The capital position was better than relatively larger exposure to business
we had expected, with most of the banking rather than retail lending,
CBA’s soft first-half performance
improvement likely to be permanent. where we see no imminent easing of
mostly reflected significant margin
competitive pressures. Given this
pressure in retail – the retail banking This suggests capital returns to
view, National Australia Bank and
net interest margin has now fallen shareholders could be larger and
ANZ Bank remain our preferred
17 basis points in the past 12 months sooner than forecast, although these
choices in this sector of the market.
(11 basis points over the half). See
Figure 1 for the most recent moves. Figure 1: Half-by-half movement in CBA retail net interest margin
The difficult trading environment is 2.80%
2.77%
not expected to turn around any time
soon, and the strong returns on equity
2.71%
still earned by the major banks in retail 2.70%
banking are likely to fall from here.
Given the challenging top line, CBA 2.60%
has stepped up its cost-cutting 2.60%
rhetoric, albeit with vague language.
It is now targeting a sub-40% cost-to- 2.50%
income ratio (CTI) but no time frame 1H18 2H18 1H19
Source: Ord MInnett Research, CBAJAMES HARDIE INDUSTRIES
LEAN GAINS
Sector: Building Materials Recomm: Accumulate Risk rating: Higher Share price: $16.43
Year to March 2018A 2019E 2020E James Hardie Industries (JHX) share price
Profit after tax ($m) 376 416 498 25
Earnings per share ($) 0.85 0.94 1.13
21
Price/earnings (x) 19.3 17.4 14.6
$
Dividend ($) 0.52 0.56 0.67 17
Dividend yield (%) 3.1 3.4 4.1
13
Franking (%) - - - Feb 18 Apr 18 Jun 18 Aug 18 Oct 18 Dec 18 Feb 19
Source: Company reports, Ord Minnett Research. Profits are on a normalised basis. Source: IRESS
James Hardie Industries posted a North American fibre cement These cost-saving initiatives are
third-quarter fiscal 2019 net profit of volume growth was below our already under way in James Hardie's
US$65.9 million, some 7.1% short of estimate in the quarter, but the Asia Pacific business and will be
Ord Minnett’s forecast. At the company pointed to a soft market introduced progressively in the US.
operating level, earnings before rather than market share slippage. We assume any benefit will be
interest and tax of US$90.6 million Management noted, however, that reinvested in marketing or R&D to
also came in 7.6% short of market conditions in December and support volume growth and primary
January were better than had been demand growth.
our projection.
expected back in November.
Our estimates post the result
On the positive side, fiscal 2019 James Hardie expects modest or
are broadly unchanged, leaving
group net profit guidance was low-single digit market growth in
potential upside to management’s
narrowed to US$295–315 million the final quarter of fiscal 2019 and
financial targets. Besides the
from US$280–320 million for fiscal 2020, which is line with
previously mentioned US targets,
previously, representing a our expectations.
the company is also aiming for
2% upgrade at the midpoint. A key driver of the stock’s multiple compound annual revenue growth
New CEO Jack Truong presented a derating over the past year has been expected of 8–12% over fiscal
strategic update highlighting that underwhelming market-share gains 2020–22 in Europe and primary
in North America. Management demand growth of 3–5% for the
cultural and organisational shifts were
homed in on the issue, attributing Asia Pacific region.
under way inside the company.
the shortfall versus targets partially
James Hardie is the dominant player We see James Hardie as being
to less business from existing
in the fibre cement market in the US, well-placed to continue penetrating
clients. The company will restructure
accounting for circa 90% category the cladding market in the US,
its sales force with incentives to limit
share (James Hardie versus other fibre which delivers circa 70% of the
this impact, while also rewarding
cement manufacturers) and around company's total revenue.
new business wins.
19% market share (fibre cement versus The medium- to longer-term
the broader siding market). James Hardie is targeting primary
opportunity will come from its
demand growth in North America of
The move to cross-functional Fermacell acquisition, if it can drive
3–5% in fiscal 2020 and 6%
frameworks and a focus on so-called fibre cement sales in Europe and
thereafter, and is also aiming for
reach its targeted €1 billion of sales
lean manufacturing principles should cost cuts of $100 million by fiscal
at typical margins within 10 years.
drive a more predictable operational 2022 from utilising lean
and financial performance. manufacturing principles.
5AUSTAL
FERRY TIMETABLE
Sector: Aerospace & Defence Recomm: Accumulate Risk rating: Higher Share price: $2.13
Year to June 2018A 2019E 2020E Austal (ASB) share price
2.20
Profit after tax ($m) 39 52 62
Earnings per share ($) 0.11 0.15 0.18
2.00
Price/earnings (x) 19.0 14.4 12.1
$
Dividend ($) 0.05 0.06 0.08 1.80
Dividend yield (%) 2.3 2.8 3.8
1.60
Franking (%) - - - Feb 18 Apr 18 Jun 18 Aug 18 Oct 18 Dec 18 Feb 19
Source: Company reports, Ord Minnett Research. Profits are on a normalised basis. Source: IRESS
Austal designs and builds construct four littoral combat ships The expansion will allow the
customised aluminium military and and two expeditionary fast vessels company to capitalise on a forecast
commercial vessels, with a customer in the past four months. significant replacement cycle for
base that includes major ferry large high-speed ferries expected
We estimate the construction value
operators and defence forces. over the next five years.
of these six vessels at US$2.5 billion,
The company recently upgraded its underwriting Austal’s shipbuilding The expected life for such ferries –
fiscal 2019 revenue, driven by capacity in the US until 2023. globally operating high-speed
significant contract wins, particularly Importantly, the company confirmed vessels with a length of 70 metres
towards the back end of 2018. it continues to expect shipbuilding or more – is around 25 years.
Management now expects full-year margins of 7–8% in its US business.
Such vessels can operate to their
revenue of $1.9 billion, up from
Austal has also won a contract for twenty-fifth year but often the
$1.3–1.4 billion previously.
the construction of a 94-metre economics of running the older
Austal also guided to earnings catamaran and potentially two vessels – repairs and maintenance,
before interest and tax guidance of Cape Class patrol boats for the technology improvements in newer
$39–41million for the first half of government of Trinidad and Tobago. boats and rival services – often
fiscal 2019, 12% ahead of make doing so a poor choice.
Austal has meaningfully expanded its
Ord Minnett’s previous forecast.
ship-building capabilities in the Asia Given global interest rates remain
Much of the revenue uplift was Pacific region over the past two years low, the decision to purchase a new
driven by its US ship-building – opening new yards in China (via a vessel is often the best commercial
operations, based in Mobile, joint venture) and Vietnam, and choice. Figure 2 below shows the
Louisiana, with the company extending the operations of its yards in potential opportunity.
winning US defence contracts to Western Australia and the Philippines.
Figure 2: Global high-speed ferry (>70 metres) market
16
14 Expected life
12 25 years
No. of vessels
Looming replacement cycle
10
8
6
4
2
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30
Vessel age in years
Source: Fast Ferry International, Shippax.
ords.com.auQUBE HOLDINGS
PAYING THE FREIGHT
Sector: Marine Ports & Services Recomm: Buy Risk rating: Higher Share price: $2.79
Year to June 2018A 2019E 2020E Qube Holdings (QUB) share price
Profit after tax ($m) 107 119 158 2.90
Earnings per share ($) 0.07 0.07 0.10
2.60
Price/earnings (x) 41.6 37.7 28.5
$
Dividend ($) 0.08 0.06 0.07 2.30
Dividend yield (%) 2.7 2.0 2.6
2.00
Feb 18 Apr 18 Jun 18 Aug 18 Oct 18 Dec 18 Feb 19
Franking (%) 100 100 100
Source: Company reports, Ord Minnett Research. Profits are on a normalised basis. Source: IRESS
The Patrick stevdedoring division relate to property and property- infrastructure surcharges should
of Qube Holdings has followed its related costs (including rent, land generate additional annual revenue
competitors in raising infrastructure tax and council rates); and of circa $57 million, a 9.9% increase
charges on terminal users at its maintenance, operational costs on Patrick's fiscal 2018 total revenue.
Sydney, Melbourne and Brisbane associated with providing Patrick’s
We have upgraded our fiscal 2019
facilities, the third such rise in landside interface operations.
net profit estimate by 1.5% and fiscal
18 months.
Patrick’s announcement follows 2020 by 5.6% to account for the
Ord Minnett views this as a pleasing Victoria International Container latest increase in charges and the
development, as it demonstrates Terminal’s decision last week to latest trends in containerised trade.
the stevedoring industry is increase its charges from $48 to $85
At first glance, this stock appears to
becoming more focused on per full container at Webb Dock in
be relatively expensive, based on its
improving financial returns. Melbourne, as well as DP World
above-market valuation metrics.
Australia’s increase last September
Patrick will lift its infrastructure
of about 70%, which came into effect In our view, however, this fails to
surcharges by 74–89% on full
on 1 January 2019. In our view, capture the longer-term earnings
containers that enter or leave its
these increases are an example of contribution from Patrick and the
terminals, effective 4 March. The
an increasingly rational industry. transformational Moorebank
new rates represent an increase of
logistics facility – which will link
$35.00 to $82.50 per container at its It is worth noting that Patrick’s
Port Botany direct to rail terminals
East Swanson dock in Melbourne; surcharges will be higher than
and warehouses on a 243-hectare
a rise of $36.40 to $77.50 per DP World’s at Port Botany – $77.50
site situated between the M5 and
container at Port Botany in Sydney; per full container versus $63.80 –
M7 motorways.
and an increase of $33.25 to $71.50 and at Fisherman Islands – $71.50
per container at Fisherman Islands per full container versus $65.15 – but We see significant latent value in
in Brisbane. lower at East Swanson Dock – $82.50 Qube, but investors will need to
per full container versus $85.30. be patient to realise the
According to the stevedore, these
investment reward.
surcharges recover a portion of the Based on full containers
costs that relate to capital representing around 80% of the total
investment and commitments made containers handled by Patrick at its
to dedicated infrastructure that East Swanson Dock, and 70% at
services Patrick’s landside interface Port Botany and Fisherman Islands,
operations; charges above CPI that we estimate the increased port
7ALLIANCE AVIATION
FLYING HIGH
Sector: Airlines Recomm: Buy Risk: Higher Price: $2.48 Ord Minnett Head Office
Sydney
Level 8, 255 George Street
Alliance Aviation (AQZ) has found initially objected, before later
Sydney NSW 2000
itself a new major shareholder in the approving, the Virgin/Alliance
Tel: (02) 8216 6300
form of Qantas Airways, with the strategic partnership. ords.com.au
Flying Kangaroo taking a 19.9%
The regulatory process can also be a National Offices
stake in the fly-in/fly-out and Virgin
long and complicated road, with the Adelaide
contract operator.
commission taking 15 months to first Level 5, 100 Pirie Street
Alliance services Virgin Australia, reject, and then approve, the Virgin/ Adelaide SA 5000
the major domestic rival to Qantas, Alliance partnership that was first Tel: (08) 8203 2500
with a long-term strategic announced in February 2016. Brisbane
partnership, via a combination of Level 31, 10 Eagle Street
We would not necessarily expect such
wet leasing and regular passenger Brisbane QLD 4000
a long decision process from the
services, particularly in Queensland. Tel: (07) 3214 5555
regulator this time around but, in our
Qantas said it wanted to take a view, if Qantas were to seek Buderim, Sunshine Coast
1/99 Burnett Street
majority position on Alliance's commission approval – and there is no
Buderim QLD 4556
register in the longer term, but there indication of when that might occur
Tel: (07) 5430 4444
are plenty of hurdles to jump before – it would certainly be a matter of
Qantas CEO Alan Joyce can bring months before the commission Canberra
his plans to fruition. completed its review. 101 Northbourne Avenue
Canberra ACT 2600
The key obstacle is approval from In the meantime, Qantas says it is Tel: (02) 6206 1700
the competition regulator, without supportive of business as usual at Gold Coast
which we see Qantas as precluded Alliance, which we interpret to mean Level 7, 50 Appel Street
from making any takeover bid. Such Alliance can continue to supply Surfers Paradise QLD 4217
approval from the Australian services to Virgin, and Qantas is not Tel: (07) 5557 3333
Competition and Consumer seeking board representation – both Mackay
Commission is far from a foregone of which should help its case with the 45 Gordon Street
conclusion, given the commission competition regulator. Mackay QLD 4740
Tel: (07) 4969 4888
For the full report, please contact your
Ord Minnett adviser. Melbourne
Level 7, 161 Collins Street
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