ALPHA Structured Investments
Alpha POWER Shares (Aegis) Portfolio - November 2008

Alpha POWER Shares (Aegis) Portfolio - November 2008

Monthly Stock Returns (including dividends)

Aegis Market Commentary

The Australian share market experienced a further decline in November, with the S&P/ASX 100 Accumulation Index down 6% for the month. Information Technology (-20.4%) was the worst performing sector after Computershare downgraded its FY09 earnings guidance. Consumer Discretionary (-14.6%) was the next worst performing sector as the outlook for retail spending continued to deteriorate. Industrials (-11.5%) and Financials (-11.4%) also experienced large declines. After recent heavy falls the Property sector (+0.2%) showed some signs of stability and was the only sector to record a small rise for the month. Telecommunications (-1.1%) was the next best performing sector again demonstrating the relatively defensive nature of this sector. The financial crisis and the flow on effect to the global economy continued to dominate trading during November, with volatility remaining high. Economic conditions continued to deteriorate around the globe with governments in most of the major economies pushing ahead with large stimulus packages in an attempt to limit the extent of an economic decline. Interest rates also continue to fall around the globe as monetary authorities attempt to kick start the credit markets, although at this stage credit market conditions remain tough with a scarcity of available funds. On 29 October the US Fedteral Reserve reduced the Fed Funds rate by 0.5% to 1% and it is possible that a further reduction will occur when the Federal Reserve meets on 16 December 2008. The Reserve Bank of Australia dropped its official interest rate by 0.75% in November and followed this up with a further 1% in December taking its rate to 4.25%. With September quarter GDP growth of just 0.1%, we expect the RBA will reduce rates further when it next meets on 3 February 2009. We retain a cautious view of the market. With the domestic and global economic outlook continuing to weaken we expect to see further downgrades in earning across the market. Although the Chinese economy continues to display growth well above that in the developed economies, there are clear signs of a slowing in growth which has had a dramatic impact on certain industries such as steelmaking and construction. This has led to a slowing in demand for resources and so the short-term outlook for commodity prices remains weak. We remain comfortable with the long-term outlook for commodities given the longer-term growth outlook for the Asian region, but in the short-term the resources sector is likely to remain weak.

Aegis’ Comments on Portfolio Stock Performance

Main outperformers

  • BHP Billiton – BHP (+10.8%). After experiencing a significant decline in September and October, BHP staged a rally during November and was the best performing stock in the portfolio. In our view, the decline in the BHP share price had been overdone and the recovery in November recognises the fact that BHP is in a strong financial position and has a portfolio of long-life, low cost assets that will benefit from long-term demand from Asia. Nonetheless, weaker commodity prices will place some pressure on near-term earnings. With iron ore contract price negotiations about to commence, there is the very real risk of a significant reduction in iron ore prices from 1 April 2009. At the end of November BHP announced that it had decided to walk away from its bid for RIO given the deteriorating global economy. We view this as a sound move given current market conditions.
  • Telstra – TLS (-1.5%). TLS was again a strong relative performer through the month with its share price declining less than the overall market. TLS has submitted its National Broadband Network (NBN) bid, albeit with several caveats. It has also withheld detailed information from its proposal, until the Government agrees on issues that TLS believes compromise its position. TLS stated that by self-funding $5B of the construction and using the Government's $4.7B as a loan, it can deliver 80%-90% coverage of the Australian population. TLS stated in its bid that it will not proceed if the Government pursues further separation of TLS. We are pleased to see TLS put forward its proposal and believe most of the caveats it has put in place are well justified in supporting its investment. Some key considerations that we believe are important to determine the successful bidder, include: the expertise in rolling out this size of network; the ability to deliver a timely rollout; and the financial capability to undertake this project. We also note the Government made an electoral promise to deliver this network. Being the incumbent, we feel TLS has a strong advantage over other bidders and, we believe, it is most likely to be the winning bidder in the NBN build. There is still little information available on which to base any accurate forecasting of the financial impacts on TLS over the outcome. However, if it was to lose in the bid process or the Government was to enforce structural separation, the risk to earnings would be on the downside.
  • Leighton Holdings – LEI (-1.9%). After a significant decline in October, LEI shares performed much better than the overall market in November. The company announced a number of major new contract wins in November including a $3.75B Dubai development won by the Al Habtoor Leighton joint venture. The company also announced that another Dubai project (the Trump Tower) has been suspended. This deal has a value of A$1.2B and was also a Al Habtoor Leighton project. While LEI has indicated the suspension will not have a material impact on results, it does highlight the risk of contract suspensions and cancellations in the current environment. Nonetheless, LEI continues to run a record order book and, given its diverse business and geographical mix, we believe it has the capability to continue growing its order book. At current levels we consider the stock to be very attractively priced.

Main underperformers

  • Commonwealth Bank – CBA (-15.4%). CBA shares came under pressure after the bank revealed it had a $460M exposure to the collapsed ABC Learning Group and acknowledged that FY09 earnings would be adversely impacted by higher bad debt levels. While the increase in bad debts is obviously a disappointment, CBA’s underlying business continues to perform well despite the challenging market conditions. CBA continues to benefit from above-system growth in home loans and household deposits, although funding conditions remain both challenging and expensive. Despite the current challenging environment, we remain comfortable with CBA on a medium to long-term basis.
  • Wesfarmers – WES (-13.4%). WES’ share price fall is disappointing given the stock operates in the Consumer Staples sector, with a large part of its earnings derived from the recently acquired Coles group of businesses. We attribute the share price weakness to comments that the company made at its October investor briefing when it stated that it would need up to five years to effectively fix the Coles supermarket business. There may also be some concerns surrounding $5B in borrowings due in October 2010. We note however that WES has put documentation in place for a €3B Medium Term Note (MTN) programme which will allow it to access funding in medium-term international debt markets as and when conditions in these markets improve. At current levels the share share price appears to factor in the above issues and offers an attractive fully franked dividend yield. However, there is some risk that the dividend may be reduced if the company does not have success in lengthening its debt maturity profile.
  • WorleyParsons – WOR (-10.2%). WOR shares continued to decline on further weakness in the oil price. As we noted in our October update, WOR is a service provider to the oil and gas industry, as well as a number of other industries and, as such, the company’s earnings are not directly tied to the price of oil. Through November the company announced a number of new contracts and business deals that will continue to support the flow of work to the group. This demonstrates the company’s ability to continue to win work in the current environment. Given the positive earnings outlook for the group and continued workflow, we believe the shares are significantly undervalued at current levels.

     

IMPORTANT NOTE:
Aegis Investment Partners Pty Ltd (ABN 98 096 109 125, AFSL 226 957) (“Aegis”) is the stock selector for the Alpha Model Portfolio – Aegis. The information contained in this document is prepared by Aegis for use solely by professional investment advisers and is not intended to be provided to retail clients. In preparing this information, it is not possible to take into consideration the investment objectives, financial situation or particular needs of any individual recipient. Investors should obtain individual financial advice from their investment advisor to determine whether information contained in this document is appropriate to their investment objectives, financial situation or particular needs before acting on that information. Prior to deciding whether to acquire, hold, or sell the Alpha Model Portfolio - Aegis, you should obtain and consider the Alpha Customised Portfolio Service Product Disclosure Statement dated 19 December 2006 (now closed for new investments but still actively being managed for existing investors) and the Alpha Customised Portfolio Service Product Disclosure Statement dated 3 March 2008 (to be read in conjunction with individual financial advice), available on request from Alpha Structured Investments (1300 769 694 or www.alpha-invest.com.au). While all information is provided by Aegis in good faith, Aegis makes no warranties as to its accuracy, reliability, completeness or whether it is free from error or omission. Subject to statutory limitations, Aegis, together with its directors, officers, employees and related body corporates, do not accept any responsibility or liability arising from decisions made relying upon information contained within this document. This document is only to be distributed to Australian residents. All intellectual property relating to this document vests with Aegis unless otherwise expressly agreed.