Alpha POWER Shares (Aegis) Portfolio - January 2009
Monthly Stock Returns (including dividends)
Aegis Market Commentary
After a relatively good start to the year, the Australian market resumed its downward trend, with the S&P/ASX 100 Accumulation Index down 4.9% for the month of January. Industrials (-11.1%) was the worst performing sector, with the deteriorating economic conditions impacting stocks exposed to the housing, construction and resources sectors. Property (-9.7%) was the next worst performing sector, with refinancing and deteriorating property market conditions still key concerns. Financials (-8.8%) also suffered a large fall in sentiment with significant falls in overseas banking stocks. Healthcare (+6.1%) was the best performing sector, while Telecoms (+0.1%) also managed a modest rise as the Telstra share price stabilised following its December decline.
One of the key features of the market over the past month has been acceleration in secondary market capital raisings, with many companies looking to bolster their balances sheets and pay down debt in order to increase financial strength in an uncertain financial environment. Some companies have been forced into equity raisings due to high debt positions and an inability to find refinancing. However, a number of companies with already strong balance sheets have sought funds in order to build their acquisition capabilities to take advantage of asset sales by distressed sellers. In January, we also saw a number of earnings downgrades ahead of the
reporting season, as the global and domestic slowdown adversely impacted corporate
revenues and earnings.
The fallout from the global financial crisis remains a key issue, with American and European banks continuing to rack up significant losses. Governments in the US and the UK provided further assistance to key financial institutions in order to prevent a complete collapse of their respective financial systems. However, we note that the Australian banking sector remains in relatively good health with strong revenue growth and sound capital positions. While bad debt charges are increasing, the sector continues to report profits as opposed to the massive losses being reported by overseas banks.
The global economic outlook continued to deteriorate and in January, the International Monetary Fund (IMF) downgraded its outlook for global economic growth to 0.5% in 2009, down 1.75% from its November update. However, behind this number, the IMF is forecasting the advanced economies to decline by 2%. For Australia, the IMF is forecasting a decline of 0.2% in 2009 and, although there is a wide range of forecasts from local economists and government bodies, the consensus is that the economy will experience a mild contraction in 2009. The Reserve Bank of Australia did not meet in January, but at its first meeting in February, it reduced its cash rate by a further 1% to 3.25% in recognition of the deteriorating domestic economic outlook. On the same day, the Australian government announced a $42B
economic stimulus package in an attempt to prevent the economy falling into recession.
With the domestic reporting season underway, the key themes to emerge so far are that the global and domestic downturn has already started to have an impact on a broad range of industries, but particularly on those exposed to housing, construction, consumer discretionary spending and resources. Companies exposed to the consumer staples sector appear to be more resilient, as demonstrated by a solid sales performance from Woolworths. Also, the trend to raise equity to bolster balance sheets continues.
Given the seriousness of the global economic downturn, the slowdown in the resources sector and the inevitable impact on the domestic economy, we retain a cautious market outlook. Our preference remains for large-cap stocks, stocks with sound financial positions and those with strong businesses and stable revenues.
Aegis’ Comments on Portfolio Stock Performance
Main outperformers
- WorleyParsons – WOR (+6.8%). WOR performed well in January, as the stock price responded to a lift in the oil price from its late 2008 lows. The company also added to its workbook by announcing a couple of project awards, including a clean fuels project in Saudi Arabia and a front-end engineering and design (FEED) services contract for Phase 2 of the full-field development of the Kashagan oil field in Kazakhstan. These contract awards demonstrate that the company is still able to win new work despite the lower oil price. We stand by our previous comments that WOR’s diversified portfolio of blue-chip clients and projects will stand the company in good stead in the current environment.
However, the stock price is likely to continue to move in sympathy with the oil price in the short term. We note that the share price has declined since the end of January.
- Woolworths – WOW (+3.9%). WOW continues to be a standout performer with its exposure to consumer staples and the value end of the department store market holding it in good stead in the current environment. In January, the company reported its 2Q09 sales results, with sales increasing by 8.1% on the pcp to $13.3B. The Consumer Electronics and General Merchandise divisions were again strong, with sales up 15.8% and 11.2%, respectively. The key Australian Food & Liquor division recorded sales up 9.8% to $9.8B, with comparable store sales up by 7.1%. In our view, the continued sales success is testament to WOW’s strong management and exceptional business model and we expect the company will be able to maintain its strength. In the short term, WOW is one of the businesses best placed to withstand slowing consumer confidence as demonstrated by the strong result from BIG W. Given the nature of the goods sold in Woolworths Supermarkets, business and cashflow volatility is minimal, and we do not believe a downturn in consumer
spending will severely hurt WOW's core business. WOW remains on track to deliver FY09 sales growth (excluding petrol) in the upper single-digit range, which should enable it to deliver its promised profit growth of 9%-12%.
- Tatts Group – TTS (+3.2%). TTS has performed well since its inclusion in the portfolio in December 2008, demonstrating the resilience of its businesses in an economic downturn. There was no specific news from the company in December, but we think the company’s businesses were likely beneficiaries of the Australian government’s December stimulus package. We expect TTS to report stronger first-half earnings when it reports its 1H09 result in February, with the company benefiting from a range of cost-cutting initiatives and
the absence of the equine flu impact in 1H08. Following the 2008 announcement regarding the loss of the Victorian Pokies licence from 2012, all remaining licences have relatively long tenure. With a strong balance sheet, the company is well placed to grow the business through acquisition and we believe it is in a strong position to pick up the NSW lotteries business. There is also the possibility the company could win the Victorian wagering licence
from Tabcorp, although we have not factored this into our valuation of the stock. We see TTS as an ideal stock in the current environment.
Main underperformers
Leighton Holdings – LEI (-39.4%). It is fair to say that LEI has been a disappointing performer for the portfolio. We initially included LEI in the portfolio for its strong order book. Nothing has changed in this regard, with the order book standing at around $37B at the end of December 2008 and continuing to grow. As recently as November 2008, the company had reaffirmed its guidance at the AGM that FY09 earnings would grow by 15%. However, in January, the company announced earnings for FY09 would now grow at only 8% to $650M due to an inability to crystallise profits in its property division. We had initially thought that the strength of the company’s other businesses would more than offset any decline in the property business and, while LEI indicated that most of its other businesses were performing strongly, this only partially offset the weaker property performance and a slowdown in the Middle East. Since month end LEI has reported a 1H09 underlying operating result of $279M after tax, 11% higher than 1H08, although the headline profit was down 56% due to asset write-downs. As previously advised, the dividend was held flat at 60 cents per share and guidance was maintained at 8% operating profit growth in FY09. Despite difficult conditions in the property business, the contract mining and infrastructure businesses are still doing well. We acknowledge that the slowdown in the resources sector could adversely impact LEI in future periods; however, the company has a solid portfolio of blue-chip clients and the order book continues to grow. We will continue to watch LEI closely.
Westpac Banking Corporation – WBC (-7.8%). WBC fell in the absence of any specific news in January. In our view, the domestic banks fell in January in sympathy with falls in the overseas banking stocks as losses mounted and a number of large offshore banks required further government assistance in order to remain viable. We continue to stress that the Australian banks are in a much more robust position than their global peers and, despite the increase in bad debts, the underlying businesses are actually benefiting from the demise of the foreign banks and a number of participants in the non-bank financial sector. Even with higher bad debt charges, the Australian banks are expected to report very respectable earnings, albeit at lower levels, and will continue to offer attractive, fully franked dividend yields. WBC and CBA are our preferred banking sector exposures due to the strength of their franchises and their relatively conservative risk profiles.
Westfield – WDC (-7%). WDC initially performed well on inclusion in the portfolio, but has disappointed over the past couple of months. In December, the group announced that its final distribution for FY08 would be 53.25cps, taking the full year distribution to 106.5cps, in line with previous guidance. However, the group indicated that FY09 distributions would most likely be in a range from 97cps to 100cps, assuming no major change in currency levels. The group also announced non-cash write-downs of $3B in the value of its portfolio, but this needs to be viewed in the context of its $50B portfolio. WDC indicated that its Australian portfolio continues to perform strongly, but that conditions had deteriorated in the UK, the US and New Zealand. Despite a strong balance sheet, after month end, WDC announced it would raise $2.9B to further strengthen its balance sheet and position the group for potential acquisitions. We were disappointed at the significantly discounted issue price, which, at $10.50, is quite dilutionary. With the capital raising, WDC further downgraded its FY09 distribution guidance to a range of 94cps to 97cps. The market price has since fallen to be just above the placement price. We will be closely watching WDC’s FY08 results announcement in February for an update on the state of its US and UK businesses.
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.
