Alpha POWER Shares (Aegis) Portfolio - February 2009
Monthly Stock Returns (including dividends)
Aegis Market CommentaryThe Australian market continued its relentless downward trend in February, with the S&P/ASX 100 Accumulation Index down 4.4% for the month. Industrials (-21.3%) was again the worst performing sector, with stocks exposed to transport, housing and construction sectors particularly hard hit. Property (-17.9%) was the next worse performing sector followed by utilities (-10.7%). Energy (+1.9%) was the best performing sector and the only sector to post a gain, while Consumer Staples (-1.1%) also performed relatively well.
February saw a large number of companies reporting profit results. Overall, there were no major surprises, with companies exposed to the economic downturn reporting lower results, cuts in dividends and, in some instances, capital raisings to shore up weakened balance sheets. The worst-hit companies were those in sectors exposed to the weak housing and construction market; lower consumer discretionary spending, particularly media; property, with most reporting property groups reporting significant drops in property values; poor financial market conditions, especially wealth management and insurance companies; and manufacturing. There were, however, some standout results. Most healthcare companies did well, with strong results from industry leaders CSL and Cochlear. Woolworths, with its strong management team and exposure to consumer staples, reported double-digit growth and an increase in dividend. Mining and energy stocks reported strong underlying results due to the
higher commodity prices over the past 6 to 12 months; however, the outlook is for weaker earnings, as prices have since fallen dramatically due to the global recession. While a number of companies hinted at weaker earnings over the next six months, many companies refrained from giving specific earnings guidance due to the uncertain economic outlook.
The global outlook remains particularly weak, with markets in the key developed economies continuing to decline amidst deteriorating economic conditions and a financial crisis that continues to threaten the survival of the banking sector in the USA and the UK. In Australia, the release of the 4Q08 GDP figures confirmed that the Australian economy contracted during the quarter, with GDP growth of –0.5%. In February, the Reserve Bank of Australia (RBA) reduced its cash rate by a further 1% to 3.25% and on the same day, the Australian government announced a $42B economic stimulus package. However, at its March meeting, the RBA left rates unchanged, preferring to wait for the impact of recent interest rate reductions to take effect. With no signs of any improvement in the global or domestic economic outlook, we retain our cautious view of the market, with a preference for larger, well-managed companies with sound financial positions, strong businesses and stable revenues. Aegis’ Comments on Portfolio Stock PerformanceMain outperformers- WorleyParsons – WOR (+6.8%). environment.
Commonwealth Bank – CBA (+15%). CBA staged a recovery in February, significantly outperforming the market and the Financials index. In early February, the bank advised its 1H09 result would be better than analyst forecasts and followed this up in mid-February with a result in line with this guidance. CBA reported 1H09 cash earnings of $2B, down 16% on 1H08. The decline was caused by an increase in bad debts, as expected, but underlying banking earnings grew strongly. Retail Banking produced a strong result, growing cash earnings by 15% due primarily to strong growth in retail deposits (+22%) and home lending (+15%). However, home loan margins remain below pre-crisis levels due to higher funding costs. Premium Banking generated strong revenue growth (up 22%); however, loan impairment costs impacted the bottom line. Wealth management reported lower earnings due to the continuing falls across investment markets. Despite the significant increase in bad debts, CBA’s earnings performance was resilient, considering the difficult trading conditions. We expect CBA’s underlying business to continue to grow despite the slowdown in economic activity. We retain our positive view of the medium- to long-term outlook for CBA, but note that the share price could remain volatile in the short term, given the difficult economic environment and potential for bad debts to remain high. Leighton Holdings – LEI (+13.6%). LEI’s share price rallied following the release of its 1H09 profit result. Although the result was broadly in line with the downgraded guidance issued in early January, no further deterioration in FY09 guidance gave the market some comfort. LEI reported an adjusted 1H09 profit of $279M, 11% above 1H08. However, the headline number of $110M was 56% lower due to write-downs on a number of investments. The result was underpinned by strong performances from the key resources and infrastructure divisions, which experienced a strong workflow. However, Leighton Properties was impacted by the weakness in the property sector and there was some softening in the Middle East. Work-in-hand increased significantly, up 24% to $37.5B at 31 December 2008. The company declared an unchanged interim dividend of 60cps (ff). LEI expects to report an adjusted FY09 profit of approximately $650M, up 8% on FY08 and maintain its full-year dividend at the same level as that in FY08. We have taken a slightly more cautious view of LEI, given the slowdown in the resources sector, although note that LEI has a strong order book and a portfolio of blue chip resources companies. Its earnings outlook is underpinned by its strong order book, although slowing market conditions could put the growth of this book at risk. We remain comforted by the fact that LEI is expected to continue growing earnings in a difficult environment. Westpac Banking Corporation – WBC (+8%). WBC went against the overall Financials sector trend in February, recovering from a poor performance through December and January. The bank provided an earnings update, advising its 1Q09 pro forma earnings were down 2% to $1.2B. (Note: The pro forma earnings are adjusted to include the results of St. George Bank as if it had been owned by WBC for both 1Q09 and 1Q08.) This was a reassuring announcement despite the fact the result included a big increase in bad debts. Underlying banking earnings continued to perform strongly, with good growth in lending and deposit volumes. The Retail and Business Banking divisions experienced solid starts to FY09 with strong revenue growth, but higher bad debts. Consumer loan arrears rates continue to trend upwards, albeit from low levels. WBC Institutional Bank continued to benefit from the reverse intermediation of capital markets, with large corporate borrowers reverting to bank credit to satisfy financing needs. Despite the significantly higher bad debts, the Institutional Bank continues to benefit from strong growth in transaction volumes. WBC’s Wealth business suffered from investment market weakness and negative investor sentiment; however, the division did experience a sound performance from its life insurance business. The SGB integration is progressing well, with high levels of customer retention and engagement. WBC remains one of our preferred banking stocks and we believe it is well positioned to take advantage of current market conditions.
Main underperformersQBE Insurance Group – QBE (-20.6%). QBE had been one of the better performers in the portfolio until recently; however, the stock has fallen on disappointment with the FY08 result. QBE reported a headline profit of $1.9B for FY08, down 3% on FY07. However, this included a couple of non-recurring gains, including a $400M gain on a hedging contract. Excluding these gains, adjusted earnings fell by 28% to $1.4B due to significantly lower investment returns. The insurance result was strong, with QBE reporting good underwriting profits across all divisions and a group insurance margin of 19.7%, down from the very strong 22.2% earned in FY07. This compares favourably with IAG and Suncorp, which are struggling to achieve double-digit insurance margins. QBE’s FY08 dividend was 126cps, up 3% on FY07. While QBE has consistently delivered solid underlying earnings growth, it did not escape the impact of the global financial crisis on its $28.5B investment portfolio in FY08. Whilst investment returns declined, the fact that QBE actually produced a positive investment return for 2008 was in itself a very creditable performance, considering the collapse in asset market values across the globe. The underlying insurance result also remains strong despite an increase in natural events through the year. Despite the lower earnings in FY08, we retain our positive view of QBE. The company remains in a very strong position and is well placed to make opportunistic acquisitions in the current environment, which will help it to continue generating superior returns over the medium to long term. It also offers an attractive dividend yield at current prices. Westfield – WDC (-7.1%). WDC was again one of the worst performing stocks in the portfolio, with the stock price impacted by a dilutionary capital raising. In early February, the group raised $2.9B in new capital at $10.50 per security, a 13% discount to the prevailing market price. WDC also released its FY08 results and, although the headline number was impacted by an expected $3.3B write-down in property values, underlying earnings rose by 7%, with a strong performance from the Australian portfolio offsetting a deterioration in the retail environment in the United States, the United Kingdom and New Zealand. WDC paid an FY08 distribution of 106.5cpu, but has given guidance of a lower distribution of 94cpu-97cpu in FY09. Although the result came in below our forecasts, WDC delivered a creditable performance, given the fairly tough global economic conditions. There will be challenges ahead of WDC in FY09, including diminished retail spend as global unemployment rises and impacts consumers' spending patterns. Longer term, the quality of WDC's business, through the ownership of major shopping centres spread across the globe, generates reliable revenue streams. WDC's management has, to date, harnessed that revenue stream to generate, over time, a growing distribution through a number of economic cycles. This supports our positive long-term view of the stock. Telstra – TLS (-6.3%). TLS released its 1H09 result, but this was overshadowed by the announced departure of CEO Sol Trujillo. Sales revenue was up 3.2%, underlying EBITDA grew 4.8% and reported profit was down 0.5% to $1.9B. TLS declared an unchanged interim dividend of 14cps (ff). The result was in line with our expectations, with the mobile and internet divisions being the key growth drivers. We continue to believe TLS will focus on organic growth and improving cost efficiencies throughout its divisions. Mobile and Broadband will remain the key growth areas over the near term. TLS’s transformation strategy is on track and although there is some key person risk with the CEO’s departure, we believe the transformation process is well and truly in place and will continue under a new CEO and existing executive team. Cost initiatives are ongoing, which should provide margins uplift in FY10, although the company has revised down slightly its expectations for FY09 due to lower call volumes, some one-off costs from the Victorian bush fires and the accelerated rollout of its T-Life stores. Importantly, the company is still targeting $6B-$7B in annual free cashflow by FY10. At current levels, we believe TLS has been oversold and see the stock as attractively priced, with a reasonable, fully franked dividend yield.
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. 
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