JCP Investment Partners view for Australian Equities
JCP Investment Partners view for Australian Equities
Our analysts recently had a one-on-one meeting with Steven Semczyszyn (Chief Investment Officer) and Wes Campbell (Head of Business Development) at JCP Investment Partners. Below are the key points from our discussion.
They see downside risk to Australia given house prices rolling over, investors pulling back and credit growth from here likely to tightened. In the current environment, JCP prefers offshore earners.
JCP have been negative/short on the banks for some time and the current issues in the banking sector are playing out in line with their expectations. They continue to see more pain for the banks (tighter lending standards, pull back on credit growth and higher borrowing costs).
They also raised an interesting point around non-recourse housing loans (which assisted in the collapse of the U.S. housing market during the GFC) and recourse loans (which is one of the main reasons many in the domestic market point to as downside protection for domestic banks).
In JCP’s view, the validity of these recourse loans may come into question if it is found that the paperwork and lending practices of the major banks were actually not up to the standards (false or missing paperwork / data etc). If indeed these loans do default and improper lending is realised, the clients may in turn sue the banks.
We have seen via the Royal Commission into the Banking sector, that the banks may not be fully across all their own data, regardless of them consistently persisting to the contrary.
Clearly this has implications for the broader economy should we see an economic / market correction. JCP are focused on Australian stocks which derive most of their revenue from offshore and on domestic stocks which are positively leveraged to population growth (supermarkets, hospitals).
Members of the firm have recently come back from the U.S. and noted the following: (1) inflation pressures are appearing, including wage growth due to labour shortages and businesses looking to invest; (2) housing market is humming along nicely; (3) whilst Trump may appear to have no set strategy, he does appear (or desires) to be bring back “animal spirits” on the perception the U.S. is moving forward. U.S. business investment continues to improve, consumer confidence is holding up (retail sales remain firm) and this should continue to support the current economic cycle.
Interestingly, JCP raised the issue of higher transportation costs (i.e. trucking) in the U.S. Indeed, companies such as Brambles Ltd (BXB) noted in their first half FY18 results that “transport inflation” was hurting earnings, which was a result of “increased economic activity, labour shortages and regulatory changes reducing market capacity”. Interestingly JCP found during their U.S. trip that legalised marijuana in the U.S. (medicinal and recreational in some states) could be contributing to this inflation.
That is truck drivers were failing their drug test and were unable to drive as a consequence. This couple with increased regulation on how many hours a day they can drive (Australia has similar rules) and reducing number of truck drivers (not too many people are choosing it as a career these days on the view it may be dwindling industry (long-term driver-less trucks) and is perhaps not as “attractive” to millennials), is contributing to transportation costs.
Telstra Trading Update (ASX: TLS)
Telstra Corporation (TLS) has provided a trading update in which it highlighted that the Company now expects FY18 operating earnings (EBITDA) to be at the lower end of previous guidance range of $10.1 – 10.6bn.
This compares to our estimates of $10.6bn and consensus estimates of $10.3bn. The key reason for the downgrade being increased pressure on TLS’ fixed and mobile average revenue per units (ARPUs). Whilst the trading update is disappointing, we are not entirely surprised given the reasons provided are largely well understood by the market.
However, what does concern us is the acceleration in the decline of ARPUs during 3Q18. On a positive note, subscriber growth remains solid in postpaid mobile and fixed broadband, costs savings remain on target and free cashflow (FCF) guidance was slightly improved. As we have noted previously, short term challenges persist for TLS given the intense competition (new unlimited data plans, TPG’s mobile launch in 2H18, NBN impact etc) which are likely to occupy investors thinking.
However, given TLS’ share price has de-rated over the past 12 months, we suspect investors may be soon be picking up the 5G optionality for little at current levels. Whilst FY18 and FY19 will be difficult, we do see upside to TLS’ share price over the long term.
We maintain our Buy recommendation on valuation grounds and look for more clarity around strategic levers the Company will look to pull in the current environment when management provide an update in the second half of June.
A2 Milk Co Ltd (ASX: A2M) Trading Update
A2M has provided a trading update in which it said FY18 group sales are expected to be in the range of NZ$900 – $920m, which is below the pre-announcement consensus forecast of approximately NZ$947m.
Further, the Company noted that this “takes into account the planned transition to new infant formula packaging during Q4”. The Company expects gross margins to remain “broadly consistent” with 1H18.
The share price reaction is highly consistent with a company that has displayed astonishing share price appreciation.
So, a slight revision relative to consensus expectations was always going to warrant such a reaction. We do not believe the demand equation has significantly moved and as noted by the Company due to transition to new labelling (looking to run down old inventory).
Whilst trading on a high PE-multiple represents a risk, we remain comfortable with A2M’s long-term prospects (new products, new geographies). Continued successful execution of strategic initiatives, as well as new growth opportunities through the Fonterra partnership render A2M an obviously high-quality company, which appears to be well and truly positioning itself to be a global dairy company.
Clydesdale Bank (ASX: CYB)
CYB first half FY18 (1H18) result was slightly weaker than consensus estimates on softer net interest margin (NIM) and other income. Underlying profit before tax was up +28% to £158m versus previous corresponding period (pcp), which was driven by: higher net interest income (+4%), lower costs (-7%) and low impairment charges (-15%).
The statutory profit before tax loss of £95m for the period was pre-flagged by the Company in April 2018 and relates to increased provisions for legacy PPI costs by £350m.
We note the company continues to make good progress on costs (improved cost guidance), switch to internal-risk-based (IRB) is on track and potential upside from Virgin Money acquisition (if approved).
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