NEWS + VIEWS – 06/09/2024

MARKETS                                             

US markets have baked in near term interest rate cuts while domestically, the worrying combination of low growth and persistent inflation is concerning economists. Nevertheless, markets have priced in a cut this year despite the Reserve Bank of Australia’s (RBA) advice to the contrary.

The VIX index, which measures expected volatility over the next three months, rose to 21.3 this week. This level is still within investible territory and well below 38.6 registered in early August.

On average, September is the weakest month for share markets as shown by the chart below of US markets. This is contrary to many ‘memories’ as some of the worst crashes came in the month of October (1987 and 2008). October on average is weak but often precedes the ‘Santa Claus’ rally in November and December.

Source: Coppo Report

PROFIT REPORTING SEASON

The reporting season concluded last week with mixed results. Even though around 40% of companies reduced their forecast earnings, investors have not stopped pushing up share prices. In the face of so-so reported earnings and reduced forecasts, the Price/Earnings (P/E) ratio for the ASX 200 is a high 18 times compared to the historical average of around 14 times. Directionally, Australian markets have recently been following US markets. However, the growth in US company earnings is much more supportive of higher prices.

The Australian market is roughly half made up of miners and banks. Miners’ share prices (and earnings) are being negatively impacted by China’s economic weakness. Consequently, investors are looking to other sectors.

One sector investors have flocked to is the banks and their share prices have been pushed relentlessly upward (e.g. Commonwealth Bank (CBA) trading at a P/E of 24 times). This is despite weaker consumer confidence and cautious guidance from banks’ management.

Non-mining companies that have reported good profits have attracted investors. For example, Wesfarmers (WES) is trading at a P/E of 27 times and logistics software provider Wisetech Global (WTC) a stratospheric 150 times. It will take a lot of growth to catch up with those multiples.

The prospect of interest rate cuts, both in the US and domestically, are providing optimism for investors. The US cuts are basically baked into share prices already. On the other hand, the RBA has been hosing down near-term interest rate reductions. This is at odds with market analysts who are seeing a weakening economy that needs an interest rate cut this calendar year. Expect share markets to be ‘disappointed’ if it doesn’t happen.

Woodside Energy (WDS) dividend down but still healthy

WDS’ underlying profit was down 13% to $US1.63 billion in the first half, despite the average price of oil falling 15% to $US62.60 a barrel.

The negative was a decrease in the dividend to $US0.69 per share from $US0.80 a year ago. Nevertheless, the grossed-up yield (including franking credits) is a healthy 10%.

Management stated that the $US12.5 billion Scarborough project in Western Australia is more than two-thirds complete and is slated to begin producing in 2026. The second Pluto train is scheduled for completion in 2027. This latter project leverages significant sunk costs in the first train, so it should deliver a strong return.

WDS’ acquisition of the Texas Beaumont ‘clean’ ammonia business and the LNG Driftwood projects were not received well by investors. WDS has a strong track record of project managing but the latter acquisition is in a new ‘field’ that carries greater risk.

BHP focussed on copper

BHP’s iron ore division will remain a core part of its earnings while it predicts that demand from China will plateau for the next few years before declining. BHP will continue investing in the iron ore business although a substantial part of the investment will be offshore.

Managing Director Mike Henry’s presentation to investors was heavily focussed on BHP’s future around copper, based on last year’s purchase of South Australia’s Oz Minerals copper assets and its return to Argentina. The failed Anglo-American bid was also focussed on copper assets.

BHP’s underlying profit was up 2% to $US13.7 billion but below expectations. Dividends were reduced to $US1.46 per share to assist funding the company’s heavy investment program.

BHP is expanding in new geographies (e.g. Guinea, US and Canada) and new businesses (e.g. potash). However, this continued diversification is not without risk. BHP needs to replicate its low cost, long life iron ore operations across its expanding copper and possibly potash assets.

Coles (COL) result better than Woolworths (WOW

A $1.7 billion profit for WOW represented a 1% fall in earnings. The food segment, representing most of the business, was able to offset a 6% increase in wages, energy and rents by slightly higher margins.

With a P/E of 26 times and muted growth expectations, WOW appears expensive despite being a ‘defensive stock’.

COL’s 4.4% rise in revenue pushed earnings up 8.2% to $3.7 billion for the year ending 30 June. The solid result reflected more people eating at home and COL reducing theft and other losses, which is still a pattern in the first two months of this financial year.

The final dividend surprised on the upside rising to $0.32 from $0.30 per share. COL’s P/E is a more investible 19 times, at least for a defensive stock.

The supermarket sector is competitive in Australia (contrary to what politicians might say) with Aldi and possibly an emerging Amazon exerting price pressure on the two majors. Both COL and WOW have been thrown into or voluntarily entered the political fray in the past 12 months. Both have suffered but COL has handled it better.

Wesfarmers (WES) expensive and betting on lithium

WES is trading at a PE of 27 times so has little room for mistakes. In particular, its lithium investments need to boost earnings by 2026 (which will require lithium prices to improve), to bring its PE back onto reasonable footings.

Bunnings continues to be the major earner in the WES stable although growth is likely to be in single figures. Kmart is another example of WES’ management skills in turning around struggling businesses, as it outperforms ‘value for money’ rivals such as Big W.

Gerard O’Shaughnessy
P 0423 771 330

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