Thursday 01 August 2019 Master of the market tips + 3 ...

[Pages:11]Thursday 01 August 2019

Master of the market tips + 3 small caps for yield

I'm not telling you anything you don't know in saying that the present climate is tough for investors. With interest rates so low, investors are looking at the stock market but many companies are overpriced. The other week on my Switzer TV programme, I interviewed someone I've known for years, master of the market and legendary Australian value investor, Anton Tagliaferro, to gauge his views on stocks worth buying.

In his article today, Tony Featherstone says that in almost 30 years of writing about equities he can't recall a market as strange as this one. He says that experience tells me that in times like these, extreme caution in the share market is warranted. However 3 stocks have caught his attention.

Sincerely,

Peter Switzer

Inside this Issue

Up close and personal with a master of the market by Peter Switzer

02

02 Up close and personal with a master of the market by Peter Switzer

05 3 small-caps for yield AVN, AQR & KMD by Tony Featherstone

08 Buy, Hold, Sell ? What the Brokers Say 10 downgrades, 5 upgrades by Rudi Filapek-Vandyck

11 Questions of the Week Time to sell? by Paul Rickard

Switzer Super Report is published by Switzer Financial Group Pty Ltd AFSL No. 286 531 Level 4, 10 Spring Street, Sydney, NSW, 2000 T: 1300 794 893 F: (02) 9222 1456

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual's objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

Up close and personal with a master of the market

by Peter Switzer

The other week on my Switzer TV programme, I interviewed someone I've known for years, legendary Australian value investor Anton Tagliaferro.

Like many of us, Anton was lamenting the fact that if you're looking for income, it's hard to know where to invest, particularly as interest rates fall. "To be honest, it's an issue people in other parts of the world have been grappling with, because you know Europe has had zero rates for a while (and their stock market hasn't exactly boomed either by the way) but Japan has had zero rates for a while, and you know Australia is sort of heading towards zero," he said.

Investors are having to deal with interest rates at unprecedented lows, along with an unpredictable factor in one Donald Trump ? the most difficult US President for investors to get a handle on!

Anton agrees with me that Trump is unpredictable and makes a lot of noise on issues such as trade but we both concur that the thing that's the major driver of markets at the moment is still this low interest rate environment. I asked him how he's approaching such a tough market environment. "I think what is clear is that certain sectors of the market are very overheated. The IT stocks obviously ? it's hard to justify many of their valuations," he said. "If you look at the REITs, the property trusts, where you've got Mirvac (MGR) at a 50% premium to asset backing, that seems a bit difficult to justify."

Anton believes the banks are a bit overheated, with CBAs share price back to where it was pre-Royal Commission. And while it may pay a good yield, the outlook is pretty tough.

"So, you've just got to stay away from the overheated areas as much as you can and try and look for value, if there is any," he says.

Let's talk stocks

The market may very much be momentum-driven at this point in time and it's hardly surprising that a lot of "old-school" non-tech stocks may have fallen out of favour. One such example is oil refiner Caltex (CTX). "So, you look at something like Caltex and everyone goes, `Electric vehicles!' But you know they're years and years away. And if you look at Caltex, they're the largest distributor and retailer of fuel, not just to cars but to trucks and airlines,' he says.

"They look pretty solid, I think ? good asset base, they own many of their petrol stations, have $2 or $3 a share of franking credits, to me it looks quite good. It pays a good yield and is growing in different markets."

Let's talk sexier stocks...

When I pressed Anton for a "sexier" stock pick than Caltex, he mentioned his recent purchase of shares in Nine Network (NEC). He says that while people may scoff and point out the well-known structural challenges facing free-to-air broadcaster Channel 9, Nine still has valuable assets like Domain and streaming app Stan within its stable of businesses.

"So, those areas are growing pretty quickly. I mean, if you put Stan on a Netflix multiple you would probably double the Nine share price overnight! So, Nine looks okay I think ... it pays a good yield, has a good balance sheet and good management."

Have you given up on this one?

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I then asked Anton about a stock that he had been a firm believer in but which rumour had it he'd given up on: Pact Group (PGH).

"I haven't given up. I mean, it's been very disappointing. There has been no doubt," he says. "The thing about Pact is it had this good solid packaging operation ? they're the largest rigid plastics packaging manufacturer in Australia."

"And they've used that to go into new areas such as contract manufacturing. So, they produce a lot of stuff for Woolworths and Coles, the non-branded stuff, the house brands. They've also gone into pallet pooling, so they do the pallet pooling for Woolworths now ? they won that contract off Brambles, and they recently won the Aldi contract too.

"They were making moves into what looked like good directions. Unfortunately, the core business, the packaging business, has been hit by the higher electricity prices, because as you know electricity prices have doubled. What Pact does essentially is it melts plastic to make containers, but it's a very electricity-consumptive industry. So, that's hurt them."

For Anton, Pact is a perfect example of why many companies are struggling in the current environment ? they're finding it extraordinarily difficult to lift their prices. "Part of it is the slow economic growth, lower inflation ? you know it's very difficult if you have an input price that goes up, to try and put your price up. Pact has definitely suffered from that," he says.

"But they have a new CEO, who has come from places like BlueScope (BSL) and Orica (ORI), where he turned them around. And his focus is to turn around the core packaging business.

"So, we think, going forward, the outlook hopefully will be better. And he said he's going to take $50 million of costs out of the packaging business."

Anton also noted the recent purchase of Pact shares by all of its directors, which he took as a sign that they're comfortable with where the company is heading with the new CEO at the helm. In the short term, he says investors in Caltex and Pact are probably not going to do well, given all the market

action seems to be in the Wisetechs, Mirvacs and CBAs. But this is because people are charging into things for yield and are "seemingly not taking much notice of the price they're paying".

Anton emphasised that now is the time for caution. The higher the market goes, the more tempted people are to come in, and when headlines scream, "Stock market hits new record highs," people will often think, "Oh wow! Maybe I should put money in the share market now because it's going quite well."

And that's probably not the best time to be thinking about it. For him, the old investing approach of dollar-cost averaging and well-worn adages such as "buy straw hats in winter" all come to mind.

"I mean it's not dissimilar to looking to buy an investment property two years ago when everybody said the Sydney property market would never go down. And here we are two years later and there's as much property as you would like for sale," he says.

My final question was whether buying primarily good quality, dividend-paying stocks is nowadays still a reliable strategy. Anton cast his mind back to the GFC, where dividends didn't in fact collapse in the same way that share prices did.

"You're correct ? the volatility of returns from dividends is a lot lower than the volatility of share prices. I think that is the case," he said.

"Let's say you've got $1 million today and you put it in the market and you're happy getting you're 4% or 5% ? that's better than a term deposit. That's fine. As long as you're prepared in the short term where that $1 million might be worth $900,000 or $850,000, which might happen if there's a correction. But your income levels should be relatively stable.

"But the key is whoever is buying today, if they're going to buy with that in mind, to not forget why they're buying, because unfortunately often what happens when people come late to the stock market, they say, `Oh that's great I'll buy $500,000 worth of shares and I'll put them away and not worry'.

"Then there's a correction and guess what they want

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to do? Sell at the bottom of the market. And that's the key. If you are going to take that longer-term approach and income is the thing, then you have to try and stick to that."

Anton concluded by cautioning that while a portfolio with income at its core is not a bad idea, investors have to be aware that, at the moment, prices are "a bit toppy".

"They may go higher in the short term and you have to perhaps put up with that depreciation in value if there is a hiccup. So, that's the thing you've got to be careful of," he says.

"And what concerns me a bit now is the headlines will soon be saying, `Stock market at new highs' and a lot of people are going to say it must be time to get in.

"And it's difficult to say the market won't go higher, but again, like the property market was in Sydney a couple of years ago, there were signs then that it was a bit overheated, and there are signs today that the stock market is overheated."

Anton is not always right in the short term but his longer-term record is why he has been labelled a "master of the market."

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.

Thursday 01 August 2019

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3 small-caps for yield

by Tony Featherstone

In almost 30 years of writing about equities I cannot recall a market as strange as this one. Sure, there have been bouts of irrationality over the years: the boom made no sense and the mining boom got out of hand. But some unusual dichotomies are at play today.

Our share market hit a record high this week, despite the yield on the benchmark 10-year Australian Government bond hitting a record low. Optimists say equities look attractive relative to bonds; pessimists say falling bond yields are signalling a deteriorating economy.

Several European countries now have a negative bond yield and there is a chance Australia could join them or get close within two years. Some economists believe the terminal rate (low point) for the Reserve Bank official cash rate is 50 basis points, implying another two rate cuts.

So we have negative bond yields overseas suggesting economy distress and local bond yields predicting a slowing economy, which is bad for corporate earnings and share prices. More on that will be known when ASX-listed companies report full-year earnings in August.

At the same time, the US-dollar gold price is up 23% from its low this year. Investors normally buy gold as a safe haven or when they expect further falls in interest rates, like now. The upshot is US-dollar gold at a five-year high and equities markets at record highs. And investors buying safe-haven and growth assets at the same time. Something has to give.

Afterpay and Xero), which are best avoided. Or Nearmap or Pro Medicus.

But many long-established small and micro-cap stocks are trading at GFC-like valuation multiples. Driven by quantitative momentum-trading strategies, money is pouring into high-growth stocks and deserting the rest. That creates pricing inefficiency.

Here is another dichotomy: the market is booming yet there are hardly any initial public offerings (IPOs). I follow the IPO pipeline and in 2007 ? the previous market peak ? there were 200. This year ? the new market peak ? we will be flat out doing 50.

Bull markets normally encourage companies to raise equity capital through an IPO and list on stock exchanges. Rising commodity prices, in particular, flush out junior explorers, some of which have little more than a PowerPoint presentation and a patch of dirt to promote.

Not this time. Resource floats have trickled to a standstill in the past few years. Perhaps the IPO market will heat up after the profit-reporting season and a rush of floats will emerge in the traditionally busy fourth quarter, when promoters rush to close offers before Christmas. I can't see it.

Experience tells me that when dichotomies such as this emerge, extreme caution in the share market is warranted. When most asset classes are rising, trades become crowded and the party usually ends abruptly and violently. Better to head for the exits too early than too late.

The dichotomy in small-cap equities is just as perplexing. Some small and mid-cap stocks are soaring and at irrational valuations. Think of the WAAAX stocks (Wisetech Global, Appen, Altium,

That has been my strategy this year: cautiously reducing equities exposure and adding more cash, fixed interest and infrastructure (assuming rates fall further). Investors should make portfolios more

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defensive and focus on the first rule of investing: capital preservation.

Case for small caps

It might seem odd to suggest value investors consider micro/small/mid-cap stocks in a market that looks overvalued and dangerous. Typically, small-caps rally at the later stages of bull markets and too often become portfolio landmines as investor greed sets in.

This small-cap market is unlike any I have seen. A narrow group of small and mid-caps, mostly technology companies, have soared. Many have languished. It is a market of two halves: small-caps bid up to crazy heights and small-caps forgotten about.

should be less affected by growth in online retailing.

Interest rates cuts and tax refunds should be a modest tailwind for bulky-goods retailers in the next 12 months. No doubt the tax cuts will pay for a lot of TVs.

At $2.42 Aventus is yielding 6.7% and should be able to maintain its distribution in a tough retailing environment, and slowly grow it over time. More will be known when Aventus reports its full-year result later this month.

Chart 1: Aventus

In search of opportunity I ran a screen through Morningstar's database to identify small-caps with a trailing yield of at least 6%.

Database screens should be viewed as a starting point for further analysis, not a list of stocks to buy. And future earnings, of course, matter most. Still, I have found over the years that screens for small-cap yield, provided the dividend is sustainable, are a handy tool.

Most stocks that came up in the screen are best avoided: they are in structurally challenged sectors, have had nasty profit downgrades or are poorly managed.

Three stocks caught my attention. I emphasise that each suits experienced investors comfortable with small-cap investing and higher risk.

1. Aventus Group (AVN)

I first wrote about this owner of bulky-goods "superstore" properties for The Switzer Report in 2016 when it was $2.23. Aventus rallied to $2.50 within a year, then tumbled to $2 late last year as retail paranoia set in. It now trades at $2.43.

My thesis for Aventus is unchanged: the Real Estate Investment Trust (REIT) has an interesting position in a property niche that is poorly represented by other REITs. "Big box" retailing has good prospects and

2. APN Convenience Retail REIT (AQR)

Like Aventus, APN has an interesting market niche: the REIT owns a portfolio of 70 service stations and convenience retail assets across Australia. Most of the assets are leased to well-known tenants, such as Woolworths and 7-Eleven, on long leases.

APN Funds Management, a well-performed property investor, launched APN Convenience REIT via an IPO on ASX in July 2017 at $3 per unit. The REIT now trades at $3.33 after rallying in the past month.

I like the long-term outlook for convenience retail. Population growth inevitably means more cars, traffic congestion and longer commute times. The number of service station locations around Australia has been relatively static despite this growth. Service station properties good locations in the larger cities, will become increasingly valuable.

Service stations tend to have long leases and quality

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clients. Also, the retail offering at service stations is expanding as 7-Eleven and others become mini-cafes and retailers. My local service station is standing room only after school as kids rush to the 7-Eleven for a Slurpee.

customer loyalty program is a valuable asset and one that Kathmandu can do a lot more with.

Chart 3: Kathmandu Holdings

At $3.33 APN is yielding 5.5%. The yield has edged lower as the price has risen, but looks attractive given the quality of the APN Convenience Retail portfolio.

Chart 2: APN Convenience Retail REIT

Source: ASX

Source: ASX

3.Kathmandu Holdings (KMD)

I am normally wary of investing in discretionary retailers for yield. The industry faces immense structural challenges and earnings can be volatile, hurting dividend stability.

Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article consider its appropriateness and accuracy, regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at 31 July 2019.

Kathmandu has fallen from a 52-week high of $3 in October 2018 to $2.07 amid the retail malaise. The outdoorwear retailer has had a tough 12 months after a cybersecurity attack, the terrorist attack in New Zealand, and a milder and drier winter than usual.

At $2.07 Kathmandu is yielding 6.7% fully franked and plenty of bad news is factored into its share price, judging by its trailing PE of 12.7 times.

I believe Kathmandu has two key advantages. First, it is a perceived as a high-price, high-quality brand. Consumers race to its discount sales to buy a $500 jacket for $300. Kathmandu has scope to maintain higher margins because it is starting from the premium end. The risk is that Kathmandu overdoes the discounting and damages brand perceptions.

The second asset is Summit Club, one of Australia's largest fashion retail databases. Having around two million customers to target online through the

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Buy, Hold, Sell ? What the Brokers Say

by Rudi Filapek-Vandyck

In the good books

1. CIMIC GROUP (CIM) was upgraded to Neutral from Underperform by Macquarie

First half net profit was below expectations. Mining division strength stood out, delivering 26% growth in pre-tax profit. Operating cash flow was well below expectations. The company has indicated it is moving to alliance-style, rather than fixed-price, contracts which have a more even cash flow profile. Macquarie upgrades to Neutral from Underperform, given the extent of the fall in the share price and support from the share buyback. The broker reduces the target to $40.00 from $43.80. A return to positive construction growth is required to support a more favourable fundamental view, the broker asserts.

2. KAROON GAS AUSTRALIA (KAR) was upgraded to Outperform from Neutral by Macquarie

The company will acquire the Bauna oilfield for US$665m, becoming the fourth largest liquids producer on the ASX. Macquarie suggests a US$100-120m capital raising may be required to fund the acquisition shortfall and strengthen the balance sheet. The broker assesses the company's three-year wait to obtain the field appears to have paid off. Seller Petrobras is undergoing an extensive divestment program to reduce debt. Macquarie believes the field is more suited to a company such as Karoon Gas, which has the ability to focus on lifting production volumes. Rating is upgraded to Outperform from Neutral. Target rises to $3.00 from $1.15.

3. REDBUBBLE (RBL) was upgraded to Hold from Reduce by Morgans

Morgans was surprised by the strength in the fourth quarter, particularly in margins, noting the company is looking at a secondary listing of shares in the US. Forecasts are upgraded to reflect the lower marketing and overhead costs seen in the fourth quarter. Morgans upgrades to Hold from Reduce and raises the target to $1.51 from $0.67. Risks are expected to diminish greatly if the company can prove cash flow self-sufficiency in FY20.

4. RESMED INC (RMD) was upgraded to Buy from Neutral by UBS

FY19 results were ahead of Citi's estimates and FY20-21 forecasts are increased by 7-8%. The broker considers the business excellent, albeit fairly valued and, hence, maintains a Neutral rating. Target is raised to $19.00 from $17.75. ResMed has tentatively agreed with the US government to resolve on a civil basis the Department of Justice investigation for payment of US$39.5m relating to issues around re-supply. Citi believes the company took appropriate measures several years ago, noting ResMed is confident in its numbers.

5. SPARK INFRASTRUCTURE GROUP (SKI) was upgraded to Neutral from Underperform by Credit Suisse

Credit Suisse is upgrading to Neutral from Underperform as the stock is trading in line with valuation. Relative underperformance is rendering Spark Infrastructure undervalued based on historical correlation of valuation multiples. Target is raised to $2.30 from $2.10. Still, the broker cautions that forecast cash flows put significant doubt on the company's ability to grow dividends and an extension of a discounted dividend reinvestment plan may be required beyond what is needed to fund the Bomen equity.

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