Welcome to the April edition of the Burrell Blog for 2019.
A Recovery consolidated, Geopolitical risks reduced...
The ASX 200 has consolidated its relief rally after the Hayne Royal Commission report trading within a 100 point range around 6263 reached on 7th March 2019. This was 621 or 11% rally from the low of 5642 on Christmas Eve.
Several clients commented that the recovery was welcome and were feeling happier with the portfolio returns year to date.
The resources sector was the upside surprise during March and the first two weeks of April. Iron Ore prices were strong following the disastrous dam wall collapse in South America. Subsequent government action has shut in production by Vale, the third major producer of Iron Ore along with BHP and Rio Tinto. Copper pricing has been strong, based partly on positive projections concerning the supply/demand balance for Copper over the next few years. The LME (London Metal Exchange) stockpiles fell to two weeks, generally a positive sign for copper prices. Oil prices stabilised around US$60 mark with the embargo on Venezuelan heavy crude production and geopolitical issues in Libya and the Middle East. Rutile and Zircon received positive forecast on prices from the recent annual industry conference in New York.
These positive commodity prices were in stark contrast to the pessimistic estimates over recent years from some of the large off shore merchant banks, which had seen China slowing and automatic impact on Australian resource companies. The key fact that China has shut in a material amount of its low quality (high Ash) coal and low quality Iron Ore means to the extent there has been some slowing in China, it has not adversely impacted the seaborne trade. Rio hit $100 and looks overvalued, with the possibility of a special dividend before 30 June more than factored into the current stock price.
Burrell was a sponsor of the Australian Energy & Minerals Investor Conference in Brisbane in late March. There were a number of interesting take aways. To begin with the 2018 conference optimism over Lithium has not been reflected in the Lithium price or Lithium stocks during the past 12 months. In a paper entitled “Lithium the supply question. The oversupply lie” delivered on 27th March, Steve Promnitz blamed an opportunistic research report from an overseas merchant for raising the spectre of Lithium oversupply, which has been talked about in almost every article over the past six months. In his paper, Steve notes the forecast for Lithium demand to increase many times from demand of 250,000T in 2018 to a forecast of over 1.8MT in 2030. Lithium Ion battery mega factory capacity has increased from three mega factories in 2015 to 72 mega factories at February 2019, an increase from 148GWh to 1590GWh. Almost all car manufacturers are seeking to add EV vehicles to their line-up and a number of countries have signed up to the 30/30 initiative i.e. 30% EVs by 2030. The conclusion from this paper was that Lithium will produce good returns over the medium term and well run Lithium companies will find their product in demand going forward. There is considerable angst in Europe that the Chinese have captured the Lithium Ion battery market with European manufacturers left well and truly behind. Just this week an agreement was announced between VW and Ganfeng to supply their Lithium Ion batteries. Orocobre with Toyota as the offtaker also seems to have its future assured. Currently trading at half the price that the last trench of shares was issued to Toyota and in the midst of an expansion to double capacity, clients should hold their current ORE positions within a diversified portfolio.
Tin was the subject of a positive paper at the conference, with the presenter noting Tin is in demand for solder for mobile phones and other electric equipment, being an industrial use in addition to its traditional tin plate cans. Manganese was also the subject of a positive paper with manganese contributing a material portion of the profit of S32 with a price of US$22,000/T. While the companies presenting were in the main small-mid caps, the insights given on some of the minerals were useful. A short list of six companies was compiled and recently added a seventh on the basis of a report from Bruce McLeary, head of Burrell Research. These companies have been included in the Burrell Small Cap and Resources Trust (BSMaRT).
While resources did well, the bank recovery stalled with an announcement of a bank levy to fund claims by disadvantaged customers. This could easily get out of hand and result in a tiger by the tail scenario. In the previous blog we commented that we had reduced bank analyst fair values (FVE) by $2, being $1 for Hayne remediation and $1 for the current credit squeeze/impact of the Sydney/Melbourne housing slow down. This still leaves several dollars of upside for each of the banks and yields which are difficult to match elsewhere. Most clients have an appropriate weighting of bank shares, but those looking to invest new moneys should not avoid the sector based on sentiment. From the value viewpoint, we may well look back in 12 months and think we should have gone over weight.
Good work on the non-bank non-resources stocks has continued with the February reporting season giving updated information to select the winners and losers from that mixed reporting season. A number of companies reported well, but there were several major companies that disappointed and the results season was by no means uniform.
Mergers and Acquisitions (M&A) have been a product of the last five weeks on the market with a range of other corporate actions including some special dividends and buy-backs. Economic information during the period was mixed. The US Federal Reserve on 21st March moved to a position of likely no fixed interest rate change in 2019, revised the GDP growth forecast down to 1.9%, a u-turn from the three increases forecast in the previous November. The German leading indicator of industrial activity, the PMI was reported at 44 being contractionary as compared to a level of 60 in December 2017. The US February deficit was a record of total debt in the US exceeding US$22 Trillion. The US deficit for the first five months was US$540B. Corporate tax year to date in the US only raised US$59 Billion compared to $87 Billion the previous year, before the Trump tax cuts. The 21% corporate tax rate in the US is clearly not sustainable and will be reversed, but probably not for some years. These economic statistics supported a low growth Europe with readers recalling the European Central Bank (ECB) on 8th March revising GDP growth down in Europe “substantially” to 1.1% for the current year, with the outlook to the downside.
Against this mixed economic outlook, it was pleasing to see some lessening of the geopolitical risks. Brexit was deferred until October. The Muller investigation report had no impact on the US stock market. Reports on the China/US trade war shifted to more positive commentary around an agreement likely to be reached over the next few months, although time will tell. China moved unilaterally to level the playing field with the announcement of new foreign investment laws applicable from January next year. These new laws abolish the forced technology transfer, a major cause of frustration between China & the west. The Chinese announcement includes a list of industries where foreign companies will be a no go zone e.g. defence and a foreign investment review board type structure, in many ways similar to Australia. There is some concern around some aspects including the proposed article 40 which includes a retaliatory provision where China can penalise countries who it decides are acting against its best interests. However overall the announcement by China of the new foreign investment laws removes a major issue unilaterally from the angst between China and the US and increases the probability of an agreement between China and the US.
The US market is currently digesting quarterly profit numbers with EPS growth forecast to be the poorest for a number of years. This has seen the US market trade sideways with companies reporting poorer earnings including some of the US banks being penalised. Well Fargo opined on 4th April that the US S&P 500 was trading at fair value. The US earnings season forecast has been revised down from +3% increase in earnings to -4%. For a stock market used to high single digit to double digit increases in EPS, this reporting season may provide a reality check. It is certainly not the time for index investing into the US stock market, but rather proven investment managers and direct holdings based on credible research.
In Australia the federal election date was announced in mid-May, preceded by a budget from the government and a counter from the shadow Treasurer. Burrell remain of the view that Labor has the best policy in the Telco sector, but that its tax policy will be negative for business and for the economy.
Lastly, the Australian market recovery has by no means been uniform with some stocks performing well, but others showing high volatility. This is presenting opportunities and our advisors are busy discussing opportunities and seeking to make positive changes to portfolios to enhance returns.
Happy investing ..
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This document contains general securities advice only. In accordance with Section 949A of the Corporations Act, in preparing this document, Burrell Stockbroking did not take into account the investment objectives, financial situation and particular needs ('relevant personal circumstances') of any particular person. Accordingly, before acting on any advice contained in this document you should assess whether the advice is appropriate in the light of your own relevant personal circumstances or contact your Burrell Stockbroking advisor. If the advice relates to the acquisition, or possible acquisition, of a particular financial product, you should obtain a Product Disclosure Statement relating to the product and consider the Statement before making any decision about whether to acquire the product.
Burrell Stockbroking Pty Ltd (ABN 82 088 958 481), a Participant of the ASX Group and the NSX.