- In commodities, we are particularly bullish on uranium, soft commodities and meat
- Oil explorer Santos is well positioned to rise in line with an oil price rebound
- Electronics retailer JB Hi-Fi is a diamond in the consumer discretionary rough
By Saxo Capital Markets
We see our local benchmark index, the S&P/ASX200 or the XJO to underperform on a global level. The 2015 end of financial year target is 4800.
International investors will continue to decrease their holdings in our local stocks due to the falling Australian dollar and falling confidence in the Australian economy. Australia as a nation is yet to achieve a structured balance and it is heavily reliant on miners and mining related companies.
Individual Australians who personally now control a third of Australia’s superannuation money through self-managed funds will start to look offshore as international performance outstrips the local markets.
There are bullish prospects next year for listed Australian companies in the uranium, soft commodities and meat sectors. Photo: Thinkstock
We expect our credit rating to be a major talking point as our trade deficit blows out of estimates on sliding commodity prices. Smaller iron ore players will be forced to shut mines while the bigger players struggle to maintain their promise of capital returns.
The 2014 third quarter GDP came in below forecasts at just 0.3% is just a sneak peak of what to expect in the coming year. Economic momentum will fade slowly into the end of next year as consumer confidence and investment weakens across the country.
We do not hold a positive outlook for the price of gold for 2015 and remain particularly bearish on Newcrest Mining, mainly due to uncertainty around the operational outlook for Lihir. The miner's Lihir assets accounts for just over half of the companies book value, yet they fail to generate strong cash flow or profitability for the company. The strengthening of the US dollar will also impact the purchasing power of international investors looking to store value in the precious metal.
Despite our outlook on gold, we are against shorting the mid-tier miners as the risk of merger and acquisition activity remains high.
Within the commodities space we are particularly bullish on uranium, soft commodities and meat. We expect our companies that operate in soft commodities to perform strongly as China buys more Australian agricultural produce. In 2013, this market was worth about $9 billion to Australian farmers and the broader agricultural sector. According to predictions by The Australian Bureau of Resource Economics and Sciences, China will account for 43% of all growth world-wide in agricultural demand to 2050.
China will increase its demand for food and other soft commodities, particularly as its population continues to grow and Chinese food consumption pattern changes significantly. Living standards are improving in China and consumers will seek higher quality food for consumption. Australia is perceived and recognized as the country that has a clean environment with high quality products. This coupled with the recent signing of the free trade agreement with China should boost demand for our goods in this sector.
Australian Agricultural Company (AAC) is our top pick for beef / live exports. AAC is a world-leading provider of beef and agricultural products that holds a strategic balance of properties, feedlots and farms comprising about 7 million hectares in Queensland and the Northern Territory. This is roughly 1% of Australia's land mass. With a market capitalization of $750 million and a book value of 98% of its current share price, ACC is an investment in the industry, inventory (cattle etc), pipeline and operational process. Excuse the pun, but here is some food for thought: can anyone put a limit on sales that could be generated from the demand in a growing Chinese middle class?!
Freedom Foods (FNP) is best positioned within the dairies space to benefit from the China-Australia free trade deal. The recent signing of a memorandum of understanding with China’s New Hope Group will see exclusive cooperation to develop and implement growth in long-term dairy milk supply through establishment of new large scale intensive dairy farms in Victoria.
Energy – can you say uranium?
Nuclear energy is likely be one of the big winners as Japan restarts more nuclear reactors in 2015. Uranium prices have started to gain attention in November as Japan gave the nod to restart two reactors at the Sendai nuclear plant.
Following the deadly Fukushima nuclear disaster in March 2011, 48 plants in Japan were closed and uranium prices have been in a long downtrend. The result of Japan shutting down its nuclear energy program has led to expensive energy imports – in particular liquefied natural gas, which has worsened trade deficits.
Nuclear power, which accounted for almost a third of Japan’s electricity generation before the Fukushima disaster, has been identified by Japanese Prime Minister Shinzo Abe as an important source of power for the country
In addition to Japan’s plan on nuclear energy, India is also preparing itself for Australia’s uranium imports in 2015 as it makes plans to move to 25% power by 2050.
We see a lot of upside growth potential in Energy Resources Australia (ERA). ERA mines uranium ore at its Ranger mine in Australia and exports to power utilities in Asia, Europe and North America. This stock has spent three years in a long consolidation period ranging between $1.825 and 95 cents since 2011, and in 2015 we expect a breakout rally to occur.
Energy - crude oil, if flowing
It’s been a wild couple of months for crude prices as we saw their prices more than halve since their post-crisis high. Although oil is far less critical to the developed world’s economies than it was in the 1970s, cheaper oil should be a net benefit. It reduces costs for most businesses, while freeing up consumers to spend more.
We see oil consumption growth for 2015 being driven by non-OECD economies, where car ownership affordability moves in line with rising wages, and as expanding industrial activity continues to support oil consumption. However oil prices will be subject to considerable volatility over the medium term, due to changes in economic and political conditions.
Our preferred stock in this space is one of Australia’s largest oil and gas producers: Santos Limited (STO), which operates in the exploration, development, production, transportation and marketing of hydrocarbons.
Santos has recently slashed $700 million from its 2015 capital investment budget, including $100 million in exploration spending in response to plunging oil prices. The oil price drop has wiped more than $8 billion from the company's market value since early September, which partially rules out the dreaded thought of a capital raising for the interim.
Following the wild sell-off in oil, Santos has seen its share price fall by about 45% so far this year. It has found temporary support at about $7.00 for now.
Shareholders breathed a sigh of relief when they saw several directors put their money where their mouths were. In a vote of confidence from Santos directors, the market has learnt in the past week that directors have been buying the stock at about the $7.00 to $7.10 mark.
We expect to see Brent crude oil price recovering from the possible bottom of $50 in 2015, and Santos is well positioned to rebound as well, and provide a once in a life time opportunity for long-term value investors.
Materials – iron ore
Iron ore had entered a new era in 2014 where supply finally outstripped worldwide demand, namely China. The years of development and construction that took place in our northern neighbor, driving up the thirst for steel was met with capital expenditure from our iron ore producers. Now it would seem that the music’s quietly fading and only those companies that are well positioned can continue the dance.
BHP Billiton, Vale and Rio Tinto are now playing a global chess game. By over supplying the market and driving prices down, the smaller miners will need to close down or be picked off one at a time. With pockets deep enough to withstand the current low prices, the aim is to dictate the ore price once again.
Our pick of the key Australian miners is Rio Tinto (RIO). Glencore’s ambitions to have a take-over of equals, is a story we see playing out in 2015. Glencore, the Anglo-Swiss commodity trading and mining company that is restricted to make another play for RIO before April, will be speaking to Chinalco on what the merger can offer. As a major investor in RIO and an investor that is heavily down on its purchase price, those government officials responsible for the position will be interested to hear of a favourable exit position.
Banks have seen their tops
The beloved Australian banks offered retail investors sumptuous yields for years, but they will begin to decline in popularity. Shares in the big four banks will start to trade in patterns seen typically in a downward market. The reporting season will no longer offer the growth seen in profits, and dividends will start to look less attractive as investors are left with capital losses.
Fear of being left with unfavorable taxation implications will see the banks been unwound in lockstep as the market continues to be greeted with news that retail investors and self-managed super funds have slowly reduced their exposures to the banks throughout the year.
Telcos with little left in the tank
In the past three years we have seen our telecommuication industry grow steadily, producing handsome capital returns. Our desk sees these returns have been generated through either chasing dividend yields or through the growth of sales, but not both.
Telstra (TLS) has long been known as one of the key companies in Australia that pays a large, stable dividend. The baby-boomer population has been transitioning to retirement and searching for an income stream to fund their lifestyles, but bank deposits have not suited their needs. The money that once belonged in term deposits has been making its way towards companies like Telstra.
Subsequently, much like a government bond, their price has been appreciating as investors accept lower yields. Telstra's share price cannot be attributed to growth in sales. While its net profit has grown of late, this has come through cost cutting and the lift will come to an end.
On the other side of the coin, Australia has a number of smaller telcos that have enjoyed substantial growth since 2010. For those above the magic one billion dollar mark, our desk looked at M2 (MTU), iiNet (IIN) and TPG Communications (TPM). Unlike Telstra, these companies pay minimal dividends and reinvest their free cash flow to growth purposes.
Opportunities that have presented themselves to these companies and sentiment for customer adoption include: poor Telstra service in recent years, Vodafone’s disastrous network breakdown causing failed calls and messages for weeks and months on end, and Optus’s average proposition. In addition, these three companies are offering dynamic solutions and service to help implement their offering.
Our view for this sector as a whole is cautiously positive. We appreciate that the Australian economic will be facing difficult times in the next year, but we also believe that society has become addicted to networking and will not cut these costs from daily lifestyles. In addition to this, our cautious confidence also comes from the Reserve Bank of Australia considering a rates drop that will cause a further push on TLS share price.
After reviewing management’s strategy and their financials, the Saxo Sydney desk has chosen TPM as our pick of this sector, because it has the most attractive operating profit margins in the industry, as well as strong revenue and net profits, a proven management strategy and excellent service.
Like a beautifully argued debate, the utilities sector for next year can be viewed through rose-coloured lenses or simply a necessity for one’s portfolio.
So what are the pros and cons in 2015 with utilities? The pros: they are commonly moved into when the economic outlook is weak. Utilities are a defensive play adopted by investors to protect capital while still holding stock market exposure as part of their diversified portfolio. As portfolio managers lighten positions in high beta stocks and look to comply with their investment mandate, the utilities sector will be a popular option for consideration.
Strong revenues and cash flows along with dependable dividends also puts a floor on this sector's downward price range in times of uncertainty. Lastly, in an industry that utilized debt heavily in their capital structure, benefits will be gained from lower interest rates and favorable borrowing conditions.
And the cons: energy has been punished of late and we have seen the mercy of our worlds markets upon the price of oil. OPEC is playing a game with the Americans and when you take the concentrated wealth of these oil nations and go to battle with the world’s largest capital market, uncertainty will weigh on the world.
Additionally when the trend is your friend and international investment is easier than ever before, money will leave our shores for better opportunity. Demand domestically will subsequently have to weaken.
So where will the XUJ be on December 31, 2015? Just shy of where it is now!
Our pick of the industry is APA Group (APA) based on its strategy of both organic growth and acquisition, significant infrastructure in place, and the fact the price to use their liquefied pipelines is not affected in the same way asthe price of energy quoted in the market.
Consumer staples: hold, don’t hold
Two names. Coles and Woolworths. That’s it. Yes there are others but the return for the risk involved is not worth the trade.
We are not impressed with these two supermarket giants the way everyone else is. For years they have been dominating the supermarket space. Squeezing their suppliers margin and dictating terms all in an attempt to increase their profits. This ‘price war’ they are in with each other is really still just a way to drive further revenue and push the competition more.
But where is this profit going? We do not see it reflected in share prices. In the past five years, Woolworths ( WOW) has had a low of just under $24 and a high at just above $38. Its share price appreciation in this time has only been 7% and the retailer has only been paying an average dividend.
Investors however have to respect their revenue streams, sheer size and product breadth. The organizations themselves are diversified entities in their own right and is certainly considered defensive. For us, we see these two stocks as being appealing to a well-diversified and low risk investor. We do not recommend a short positions in these names as a dip in their price is more often than not considered a buying opportunity to your typical Aussie mum and dad.
Consumer discretionary: diamond in the rough
GDP growth, as we’ve been warned, will be subdued, unemployment will rise and consumer sentiment is low. Even approaching Christmas there are few buzzwords in the air around our spending. Any drop in interest rates by our good RBA governor Glenn Stevens will go towards paying down higher mortgages and less towards the shops.
There is one investment we see light in – JB Hi-Fi (JBH). Its annual report failed to impress, but looking beyond the raw data and neatly balancing the numbers with management strategy, profits in 2015 will surpass market expectations.
Taking a step back, one would notice the electronics chain as a ‘younger’ retail outlet. Electronics, gaming and gadgets are all desired by the 18 tp 35 year old market. As anyone in marketing will tell you, this age category has the highest disposable income and does not need the service that accompanies their higher cost competitors. In addition to this previously built image and loyalty, the retailers is now expanding into the higher-margin white goods sector. In the management growth strategy, the retailer has identified that the cost of converting a store to accommodate white goods is rather minimal, and importantly has a rapid recovery of capital outlay. On a synergy front, its existing clientele are in the stage of life where they are beginning to accumulate white goods.
– Edited by Robert RyanThis Australian Market Forecast was compiled by the Sydney trading desk at Saxo Capital Markets. Post your comment below to engage with Saxo Bank's social trading platform.
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