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Ords Insights - Investment Strategy
1. Contractors
INFRASTRUCTURE TRUMPS RE
Cash Expectations
LOWER GROWTH LEADS TO CLOS
I N S I G H T S
2 0 1 8 I S S U E O N E
Investment Strategy
Infrastructure – Essential Services
Australian Equities
Themes for 2018
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3. ords.com.au 1
2 Infrastructure – Essential Services
In recent decades, the opportunity to own
infrastructure assets has expanded greatly.
6 Asset Allocation
8 Australian Equities Strategy:
Themes for 2018
New themes include inflation beneficiaries
and companies with balance sheet appeal.
10 Leading Lights – Preferred Stocks
12 Investment Fundamentals
14 Interest Rate Securities
We favour securities with maturities
between three and five years.
16 International Stocks
18 Currency
19 Alternative Investments
20 Primary Forecasts
82
CONTENTS
4. 2 Ords Insights | 2018 ISSUE ONE
INFRASTRUCTURE
Essential Services
Almost every day we rely on
infrastructure to make our lives a
little easier – communication towers,
oil and gas pipelines, railroads, toll
roads, airports and ports.
In recent decades, the opportunity to
own these infrastructure assets has
expanded greatly. The attraction is
that they typically generate reliable
earnings by providing essential
services to the community, yet with
limited competition. Through time,
these predictable cash flows are
expected to deliver income and
capital growth for investors.
For long-term investors reliant on
regular income, they are particularly
attractive, given the long-dated
nature of the concessions that
infrastructure assets often
incorporate.
Infrastructure companies are
generally less heavily regulated than
utilities, which allows companies to
benefit from a greater number of
people using their services.
As economies develop, aviation,
shipping and vehicle traffic increase,
as does demand for communications
and energy.
Given the essential nature of these
services, the fees charged to use
them can be varied with limited
impact on demand. As a
consequence, earnings are more
reliable than those for a typical
industrial company and generally
enjoy inherent protection against
inflation. This dependability is also
the reason that infrastructure
companies can support higher levels
of leverage.
The Australian stock market has a
well-developed infrastructure sector,
thanks in no small part to the efforts
of local investment banks such as
Macquarie supporting its expansion.
Within the sector we have several
preferences: APA Group, Qube
Holdings, Sydney Airport
and Transurban.
APA Group
Category: Pipelines
Market Cap’n: $9.4bn
Price: $8.05
FY19E Yield: 5.8% (0% unfranked)
APA Group owns and/or manages
15,000 kilometres of natural gas
pipelines across mainland Australia,
valued in excess of $20 billion. This
network connects sources of supply
with 1.3 million Australian homes and
businesses, delivering half the
nation’s natural gas usage. The group
also has interests in gas storage
facilities, gas-fired power stations
and wind farms.
At its 2017 full year result announced
last August, APA reported underlying
earnings (before interest, tax,
depreciation amortisation) of
$1.47 billion, above the top end of
guidance and 11% above the previous
year’s result. This was the eighth
consecutive year of growth for
the company.
5. ords.com.au 3
Qube Holdings
Category: Transport Logistics
Market Cap’n: $3.8bn
Price: $2.30
Price Target: $3.00
FY19E Yield: 2.5% (100% franked)
Finding a solution to NSW’s
complex and inefficient import/
export logistics chain isn’t likely to
be easy, but it should be
rewarding. Qube’s solution is to
realign the leading stevedore with
the key logistics operator and
drive greater acceptance of rail by
investing in Sydney’s largest
integrated intermodal terminal. In
our view, this solution should see
all the squares line up for Qube
shareholders.
By way of background, Qube is an
integrated provider of import and
export logistics services. It
operates three divisions covering
automotive, bulk and general
stevedoring; landside logistics; and
strategic development assets.
Qube has been focused on growth
through acquisition. With the
purchase of a 50% interest in Patrick,
Australia’s leading stevedore, it has
evolved into an execution-based
strategy for logistics infrastructure
investment. That is, investors in the
stock are taking a view on the
success of the new intermodal
terminal at Moorebank. The
company’s other businesses will
continue to ride the ups and downs
of the broader economic cycle, but
Moorebank has the potential to
change the logistics landscape for
the state.
Why? Because over the next 25–30
years we are expecting the volume
of shipping containers passing
through Port Botany in Sydney to
grow from 2.6 million per annum
today to 8.4 million by 2045. The
existing logistics infrastructure,
however, is unable to handle this
volume. Hence the need for a
solution, which Qube offers.
The Patrick acquisition creates
a strong commercial alignment
between stevedore and logistics
operators that should drive efficiency
gains and lower freight costs for
customers, and ultimately lead to
greater acceptance of rail as an
alternative to road. Anyone faced
with driving on Sydney’s clogged
roads would be nodding their head
at this point.
Moorebank is therefore a pivotal
move for Qube. We expect that
Moorebank could be contributing up
to a third of the group’s earnings in
10 years’ time.
APA also announced $1.2 billion in
new projects, which is testament to
its ability to help customers with
their requirement for reliable and
affordable energy. These projects,
entailing gas transmission,
midstream processing and
renewable power generation, will
start delivering $70 million of
additional revenue in 2019 and
$200 million in 2020 and beyond.
One of the key value drivers for APA
is operating cash flow, which
increased 13% in 2017. This is the
amount of cash flow generated from
operations, after subtracting interest
and tax payments, and it is what APA
uses to continue to grow the
business and pay distributions to
shareholders.
APA has a prudent approach to
distribution growth, which has meant
that distributions have increased
every year since listing in 2000.
The attraction of infrastructure assets is that they typically
generate reliable earnings by providing essential services to the
community, yet with limited competition.
39,950 PJ
17,384 PJ
55,218 PJ
31 PJ
Sydney
860 PJ
199 PJ
1,017 PJ
2,483 PJ
85 PJ350 PJ
Mondarra Gas Processing
Storage Facility
Emu Downs
Wind Solar Farm
Badgingarra
Wind FarmPerth
KKP
EGP
YGP
YPS
GGP
PPS
NGP
TGP
AGP
CGP
EPX
MSP
CWP CRP
SESA
SGP
MGP
Orbost Gas
Processing Plant
Dandenong
LNG Facility
VTS
SWQP
RCWP
RBP IOC
BWP
WGP
DPS LPS
BGP
WPP
MP
PGP
MMGP
Darwin
Mount Isa
Brisbane
Melbourne
Gladstone
Wallumbilla
Daandine PS
Kogan North GPP
Darling Downs
Solar Farm
Directlink
Tipton West GPP
North Brown Hill
Wind Farm
AdelaideGas storage
Wind farm
Solar farm
Integrated operations centre
Gas-fired power station
Gas processing plant
LNG plants
Natural gas and ethane 2P
reserves, as at November 2017
Source: EnergyQuest December 2017
APA assets and investments
APA operated assets
Other natural gas pipelines
Electricity interconnectors
APA’s uniquely integrated energy assets
INVESTMENTSTRATEGY
Source: APA financial report
6. 4 Ords Insights | 2018 ISSUE ONE
Sydney Airport
Category: Airports
Market Cap’n: $15.3bn
Price: $6.72
Price Target: $8.45
FY19E Yield: 6.0% (0% unfranked)
Sydney Airport operates the
Kingsford Smith Airport in Sydney.
The company develops and
maintains the airport infrastructure
and leases terminal space to airlines
and retailers.
The stock offers investors significant
leverage to a number of attractive
characteristics:
Strength in international passenger
growth – An international passenger
generates around three times the
revenue of a domestic one. A number
of factors support our belief that
international visitors growth will
continue at a healthy pace: the
burgeoning middle-classes in Asia;
potential depreciation of the
Australian dollar; and an ongoing
decline in the cost of air travel,
fuelled by further evolution in the
types of air travel.
Exposure to one of Australia’s most
productive retailing precincts –
We estimate that the international
terminal achieves average sales per
square metre of $25,000–50,000
depending on whether it's duty
free or non-duty free. This is well
in excess of the most productive
specialty stores in a conventional
shopping centre.
SYDNEY
NORTHERN
BEACHES
KURNELL
PARRAMATTA
SYDNEY
AIRPORT
PRECINCT
PORT
BOTANY
PRECINCT
COOK RIVER
INTERMODAL
TERMINAL
MOOREBANK
INTERMODAL
TERMINAL
MACARTHUR
INTERMODAL
SHIPPING
TERMINAL
CHULLORA
INTERMODAL
TERMINAL
ENFIELD
INTERMODAL
LOGISTICS
CENTRE
PROPOSED WESTERN SYDNEY
INTERMODAL TERMINAL
BADGERY
CREEK
AIRPORT
PRECINCT
YENNORA
INTERMODAL
TERMINAL
CLYDE
INTERMODAL
TERMINAL
BANKSTOWN
AIRPORT
MILPERRA
CBD
Transport Gateway
Shared Heavy Rail Proposed Motorway Extension
Road/Motorway Investigation
Transport Investigation
IntermodalTerminal
Dedicated Freight Rail
Motorway
Motorway Expansion
Sydney’s Infrastructure Assets Developments
Large scale cities like Sydney require investment in a complex set of infrastructure assets. APA, Qube,
Sydney Airport and Transurban are integral to the delivery and management of these essential assets.
Source: Sydney Metropolitan Strategy
7. ords.com.au 5
Enviable car parking margins –
We estimate car parking operating
margins of 70–75%, above those of
other airports of 56–66% and
40–45% for non-airport operators.
Furthermore, capacity expansions
have generated a return on
investment of 35–65%, so
further car park development
should be accretive.
The development of the second
Sydney airport at Badgerys Creek,
due to open in 2026, is a longer-term
risk, but probably overstated. It’s not
clear that the increased competition
will result in a significant drag on
Sydney Airport’s earnings growth,
let alone an earnings reduction over
the foreseeable future. It’s expected
that about 80% of passengers
passing through Badgerys Creek will
be domestic travellers, and mainly
leisure rather than business, making
it best suited for low-cost carriers.
This suggests Kingsford Smith
Airport should retain its position as
the preferred airport for domestic
and international full-service carriers
due to, among other things, its
proximity to Sydney’s CBD and its
established transport network.
Transurban
Category: Toll roads
Market Cap’n: $26.5bn
Price: $11.68
Price Target: $14.35
FY19E Yield: 5.2% (10% franked)
Transurban manages and develops
urban toll–road networks in Australia,
with 13 assets spanning Sydney,
Melbourne and Brisbane, and also in
the United States, with two roads in
the Washington DC area.
The group also has several
construction projects underway
including the NorthConnex tunnel in
Sydney, the West Gate Tunnel Project
in Melbourne and the 395 Express
Lanes in Virginia.
The company’s $9 billion development
pipeline and management initiatives
should assist it to continue to grow toll
revenues and operating earnings at a
rate in exceeding local economic
growth in the near term.
In addition, there is the potential for
acquisitive growth to enhance this,
whether it’s a stake in the WestConnex
toll road in Sydney, or a U.S. toll road
that possibly comes up for sale.
The distribution outlook is also
favourable. We forecast 3-year
compound annual distribution
growth of around 10%.
A question that is consistently raised
about infrastructure stocks is what
the impact of rising interest rates will
be. Typically when long-term interest
rates have risen, as we’ve seen
recently, there has been a short-term
sell-off in bond-proxy stocks.
However, these stocks outperformed
strongly thereafter. We believe this
reflects firstly, investor realisation
that inflationary expectations are
often too high – that is, the
normalisation of long-term interest
rates takes longer.
Also, infrastructure stocks are
insulated from a gradual rise in
inflation through, in Transurban’s
case, CPI-linked tolls, as well as active
debt management – that is, taking
advantage of historically low rates to
lock in cheap debt as well as
extend maturities.
INVESTMENTSTRATEGY
8. 6 Ords Insights | 2018 ISSUE ONE
Cash
Interest rate
Property
Equities
Strategic
allocation
Dynamic
allocation
55%
10%
30%
5%
60%
10%
22.5%
7.5%
Dynamic
allocation
70%
10%
15%
5%
75%
10%
7.5%
7.5%
Strategic
allocation
Risks to our outlook
Greater volatility
Higher inflation
Positive correlations
between bonds
and equities
ASSET
ALLOCATION
Outlook
Our macro views remain constructive: growth momentum is robust, global inflation is normalising but
unlikely to see a dramatic uptick, and the Federal Reserve will continue to tighten policy but remain
accommodative. Domestically, the latest reporting season finished with a slight improvement in profit
expectations while the RBA will remain on the sidelines. This background supports our overweight
position in equities over fixed income, however, an escalation in trade tensions between the U.S. and China
threatens global growth. For this reason we recently trimmed our near-term risk exposure by reducing the
International Equities position and reallocating into Cash.
Source: Ord Minnett Research.
Asset Class
Dynamic
Positioning Comments
Equities
Australian O/W Reporting season offered further fundamental support. Our preferred themes: global over
local; balance sheet appeal; inflation beneficiaries; and areas of structural growth.
International O/W Underpinned by strong corporate fundamentals. Valuation attractive following the technical
sell-off in February. Regionally, hold unhedged Japanese exposure through iShares MSCI
Japan (IJP) and Eurozone via EuroStoxx ETF (ESTX), as well the U.S. tax trade through
iShares SP Small Cap 600 (IJR). Sector-wise, with inflation normalising, hold international
financials via Betashares Global Banks (BNKS).
Property Neutral The sector struggled with the recent bond sell-off, but their defensive characteristics
produced outperformance as equities sold off. Positioning may change once direction of
bond markets is clearer. Favour developers with growth options.
Interest rate Favour variable over fixed rate.
Fixed rate U/W Rising inflation expectations have triggered bond sell-off, compounded by more hawkish
rhetoric from the Federal Reserve. Hold 3-6 month term deposits. Wrong point in cycle to
hold large position in fixed-rate bonds.
Credit Neutral Limited potential for further spread tightening. However, support comes from demand
exceeding supply ($7 billion in listed interest rate securities will be redeemed this year).
Cash O/W RBA unlikely to move near-term. O/W based on geopolitical tensions.
Balanced allocation Growth allocation
9. ords.com.au 7
ASSETALLOCATION
Strategic Allocation Dynamic Allocation
Asset class
Conservative
Moderately
conservative
Balanced
Growth
Highgrowth
Position Variation Implementation
Equities 25% 30% 55% 70% 85%
Australian 20% 25% 40% 45% 55% O/W +0.0 to 2.5% Listed
O/W Offshore earners (ALL, BLD, RHC),
balance sheet appeal (ANZ, AWC, ORA, RIO,
SSM), inflation (AGL, OSH, QUB)
U/W Bond proxies, consumer, telecoms
UMA
Core Equities Portfolio,
Emerging Companies Portfolio
International 5% 5% 15% 25% 30% O/W +0.0 to 2.5% Listed
Market ETFs: iShares Global 100 (IOO
IHOO - Hedged), EuroStoxx ETF (ESTX),
Shares MSCI Japan ETF (IJP), iShares SP
Small Cap 600 ETF (IJR).
Sector ETFs: Betashares Global Banks
(BNKS - Hedged)
UMA
International equities portfolio
Property 5% 10% 10% 10% 10% Neutral 0% Listed
O/W Developers (CHC, GMG),
diversified (GPT)
UMA
Zurich Australian Property Securities,
Resolution Capital Global Fund
(International)
Interest Rate 50% 45% 30% 15% 0%
Fixed rate 25% 20% 15% 5% 0% U/W -5.0 to -7.5% Listed
Corporate Bond ETFs (PLUS, VACF)
UMA
PIMCO Diversified Fixed Interest
Term deposits
3-6 months offers most attractive term
premium
Credit 25% 25% 15% 10% 0% Neutral 0% Listed
Listed Interest Rate Securities Model
Portfolio, floating rate bond ETFs
(FLOT, QPON)
UMA
Interest Rate Securities Portfolio,
Bentham Global Income (International)
Cash 20% 15% 5% 5% 5% O/W +0.0 to 2.5% Listed
Australian High Interest Cash ETF (AAA)
Fund
Accelerator Cash Account
Strategic asset allocation and dynamic positioning
Source: Ord Minnett Research. Shaded weightings next to Equities – Australian and international, and interest rate - fixed rate and credit are
suggested weightings only.
10. 8 Ords Insights | 2018 ISSUE ONE
AUSTRALIAN
EQUITIES
STRATEGY
Some trends from 2017 should
continue in 2018, including Australia’s
de-synchronisation from other
developed markets, so the global-
over-local theme remains relevant.
New themes include inflation
beneficiaries and companies with
balance sheet appeal. Recent
additions to our preferred lists include
Alumina (balance sheet appeal),
Aristocrat (global over local), Austal
(structural growth) and Qube
Holdings (inflation hedge).
Global over local
The global economy should sustain
above-trend economic growth in
2018. Compositionally, this assumes
better growth in emerging markets
such as India and Latin America, a
modest slowdown in China’s growth,
and a steady Europe and U.S. By
comparison, we expect Australian
growth at a below-average pace
of 2.7%.
Corporate earnings growth overseas is
also forecast to be double that of
Australian companies in 2018. Based
on our currency views, regional
earnings growth forecasts and outlook
for offshore equity markets, having
meaningful global exposure makes
sense. Our International Equities
Portfolio is discussed in detail on
pages 16 and 17.
Among Australian stocks, slot
machine manufacturer Aristocrat
sources around 80% of revenues
Themes for 2018
11. ords.com.au 9
AUSTRALIANEQUITIESSTRATEGY
The global
economy is
expected to
sustain
above-trend
economic
growth in
2018.
AGL Energy is favourably exposed to
higher electricity prices – one of the
few sources of inflation in Australia
– having pushed through price
increases to retail customers in the
past year. Another beneficiary of
higher energy prices is Oil Search.
Oil prices have risen as OPEC
extends its output cuts to the end of
2018, while LNG prices have
increased after regulation was
introduced to restrict Australian
exports. Oil Search is one of the few
producers able to take advantage of
this pricing environment, given it is
producing above nameplate capacity
and is able to sell additional tonnage
on spot markets. Following QBE’s
new CEO rebasing guidance, we
think the share price could be near a
bottom. Our analysts think there is an
increased chance that global
insurance premiums will rise
following 3Q17 losses sustained by
the industry. Furthermore, higher
global inflation will induce higher
bond yields, which would benefit
QBE’s investment yields. Finally, we
see Qube Holdings pushing through
higher port infrastructure charges
following a move by one of its key
competitors, creating some revenue
upside in its Patrick’s division. We
expect this could also increase the
appeal of its Moorebank project,
helping it lock in further tenancy
agreements this year.
Structural growth
This theme covers companies that
may not deliver earnings upside in
the near term, but we are willing to
be patient around the investment
thesis given leverage to longer-term
structural trends – such as the ageing
population, growth in
superannuation assets, infrastructure
and renewables. Our positive view
on Austal, a WA-based shipbuilder, is
premised on it being well-positioned
to benefit from a strong pipeline of
opportunities in the defence sector,
especially given the geopolitical
climate. Other structural growth
stories include AMP in superannuation,
APA Group in infrastructure and
renewables, and Ramsay Healthcare
in private hospitals.
offshore, primarily in the US, but also
in Asia and Europe. It is also
diversifying its revenue sources by
investing in the high-growth digital
space as consumers shift towards
online gambling channels. Another
stock providing offshore exposure is
Boral (a building materials provider
leveraged to U.S. construction and
rebuilding activity, as well as local
infrastructure works).
Balance sheet appeal
Given financial stability risks in
Australia and the patchy track record
our market has had in meeting
earnings expectations, it is hard to go
past companies with sound balance
sheets. These companies should
offer some defensiveness should
financial stability risks increase, yet
still have flexibility to pursue
earnings accretive strategies (e.g.
acquisitions, share buybacks). ANZ is
our preferred retail bank given it has
one of the stronger capital ratios of
the major banks, opening up the
possibility that it could look at capital
management options in 2018.
Rio Tinto and Alumina are our
preferred resources exposures given
their relatively under-geared balance
sheets, valuation upside, and
exposure to our preferred base
metal, aluminium. Service Stream is
currently in a net cash position,
which it is likely to use for bolt-on
acquisitions, supplementing its
revenues from the NBN rollout, but
giving it flexibility for capital returns
as well. Similarly, Orora has capacity
to pursue further acquisitions.
Inflation beneficiaries
We anticipate global inflation will
rise in 2018, driven by input cost
pressures (including energy prices)
and tightening labour markets. Yet
the scene in Australia is different,
with spare capacity in labour markets
and increasing competition creating
disinflationary risk. We seek
companies that can hedge against
both outcomes – that is, their ability
to push through price increases that
can either offset local disinflationary
pressures or absorb the risks
emanating from rising global inflation.
12. %
10 Ords Insights | 2018 ISSUE ONE
LEADING
LIGHTS
Preferred Stocks
2019
Company Name Price
Price/
Earnings (x)
Dividend
Yield Franking Comment
Core blue chip
AGL Energy $22.01 12.4 6.0% 80% Free cash flow generation increasing with improving retail margins
and higher electricity costs.
ANZ $28.01 11.4 6.0% 100% Valuation upside while the bank continues to improve its
operating model.
CSL Ltd $166.59 30.6 1.4% 0% Core health-care exposure as global leader in supply of
plasma products.
GPT Group $4.79 15.2 5.4% 0% Property portfolio is in sound shape, with steady income and
distribution growth over coming years.
Oil Search $7.18 17.4 2.7% 0% Well placed to weather commodity price volatility due to the
low-cost nature of its assets.
Ramsay Health $62.93 20.3 2.5% 100% Additional growth potential and further procurement savings.
RioTinto $76.64 11.5 5.2% 100% Long-life mining investment opportunities.
Transurban $11.68 39.9 5.2% 10% Infrastructure remains an attractive asset class.
Westpac $29.52 12.0 7.3% 100% Domestic mortgage focus is proving advantageous.
13. ords.com.au 11
2019
Company Name Price
Price/
Earnings (x)
Dividend
Yield Franking Comment
Value (Income)
AMP Limited $5.23 13.9 5.4% 90% Offers organic growth due to revenue margin compression and
improvement in its wealth protection business.
APA Group $8.05 36.3 5.9% 0% Owns and operates Australia's largest natural gas infrastructure
business as well as gas storage and wind farms.
Charter Hall $5.91 13.0 6.5% 0% Earnings and distributions are supported by continued capital
inflow into the asset class.
Event Hospitality $13.77 17.0 4.2% 100% Improved conditions will generate stronger returns for hotels
division, while strong film slate provides medium-term support.
NAB $29.34 12.2 6.7% 100% Dividend yield well ahead of its major bank peers.
Suncorp Group $13.75 14.5 5.1% 100% Solid yield through capital management initiatives.
Wesfarmers $43.56 18.2 5.2% 100% Generating significant cash flows.
Growth
Aristocrat Leisure $25.22 20.8 1.9% 30% Strong recurring revenue and exposure to fast-growing Americas.
Boral Limited $7.42 15.6 3.7% 100% Strong earnings trajectory driven largely by road infrastructure
spend and construction materials price increases.
Caltex Australia $31.63 13.0 4.2% 100% Core business remains attractive, with refiner margins supporting
earnings growth and cash generation.
Macquarie Group $105.39 13.9 5.0% 40% Valuation upside, supported by an improving outlook from
the group.
Magellan $25.79 16.1 4.7% 100% Exciting opportunities from new strategies.
Orora Limited $3.35 17.8 4.0% 0% Strong cash-flow generation gives ability to invest in value-creating
opportunities.
Treasury Wine
Estate
$17.30 28.5 2.4% 80% Company’s turnaround continues, with multiple drivers of
earnings growth.
Small caps
Afterpay Touch $6.88 34.4 0.0% 0% Dominant player in the rapidly expanding
'Buy Now, Pay Later' space.
Austal Limited $1.79 15.0 2.2% 0% Solid balance sheet and impressive tender pipeline.
Corporate Travel $24.63 25.5 2.2% 50% Well positioned with market share gains from a low base and
international expansion strategy.
Hansen
Technologies
$4.34 19.8 1.4% 100% IT services company that combines recurring revenue from a
diversified customer base and material MA option value.
Hub24 Ltd $10.28 35.3 2.3% 0% Investment platform continues to show strong momentum, with
significant upside from existing clients and technology.
People
Infrastructure
$1.15 10.0 5.5% 100% Expanding temporary labour and workforce management company
with sound safety record and compelling sector exposures
Pinnacle
Investment
$4.30 22.6 4.2% 100% Strong growth expected based on impressive average growth in
funds under management at a number of affiliates.
RCR Tomlinson $4.15 11.6 3.4% 0% A construction, services and engineering services contractor
operating in infrastructure, energy and resources markets.
Service Stream $1.62 12.9 4.9% 100% As a contractor to the NBN, it is well positioned to participate in the
rollout and increased mobile infrastructure spending.
Steadfast Group $2.70 20.0 2.9% 100% Earnings are defensive with strong free cash flow generation.
WorleyParsons $14.92 18.1 2.7% 0% Improving market conditions for resources and energy companies
will increase the company’s activity levels.
LEADINGLIGHTS
Source: Iress, Ord Minnett Research.
14. 12 Ords Insights | 2018 ISSUE ONE
INVESTMENT
FUNDAMENTALS
EPS
Growth
(FY17-19
p.a.)
Price/
Earnings
(x)
Price/
Earnings
Growth
(x)
Price/
Book
(x)
Dividend
Yield
SP/ASX 200 9% 15.5 1.7 1.9 4.6%
Consumer
discretionary
6% 17.6 2.8 2.3 3.9%
Consumer
staples
7% 18.7 2.8 2.4 4.2%
Energy 18% 15.1 0.8 1.4 3.4%
Financials 3% 13.1 3.9 1.7 5.8%
Banks 3% 12.4 3.9 1.6 6.2%
Healthcare 11% 27.2 2.4 5.2 1.9%
Industrials 11% 21.2 1.9 3.1 4.1%
IT 14% 25.7 1.9 5.1 2.2%
Materials 31% 15.4 0.5 2.2 3.7%
Property 6% 14.9 2.6 1.0 5.4%
Telcos -2% 11.7 -7.6 2.3 5.9%
Utilities 15% 19.5 1.3 2.0 5.6%
Source: Datastream, Ord Minnett Research. Price/earnings, price/book and dividend
yield use 12-mth forward consensus estimates. Price/earnings growth uses 3-yr
EPS Growth.
Recent earnings growth has allowed the price/
earnings ratio of the Australian market to level off.
Source: Datastream. 12-mth forward consensus estimates are used.
Red line represents the average ratio.
Source: Datastream, Ord Minnett Research. 12-mth forward consensus estimates.
The market’s dividend yield of 4.6% is near the long-term
average, while the payout ratio has retraced to a more
sustainable level.
Resource stocks are offering the highest earnings growth
in coming years, which underpins low price/earnings
growth ratios. Banks and telcos are trading at the lowest
price/earnings across the market while property is the
only sector trading at book value. Banks offer the highest
dividend yield.
8
10
12
14
16
18
20
1993 1996 1999 2002 2005 2008 2011 2014 2017
Price/Earnings(x)
Monthly
40%
50%
60%
70%
80%
90%
3%
4%
5%
6%
7%
8%
2004 2006 2008 2010 2012 2014 2016 2018
PayoutRatio
DividendYield
Monthly
Dividend Yield Payout Ratio (RHS)
15. ords.com.au 13
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16. 14 Ords Insights | 2018 ISSUE ONE
INTEREST
RATE
SECURITIES
Business conditions are positive and
non-mining business investment
is increasing, with higher levels of
public infrastructure investment
supporting the economy.
On housing, market conditions have
eased in Sydney and Melbourne,
helped along by Australian Prudential
Regulation Authority's (APRA)
efforts to contain the build-up of risk
in household balance sheets. That
said, household debt remains at
record levels.
Despite strength in labour markets,
wage growth remains low and
is expected to remain subdued.
A run of weak inflation outcomes,
reflecting low growth in labour
costs and strong competition in
retailing, is forcing the Reserve
Bank of Australia's (RBA) hand.
The central bank's efforts continue
to be hindered by a resilient
Australia dollar which, should it
appreciate further, will slow the pick-
up in economic activity and inflation.
Low interest rates continue to
support our local economy, with
further progress in reducing the
output gap and the expectation that
inflation returns to the RBA’s target
range, although progress is likely to
be gradual.
We continue to believe the
RBA cash rate will remain at
1.50% for the remainder
of 2018.
The Australian economy is expected
to grow more rapidly in 2018 than it
did last year. However, fourth-quarter
GDP figures missed expectations and
this consolidates our view that the
cash rate will remain firmly on hold.
Stretched household balance sheets
and stagnant wage growth mean the
outlook for consumption remains a
persistent source of uncertainty, with
the subdued consumer ultimately
hindering growth from returning to
above 3%.
17. ords.com.au 15
INTERESTRATESECURITIES
Market wrap and outlook
Listed interest rate securities had
a solid year in 2017, delivering over
6.1% on a net basis, driven by strong
demand and shrinking supply.
Fundamentally, low volatility drove
global bond spreads to record lows
and supported pricing, as did the
strengthening of the banks’ capital
positions following the finalisation of
the Basel III framework.
This almost two-year price run has
pushed valuations into overvalued
territory at the start of 2018, but
since then we have seen a pick-up
in volatility across all risk assets.
Hybrids have not been immune from
this, experiencing a sustained sell-
off and a subsequent return to more
palatable valuations.
Term premiums, the additional
return received for accepting longer-
dated maturities, were essentially
eroded. However, we are now seeing
a return of the term premium and a
healthier looking yield curve versus
the flat curve that has characterised
the hybrids market for the past six
months.
During the period of correction in
early February, Australian equites
shed 3.7%, while hybrids fell just
0.43% over the same period,
adhering to historical performance
patterns during periods of elevated
uncertainty – hybrids typically do a
better job of holding their value than
ordinary shares.
Overall, the backdrop for listed
interest rate securities is positive
and we see credit positives, both
technical and fundamental.
The technical backdrop is expected to
remain robust, with almost $7 billion
in listed interest rate securities
expected to be redeemed this year.
Given banks are operating well in
excess of their capital requirements,
with some even announcing
buybacks, it’s unlikely we’ll see the
appetite for funding from banks that
we’ve become accustomed to in
recent years. We expect scarcity of
supply and persistent demand will
continue to support the pricing of
listed interest rate securities.
Fundamentally, APRA’s efforts to
bolster the domestic banking system
have effectively removed some
of the risks related to investing in
these securities, thereby increasing
their appeal. In addition, corporate
earnings remain robust and
corporate debt levels are stable.
Positive economic momentum
continues to drive market interest
rates higher globally and Australia
will inevitably follow suit, at least
at the mid-to-longer end of the
curve. While we acknowledge
capital values will face volatility in
the near term as long term interest
rates undergo repricing, a pick-up
in interest rates will serve listed
interest rate securities investors well
in the medium to long term through
higher distributions.
Preferred securities
Our preferred securities list is
comprised of additional tier 1
hybrids, as subordinated note
valuations remain stretched,
despite the recent correction.
Given term premiums remain
suppressed, we favour securities
with maturities between three
and five years. In saying this, both
Bendigo Bank CPS 4 (BENPG) and
Bank of Queensland Capital Notes
(BOQPE) are undervalued according
to our fair value assessment
and compensating investors for
accepting the longer maturity date.
Commonwealth Bank PERLS VII
(CBAPD) is one of our preferred
securities, offering capital upside
and a modest income stream.
Other preferred securities include
ANZ Capital Notes IV (ANZPG), CBA
PERLS IX (CBAPF) and NAB Capital
Notes II (NABPD). In each case, we
retain a ‘fair value’ assessment,
with each offering value on both an
absolute and relative basis. Each of
them have relatively high coupon
margins; these types of securities
generally trade at a premium
and should therefore experience
less capital price volatility than a
security such as Westpac Capital
Notes II (WBCPE), which has a lower
coupon margin of 3.05% for the
same time to call.
Code Issue
Expected
Maturity
Last
Price
Coupon
Structure
Coupon
Rate (Net)
Running
Yield
Yield to
Maturity
Trading
Margin
ANZPG ANZ Capital Notes IV 20/03/2024 $104.60 BBR90 + 4.70% 4.55% qtly 6.16% 4.16% 1.5%
BENPG Bendigo CPS 4 13/06/2024 $98.80 BBR90 + 3.75% 3.85% qtly 5.50% 6.80% 4.1%
BOQPE Bank of Queensland
Capital Notes
15/08/2024 $99.90 BBR90 + 3.75% 3.88% qtly 5.51% 6.47% 3.7%
CBAPD CBA PERLS VII 15/12/2022 $96.40 BBR90 + 2.80% 3.20% qtly 4.71% 6.10% 3.5%
CBAPF CBA PERLS IX 31/03/2022 $100.82 BBR90 + 3.90% 3.98% qtly 5.60% 5.98% 3.5%
NABPD NAB Capital Notes II 07/07/2022 $106.15 BBR90 + 4.95% 4.73% qtly 6.32% 6.06% 3.5%
Source: Iress, Ord Minnett Research. Coupons, yields and margins incorporate franking credits.
Preferred interest rate securities
18. 16 Ords Insights | 2018 ISSUE ONE
Ord Minnett manages
an international
equities portfolio on
behalf of clients,
which currently holds
the stocks on the
opposite page.
In this edition of
Insights we highlight
ASML, a technology
company that
produces extremely
complex machinery
that forms an
important step in the
production of
microchips.
SA ML
COMPANY ASML Holdings
TICKER ASML.AMS
EXCHANGE Amsterdam
SECTOR Technology
SUB-INDUSTRY Semiconductors
Description
ASML counts all the world’s
top microchip companies as its
customers. The increasing demand
for smaller and faster microchips,
enabled by ASML’s leading-edge
technology, supports a strong
outlook for the company over the
longer term.
ASML’s machines focus on the
lithography stage of the chip
production process. The machines
are essentially projection systems
using laser light to lay out the
transistors (the ‘brain cells’ of
a microchip).
The light is projected using a mask
(also known as a reticle), containing
the blueprint of the pattern that will
be printed. A lens or mirror focuses
the pattern onto the wafer – a
thin, round slice of semiconductor
material – which is coated with a
light-sensitive material. When the
unexposed parts are etched away,
the pattern is revealed. Lithography
patterns the structures on a
microchip and therefore plays an
important role in determining how
small the features on the chip can be
and how densely chip makers can
pack transistors together.
Investment thesis
The guiding principle for ASML is
to continue the push towards ever-
smaller, cheaper, more powerful and
energy-efficient semiconductors.
The long-term growth of the
semiconductor industry is based on
the principle that the power, cost and
time required for every computation
on a digital electronic device can
be reduced by shrinking the size of
transistors on chips.
The cost and size reductions
achieved by ASML’s technology
in high-volume manufacturing
will drive a wave of innovation by
enabling microchips supporting
artificial intelligence at the edge
of the network, in devices such as
smartphones, personal computers,
the Internet of Things endpoints,
automobile, as well as next-
generation memory chips.
INTERNATIONAL
STOCKS
19. ords.com.au 17
Stock Headquarters
Currency
Marketcap’n
(A$bn)
Price/Earnings
(FY18E,x)
EPSGrowth
(FY18E)
Dividendyield
(FY18E)
Description
Consumer
Diageo PLC UK GBp 106 20 8% 2.9% Distiller
Estee Lauder Companies Inc USA USD 68 30 12% 1.2% Beauty products
Masco Corp USA USD 17 14 14% 1.1% Home improvement and building products
McDonald's Corp USA USD 158 19 8% 2.8% Quick service restaurants
Nestle SA Switzerland CHF 318 18 9% 3.5% Multinational packaged food company
Relx NV Netherlands EUR 55 17 8% 3.0% Media publisher and information provider
Energy
Total SA France EUR 186 12 5% 6.6% Integrated oil, gas and chemical producer
Financials
BlackRock Inc USA USD 114 17 12% 2.3% Global investment management company
Intercontinental Exchange Inc USA USD 56 19 12% 1.4% Financial exchange operator
Mastercard Inc USA USD 242 25 18% 0.6% Payment solutions supporting credit and
debit transactions
Partners Group Holding AG Switzerland CHF 25 25 7% 2.9% Private equity manager
Healthcare
Edwards Lifesciences Corp USA USD 37 27 13% 0.0% Products and services to treat
cardiovascular disease
Johnson Johnson USA USD 455 16 5% 2.9% Consumer, pharmaceutical and
medical devices
Thermo Fisher Scientific Inc USA USD 109 18 11% 0.3% Analytical instruments and supplies
Industrials
Honeywell International Inc USA USD 146 17 10% 2.2% Diversified technology and manufacturing
Raytheon Co USA USD 79 19 15% 1.7% Defence and homeland security
technologies
Technology
Alphabet Inc USA USD 1,006 23 17% 0.0% Widely used web-based search engine
Amazon.com Inc USA USD 965 101 85% 0.0% Online retailer and IT services
ASML Holding NV Netherlands EUR 114 23 21% 1.1% Equipment for microchip manufacture
Capgemini SE France EUR 28 15 9% 1.9% IT services contractor
Facebook Inc USA USD 680 20 22% 0.0% Leading social media company
Tencent Holdings Ltd China HKD 689 NaN 25% 0.2% China-based IT exposure
Other
iShares MSCI Japan ETF USA YEN 36 13.1 34% 1.0% Japanese stock market exposure
INTERNATIONALSTOCKS
20. 18 Ords Insights | 2018 ISSUE ONE
CURRENCY
Exchange Rate Forecasts
Further U.S. dollar (USD) weakness at
the start of the year has prompted a
number of changes to our currency
forecasts. The Australian dollar (AUD)
is affected by this dynamic, and so we
have marked our AUD forecasts for
2018 higher than they were in 2017.
For currencies such as the euro and
swiss franc, the forecast revisions
have been driven by both USD
weakness and some supportive
region-specific factors. For the AUD,
it is harder to make the case that a
shift in domestic fundamentals
requires currency upgrades, but the
persistence of USD weakness doesn’t
look like it will fade anytime soon.
RATES* CURRENT JUNE-18
AVERAGE FOR QUARTER
DEC-18
Source: IRESS, Ord Minnett Research
* Per Australian Dollar
Fundamental anchors for a lower
AUD/USD are compelling:
Rate differentials versus USD are
negative (the US cash rate will
easily exceed the Australian cash
rate by year end);
Cyclical divergence between the
Australian and global economies
will persist; and
Our forecasts see little upside for
Australia’s key commodity prices.
But from a valuation perspective, the
AUD is close to its long-run average
on a real effective exchange rate
basis. This is consistent with the idea
that, while we retain bearish
trajectories for the AUD, the decline
is reasonably modest.
For the AUD/USD rate, the last couple
of years have delivered a strong
technical uptrend, and so we are
mindful of the possibility that the
currency continues to mark higher
lows over time, limiting the extent of
any depreciation.
While we retain
bearish trajectories for
the AUD, the decline
is reasonably modest.
0.77 0.78 0.75
81.3 87.0 80.0
1.01 1.02 0.93
4.87 4.90 4.69
0.63 0.62 0.59
0.55 0.55 0.52
1.07 1.08 1.10
6.03 6.10 5.85
0.73 0.72 0.68
21. ords.com.au 19
A
lternative investments are
generally defined as
investments that fall
outside the normal asset allocation
guidelines.The compelling trait of
alternative investments is that they
tend to be lowly correlated with
traditional asset classes.The
desired outcome is that sensible
use of alternative investments will
further optimise an investment
portfolio’s risk and return
characteristics. Examples of
alternative investments include
hedge funds, precious metals,
infrastructure (non-listed) and
private equity1
.
In this section, we’ll review an
alternative asset investment
product that Ord Minnett can
provide access to through various
investment platforms. In this
edition we cover the Partners
Group Global Value Fund, which
invests in private equity.
Private equity is a common term
for investments that are typically
made in non-public companies
through privately negotiated
transactions. The private equity
market is diverse and can be
divided into different segments,
which may exhibit distinct
characteristics based on
combinations of various factors.
These include the type and
financing stage of the investment,
the geographic region in which
the investment is made and the
vintage year.
Partners Group is a global private
asset management firm specialising
in private forms of equity, debt,
infrastructure and real estate. The
firm manages a broad range of
funds for an international clientele
of institutional investors, private
banks and investors. Partners
Group is headquartered in Zug,
Switzerland and has offices in
Europe, the U.S. and Asia. The firm
is listed on the SIX Swiss Exchange
and is majority owned by its
partners and employees.
The Value Fund, which was launched
in Australia in 2012, is an Australian
unit trust with the objective of
achieving capital growth over the
medium and long term by investing
in private equity. It provides investors
with broad diversification across
geographies, financing stages and
investment class types. The fund
uses Partner Group’s relative value
investment approach to
systematically invest in those
segments and investment types that
offer attractive value at a given point
in time, in order to significantly
enhance risk adjusted returns.
The Value Fund allows investors to
subscribe and redeem shares on a
monthly basis, thus avoiding the
long lock-up periods common in
most private equity funds.
Management fees are capped at
1.75% per annum, a standard rate for
private equity funds.
In terms of the portfolio composition,
at the end of 2017 geographically it
was invested 44% in Europe, North
America 41%, Asia-Pacific 12% and
Rest of World 3%. Exposure by
financing stage was 72% buyout,
25% special situations, and the
remaining 3% venture capital. By
transaction type, 60% was direct,
26% primary and 14% secondary.
Partners Group Global Value
Fund investment returns
Year
Annual
Return
Cumulative Value of
$100 invested
in 2007
2007 -4.7% 95
2008 7.6% 103
2009 -7.6% 95
2010 20.5% 114
2011 12.4% 128
2012 7.7% 138
2013 18.1% 163
2014 16.5% 190
2015 12.3% 214
2016 9.2% 233
2017 9.2% 255
1 Due to the characteristics associated with many
alternative investment strategies, including the lack
of transparency and liquidity constraints, alternative
investments should represent a small percentage of
an investment portfolio. Furthermore, alternative
investments typically attract higher fee levels,
which can impact performance.
ALTERNATIVE
INVESTMENTS
Partners Group Global Value Fund
22. PRIMARY
FORECASTS
FORECASTS STRATEGY
JapanTopix
UKFTSE
EuroStoxx
USSP500
ASX200
13%
11%
18%
6%
8%
Category 1Q18 2Q18 3Q18 4Q18 2018 2019
Economic growth
Global 3.4 3.5 3.4 3.3 3.4 3.2
Developed 2.1 2.4 2.3 2.2 2.4 2.1
Emerging 5.6 5.3 5.2 5.1 5.2 4.9
Australia 3.5 3.1 2.4 1.7 2.7 2.6
US 2.0 2.3 2.5 2.5 2.5 2.2
China 7.4 6.6 6.3 6.3 6.8 6.4
Rates (period end)
RBA 1.50 1.50 1.50 1.50
10yr yield 2.70 2.68 2.80 2.90
US Fed 1.75 2.00 2.25 2.50
10yr yield 2.85 3.00 3.05 3.15
Currency
AUD/USD 0.77 0.78 0.76 0.75
US DXY 114 116 114 113
USD/JPY 106 111 108 106
USD/CNY 6.33 6.28 6.27 6.25
Commodities
Iron ore fines (US$/t) 70 65 65 60
Brent (US$/bbl) 70 78 68 60
Copper (US$/t) 7,120 7,300 7,500 7,700
Gold (US$/oz) 1,340 1,380 1,450 1,460
Markets
We expect positive returns in 2018 from
most major stock markets.
The Japanese market, we believe, offers
the greatest upside, followed by the
Euro zone and the U.S.
The Australian and U.K. markets are
showing less potential on a price basis,
but given their higher yield, total returns
will be more closely matched to the other
markets mentioned above.
23. ords.com.au 21
Ord Minnett Limited ABN 86 002 733 048; ASX
Market Participant AFS Licence Number 237121
ords.com.au ords.com.hk
RECOMMENDATIONS
GUIDELINES
Ord Minnett recommendations are
based on the total return of a stock
– nominal dividend yield plus capital
appreciation – and have a 12-month
time horizon.
SPECULATIVE BUY
We expect the stock’s total return (nominal
yield plus capital appreciation) to exceed
20% over 12 months. The investment may
have a strong capital appreciation but also
has high degree of risk and there is a
significant risk of capital loss.
BUY
The stock’s total return (nominal dividend
yield plus capital appreciation) is expected to
exceed 15% over
the next 12 months.
ACCUMULATE
We expect a total return of between 5% and
15%. Investors should consider adding to
holdings or taking a position in the stock on
share price weakness.
HOLD
We expect the stock to return between 0%
and 5%, and believe the stock is fairly priced.
LIGHTEN
We expect a loss of between 0% and 15%.
Investors should consider decreasing
their holdings.
SELL
We expect a total loss of 15% or more.
Investors should decrease their holdings.
RISK ASSESSMENT
Classified as Lower, Medium or Higher,
the risk assessment denotes the relative
assessment of an individual stock’s risk
based on an appraisal of its disclosed
financial information, historic volatility of its
share price, nature of its operations and other
relevant quantitative and qualitative criteria.
Risk is assessed by comparison with other
Australian stocks, not across other asset
classes such as Cash or Fixed Interest.
OFFICES
Adelaide
Level 5, 100 Pirie Street, Adelaide SA 5000
Tel: (08) 8203 2500 | Fax: (08) 8203 2525
Brisbane
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Tel: (07) 3214 5555 | Fax: (07) 3214 5550
Buderim, Sunshine Coast
1/99 Burnett Street, Buderim QLD 4556
Tel: (07) 5430 4444 | Fax: (07) 5430 4400
Caloundra, Sunshine Coast
79-81 Bulcock Street, Caloundra QLD 4551
Tel: (07) 5491 3100 | Fax: (07) 5491 3222
Canberra
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Tel: (02) 6206 1700 | Fax: (02) 6206 1720
Coffs Harbour
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Tel: (02) 6652 7900 | Fax: (02) 6652 5716
Gold Coast
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Tel: (07) 5557 3333 | Fax: (07) 5574 3377
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Tel: (07) 4969 4888 | Fax: (07) 4969 4800
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Tel: (03) 9608 4111 | Fax: (03) 9608 4142
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Tel: +852 2912 8980 | Fax: +852 2813 7212