Monday 7 August 2017 My SMSF

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1 Monday 7 August 2017 My SMSF My SMSF had its best year ever over with the fund up 50%. There are a number of reasons for this great return, so in today s note I explain the investment strategy and what I bought last week. Also in the Switzer Super Report, the income and growth portfolios had moderate gains in July during a flat month for the Australian stock market. Paul Rickard reveals what happened. Plus, as we head into the second week of reporting season, James Dunn looks at who is announcing results this week. CBA is expected to produce a record full-year result. Sincerely, Peter Switzer Inside this Issue 02 My 50% return last year, and what I bought last week Investment strategy by Peter Switzer 04 Portfolios post modest gains in July Growth and income by Paul Rickard 08 Portfolios post modest gains in July Results this week by James Dunn 10 Buy, Sell, Hold what the brokers say Upgrades and downgrades by Rudi Filapek-Vandyck by Paul Rickard 04 Reporting season week 2 record profit expected for CBA 12 Hot stocks: James Hardie and ResMed Stocks to watch by Bernadette Morabito Switzer Super Report is published by Switzer Financial Group Pty Ltd AFSL No Queen Street, Woollahra, 2025 T: 1300 SWITZER ( ) F: (02) 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.

2 My 50% return last year, and what I bought last week by Peter Switzer Over , my family SMSF had its best year ever, with our fund up 50%. This was a spectacular return, which I never expected, but I was happy to collect it. Let me emphasise that I never expected such a good result overall, though I wouldn t have been surprised at the 14% return, as this is the kind of return I aim for most years, given how I generally invest. And it came from a slight tweaking of our investment strategy, which is generally a high exposure to stocks, as my sons are in their 30s and Maureen and I plan to keep working for some time yet in our good businesses. Last week, I sunk another chunk of money into my SWTZ or Switzer Dividend Growth Fund when I saw it at $2.47. I missed it at $2.46 a couple of weeks ago because it was snapped up and rode up to $2.51 before it sold off with the market. The great return happened for a number reasons. A pain-in-the-neck mate/adviser says he ll put $5 million in when it hits $2.45, but I m hoping the market proves him wrong! That said, I like it that he thinks his clients should be in SWTZ and I know why. First, most of you know that I liked BHP at $14 but only got in once I saw the uptrend around $15 or so. At the same time, we went long Rio as well. Second, because of my planned development of SWTZ, with George Boubouras Contango Asset Management, we were given an allocation when the fund listed and because we believed in George, we put our hand up for more. It listed very strongly but has had some headwinds lately, which I think George will navigate successfully in coming months. Third, to buy into Contango, we had to sell some capital gainers, such as Telstra, before it dived, some regional banks and a few others. I also sold my old BHP and Rio stocks where we had capital losses so these offset many of the gains. Fourth, my ETFs for the ASX200 index, which I bought in numerous dips (which I often recommend you do too) have made some nice gains. Remember, the overall index plus dividends was up about 14% over My Switzer Dividend Growth Fund, or SWTZ, is a financial representation of how I like to invest, as my radio ads say. SWTZ is what I d be happy for the core of my markets-oriented funds to be in when I m in retirement because it chases dividends/income. Let s assume for simplicity that you want at least $70,000 in retirement each year and have an SMSF with $1.1 million in it. Let s say you put $100,000 into a cash account, putting a fair chunk of it into a term deposit and the rest in cash. Your million dollars left over aims to make 7% a year to give you $70,000, but when the market returns 14%, say like last year, you ve realised $140,000, so you could put an extra $70,000 into your savings account over and above the $70,000 you want to live on. You could create a bigger and bigger buffer in good 02

3 years until the saving account is so big you could reinvest in stocks again, while keeping money aside for when the market dividends don t give you $70,000. I know SWTZ will never break any sea-speed records, but I m certain it will take me, and my family SMSF, to the safe wealth-building harbours we want to go to. The important characteristic of SWTZ is that it will have stocks that rebound well after a market crash dividend-payers do that and during the crash period the dividends should hold up pretty well because dividends don t crash like share prices. 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 regards to your circumstances. Remember, during the GFC when the market crashed 50%, CBA cut its dividend for one half- year period and then in the next period increased the dividend. So, over a three-year period, the dividend-return rose! Let me recap for CBA: 2008 the dividend was $ it fell to $ it rose to $2.90. That s an average of $2.61, which is higher than the 2007 dividend of $2.56. So, over the scariest time for stocks in living memory, the dividends of CBA actually grew! Not all companies are like CBA, but we all know stock markets aren t reliable, so I like to take a low risk investment skew within a relatively risky approach in being quite heavily exposed to the stock market. I m prepared to cop a capital loss, short-term, and even for a few years, because I know the companies I m invested in will pay reliable and generally increasing dividends during tougher times. And their share prices will recover over time. That s what SWTZ is designed to do in scary times, but in those seven to eight years out of 10 when markets go higher, because it is a dividend and GROWTH fund, we could get some great years. In those years, crash-buffer savings accounts can be built up by those SMSF investors/retirees. Apart from the fact that we pay dividends every three months, the overall strategy and the make-up of the companies in the fund are why I m happy to have my name on the Switzer Dividend Growth Fund. 03

4 Portfolios post modest gains in July by Paul Rickard Both our income and growth model portfolios posted moderate gains in July, notwithstanding that the Australian share market finished absolutely flat for the month. Year-to-date, the local share market continues to lag offshore markets, recording a total return of 3.15% for the first six months (0.97% before dividends). The income portfolio has returned 2.17% this year, moderately underperforming the benchmark index by 0.98% in part due to its weighting in top 20 stocks. The growth portfolio has over the seven months exactly matched the performance of the index, with a return of 3.15%. This is our seventh monthly portfolio review. The purpose of these portfolios is to demonstrate an approach to portfolio construction. As the rule sets applied are of critical importance, we provide a quick recap on these. Portfolio recap In January, we made some adjustments to our Australian share Income Portfolio and Growth-Oriented Portfolio (see here and here). To construct the income portfolio, the processes we applied included: we used a top down approach looking at the industry sectors; so that we are not overly exposed to a market move, we have determined that in the major sectors (financials and materials), our sector biases will not be more than 33% away from index; we require 15 to 20 stocks (less than 10 is insufficient diversification, over 25 it is too hard to monitor), and have set a minimum stock investment of $3,000; we confined our stock universe to the ASX 150; we have avoided stocks from industries where there is a high level of exogenous risk, such as airlines; for the income portfolio, we prioritised stocks that pay fully franked dividends and have a strong earnings track record; and within a sector, the stocks are broadly weighted to their respective index weight, although there are some biases. The growth-oriented portfolio takes a different approach in that it introduces biases that favour the sectors that we judge to have the best medium-term growth prospects. Critically, it also confines the stock universe to the ASX 150 (there are many great growth companies outside the top 150). Overlaying these processes are our predominant investment themes for 2017, which we expect to be: Interest rates remaining at low levels, although some upward movement in bond rates; The US Fed likely to increase US interest rates by 0.75%, but probably no move in Australia by the RBA; The Australian dollar at around 0.70 to 0.75 US cents, but with risk of breaking down if the US dollar firms; Commodity prices remaining reasonably well supported; A positive lead from the US markets and President Trump; A moderate pick-up in growth in Australia back towards trend levels; and No material pick up in domestic inflation. 04

5 Performance in July, is down by 16.3%. The income portfolio to 31 July is up by 2.17% and the growth-oriented portfolio by 3.15% (see tables at the end). Compared to the benchmark S&P/ASX 200 Accumulation Index (which adds back income from dividends), the income portfolio has underperformed the index by 0.98% and the growth-oriented portfolio has exactly matched the index. The top 20 stocks did relatively better in July with a return of 1.1%, but continue to lag the overall market in 2017 with a return of 1.8%. The midcap 50, an index which represents stocks ranked 51st to 100th by market capitalisation, is up by 8.1% this year. Sector returns for the month of July and since the start of the year are set out in the following table. Share market flat in July as financials rally and heath care takes a breather In somewhat of a first, the sharemarket finished absolutely flat in July. Rangebound, the market traded quietly, well supported around the 5675 level and well offered around the 5800 level. Despite the lack of overall movement, there were some major movements in the sectors. Income portfolio The largest sector by market capitalisation, financials, with a weighting of 38.0%, added 1.3% in July following APRA s confirmation on the capital levels that the major banks would need to target, which most analysts believe can now be achieved without the banks needing to conduct dilutive capital raisings. Year-to-date, financials have returned 2.5%, 0.7% below the overall market return. Material stocks also enjoyed strong support as an improving outlook for world economic growth meant that iron ore and other metal prices remained well bid. The sector added 3.6% to be up by 5.7% since the start of the year. The income portfolio is underweight material stocks and marginally overweight financial stocks. Otherwise, the sector biases are relatively small. We have avoided real estate (potential impact of higher interest rates, plus lack of franking on real estate investment trusts), and health care (low dividends and pricing multiples). In a bull market, we expect that the income-biased portfolio will underperform relative to the S&P/ASX200 due to the underweight position in the more growth-oriented sectors and the stock selection being more defensive, and conversely in a bear market, it should moderately outperform. Going the other way were health care stocks. Following a fabulous first six months, profit takers knocked the sector back by 7.5% to cut the year-to-date return to 14.0% still the best performing sector. Some of the other high-performing sectors, such as utilities and industrials, also slipped during the month. It is forecast to generate a yield of 4.90% in 2017, franked to 87.3%. After the first seven months, it has returned as income $2,492 or a yield of 2.49%, franked to 87.7%. With second half dividends typically a little higher than the first half, it should marginally exceed the forecast. Telecommunications remains the worst performing sector this year, and following a further loss of 4.3% Year-to-date, the income portfolio has returned 2.17% (including dividends) compared to the accumulation 05

6 index return of 3.15%. This is a credible performance given that the portfolio has no health stocks (the best performing sector), and has a heavy concentration of top 20 stocks (the top 20 index has returned 1.8%). In what is proving to be a market of individual stocks rather than a stock market, the strong performances of Sydney Airport, Transurban and Boral are offsetting the performances of Brambles and Telstra. No changes to the portfolio are contemplated at this point in time, although we are keeping the exposure to Brambles under close review. With the exception of ANZ, NAB and Westpac, all other constituents will file half year or full year reports in the reporting season over the next few weeks. The income-biased portfolio per $100,000 invested (using prices as at the close of business on 31 July 2017) is as follows: sector in The major underweight positions are in real estate and consumer staples. The stock selection is biased to companies that will benefit from a falling Australian dollar either because they earn a major share of their revenue offshore, and/or report their earnings in US dollars. While we are not surprised to see the Aussie dollar test 80 US cents due to the strength in commodity prices and less aggressive tightening stance by the US Federal Reserve, this assumption is clearly under pressure at the moment and may need to be re-assessed. Year-to-date, the portfolio has returned 3.15%, exactly the same as the benchmark accumulation index. Similar to the income portfolio, this is a credible performance given the weighting in top 20 stocks. An overweight position in telecommunications has also impacted performance, offset by the overweight position in healthcare stocks. In what is proving to be a market of individual stocks rather than a stock market, losses on stocks such as Brambles are compensated by gains on stocks such as Boral. Click here for a larger version of the table. Growth portfolio A critical construction decision with the growth portfolio has been to take a neutral sector bias in the materials sector. This has led to the inclusion of Rio (along with BHP and Boral). Overall, the sector biases are relatively small. Despite healthcare underperforming in 2016 and many of the stocks trading on high multiples, we believe that the tailwinds are so strong that our sector position is materially overweight. Mindful of the exposure to the retail sector, both direct and indirect, and the impact that concerns about the disruption being caused by nontraditional participants such as Amazon are having on performance, we reduced our exposure in May by exiting our holding in Westfield. This resulted in a loss of $384. Westfield was replaced in the portfolio by share registry and superannuation administrator, Link Group (ASX Code LNK), which in June announced the acquisition of Capita Asset Services and an entitlement issue. In the meantime, we continue to keep positions in Wesfarmers and JB Hi-Fi under close watch. Our growth-oriented portfolio per $100,000 invested (using prices as at the close of business on 31 July 2017) is as follows: The other overweight position is in telecommunications, the only negative performing 06

7 ¹ Position in Westfield realised on 31 May at $8.48 per share, leaving loss of $384. Balance of $3,616 invested in Link at $7.75 per share. ² Link 4:11 entitlement issue at $6.75 per share. Entitlements sold through institutional tender at $1.10 per entitlement. ³ Portfolio not able to participate in TPG 1:11.13 non renounceable entitlement offer at $5.25 per share Click here for a larger version of the table. 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 regards to your circumstances. 07

8 Reporting season week 2 record profit expected for CBA by James Dunn The June 30 reporting season moves up a gear this week, with the highlights being full-year reports from Commonwealth Bank (CBA) on Wednesday and AGL (AGL) on Thursday. rise. But shareholders will be concerned that the new capital requirements, the bank levy and now the possible penalties from the AUSTRAC case may affect their dividends. Undoubtedly, CBA s result will be over-shadowed by the scandal surrounding the bank s apparent breaches of Australia s money-laundering rules, with the Australian Transaction Reports and Analysis Centre (AUSTRAC) alleging 53,700 breaches of the rules surrounding the reporting of deposits of $10,000 or more, into its ATMs. Analysts say the proposed bank levy could take about 4% 5% off bank earnings. And last month the Australian Prudential Regulation Authority (APRA) finalised its capital requirements, which were CET1 (common equity tier 1) ratios were lifted by 150 basis points (1.5%) for the major banks and 50 basis points (0.5%) for the regional banks, with the new capital targets to come into effect by January After the financial planning, Comminsure and IT contract bribery scandals, the AUSTRAC allegations are the very last thing that Commonwealth Bank s 800,000 shareholders want to see especially with the lurid headlines about the potential fine of $18 million for each breach or a cool $967 billion. Whatever penalty emerges, it will not be that much. So, CBA shareholders should concentrate this week on the FY17 profit result. It s going to be a belter: CBA will report a full-year profit of somewhere around $9.7 billion, a record amount, and a rise of about 2.6%. On an earnings-per-share (EPS) basis, FNArena s figure of the analysts consensus expectation of cents would represent a 0.4% rise; Thomson Reuters has analysts expecting cents. For many shareholders, the dividend is the most important number in the result: both FNArena and Thomson Reuters predict 424 cents, placing CBA on a 5.2% fully franked yield, which grosses-up to 7.5%. With analysts expecting CBA to boost its dividend in FY18 FNArena says cents, Thomson Reuters projects 432 cents those dividend yields should The other most important numbers for CBA (and any bank) are the jaws the balance between income and costs and the net interest margin (NIM), what the bank pays for deposits compared to what it charges for loans (in effect, the profit from lending.) Margins are definitely feeling the strain of higher funding costs. According to KPMG, at the half-year point of FY17, the big four banks had an average net interest margin of 2% on a cash basis, down 0.03% from six months earlier. That is getting down to record low levels, but analysts expect them to expand this, on the back of the latest round of mortgage repricing, given their strong market position. Regardless of what the Reserve Bank of Australia (RBA) has done, the big banks have raised residential lending rates four times since December 2016, helping to offset slowing credit growth. The big question is whether they can keep doing that to boost profitability as loan growth slows. The banks have indicated that they intend to cut costs even more than they have done: investors should pay close attention to cost growth. There could be some upside surprises on this front, with cost growth cut 08

9 back. CBA does appear fully priced. FNArena says the analysts consensus price target on the stock is $80.93, just 15 cents (0.2%) ahead of the current share price: Thomson Reuters puts the analysts consensus price target at $83.20, implying potential upside of 3%. Other major stocks reporting this week are global hearing implant leader Cochlear on Wednesday, and local energy heavyweight AGL Energy on Thursday. In May, Cochlear reconfirmed its earnings guidance for investors to expect a full year net profit between $210 million to $225 million, which would be up 10% to 20% on the prior year. The guidance was re-affirmed despite the recent news that Chinese government tenders were expected to be below FY 2016 s levels (a result that was not factored into the original guidance.) Analysts expect a 17% boost in EPS from Cochlear and a similar rise in the dividend however, Cochlear is not a yield play, offering a 1.9% fully franked yield on FY17 consensus numbers. And the capital gain outlook does not appear promising, either: FNArena has an analysts consensus price target of $132.78, which is 6.3% below the current price of $141.66: Thomson Reuters puts the analysts consensus price target even lower, at $129.69, a discount of 8.4%. current share price; Thomson Reuters puts the consensus price target a bit lower, at $ On Thursday, AMP reports half-year numbers, with about $460 million expected for interim net profit and 14 cents for the dividend: that profit would compare poorly with the $523 million profit reported a year ago (the dividend was also 14 cents). AMP has struggled with the structural decline in the life insurance industry, and is trying to sell its loss-making insurance arm and reorient itself to higher-growth businesses in wealth management such as services for SMSFs, AMP Bank, AMP Capital and its operations in China. Click here to see a larger version of this table. 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 regards to your circumstances. AGL is one of broker UBS potential upside surprise candidates for this earnings season, although the electricity and gas price rises it recently announced will not show up in the results, having taken effect on July 1. AGL is expected to report net profit of about $744.2 million, with FNArena s analysts consensus estimate projecting cents in EPS up from a loss of 60.5 cents a share last year and Thomson Reuters collation of forecasts pointing to a consensus expectation of cents. FNArena says analysts expect a dividend of 89.2 cents, up 31% on the 68 cents paid in FY16, while Thomson Reuters has analysts expecting 88.3 cents, franked to 89.35%. That puts AGL on a dividend yield of about 3.5%. FNArena says the analysts consensus price target for AGL Energy is $27.04, about 6.7% above the 09

10 Buy, Sell, Hold what the brokers say by Rudi Filapek-Vandyck In the good books NORTHERN STAR RESOURCES LTD (NST) Upgrade to Outperform from Neutral by Macquarie B/H/S: 1/3/2 Northern Star has delivered substantial upgrades to the Jundee and Kalgoorlie operations. Macquarie observes this is a significant upgrade to the long-term outlook, and the company now has a reserve and resource base capable of supporting a 600,000 ounces per annum run rate over 10 years. Incorporating near-term guidance means a modest reduction to the broker s earnings forecasts for the next three years. FY18, FY19 and FY20 forecasts are lowered -8%, -13% and -7% respectively. Target is raised to $5.40 from $4.00. Rating is upgraded to Outperform from Neutral. entitlement offer, cash and debt. Morgans continues to view diversification into this higher quality and higher margin market positively. With a materially stronger growth profile, the broker believes the valuation is compelling and upgrades to Add from Hold. Target is raised to $13.50 from $ In the not-so-good books FORTESCUE METALS GROUP LTD (FMG) Downgrade to Hold from Add by Morgans B/H/S: 3/4/1 Morgans believes the stock is trading close to fair value, and with benchmark iron ore prices back above US$70/t the broker downgrades to Hold from Add. The broker suspects the stock could rally from this point if the large discounts on its lower-grade iron ore starts to normalise towards the long-term range. To get there though, China needs to absorb a large stockpile that has been building at port. Target is $5.95. WEBJET LIMITED (WEB) Upgrade to Add from Hold by Morgans B/H/S: 3/2/0 The company will acquire UK-based JacTravel for $330m. Morgans observes the size and nature of the transaction means the acquisition is not without risk but the strategic importance of the deal is irrefutable, as it transforms Webjet into the number two player in business-to-business travel globally. The transaction will be funded via a combination of an 10

11 MANTRA GROUP LIMITED (MTR) Downgrade to Neutral from Buy by Citi and Downgrade to Equal-weight from Overweight by Morgan Stanley B/H/S: 3/5/0 Citi downgrades to Neutral from Buy on the belief that consensus market forecasts are too optimistic, albeit not dramatically so. One factor mentioned is the anticipated Commonwealth Games uplift, which Citi suggests is likely to be more moderate than the market expects. 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 regards to your circumstances. A strong Aussie dollar represents yet another downside risk, the analysts point out. Estimates have been cut. Price target drops to $3.15 from $3.27 in response. Morgan Stanley observes strength in Australian outbound growth and moderation in inbound growth as a higher Australian dollar makes the country more expensive for foreigners and translation of offshore assets. The broker finds it hard to draw many positives for the company from the current conditions and downgrades to Equal-weight from Overweight. Target is reduced to $3.20 from $4.20. Industry view is In-Line. 11

12 Hot stocks: James Hardie and ResMed by Bernadette Morabito The August reporting season has now entered its second week and our stock pickers are keeping a close eye on the company earnings results and how the market reacts to the news. This theme runs through their stock selections this week. Michael McCarthy from CMC Markets likes James Hardie Industries (JHX). The share price has tumbled over the last three months on the back of construction downturn fears and a stubborn Australian dollar which has been hovering around US 80 cents. There was some disappointment over the softer-than-expected mask sales in the US, notes Wong. However, a number of issues ResMed faced over the past six months appear to be short term. FY18 should look better. However, McCarthy thinks these factors are more than priced in. He says the quarterly earnings report (released tomorrow) could be the catalyst for a significant share price re-rating. Source: CommSec At the time of writing, shares in JHX were trading at around $18.70, down from a 52-week high of $23.19 and above a 52-week low of $ See the one-year chart below: In the dislikes list this week are Wesfarmers (WES) and Pioneer Credit (PNC). While acknowledging the stronger track record of the WES management team, I see crosswinds for many of their exposures, explains McCarthy. The FY result on August 17 could see further de-rating target price $ That price is well below the current 52-week low of $39.50 see the 12-month chart below. Source: CommSec Prime Value s ST Wong is also eyeing a stock that s taken a recent dip. Despite the stock being sold down on last week s fourth quarter results, he anticipates a better FY18 for the global manufacturer of CPAP masks and machines, ResMed. Source: CommSec 12

13 Wong has nominated Pioneer Credit (PNC) for his dislikes list. He suspects that the recent run up in share price has a lot to do with the market s anticipation of a good corporate earnings result. Prudent to take some profits, he says. The financial services provider will report their annual results to 30 June 2017 on August 24. Source: CommSec Our Super Stock Selectors is a survey of prominent analysts, brokers and fund managers. Each week we ask them to name a stock they like, and one they don t like. We purposely ask for likes and dislikes instead of recommendations, so it provides an idea of what the market is looking at, rather than firm buys or sells. 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 regards to your circumstances. 13

14 Powered by TCPDF ( Don't miss this Reporting season is underway, so what does it mean for the stock market? Paul Rickard and Peter Switzer discuss this and more in this month s webinar. 14