Materials Analyst/Strategist, Janus Analysis

Gaius King

Materials Analyst/Strategist

Accelerating Tomorrow’s Independent Research

Boost Research

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Equity Bottom-Up

<ul>
<li>
<a href="https://www.smartkarma.com/entities/23731" target="_blank" data-smartkarma-citation="entities:23731:1">Vale SA (VALE US)</a> have had two major fatal dam-failures in three years</li>
<li>Possible (probable?) design flaw</li>
<li>Expect all Vale's iron ore operations to be technically audited</li>
<li>Substantial Management &amp; Board changes inevitable</li>
<li>Probability that a portion of Vale's existing operations will fail engineering inspection.</li>
<li>Forecast resultant capacity constraints</li>
<li>
<a href="https://www.smartkarma.com/entities/13" target="_blank" data-smartkarma-citation="entities:13:1">Rio Tinto Ltd (RIO AU)</a>,  <a href="https://www.smartkarma.com/entities/147" target="_blank" data-smartkarma-citation="entities:147:1">Bhp Billiton (BHP AU)</a>, <a href="https://www.smartkarma.com/entities/41" target="_blank" data-smartkarma-citation="entities:41:1">Fortescue Metals (FMG AU)</a> to benefit from lost production</li>
</ul>



Vale SA (VALE US) have had two major fatal dam-failures in three years
Possible (probable?) design flaw
Expect all Vale's iron ore operations to be technically audited
Substantial Management &amp; Board changes inevitable
Probability that a portion of Vale's existing operations will fail engineering inspection.
Forecast resultant capacity constraints

Rio Tinto Ltd (RIO AU),  Bhp Billiton (BHP AU), Fortescue Metals (FMG AU) to benefit from lost production


Vale in Trouble - Expect Rio, BHP, FMG to Benefit (Flash Note)

Chief Economist

Diana Choyleva

Enodo Economics

Enodo Economics is an independent macroeconomic forecasting company that untangles complexity, challenges the consensus, and makes sense of the future. Our focus is on China – one of the most misunderstood economies in the world, but one of the most important to figure out.  Enodo’s chief economist, Diana Choyleva, has been analysing China for almost 20 years, while Enodo’s team boasts a combined 140 years’ experience covering China’s economy, politics and markets. 

Macroeconomics

<h2>China News That Matters</h2>
<ul>
<li>Steakhouse showdown for Trump and Xi yields a trade truce</li>
<li>Housing slumps, wealth gap yawns</li>
<li>Pumping iron as prices go bear</li>
<li>Stocks beaten up – but worth a punt?</li>
<li>Lessons in democracy (on one side of the Strait)</li>
</ul>
<div class="content-remarks">
In my weekly digest China News That Matters, I will give you selected summaries, sourced from a variety of local Chinese-language and international news outlets, and highlight why I think the news is significant. These posts are meant to neither be bullish nor bearish, but help you separate the signal from the noise.
</div>

China News That Matters

Steakhouse showdown for Trump and Xi yields a trade truce
Housing slumps, wealth gap yawns
Pumping iron as prices go bear
Stocks beaten up – but worth a punt?
Lessons in democracy (on one side of the Strait)


In my weekly digest China News That Matters, I will give you selected summaries, sourced from a variety of local Chinese-language and international news outlets, and highlight why I think the news is significant. These posts are meant to neither be bullish nor bearish, but help you separate the signal from the noise.


G20/Property Woes/Steel & Iron Slump/Equity Market/Taiwan Election Shocker

Macro and Australian equity strategist, Macro Strategy Advisors

Shane Lee

Macro and Australian equity strategist

Macro Strategy Advisors

Cross Asset Strategy

<ul>
<li>
A Correction and Not and End-Cycle Sell-off. In our note dated 20 October – “It’s Not Over Yet, But Lift the Bar on Defence” - we argued that the global equity market sell-off was likely a correction and not the beginning of an end-cycle sell-off.  We retain this view, but think better news on trade tariffs is needed if the market is to bounce back.  The US equity market PE derating is more a fundamental adjustment to slower earnings growth rather and better news on costs would be well-received.  The Fed will probably remain unfazed by the October risk-off period, so tightening financial conditions remain a headwind for equities unless the Fed pauses. </li>
<li>
Risk-off Underpinned by Fundamentals: US reporting season has shown that underlying late-cycle cost pressure has been managed relatively well.  However, the large lift in tariffs by the Trump Administration has added to these pressures and the prospect of more tariffs is weighing on the outlook.  The BXB quarterly result showed how these forces are coming together.  Global equity markets fell by 7.3% in the month, with Japan, the US and Asian markets particularly hard hit.  The Australian market began its decline in September (-1.4%), but saw a smaller decline in October than most other developed markets (-6.1%).  Emerging markets in Latin America, apart from Brazil, were also hit hard. </li>
<li>
Cost Pressures Seem to be Modest. During AGM season management has generally guided earnings estimates for FY19 a little lower on the back of higher costs.  Industrial stocks with US operations are under cost pressure (eg. BXB), but higher oil prices are reaching into areas such as airline ticket pricing (FLT).  The Miners are in a sweet spot – production has generally been solid against the backdrop of high bulk commodity prices and a weaker Australian dollar.  The Banks are reimbursing customers for overcharging in an attempt to front-run the recommendations of the Royal Commission.</li>
<li>
The Earnings outlook Still Looks Solid. The Upgrades: downgrades ratio for the market is above average and FY19 earnings growth is tracking similar to FY18 and around 8%.  In our latest model portfolio update, we increased the number of stocks in the portfolio and bought in a defensive earnings tilt.  The Tech sector (-11.5%) was swept up in the global sell-off in the sector and our exposure to WTC has been a drag on the portfolio, but the outlook for the stock seems positive, with management upgrading FY19 guidance.</li>
<li>
The Sell-off Ramped up Short Positioning. Short positioning generally increased during the sell-off.  The most shorted stocks in the ASX 200 are JBH, ORE and GXY.  ING, CSR and IFL saw the largest increase in short positioning, while CYB, AHY and VOC saw the largest falls in short positioning.</li>
<li>
Solid Economic Data Shows the Economy is on a Solid Path. Strong employment data indicates the domestic economy is still growing above trend.  Weak building Approvals and housing finance data highlighted the softness in housing, while weak inflation data for Q3 reinforced the RBA’s rates-on-hold policy agenda.  The Miners and weak currency helped deliver a strong trade surplus in September leaving Australia’s call on global savings relatively small.</li>
</ul>



A Correction and Not and End-Cycle Sell-off. In our note dated 20 October – “It’s Not Over Yet, But Lift the Bar on Defence” - we argued that the global equity market sell-off was likely a correction and not the beginning of an end-cycle sell-off.  We retain this view, but think better news on trade tariffs is needed if the market is to bounce back.  The US equity market PE derating is more a fundamental adjustment to slower earnings growth rather and better news on costs would be well-received.  The Fed will probably remain unfazed by the October risk-off period, so tightening financial conditions remain a headwind for equities unless the Fed pauses. 

Risk-off Underpinned by Fundamentals: US reporting season has shown that underlying late-cycle cost pressure has been managed relatively well.  However, the large lift in tariffs by the Trump Administration has added to these pressures and the prospect of more tariffs is weighing on the outlook.  The BXB quarterly result showed how these forces are coming together.  Global equity markets fell by 7.3% in the month, with Japan, the US and Asian markets particularly hard hit.  The Australian market began its decline in September (-1.4%), but saw a smaller decline in October than most other developed markets (-6.1%).  Emerging markets in Latin America, apart from Brazil, were also hit hard. 

Cost Pressures Seem to be Modest. During AGM season management has generally guided earnings estimates for FY19 a little lower on the back of higher costs.  Industrial stocks with US operations are under cost pressure (eg. BXB), but higher oil prices are reaching into areas such as airline ticket pricing (FLT).  The Miners are in a sweet spot – production has generally been solid against the backdrop of high bulk commodity prices and a weaker Australian dollar.  The Banks are reimbursing customers for overcharging in an attempt to front-run the recommendations of the Royal Commission.

The Earnings outlook Still Looks Solid. The Upgrades: downgrades ratio for the market is above average and FY19 earnings growth is tracking similar to FY18 and around 8%.  In our latest model portfolio update, we increased the number of stocks in the portfolio and bought in a defensive earnings tilt.  The Tech sector (-11.5%) was swept up in the global sell-off in the sector and our exposure to WTC has been a drag on the portfolio, but the outlook for the stock seems positive, with management upgrading FY19 guidance.

The Sell-off Ramped up Short Positioning. Short positioning generally increased during the sell-off.  The most shorted stocks in the ASX 200 are JBH, ORE and GXY.  ING, CSR and IFL saw the largest increase in short positioning, while CYB, AHY and VOC saw the largest falls in short positioning.

Solid Economic Data Shows the Economy is on a Solid Path. Strong employment data indicates the domestic economy is still growing above trend.  Weak building Approvals and housing finance data highlighted the softness in housing, while weak inflation data for Q3 reinforced the RBA’s rates-on-hold policy agenda.  The Miners and weak currency helped deliver a strong trade surplus in September leaving Australia’s call on global savings relatively small.


Aussie Equities Month in Review (Oct 2018)

Thematic (Sector/Industry)

<ul>
<li>
Solid Earnings Momentum Hits a Brick Wall. It’s still early days, with only 40% of stocks reporting during the first 2 weeks of reporting season, but cracks are beginning to appear in the earnings outlook.  FY18 expectations have been mostly met with a slight skew towards upside surprise in results.  However, FY19 earnings are under downward pressure led by the Resources, Financials and Consumer Discretionary.  </li>
<li>
Downgrades following Reporting: WES, TLS, RIO, ORG, SUN, AGL, QBE, AZJ, CWN, DXS, SHL, TAH, VCX, DMP, SEK, IOF, LNK, MFG, NXT, ORA, NVT, PGH, SKC have all seen analysts cut 12-month forward earning growth by more than 3% during reporting season even though the market has responded reasonably positive to these stocks. COH guided to lower FY earnings growth than the market expected and ECX downgraded FY18 earnings during the first week of reporting season.</li>
<li>
Front Running Reporting: ABP, FMG, SAR, NCM, TGR, BPT, AAD are all due to report during the next few weeks and have seen 12-month forward earnings downgraded by analysts.  These stocks are at risk of seeing a drop in FY19 guidance when they report even if there is a surprise in FY18. </li>
<li>
Downgrades for stocks not reporting: AWC, ILU, RWC, SFR, SIG, SIQ, SDA, XRO, WSA, FBU, XRO, DOW, IGO, RRL, BAL, AHY, DHG, GXY, ORE, IFN, NAN have all seen 12-month forward EPS growth downgraded in the past 2 weeks.</li>
<li>
Cost management Rather than Revenue Growth Driving Earnings: Cost pressures are well contained limited to stocks exposed to higher electricity costs and those in the aged care industry (labour).  Indeed, the beats on EPS (63%) are exceeding the beats on revenue.  The Banks are managing cost pressures in short-term funding markets by raising mortgage rates on interest-only and investor mortgages to satisfy the regulator.  Savers are also covering cost increases after seeing deposit rates trimmed.</li>
<li>
Capex for Offence and Defence. Growth stocks such as CSL, TWE and RMD are investing to deliver in long-term growth and the market is giving it a tick of approval to this strategy.  We hold CSL, TWE and COH in our portfolio and will stay for the ride even though valuation pressures are rising.  TLS and CBA are investing to shore-up earnings, leaving little room for near-to-medium-term earnings surprise; but valuations seem cheap. </li>
<li>
Holding Steady with our View. Despite the lift in downgrades, we will not make changes to our portfolio until reporting season is complete.  We’re disappointed in the downgrades to Materials, given our overweight position in Resources.  The strength in key commodities and weakness in the Australian dollar are diving strong FY18 results, but analysts seem to think the cycle has peaked.  </li>
</ul>



Solid Earnings Momentum Hits a Brick Wall. It’s still early days, with only 40% of stocks reporting during the first 2 weeks of reporting season, but cracks are beginning to appear in the earnings outlook.  FY18 expectations have been mostly met with a slight skew towards upside surprise in results.  However, FY19 earnings are under downward pressure led by the Resources, Financials and Consumer Discretionary.  

Downgrades following Reporting: WES, TLS, RIO, ORG, SUN, AGL, QBE, AZJ, CWN, DXS, SHL, TAH, VCX, DMP, SEK, IOF, LNK, MFG, NXT, ORA, NVT, PGH, SKC have all seen analysts cut 12-month forward earning growth by more than 3% during reporting season even though the market has responded reasonably positive to these stocks. COH guided to lower FY earnings growth than the market expected and ECX downgraded FY18 earnings during the first week of reporting season.

Front Running Reporting: ABP, FMG, SAR, NCM, TGR, BPT, AAD are all due to report during the next few weeks and have seen 12-month forward earnings downgraded by analysts.  These stocks are at risk of seeing a drop in FY19 guidance when they report even if there is a surprise in FY18. 

Downgrades for stocks not reporting: AWC, ILU, RWC, SFR, SIG, SIQ, SDA, XRO, WSA, FBU, XRO, DOW, IGO, RRL, BAL, AHY, DHG, GXY, ORE, IFN, NAN have all seen 12-month forward EPS growth downgraded in the past 2 weeks.

Cost management Rather than Revenue Growth Driving Earnings: Cost pressures are well contained limited to stocks exposed to higher electricity costs and those in the aged care industry (labour).  Indeed, the beats on EPS (63%) are exceeding the beats on revenue.  The Banks are managing cost pressures in short-term funding markets by raising mortgage rates on interest-only and investor mortgages to satisfy the regulator.  Savers are also covering cost increases after seeing deposit rates trimmed.

Capex for Offence and Defence. Growth stocks such as CSL, TWE and RMD are investing to deliver in long-term growth and the market is giving it a tick of approval to this strategy.  We hold CSL, TWE and COH in our portfolio and will stay for the ride even though valuation pressures are rising.  TLS and CBA are investing to shore-up earnings, leaving little room for near-to-medium-term earnings surprise; but valuations seem cheap. 

Holding Steady with our View. Despite the lift in downgrades, we will not make changes to our portfolio until reporting season is complete.  We’re disappointed in the downgrades to Materials, given our overweight position in Resources.  The strength in key commodities and weakness in the Australian dollar are diving strong FY18 results, but analysts seem to think the cycle has peaked.  


Aussie Reporting Season Update: Cracks in the Mirror

<ul>
<li>
Stick to Growth. Growth has outperformed Value by 10%pts year-to-date and we expect its outperformance to continue for the remainder of the year, given the limited opportunities for a sustainable upswing in earnings growth and market pricing that is already stretched.  However, we acknowledge Growth’s outperformance is nearing a threshold that normally means it underperforms.  In this note, we put aside our preference for it as an investment style and list our preferred Value stocks.</li>
<li>
Cheap stocks with Mispriced longer-term Earnings. Our top picks are OZL, OSH, SIQ, TWE, AMC, ORA and these stocks are cheap based on the consensus outlook for EPS growth and the book value for equity.  Furthermore, growth in longer-term cashflow embedded in the share prices of these stocks seems too low. </li>
<li>
Value Traps Persist. There are many stocks within the ASX200 universe that look attractive because they are cheap.  However, any Value reward must be coupled with a turnaround in longer-term earnings growth Stocks such as JHG, GEM, JBH, GXL, MFG, BXB, BOQ, SKI, PPT, SWM and AMP appear cheap based on analysts’ EPS and growth of equity estimates.  However, the longer-term cashflow growth embedded into these share prices seem overly optimistic and this questions their Value proposition. Diversified Financials stocks MFG, PTM, IFL, JHG and CPU also seem to have very optimistic longer-term cashflow prospects factored into their share prices.</li>
<li>
Be wary of Junior Miners and Consumer Discretionary stocks. Junior miners such as ORE, SYR, SFR, FMG, WSA and RRL all appear cheap on their 12-mth earnings outlook, but the longer-term cashflow growth embedded into their share prices seems excessive.  The market also appears overly optimistic on the cashflow growth prospects of SUL and HVN.  </li>
<li>
Cheap Banks with a relatively high bar for cashflow growth. The share prices of the Major Banks seem to be supported by cashflow growth that exceeds the current pace of nominal GDP growth (5.6%) by around 2-3%pts.  These stocks look cheap, but we question whether cashflow growth can return to the longer-term average prior to the financial crisis.  The household sector has a large amount of debt and the population continues to age.  WBC is relatively cheap and is more attractive than the other Banks.  BEN is also attractive, but it has more realistic future cashflow prospects.</li>
</ul>



Stick to Growth. Growth has outperformed Value by 10%pts year-to-date and we expect its outperformance to continue for the remainder of the year, given the limited opportunities for a sustainable upswing in earnings growth and market pricing that is already stretched.  However, we acknowledge Growth’s outperformance is nearing a threshold that normally means it underperforms.  In this note, we put aside our preference for it as an investment style and list our preferred Value stocks.

Cheap stocks with Mispriced longer-term Earnings. Our top picks are OZL, OSH, SIQ, TWE, AMC, ORA and these stocks are cheap based on the consensus outlook for EPS growth and the book value for equity.  Furthermore, growth in longer-term cashflow embedded in the share prices of these stocks seems too low. 

Value Traps Persist. There are many stocks within the ASX200 universe that look attractive because they are cheap.  However, any Value reward must be coupled with a turnaround in longer-term earnings growth Stocks such as JHG, GEM, JBH, GXL, MFG, BXB, BOQ, SKI, PPT, SWM and AMP appear cheap based on analysts’ EPS and growth of equity estimates.  However, the longer-term cashflow growth embedded into these share prices seem overly optimistic and this questions their Value proposition. Diversified Financials stocks MFG, PTM, IFL, JHG and CPU also seem to have very optimistic longer-term cashflow prospects factored into their share prices.

Be wary of Junior Miners and Consumer Discretionary stocks. Junior miners such as ORE, SYR, SFR, FMG, WSA and RRL all appear cheap on their 12-mth earnings outlook, but the longer-term cashflow growth embedded into their share prices seems excessive.  The market also appears overly optimistic on the cashflow growth prospects of SUL and HVN.  

Cheap Banks with a relatively high bar for cashflow growth. The share prices of the Major Banks seem to be supported by cashflow growth that exceeds the current pace of nominal GDP growth (5.6%) by around 2-3%pts.  These stocks look cheap, but we question whether cashflow growth can return to the longer-term average prior to the financial crisis.  The household sector has a large amount of debt and the population continues to age.  WBC is relatively cheap and is more attractive than the other Banks.  BEN is also attractive, but it has more realistic future cashflow prospects.


Holding the Reigns on Aussie Value Stocks

Australia

Fortescue Metals Group Ltd. explores for and produces iron ore. The Company conducts business worldwide.

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Fortescue Metals (FMG AU)

Vale in Trouble - Expect Rio, BHP, FMG to Benefit (Flash Note)

Vale SA (VALE US) have had two major fatal dam-failures in three years Possible (probable?) design flaw Expect all Vale's iron ore operations to...

Boost Research

G20/Property Woes/Steel & Iron Slump/Equity Market/Taiwan Election Shocker

China News That Matters Steakhouse showdown for Trump and Xi yields a trade truce Housing slumps, wealth gap yawns Pumping iron as prices go...

Diana Choyleva

Aussie Equities Month in Review (Oct 2018)

A Correction and Not and End-Cycle Sell-off. In our note dated 20 October – “It’s Not Over Yet, But Lift the Bar on Defence” - we argued that the...

Shane Lee

Aussie Reporting Season Update: Cracks in the Mirror

Solid Earnings Momentum Hits a Brick Wall. It’s still early days, with only 40% of stocks reporting during the first 2 weeks of reporting season,...

Shane Lee

Holding the Reigns on Aussie Value Stocks

Stick to Growth. Growth has outperformed Value by 10%pts year-to-date and we expect its outperformance to continue for the remainder of the year,...

Shane Lee

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