Big four banks: be patient, but ready to ride out gyrations

A few weeks back we wrote how the banks tend to underperform the overall market following the traditionally strong months of March and April. This season has not upset that theory.

The four big banks have stumbled a hefty 11 per cent over the past few weeks, Westpac setting the pace with a 15 per cent decline. Driving the selloff has been the departure of foreign investors who are petrified the Australian dollar is going to drop to US90¢ in a hurry.

While the Australian retail investor has been blamed for the overzealous buying of the high-yielding stocks, the real culprit since October has been the foreign funds desperate to buy yield. Foreign ownership of the Australian market is tracking about 10 per cent higher than the long-term average.

So with foreign money fleeing our shores, when will it be time to buy our banks? That is a difficult question because in global terms our big four, especially CBA and Westpac, are still extremely expensive.

Our four major banks are trading on fully franked perspective yields of between 5.5 per cent and 6.8 per cent following the recent selloff. With the possibility of another interest rate cut from the Reserve Bank, increasingly the chances of a spike in term deposit rates in the near term looks unlikely. Under this scenario it would be wise to simply buy any of the big banks when the yield gets to 6.5 per cent or better and ride out the gyrations caused by the fast-moving foreign funds.

CARDNO

At the end of 2012 we wrote about the dangers of investing in engineering group Cardno following a surprise downgrade to its earnings. The shares fell 21 per cent rapidly from $7.55 to $5.89 on the bad news. I was made to look silly when the stock bounced back to $7.30 within a few months, inspired by the company hitting the top end of its revised half-yearly earnings forecast.

But we should not ignore history. A few weeks back Cardno was forced to downgrade its full-year numbers by 10 per cent, causing another selloff. The stock is now trading at $5.35 a share, 28 per cent below where the price sat before the original downgrade late last year.

So where to from here? The stock's price-to-earnings (P/E) multiple has shrunk from about 13 times this year's earnings to just 10 times, making it look cheap. But we should hasten slowly. Cardno has spent the equivalent of its current market value on acquisitions since 2004 and in that time it has delivered no organic earnings growth.

Acquisition models tend to work when the company can keep buying businesses, seemingly adding to the bottom line. When the spending spree ends we invariably see the underlying businesses are treading water and not growing.

It is too early to put Cardno in this category, but until the company can generate decent organic growth it would be better to stand on the sidelines.

ALS

This week the highly successful mineral and industrial testing group ALS reported its earnings for the full year to March 31. Net profit came in at $238 million, the bottom of its guided range. The profit result inspired a rally of 16 per cent during the week.

Usually a result at the bottom of a range causes the share price to soften, but on this occasion the spate of downgrades in the mining services world had the investment community expecting the worst.

Most of the commentary about the result focused on earnings bottoming out in the year to March 2014, at which time the company would earn about $195 million and trade on a P/E of more than 15.

With strong industrial and environmental earnings and a bounce back in resources, the company could grow strongly again from 2015. ALS still generates about two-thirds of its earnings from commodities. With each passing day it would seem the spending on commodities has peaked. The problem with commodity booms and busts is historically the booms last about 15 to 20 years and the busts can be even longer.

If the Chinese-inspired boom is over, we could expect the mining sector to suffer for many years. For ALS it will be a matter of being able to generate enough revenue growth from its non-mining business. This would seem a hard task and it is easy to see the shares at about $8 before year's end.

matthewjkidman@gmail.com

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