Eureka Correspondence

Selling the banks, bank alternatives, and gross-up yields.

Selling the banks

I am in a similar position as the bloke in the front row for John Abernethy’s talk on banks in Melbourne last week. There were a couple of issues ignored with the advice to sell the CBA shares and put the cash into term deposits. What about capital gains tax? Taking your example of the 10,000 CBA shares, their sale would generate a capital gain of $740,000. The tax payable on that would probably be about $180,000 (unless they were in his SMSF – unlikely as they must have been purchased in the 1980s). So, his CBA shares would need to drop by more than 25% to put that decision in the black. Another, lesser, difference is the loss of franking credits. Could we look at a plan B, please?

Name withheld

John Abernethy’s response: Thanks for your query. I specifically asked the gentleman in the front row whether the CBA shares were held in his superannuation pension fund. He answered yes and that answer led to a discussion that the decision to sell CBA was not affected by tax.

Our StocksInValue valuation for CBA as at 2015 is about $69. Thus, for non-owners of CBA, there is no hurry to buy. Owners need to consider their position and alternatives.

From 2007 to 2009 CBA share price fell by 60%. It was overvalued in 2007. The decision to not sell in 2007 – when it was priced for perfection – was an expensive error. An owner could have sold one CBA share and bought back two CBA shares a year later for no net outlay.

I know that you would say that is easy in retrospect but that is what often happens in the share market over time when shares become expensive. The key warning sign is over valuation. I think you bought in 2009 because it was cheap.

Why query expensive when you can perceive cheap?

My view, which is not advice, is that the CBA price will fluctuate greatly in the next few years. If you believe it is incapable of falling back to or into value then do nothing.

Bank investment alternatives

I am amused by John Abernethy’s suggestion of selling the banks. If the big four banks are in trouble then the rest of the market will be wiped out. If you sell the banks your logical alternative is to buy corporate bonds or put your cash under the mattress. My view is to hold the banks and if they fall again, buy more as I did in 2009. Financial advisors have been telling me that I am overweight in banks for more than 10 years. Term deposits are a losers game and less secure than higher yielding bonds.

Name withheld

John Abernethy’s response: You misunderstand the concept of value and the clearly observable movement of share prices to act erratically over time but trend around value.

When a market price is well over value then it needs to be noted. If value is not relevant to you then there is nothing for you to worry about until something happens. I accept that.

Prices can drop independently of a company being in trouble. They can fall, like any asset price, because they are expensive.

Bank yields grossed-up

As someone who was heavily invested in bank shares during the GFC, I take on board the risk of being too heavily weighted in bank shares. However, I would just like to correct the bank yield figures quoted in Alan’s Saturday briefing. NAB, ANZ, CBA and Westpac have an average yield of 7.6% when franking credits are added, as they should be, for Australian investors. Additionally, the average dividend growth for these banks over the past 10 years has been greater than 5% per annum. This means that if an investor purchased shares today, they could reasonably expect a dividend yield of close to 8% over 12 months. This is double the best term deposit rate on offer, not nearly the same.

Mark Umbers

Taxing share trades

I strongly object to the idea floated in the article Don’t tax everyone. Tax the share traders suggesting that those who trade shares should pay a duty of 0.2% per transaction. It then states in the summary that the chief beneficiaries are investors.  Wow, what a benefit, another tax to take out of whatever might be earned by investing in shares and that is a benefit? My method of risk management is active investment where I get out of an investment if the price falls below a level where I decide it is no longer going in my favour. That is the only way to manage risk in an effective way. The buy and hold strategy no longer works (if it ever did) and if Mr Abernethy thinks he is so clever that he knows which shares are going up in value no matter what, and that all others are just traders who should be taxed out of existence, he is welcome to his views but should keep them to himself.

I do not share his views but if the government gets hold of his idea and puts it into practice I am going to be penalised for using the only way that I know of that really manages the risk of being in the market. I would love to be able to hold a share forever while it gives me a dividend and maintains its price but most rising stocks have a good run and then decline. I do not want to hold them while they do that in the hope that at some stage they might recover. I also do not believe it to be in my interest to hold stocks while the market drops like it did in 2008.

So when I try to make sure I protect my investments I will have to pay a tax! I have no objection to a tax on those who trade by having optic fibre connection to a nearby exchange and profit from front running trades by means of trades that last for milliseconds but this proposition is definitely of no benefit to investors of any kind.

Will Kraa

John Abernethy hits the hot button calling upon not just politicians but all participants in our economies to look past the vested interested thinking processes which are choking off common sense considerations for improving the economic strengths of our federated nation. Surely it is unarguable that revenue should be taken from mere speculative transactions before liquidity is removed from struggling businesses who make things and employ people, and from people who are just struggling. On either sides of the political spectrum, it must make the majority of voters more relaxed and comfortable with the decision makers. Why can’t they see it? How can we make them think more?

Gary Colman

The risk with Transurban’s debt

Regarding Robert Gottliebsen’s article “Tapping Transurban’s toll stream” on 2 May 2014, I am confused about the reference to gearing being 44% of total enterprise value and being a fraction high.

According to my online broker site, TCL’s debt/equity ratio was 146.7% and shareholder equity about 75% of long term debt at 30/6/13, indicating that debt is extremely high.

Given the nature of an infrastructure asset like TCL, could you please explain how this translates into a safe prospective investment?

Richard Sykes

Robert Gottliebsen’s response: First, thank you for your query. I must confess I used the figures quoted in the prospectus and your letter had me going back to the prospectus to see how directors made the calculation. In essence, as at December 31 they struck an enterprise value of $10.1 billion, calculated using the December 31 share price of $6.84. They then added the Transurban proportion of total Transurban group debt, which amounts to $8.3billion to reach an enterprise value of $18.4 billion. The proportion of total debt to that enterprise value represents 45%. To calculate the same sum after the acquisition, they simply valued the Queensland Tolls at the value paid. The borrowings rise to $10 billion

If we go back to the balance sheet as at December 31 (prior to acquisition) and use the book value of shareholder funds, we see that shareholder funds are stated at only $3.2 billion compared to the market value of the enterprise of 10.1 billion. Using the book value of assets you get very high gearing sums. There is no doubt that if Transurban put its toll roads up for sale they would get substantially more than the book value and probably a lot more than the sharemarket value. The Queensland Motorways price showed that.

What encourages me is that in the first full year of the combined acquisition directors estimate a free cash flow of $740 million or 39 cents a share – their forecast distribution level. There are some big gains ahead.

I would like the debt to be lower but toll roads lend themselves to a level of gearing because of their reliable cash flows.

The right supermarket policies

In regards to the article Why you must adapt to economic change, Robert Gottliebsen mentions the Wal-Mart supply chain techniques that Woolworths has applied, producing higher profits in MercuryOne. The techniques mentioned may have a significant cost as Wal-Mart keeps pressuring its suppliers for lower prices and not paying suppliers until the goods are sold to the final customer. These harsh commercial terms have the potential to drive a large number of vendors out of business to the point where Wal-Mart has cut off its nose despite its face. There is no point in having low prices if the shelves are empty as supplies are not available. Woolworths would do well to consider these outcomes. Wal-Mart has best practice logistics but perhaps not so best sustainable supply acquisition policies.

Mal Phillips

The leverage effect

I do not understand why cash and bonds are advocated as an asset class if a person has debt or gearing. Surely debt is a form of “anti-cash” and any stability offered by the returns generated by cash and fixed interest is offset by the cost of debt.

If a person invested cash into reducing debt wouldn’t they achieve the same outcome of reducing volatility and also increase the income of a portfolio by reducing the net interest costs? It seems like somebody talked about asset allocation one day with a mandatory cash exposure and everybody has followed that thought process.

Editor’s response: Thanks for your question. While you are correct in saying cutting back on debt reduces volatility, you aren’t considering the effect of leverage on your investments. By borrowing capital, investors can increase their potential returns despite the borrowing costs because they have access to more capital. For example, if you borrow money at 6% and invest it in an asset that provides a 12% return, you will be ahead by $6,000 for every $100,000 you’ve invested. See our article Investors gearing back into equities for more information.

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