Five blue-chips heading for a fall

The sharemarket broke its forward run today, no doubt pausing for a breather. Market sentiment points to continued gains, particularly across the blue-chip end of the board.

Seeking to identify potential portfolio problems in the ASX 50, I take the view that there is information in a host of locations about the prospects for a stock. I’ve run a screen over options markets, debt markets, short sellers, director transactions, analyst sell recommendations and index reweighting for signs of potential under performance. Merging with a number of quality, financial stability and valuation scores before finally overlaying some common quantitative screens: The outcome is that Qantas (QAN), QBE Ltd (QBE), Fortescue (FMG), Newcrest (NCM) and Woolworths (WOW) are highlighted as stocks at risk.

QBE (QBE)

Quantitative commentary:

• The key reasons for QBE appearing on this list is that short sellers and the options market are giving negative indications.
• Credit Default Spreads (CDS) are hard to read currently – spreads have come in for all stocks, but admittedly they have come in further for QBE than most other stocks.
• On a valuation basis the recent rally looks over done.
• Balance sheet looks stretched. Whilst equity capital raising is unlikely short term, deviation from QBE’s articulated strategy could bring back questions around QBE’s capital levels
• Returns on capital are average but the key to longer term performance is shown in the chart below.

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Qantas (QAN)

Quantitative commentary:

• QAN is different to other stocks on this list in that none of my quant signals are suggesting imminent or worsening issues.
• However, QAN scores so badly on most other measures that even mildly negative scores in the key categories are enough to bring it into the spotlight for all the wrong reasons.
• A sudden shift from investors towards buying put options rather than call options raises my suspicions.
• The balance sheet looks stretched and is relying on an earnings recovery to make debt metrics palatable.
• Returns on capital are below average (at best).

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Fortescue Metals (FMG)

Quantitative commentary:

• FMG rates poorly among short sellers and buyers of options.
• While FMG rates poorly on a number of fundamental and balance sheet measures, the way these are calculated will bias against FMG while it’s in start-up mode. However, in the end as a leveraged play on the iron ore price, historical fundamentals aren’t going to give too many clues to future performance anyway.
• FMG has a number of positive scores as well.
• The balance sheet looks stretched and is relying on the iron ore prices staying high to make debt metrics palatable.
• Quant strategies are divergent.

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Woolworths (WOW)

Quantitative commentary:

• WOW to be frank does not rate particularly negatively on my rating system. Its inclusion is more about choosing the lowest rated “expensive defensive” to include for those who have a more bullish economic outlook and are expecting interest rate expectations to rise.
• The key negatives for WOW are analyst recommendations where WOW is rated the second-worst in the ASX 50, and insider transactions where over $1 million has been sold by insiders recently.
• The options market has more put options than call options open currently for WOW.
• On most other measures, WOW rates more positive than negative.

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Newcrest (NCM)

Quantitative commentary:

• NCM has taken a turn for the worse across a number of measures.
• The key risk to my call is an improvement in its production issues.
• Over recent years weakness in the gold price has led to gold stocks underperforming but increases do not appear to have had a commensurate positive effect. This plus production issues means less faith in valuation measures.
• The recent trends in both short selling and the options markets point to further concerns.
• Return on equity has not been particularly good, and forecasts continue to suggest poor returns for shareholders.

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NOTE TO RETAIL INVESTORS: This is a document prepared for institutional investors by our quantitative research staff. The recommendations are not targeted to a retail investor audience and may be inconsistent with fundamental research you receive from Wilson HTM.

This is an edited version of an article written on Monday May 13 by Damien Klassen and John Lockton of Wilson HTM Investment Group. www.wilsonhtm.com.au