Withdrawals can't hide good yields
A few weeks back we wrote how the banks tend to underperform the market following the traditionally strong months of March and April. This year has not upset that theory.
The big four banks have stumbled a hefty 11 per cent over the past few weeks, with Westpac setting the pace with a 15 per cent decline. Driving the sell-off has been the departure of foreign investors who are petrified the Australian dollar is going to drop to US90¢ in a hurry.
While local investors have 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 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 four big banks, especially CBA and Westpac, are still extremely expensive.
So much for the negatives! Our four major banks are trading on fully franked prospective yields of between 5.5 and 6.8 per cent following the recent sell-off. With the possibility of another interest rate cut from the Reserve Bank, 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 last year we wrote about the dangers of investing in engineering group Cardno following a surprise downgrade. The shares rapidly fell 21 per cent 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.
We should never ignore history though. A few weeks back Cardno was forced to downgrade its full-year numbers by 10 per cent, causing another sell-off. The stock is now trading all the way down at $5.35 a share, some 28 per cent below the original downgrade back 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 organic growth it would be better to stand on the sidelines, despite the eye-catching share price.
ALS Ltd
As I have mentioned before, being negative all the time is a curse when it comes to sharemarket investing because over time prices rise. For the moment, though, the market has more stories to avoid than support.
This week saw the mineral and industrial testing group ALS report its earnings for the full year to March 31. The net profit came in at $238 million, the bottom end of its guided range. The result inspired a rally of 16 per cent in the share price. A result at the bottom end of a range usually 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 around 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 over 15 times. With strong earnings in the industrial and environmental part of the business and a bounce back in resources, the company could grow strongly again from 2015 onwards.
This is interesting logic. ALS still generates about two-thirds of its earnings from the commodity side of the economy. With each passing day it would seem spending on commodities has peaked and is heading south. The problem with commodity booms and busts is the length of the cycle. Historically the booms last about 15 to 20 years and the busts can be even longer. If the current Chinese-inspired boom is over we could expect the mining sector to suffer from low activity for many years and not just one or two.
For ALS, it will be a matter of being able to generate enough revenue growth from the non-mining side of its business to compensate. Despite excellent management this would seem a hard task and it is easy to see the company trading at about $8 before the end of the year.
matthewjkidman@gmail.com
The Herald accepts no responsibility for stock recommendations.
Frequently Asked Questions about this Article…
The article says foreign investors have been selling bank stocks because they're worried the Australian dollar could fall quickly (the piece mentions fears it could drop to about US90¢). That rush for yield followed by sudden currency concerns has pushed foreign ownership higher than average and contributed to recent bank sell-offs.
According to the article, the big four banks stumbled about 11% over the past few weeks, with Westpac leading the fall with a roughly 15% decline during that period.
The article notes the big four are still relatively expensive in global terms, especially CBA and Westpac, but after the sell-off they are trading on fully franked prospective yields between about 5.5% and 6.8%. The columnist suggests it could make sense to buy if the yield reaches about 6.5% or better and to ride out short-term gyrations caused by foreign funds.
The article points out the possibility of another Reserve Bank interest-rate cut and says a near-term spike in term deposit rates looks unlikely. If term deposit rates stay subdued, bank dividend yields become relatively more attractive versus term deposits, supporting the case for bank shares at higher yields.
Cardno suffered a surprise downgrade last year that sent the shares down, briefly bounced back, then recently downgraded full-year numbers by 10%, pushing the share price down to about $5.35. Its P/E has fallen from roughly 13 to about 10. The article warns that Cardno has spent about the equivalent of its market value on acquisitions since 2004 without delivering organic earnings growth, so the author recommends staying on the sidelines until the company demonstrates sustainable organic growth.
ALS reported a net profit of $238 million for the year to March 31, which was at the bottom end of its guided range. Because the market had been expecting worse amid a string of mining services downgrades, the 'better-than-feared' result sparked a roughly 16% rally in the share price.
The article notes ALS still derives about two-thirds of its earnings from the commodity side. If commodity spending has peaked and falls, ALS will need substantial revenue growth from its non-mining operations to compensate. The columnist suggests that, despite good management, this could be a tough task and even forecasts the stock might trade around $8 before year-end if pressures persist.
The article explains acquisition-led growth can mask a lack of organic earnings improvement: companies that grow mostly by buying businesses may look to add to the bottom line while the underlying operations tread water. When the acquisition spree ends, earnings can stall. For investors the takeaway is to be cautious until a company demonstrates sustainable organic growth rather than relying mainly on acquisitions.
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