Investment Matters

What Matters this week

The share-market woke up with a bad case of hay fever this week - sneezing its way through a period of spring volatility.  While some investors may have the itch to act after reading the tape this week, we should remind ourselves we are dealing with a voting machine in the short term and a weighing machine in the long (and that we’re in it for the long!).

IT stocks were sold off indiscriminately after Lumentum (supplier of Apple’s FaceID) cut its profit outlook.  One of its “largest industrial and consumer customers” (which anyone with a couple of loosely connected neurons could have guessed was Apple) decided to cancel its orders.  The market took this as a sign that Apple’s phone sales are slowing – which it saw as a bad omen for technology sales in general. Both the FAANGs (FacebookAmazonAppleNetflix and Google) and our own WAAAXs (WisetechAltiumAppenAfterpay and Xero) took a slug.  The S&P/ASX 200 Information Technology index lost 2.6% on Tuesday while the NASDAQ was down 2.8% on Monday.  This week’s broad sell-off speaks to the fragility of lofty tech-stock valuations - investors are quick to rush for the exit at any sign that the high growth priced in won’t be achieved.

Private equity fund BGH Capital must have been feeling like the last kid picked for the football team after receiving a double dose of rejection on Monday. Its consortium with Australian Super had bids for both Navitas and Healthscope rejected.  Healthscope (+12%) has alternatively granted exclusive due diligence rights to Canadian fund Brookfield Asset Management – whose $4.3 billion bid outdid BGH & Australian Super’s offer of $4.1 billion.

The hunt for acquisitions is heating up in private equity. There have been record inflows globally, sale multiples are at all-time highs (EV:EBITDA in excess of 11x) and deal counts are low.  What this means is more money chasing fewer deals - BGH and its peers will need to pay up or miss out as the private equity cycle peaks.

Treasurer Josh Frydenberg announced that the government is planning to put two initiatives in place to (finally) improve access to credit for small and medium enterprises (SMEs).  The first is a $2 billion warehouse facility which will look to securitise loans from non-bank lenders, allowing them to be on sold to investors (such as superannuation funds).  The hope is the government will create a market for these securities, which will lower funding costs for lenders and borrowing costs for businesses.  The second initiative is a pooled fund utilising capital raised by the big banks which will be used to provide loans to SMEs.

Once again when it comes to government policy, it’s a case of better late than never.  It has become increasingly difficult for SMEs to obtain financing since the GFC (thanks to capital requirements and preferential lending for residential property by the banks).  The question is whether the government will be able to develop a market for small business loans through securitisation.  Considering there is clearly little appetite for SME loans at the moment, this solution is a little like packaging celery sticks (bear with me on this analogy …).  The packaging is convenient and reduces your risk (less risk of cutting yourself), but if you detest celery, better packaging isn’t going to make you buy it.

The agricultural sector had a better than expected week, in spite of the drought.  Elders (+0.4%) reported an increase in underlying net profit after tax (NPAT) for FY-18 of $5.2m which beat guidance and expectations.  Furthermore, Ruralco (+10%) announced an increase in underlying NPAT of 10% for FY-18.  The old adage “buy the rumour sell the fact” sometimes holds true in reverse – with the market selling the rumour and buying the fact.  This speaks to the tendency for the market to overreact and catastrophise.

Shares in LendLease (-7%) failed to recover after Friday’s announcement of a $350m after tax provision.  The provision has arisen from a number of project issues including lower productivity of NorthConnex and remedial work as a result of defective designs.  The announcement caused $2.3 billion to evaporate over a week … painful.

The banks were back in the headlines this week (have they ever left them?) as the Federal Court threw out a proposed $35m settlement of the case between Westpac and ASIC over Westpac's breach of responsible lending laws.  Justice Nye Perram rejected the settlement on the basis that it cited the contravention of Section 128 of the National Consumer Credit Protection Act – which prohibits a credit contract being made without an assessment being carried out.

Justice Perram highlighted that this was not the issue at hand - Westpac clearly made assessments of borrower creditworthiness (and therefore had complied with Section 128) - it is the extent and the nature of these assessments that is the issue (which relates to Section 129).  He therefore refused to accept a settlement that did not address the primary issue - how and how many loans breached the law.  The case is pertinent given the conjecture around exactly how the banks should fulfill their obligation to lend responsibly – particularly how they verify borrower's expenses.  The deal ASIC and Westpac come back to the courts with (and whether they can agree on one) is extremely important – it has the potential to set precedent for how consumer lending is conducted in Australia.

Lastly, the Australian Financial Review (AFR) revealed this morning that Myer’s sales are down 5.5% on a year on year basis for 1Q2019. While the news on its own is disparaging the failure of management to notify the market of a material change in its earnings forecast is the bigger issue. The Financial Review estimates that at the current run rate Myer will post a decline in underlying profit for 1H19 of $24.15 m, which represents a 60% reduction in profit compared to last year. Under the ASX’s continuous disclosure guidelines, companies should notify the market when there is a material difference (defined as between or greater than 5-10%) between its expected earnings and published earnings guidance. While the report by the AFR shouldn’t be taken as gospel, it’s highly probable given the magnitude of the sales decline that the company will breach this level. Shares in the company were placed in a trading halt at mid-day today pending an announcement. Poor disclosure is definitely not what you want to see as a shareholder trusting management to act in your interests…..

- Paul Grace