Behind the themes expressed in the recently completed reporting season, one stood out: the incredible influence the bond market is having on share prices. The impact of lower rates touched almost every sector.
Take listed property trusts (A-REITs) as an example.
They continue to benefit from cap rate compression as low long-term interest rates raise the attractiveness of commercial property on long-term leases. Smart owners are taking advantage of this. Witness Crown’s proposal to spin off 49% ownership in most of its Australian hotels, the Viva Energy REIT float and Charter Hall’s Long WALE partnership listing.
If and when long term interest rates rise this sector will be the first to show it, in the form of lower share prices.
Long average lease terms make them highly attractive in the current low interest rate environment but much less so if and when long-term bond rates rise.
General insurers QBE Insurance and IAG had a rough year, facing pricing pressure, increasing competition and low returns from their investment portfolios (QBE didn’t even manage a 2% return).
Low interest rates have also pushed up long-term liabilities. There’s no value here.
In retail, Woolworths and Wesfarmers took the opportunity to wipe the slate on poorly performing businesses with multi-billion dollar writedowns, signalling an end to the sector’s margin expansion and profit growth.
The big retailers have also let their dividends creep up at the same time as their debt levels. Realising they’ve been too complacent, both have cut dividends, as did Flight Centre. By contrast, JB Hi-Fi has been a beneficiary of the collapse of competition (ie Dick Smith) and the exit of various competitors from the consumer electronics space (including department stores).
In resources, cost improvements were a big theme, although top line profits were hit by impairments and high depreciation charges from the boom years.
Cash flows are much better and the top end miners (South 32, BHP Billiton and Rio Tinto) are repairing balance sheets and even talking about spending cash again. Two were already on our Buy List but price rises put paid to that. It would be nice to get another opportunity in this sector.
It was a year of consolidation for the telcos, where three giants – Telstra, TPG and Vocus – have emerged. None reported outstanding results and industry growth is slowing. Once a hot part of the market, it looks as though maturity is catching up. But after a 15% price fall since July, Telstra is looking more attractive.
There were a few standout results – Computershare’s prompted a 17% share price rise in a few weeks and Bellamy tripled profits and boosted margins and revenue – but large caps generally underperformed. With stretched valuations a few large fund managers are moving into small caps, pushing up the prices as a result. We’re hopeful of opportunities here when the inevitable disappointments force them out of their new found loves.
With growth stocks outperforming over the past year perhaps the ‘rush to yield’ has gone into reverse. With interest rates falling the market has been happy to pay up for stocks with good and growing cash flow but leaving aside big yielding stocks like Telstra, the banks and IOOF where growth seems limited. But with fully franked yields of 6% plus, you don’t need much growth in this environment.
The banks will start growing again – eventually – and ironically the lack of growth (and the lower discount rate that results) means valuations are less dependent on near-term performance. Even more than ever, what matters is the long term and we expect the big banks to retain their privileged positions in our economy. That’s why they’re closer to an upgrade than other blue chips.