These two stocks are under the weather – MYR, RCG

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In this section, we look at two stocks that are in a bit of trouble. You might say they’re sick both fundamentally and technically. For one reason or another both stocks have caught our attention and we think investors should be cautious because the downside risks are increasing. When assessing them we look at the story behind these two companies and we assess them both fundamentally and technically. As with all stock, these too do carry risk which we urge you, as always, to consider. Company Overview Myer (MYR) – Shares were hammered this week falling 11% following renewed concerns about the launch of Amazon and weak consumer spending. The concerns came from a bearish report released by Credit Suisse. The broker downgraded the stock to Underperform from Outperform with a target price of 82c which is a 44% downgrade from its previous target price of $1.44. Quite a savage hit. The report was gloomy to say the least. The broker says the entry of all conquering Amazon and TK Maxx is set to smash Myer and the discretionary retail space in ways that Myer won’t be able to overcome. Both new entrants will be selling premium brands but at discounted prices. TK Maxx has outlined its plans to open 35 stores and Amazon to roll out its E-Commerce offering and convert shoppers to the digital revolution. On the back of all this, Credit Suisse sees no hope for Myer and has downgraded its forecasts on the back of weak sales growth. RCG Corp (RCG) – Earlier this month the footwear retailer was slammed with shares being sold off by almost 28% after it announced a FY profit downgrade. Guidance was cut by 11% which makes it the second downgrade in three months after sales of brands such as Skechers, Vans and Doc Martens stayed soft in March and April. It’s shocking news for the company that is trying to stay afloat. It now expects underlying EBITDA for the year ending June to come in between $74m-$80m compared with $60m in 2016. Shares have tumbled from $1.06 at the start of April to 60c on Monday. That’s an almost 50% loss in the space of month.

Fundamentals

On the StockOmeter both MYR and RCG rate pretty ordinary. MYR came in at around 55 but we think this could fall further. The stock is trading on a PE of 12.62x but its ROE is low and falling. That’s a worry. In-fact the only retailers that have rising ROE’s are WOW and WES. RCG isn’t any better. The StockOmeter reading is 53, much of a muchness. PE is lower at 9.74x and its ROE is also quite low and dropping. If you had to pick between the two on fundamentals, you’d probably pick RCG. It’s cheaper and its ROE is higher. Its dividend is also higher. Technical Analysis
Both RCG and MYR charts aren’t too attractive. On technicals RCG is a falling bus. Whilst there could be a bounce, we advise not to go near it. Everything is pointing to bearish sentiment, the stock is in free fall and has exhibited a death cross. MYR too is exhibiting early signs of a sustained downtrend. It too is showing bearish sentiment. We advise against buying either stocks on technicals.

Broker Views

Myer Holdings (MYR)

  • Citi has a Buy recommendation with a target price of $1.30. The broker seems fairly bullish on the stock and says Q317 sales will come in at $663m which represents a fall of 1.9% on the pcp. Like for like sales are tipped to fall by -0.9%. This represents a fall of -0.5% like for like sales from 2Q17.

RCG Corp (RCG)

  • Morgans has downgraded to Hold from Buy recommendation with a target price of 68c. The recent trading update and subsequent profit downgrade disappointed the broker. As a result Morgans has lowered their forecasts for FY17 to be in line with the company’s downgraded forecasts.

Unconventional View The retail sector seems to be stuck in a world of pain. There are real concerns that the damage has already been done with the imminent arrival of Amazon. Just take a look at this week’s dismal retail sales figures. Retail sales missed by a long shot sliding 0.1% in seasonally-adjusted terms coming in well below a consensus forecast of +0.3%. It’s concerning to say the least. It marks the third fall in the last four months. Some blaming Cyclone Debbie for the weak result. Analysts now fear the retail sector is in dire straits with the imminent arrival of Amazon. Citigroup says the retail sector is on the verge of recession. If you were holding out, those hopes have been dashed with these retail sales figures. RCG has downgraded profit and Myer isn’t looking good. On Thursday MYR posted a Q317 sales fall of 3.3% down to $653m which was lower than Citi’s forecast of -1.9% at $663m. This result has dashed MYR’s hopes of delivering its 3% annual sales growth target and any real recovery in its share price. MYR has however reiterated its guidance for FY EBITDA growth to exceed sales growth in FY2017 and increased NPAT over FY2016. We think Credit Suisse may have over-reacted just a wee bit on their MYR downgrade earlier in the week. But competition is set to get a whole lot tougher in this space. The entry of Amazon and TK Maxx will all be too much for Myer and RCG. Whilst there is still some time before either of these two entrants launch, the market has already taken to both and sliced them in half. MYR first floated at $4.10 and reached a low of 83c back in 2015. Looks like it’s going back there again. The only catalyst that could surprise on the upside is a takeover bid from either Solomon Lew or Woolworths SA. Lew is still lurking around and hasn’t detailed his plans with his 11% stake in the company. We think this story has some way to play out. The retailer’s online offering is archaic in comparison to Amazon. It takes up to 7 days for delivery which is a lifetime in the online space. A takeover move by Lew’s could present new direction and new blood to a deteriorating business. So don’t write off MYR just yet. Myer is due to release its third quarter sales results on Thursday. In summary, we wouldn’t buy either stock. There’s too much downside risk and the environment looks too challenging. We simply can’t see either MYR or RCG getting out of this pickle anytime soon. The charts are horrible and the fundamentals aren’t appealing. Unless you’re looking for a short-term trade on a bounce, we think it’s best to avoid both stocks.

Stocks to buy after the budget – DOW & CIM

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In this section, we look at a few stocks that are set to benefit from measures announced in this week’s Federal Budget. For one reason or another these stocks have caught our attention and we think investors should look at buying these stocks because there is upside potential. When assessing them we look at the story behind the rise and assess them both fundamentally and technically. As with all stock, these too do carry risk which we urge you, as always, to consider. In this week’s Federal Budget one of the big-ticket items was $75bn to be spent on infrastructure. The big spending spree has boosted a few of the country’s infrastructure stocks which stand to benefit from these plans. The Government’s is looking to transition from the mining investment boom to a stronger, more diversified, infrastructure investment boom. It intends to do this via heavy investing in roads, rail, dams and infrastructure in cities and regions. Here are some of the planned upgrades:

  • Melbourne-Brisbane inland rail link gets $8.4b with construction to begin this financial year.
  • Second airport for Sydney at Badgerys Creek $5.3b over 10 years.
  • $844m to upgrade Bruce Highway.
  • $550m Victorian regional rail fund, $30m for airport link business case.
  • Government in talks to buy back share of Snowy Hydro from Victorian and NSW governments.
  • $37m for new energy infrastructure and gas pipeline in South Australia.

The Government infrastructure spending has renewed interest in construction, tollway and infrastructure stocks all posting positive gains this week:

 From the above list we have selected two stocks that we think will continue to outperform. Downer EDI (DOW) and CIMIC Group (CIM) are two stocks that we think are highly leveraged to the infrastructure theme.

 Downer EDI (DOW) – Provides services to customers in Transport Services, Technology and Communications Services, Utilities Services, Rail, Engineering, Construction and Maintenance and Mining. It’s quite a diversified business but has 3 main divisions – Downer Infrastructure, Downer Mining and Downer Rail. The two business that are directly exposed are Downer Infrastructure and Rail. Transport services comprises Downer’s road, rail infrastructure, bridge, airport and port businesses. Downer provides total rail asset solutions including freight and passengerbuild, operations and maintenance, component overhauls and after-market services. CIMIC (CIM) – The former Leighton Holdings, is a large scale construction, mining, mineral processing, engineering, concessions, operation and maintenance services to the infrastructure firm. It operates in more than 20 countries throughout the Asia Pacific, the Middle East, North America, Sub-Saharan Africa and South America. The company owns Leighton Contractors and Thiess which a construction, mining, and services contractor. Alliances include Sedgman, Silcar and Marine and Civil.
Fundamentals
  

On the StockOmeter both DOW and CIM rate pretty ordinary which is surprising considering both have excellent technical. On a PE basis, DOW probably comes up cheaper than CIM. DOW is trading on a PE of 16.76x and CIM on a PE of 22.96x. However CIM has a far higher ROE than DOW which means it’s a lot more profitable therefore justifying its higher PE. Both stocks have similar debt and yield levels. If we had to pick between the two, you’d probably go DOW on fundamentals. It came in with a StockOmeter reading of 65 versus CIM’s 51. Both stocks are attractive on technicals.

Technicals

On the charts, both stocks are displaying a bullish uptrend formation. CIM has just broken out on the upside following the budget plans. Those looking to buy CIM should be loading up on this bullish break out. DOW has also rebounded and has continued along its uptrend pattern. Again, those looking to buy should do so on this break out. Broker Views

CIMIC (CIM)

  • Macquarie has an Outperform recommendation with a target price of $42.50. The broker has a positive write up of the company following its April 1Q profit numbers. Profit guidance was reaffirmed and the broker likes the company’s leverage to infrastructure.

RCG Corp (RCG)

  • Deutsche Bank has a Hold recommendation with a target price of $5.91. The company held an investor briefing in May. From it, the broker notes that all divisions of the company are performing well. Even resources are looking better. Including the Spotless transaction, the broker estimates the stock is trading on a 12 month forward PE of 14x – that’s fair value in the broker’s eyes.

Unconventional View Clearly the infrastructure sector has received a kicker with this week’s big infrastructure spending plans. Investors look to be betting that stocks leveraged to this sector will do well this year and have confirmed their faith this week.  Macquarie has released a report following the budget. The broker says there is a multi-year positive earnings growth outlook for stocks such as Downer and Cimic provided projects are delivered on time and within budget. Macquarie expects CIM and DOW to have the highest exposure to infrastructure through the budget. Following that Monadelphous (MND) and Lend Lease (LLC) are other stocks that will also benefit. CIM has 30-35% of revenue exposed to Australian infrastructure across roads & bridges, rail, telco, water, health and social. It’s also has rail exposure through the UGL acquisition. DOW has around 20% of its revenues exposed to Australian infrastructure post the Spotless acquisition. DOW will also help provide rolling stock on new rail links and asphalt supply on new road projects. It includes road maintenance business, utilities and telco services, and passenger rail. Macquarie says the ‘the public sector pipeline alone’ provides enough upside for DOW, CIM as well as LLC and Boral to outperform. Now that’s saying something.

Which-ever you look at it the ramp up in infrastructure spending will be a big opportunity for both these stocks and it will provide a rise in tendering opportunities. For that reason we like both stocks and we think the addition of either will capture the upside potential. Toll-road operator Transurban (TCL) will also capture significant upside with any upgrades to the Monash Freeways.

Looking for an Aussie Small Cap Fund? – 8IP Australian Small Companies Portfolio

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When it comes to active and passive index hugging Australian blue chip funds, investors are almost spoilt for choice. There are a stack of funds that make the whole selection process confusing. You’ve got your Magellan’s right through to the Platinum’s. But when it comes to small caps funds there are dime and a dozen. Small Cap Shares are highly sought after and we know trying to pick small cap shares yourself is no easy task. Small caps help boost your investment returns and it’s much easier for a small to double or triple in size than for a top 10 company to grow by 5 or 10%%. So for that reason it’s a good ideato have a small cap fund in your portfolio to really boost its value. The hardest part however, is selecting a small cap Australian fund that actually performs. One where the fund manager has a knack for selecting the right growth stocks consistently. For that reason we’ve only found a few that are worth mentioning: the Katana Australian Equity Fund, the Monash Absolute Investment Fund and we have one more addition: the 8IP Small Companies Portfolio. The fund is headed up by PM Kerry Series (ex Co-founder of Perennial Investment Partners) and Stephen Walsh (head of investment banking at Wilson HTM), with Allan Moss (MD, CEO of Macquarie Group) and Simon Barratt (Chairman LEK Australia) on the Advisory Baord. So as you can see the team has a wealth of experience and knowledge. Like the other two, this fund also ticks all the right boxes. The 8IP Australian Small Companies Portfolio provides a concentrated exposure to Australian small companies. The investment team looks to identify and invest in companies with under-recognised growth potential. The Portfolio aims to outperform the S&P/ASX Small Ordinaries Accumulation Index over rolling five-year periods. Of-course returns are not guaranteed.

 The Investment Process
8IP seeks to invest in three types of companies: 1)     Companies with a multi-year competitive advantage.2)     Turnaround situations or3)     Under-researched companies. The investment team believes that these types of companies are often mispriced by the stock market. The 8IP investment team attends almost 500 company meetings per year and also sources information from independent external research providers. As 8IP performs detailed fundamental analysis on a large number of companies that fall outside the S&P/ASX 100 Index, the Fund has a wider opportunityset than many other funds. By carefully examining companies in this diverse investment universe in a systematic and disciplined manner, 8IP identifies mispricing which can be common in this less liquid and information starved market segment. The Fund then seeks to profit from these opportunities. The fund uses an investment philosophy which believes that the market is mostly right in its pricing of stocks. But when the following situations occur, the market tends to get its pricing wrong:

  • Sustainable high achievers (Stars) – The market tends to underestimate good news. Companies that deliver durable above market growth in revenue and returns.
  • Turnaround situations (Turnaround) – The market overestimates bad news such as a profit downgrade.
  • Under-research stocks (Under-researched) – And finally the market under-estimates good news and a re-rating occurs as coverage and liquidity increases.

The fund first looks at the Ex ASX 100 and uses a screen process to drill down from 2000 stocks to 100. It then uses fundamental research, risk reviews and portfolio construction to get down to the remaining 30 stocks that will make up the portfolio. Stocks are picks according to the following filters: Stars, Turnaround and Under-researched. The investment team scours annual reports, announcements, websites, Linkedin, Broker reports, Matau reports and trade media to gain a wide understanding of the company and its history. It also talks to management on a regular basis and conducts regular site visits. Finally, modelling and valuation is done by the quant analysts using relevant valuation metrics to help calculate a target price. The key reasons for selling a position are: if the stock moves to a lower conviction category due to price rise, or it hits its target valuation, or that earnings outperformance has ended. It may also be sold if there are better alternatives or the macro/risk situation has changed. We believe this is the difference between a normal fund and a great fund. Having a selling discipline is an important feature that we value quite highly. Many funds don’t have such a disciplined approach to selling and we find that to be one of the reasons for their underperformance.

Performance attribution

The fund’s top holdings are companies that we are quite familiar with which gives us a level of confidence. We have written about Skydive the Beach (SKB) for UWJ and it happens to make up 10.8% of the fund. The fund also holds Airxpanders and Cooper Energy. The Model Portfolio had a bumper year +26.22% (net-of-fees paid) for the calendar year. The top three contributors to return for the quarter were Freedom Insurance Group Limited, Compumedics Limited and Cooper Energy Limited. The top three contributors to return for the calendar year were Gascoyne Resources Limited, Prospect Resources Limited and Skydive the Beach Group Limited. Its annualised return since inception has been 42.04%.
As you’ll expect this fund is a high punching, small cap fund that delivers phenomenal returns. It’s the sort of returns you’d expect to see from taking on such high risk. That said, 8IP can manage risk by allocating up to 50% to cash.   All in all, we think the 8IP Aussie Small Companies Portfolio is perfect for those investors that are looking for that high return alpha from small cap Aussie stocks that they can’t find else-where. There sort of funds are a few and far between. In that respect, it the fund would make a neat addition to a diversified portfolio. As with all small cap funds however, these carry higher risks than the average index hugging fund. So we urge you, as always, to consider.  If you would like to learn how to access the 8IP Australian Small Companies Portfolio, contact your Sornem advisor. 

3 stocks from the herd – XRO, BLD, ANZ

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In this section we provide readers with three stocks that have attracted the interest of the broking community or the ‘herd’. Broker recommendations tend to be biased and highly optimistic. We try and breakdown these barriers and give our own honest opinion. It is important to keep in mind that technical analysis is only one part of the investment process and any recommendations do not give consideration to the underlying fundamentals of each business. Xero (XRO) – Current Price $21.80 – Xero is a New Zealand-based software company that develops cloud-based accounting software for small and medium-sized businesses. Its products are based on the software as a service (SaaS) model and sold by subscription, based on the type and number of company entities managed by the subscriber. Its main rival is MYOB. Shares have rallied this week after the company announced its net loss had shrunk to NZ$69.1m from NZ$82.5m a year earlier. The company said it now has 1,035,000 subscribers, after adding 318,000 over the past year. Broker View: Credit Suisse (NEUTRAL $23.50) – The broker has downgraded its recommendation from an Outperform to Neutral. Whilst it believes the Australian business is strong, it is uncertain about the North American venture. It also notes the stock is up 33% in 6 months and for that reason it’s looking fully valued.

Unconventional View: We disagree with Credit Suisse. The StockOmeter ranks XRO quite poorly, but that’s because the company isn’t making money. As a result its PE, ROE and Dividend Yield are all Null. So it loses points making the StockOmeter largely irrelevant at this point. So let’s ignore it as this story isn’t a fundamental one. We’ve like XRO for quite some time, but the stock has been trading largely sideways and has been overlooked by brokers because it still is at a loss. Well this week, the company turned the corner and is very close to booking a profit. And that’s close enough for us to buy the stock for the Ferrari portfolio. The New Zealand company posted a Net loss of NZ$69.1m from NZ$82.5m last year. While it is still a loss, it’s a huge improvement and makes us even more confident that it’s heading towards profitability. We think this is something investors should reallybe looking at. As the market starts to realise and take into account XRO’s being profitable in a few years, more and more brokers will start to jump on board and the share price will start to move higher. It didn’t pay a dividend as expected. Operating revenue was up 51% to NZ$295m and its cash balance was NZ$113.7m. These are all the signs of a company that is making great in-roads and break even is just around the corner. That’s why we are advising investors to jump in now before the break-even point. The other big tick was that XRO pushed past the 1.04 million paying subscribers mark compared with 862,000 at the end of September. XRO is really kicking goals and moving customers onto its platform in leaps and bounds. Some of the fundamental guys will argue that the company has never turned a profit. But so what? It took years before Facebook turned a profit. So what you’re betting on is that XRO will continue at this run rate by successfully adding on subscribers and break even sooner rather than later. XRO is innovative and leagues ahead of MYOB. Their next innovation is code free accounting so that it doesn’t need to worry about coding a transaction, they can just send the transaction in, and Xero codes it for them. The other thing to keep in mind, is the moment XRO become profitable – In come the institutional investors. Passing this milestone will means a change in its share register as larger funds and brokers start to cover the stock. Is cash balance remains healthy and Xero must now show it can deliver on expectations of cashflow break-even in its 2019 financial year. That’s the goal. We think it can. On the chart, XRO has broken out on the upside of what looked like a pennant flag. This bullish break out looks to have formed a new short term uptrend, which we think will continue. Investors should look to buy on the back of this break out.

 Boral (BLD) – Current Price $6.82 – Is a cement, concrete, quarry materials, asphalt, and concrete supply business that looks after the Australian building and construction industry. It also manufactures and supplies bricks, roof tiles, timber and windows to the residential and non-residential construction sectors. Boral Gypsum is a supplier of plasterboard and interior lining products across Asia, where it has manufacturing positions in eight countries. And is has significant presence in USA. Boral supplies clay bricks and manufactured stone veneer (Cladding), and in clay and concrete roof tiles (Roofing) in the USA. This week the company announced the successful acquisition of Headwaters Incorporated,a leading building products manufacturer and fly ash marketer in North America. Boral USA and Headwaters combined will form a new division to be named Boral North America – a US$1.8 billion revenue business. Broker View: Deutsche Bank (BUY $8.07) – The broker is bullish on Boral. It says the acquisition of Headwaters makes sense and with its combined synergies it makes the stock even more attractive. Deutsche is also quite confident on the US economy which should bode well for Boral.

 Unconventional View: We agree with Deutsche Bank. Just about every broker for that matter has a Buy on Boral so we’re with the herd on this one. The StockOmeter however ranks BLD in the Not Bad territory with a reading of 54. This is because its ROE seems to be falling and it is trading on a rather high PE of 23x. Debt is low and its yield is ok. So overall its fundamentals are so so.

Nevertheless, we think Boral will benefit from the $75bn infrastructure funding package. It includes funding for rail, a second airport in western Sydney, highway funding and for Snow 2.0. All of these projects should provide a large increase in tendering opportunities for Boral as well as other infrastructure plays. According to a Macquarie report BLD has significant revenue exposure to infrastructure development activity going forward. We think this provides upside potential for the stock.

 The other thing to look at is the Headwaters acquisition. With the US economy in full recovery mode, Boral USA is perfectly position to reap the benefits. Deutsche has factored in some US$80m in sydnergies with the Headwateters business. Most brokers have raised their estimates just on the back of the transaction. UBS has upped its FY17 estimates by 2%. So on that basis, we think Boral’s outlook is quite rosy. On the chart, BLD looks to have bounced following the budget release. It is however trading at the top of its uptrend channel. We advise investors wait to see if it bounces of breaks this resistance line. Either way though, BLD is in a strong uptrend channel and is worthy of a place in your portfolio.

ANZ – Current Price $29.07 – This week the Federal Government unveiled sweeping changes to its budget that affect the banking sector. Australia’s big four banks plus Macquarie will wear a new tax worth $6bn. The bank levy is forecast to raise approximately $1.5 billion per year over the next four years. The government will also create a “one-stop shop” for all financial complaints, called the Australian Financial Complaints Authority (AFCA). It will seek to ensure consumers have access to free, fast and binding dispute resolution services. All financial companies that deal with consumers will be required by law to be a member of the AFCA. The Australian Prudential Regulation Authority (APRA), will also be beefed up to oversee the new Banking Executive Accountability Regime. APRA will be able to suspend banking executives and issue hefty fines. Broker View: USB (HOLD $30.50) – The broker says the half year result was messy and there are a few items that have distorted the picture. Although the bank has strengthened its balance sheet it came at the expense of revenue power. The sale of the Asian business will reduce profit by $88m.

Unconventional View: Whilst USB have a hold, we’re a tad bit more bearish. Now two weeks ago we wrote up ANZ in 3 stocks from the herd (click here) and gave it quite a positive glow. We thought the bank would post a bumper profit result together with a shrinking net interest margin which would help continue its positive momentum. We were wrong. And that’s the way the cookie crumbles. Can’t always be right. ANZ posted a $3.4bn cash profit for the six months to March 31 which was below expectations of a $3.5bn profit. The result was messy to say the least. It was hit by writedowns and shares tumbled on the open. ANZ Bank shares 2.8% to $32.00 at market open. Ouch. The below par result set the scene for the bank reporting season. The sector remains constrained with intense competition and pressure on margin, subdued lending growth, rapidly changing customer expectations and increasing regulation. Sure the result was messy but impaired assets declined 7% and the total provision for bad debts edged down to $720m. Thee credit environment was stable despite pockets of weakness. What makes us bearish isn’t the profit result. It’s the Government’s bank bashing that has us concerned. The banking sector has been put on notice. The entire game has changed. A new levy on the banks has really spooked investors accelerating the Bank reporting sector sell off and ANZ is leading the fall. It’s down 12% since the start of May. This levy has really opened up pandora’s box and bankers are furious at the fact that there was no consultation. The big banks are really seeing this as a kick in the teeth and are banding to wage a mining tax-style ad war against the tax grab. The banks walked away from a meeting with Treasury, none the wiser. The new tax will be levied on borrowing used to fund bank lending, including corporate bonds and large deposits, but it will not affect shareholder capital and smaller deposits below $250,000. The tax will is likely to be a hit of 5% of their earnings or will cost ANZ $417m. The concerning part is that ANZ is more than likely to cut its dividend to absorb the impact of the 0.06% tax on liabilities. It has no other choice. This will lower EPS and lower the attractiveness of ANZ. The banks could go ahead and pass it onto customers but this won’t look too good. So in the end we think shareholders will be left to foot the bill via a dividend cut. The market has already hammered banks by the tune of $14bn in market capitalisation that was lost this week. And to top it off the banks copped a stack of analyst’s downgrades on Wednesday as a result the levy.

 We pinched this from the AFR.  There’s no denying that the banks are a money-making machine,but with this uncertainty in the air and brokers downgrading recommendations, we think it’s a good idea for the shorter term investors to stay clear of the banks. Wait till this is all over, then pick the banks back up at a lower price. If you look at the ANZ chart, the stock has busted through its uptrend support line. It looks to be forming a new short term downtrend. This is a bearish sell indicator. ANZ could drop a lot further. We think now is the time to lock in profits.

 

Looking for a Euro Fund – THB

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Following our article “It’s getting warmer in Europe and Japan” (click here), we’ve been searching for a fund that is exposed to both the EU and Japan that we can recommend to clients besides the Platinum Europe & Japan funds. It wasn’t an easy task. Surprisingly there aren’t many funds that specifically cover this space. Sure you’ll find a stack of funds that invest globally and have some small percentage allocated to Europe, but there aren’t many that solely invest in EU and Japan. That’s when we came across the THB International Opportunities Fund.

About the Fund and the Company Founded in the US 1982, THB has been investing and trading in smaller cap securities for over 30 years. It has a long and rich history and very experienced team. The investment team is made up of ten investment professionals and was founded by three principals Alexander J. Thomson, Richard A. Horstmann and William W. Bryant. It has achieved a superior long- term record of investment performance using a disciplined small cap value approach to equity management. The firm has outperformed the Russell 2000 Index of small cap stocks seven out of the past eight years, and it has ranked among the top 20% of investment managers in its peer group over the past six years. The fund manager is a boutique investment advisor that specialises in Micro Cap and Small Cap equity strategies. It manages more than $1.7 billion via four main funds – Micro Cap, Mid Cap, Small Cap Core and the International Opportunities funds. THB is able to discover companies that are traditionally neglected from researchers and investors with above average growth potential and attractive valuations. They use a bottom-up approach to help identify stocks that the market has undervalued, failed to recognise the inherent value or has overlooked the resulting synergies available with respect to potential acquisition. Brookvine is the company engaged to advise THB on the Australian investment markets and to manage the marketing side of its business. THB is 100% employee owned. The latest fund is the THB International Opportunities strategy. It seeks long term capital appreciation over full market cycles by investing primarily in companies within the MSCI World ex-US Smallcap Index that it believes are undervalued, exhibit lower risk characteristics, and have superior operating metrics. The fund holds up to 150 securities and has high active share. Basically a focused portfolio of high quality names can offer superior risk-adjusted returns. THB takes a very long term view of the investment horizon, and seeks to outperform over full market cycles by seeking out investment opportunities trading below their intrinsic value. THB’s mantra is to think like owners and look to invest alongside proven management teams. The fundies aim is to construct a portfolio of high quality, self-funded, low risk companies with valuation metrics similar to or lower than the benchmark, yet with superior long term characteristics. The best companies are able to grow their businesses organically and via acquisitions using internally generated cash flows. Debt should be kept to a minimum with a preference for companies who retire shares outstanding.

The Investment Process


The fund manager’s investment decision process starts off by screening over 2,000 companies with market capitalisations between $50 million and $750 million. It uses Quant screening processes to sift through the rather large universe. Then it goes onto fundamental valuation techniques to reduce the universe to approximately 125 firms, with a preference for low price to earnings, low market cap to gross revenues, strong management and low institutionalownership. Management then conduct proper research and company meetings to gain a good understanding and insight into the company. Companies that appear to have fundamental change in progress and a minimum of 50% capital appreciation potential over two years are considered as potential investment candidates. THB retains a buy/sell discipline based on changes in valuation assessment, fundamental analysis, diversification and market environment.  THB applies a Quality Assessment and Risk Ranking during the research and portfolio to monitor, evaluate, compare, size, and manage risk. It also helps keep abreast the each stock’s ongoing progress. It is an active approach that helps screen companies to fit its desired profile. THB’s ultimate goal is to find stocks of companies that are trading below their intrinsic value and have superior operating metrics.

Performance

The fund’s benchmark is the MSCIWorld ex USA Smallcap Index (Index) which returned 7.7% in USD in Q1. The THB International Opportunities Composite returned 11.4% in USD (net of fees) in Q1, outperforming the Index by 3.7%.

The Major Holdings
The strong performance came from positive stock selection in Japan and Germany and an overallocation to Germany. From a sector perspective, positive stock selection in Industrials, Consumer Discretionary, and Materials contributed the most to performance. THB’s top five performing stocks were CTT Systems (Sweden, Industrials; +0.6%), bet-at-home.com (Germany, Consumer Discretionary; +0.6%), Treatt Plc (United Kingdom, Materials; +0.5%), Cellavision (Sweden, Health Care; +0.5%), and Kirkland Lake Gold (Canada, Materials; +0.4%). The bottom five performing stocks (from a contribution standpoint) were Starbreeze (Sweden, Technology; –0.2%), Hong Kong International (Hong Kong, Industrials; –0.1% ), Mobile Embrace (Australia, Technology; –0.1%), Tracsis Plc (United Kingdom, Technology; –0.1% ) and Kenko Mayonnaise (Japan, Consumer Staples; –0.1%).

  • Country performance was strongest in Austria (+18.7%), followed by Italy (+15.3%) and Switzerland (+12.5%).
  • Country performance was weakest in Norway (–2.1%) and Finland (+0.5%).

  

Why invest with THB? The word on the street right now is that Europe and Japan are the place to be. The US and Aussie stock markets have had an amazing year. The ASX 200 Index is up 17% and the Dow Jones Index is up 16.84% since this time last year both rallying off solid economic data, strong corporate earnings and Trump’s emphatic victory but are we at that inflection point? The ASX 200 Index is trading on a PE of 19.21x compared to its long term average of around 15x. The S&P 500 Composite Index is trading on a PE of 21.42x. This makes valuations look a bit stretched and people seem to be getting greedy. There are however a few factors on the horizon that are a little concerning and have led us to change our outlook on both the Aussie and US markets. Last quarter marked a pivotal point in recent economic history. The US Federal Reserve not only raised interest rates but flagged another two more rate rises this year, all but ending the days of easy money creating a massive knock on effect throughout the rest of the world. The concerns are when rates go up it causes a knock on effect here with banks, property market, bonds and stock market. A lot of this year’s gains have also come on the back of Trump’s promise to spend big on infrastructure and reduce taxes. If this fails to materialise, you can only expect a violent sell-off as markets reposition. Valuations are a little stretched. It’s time to think outside the box, lock in profits and redeploy into new opportunities. We think the answer is Europe and Japan. What we’re seeing is global fund managers eyeing both European and Japanese stocks that are currently trading at deep value discounts after being sold off last year. Sure there’s still a lot of political noise such as rising populism, key elections in France and Germany and Brexit still in the mix but we think these concerns are well overdone. EU equities are trading at roughly a 47% discount to the US. BA Merrill Lynch found that the two most popular destinations for investors to park their money was Japan and Europe. European Purchasing Managers Indices are in expansion mode and rising, fundamentals are great and there is positive growth in countries such as Ireland, Spain, Netherlands and Greece. Whilst it’s not blistering, it’s a good sign. The FTSE 100 is up 21.9% since its post Brexit mark, Germany’s DAX is up 22% and France’s CAC is up 15%. A lot of it is to do with shifts in currency when the Pound was obliterated. The team at THB who are steering the International Opportunities Fund seems to be all over it. The fund outperformed the MSCI World ex USA Smallcap Index (Index) which returned 7.7% and the fund returned 11.4%. And if you drill down into its country holdings the strong performance came from Europe: Austria (+18.7%), Italy (+15.3%) and Switzerland (+12.5%). We think it’s difficult to find this type of European exposure, there aren’t many funds out there that have such concise exposure and ETF’s are benchmark hugging. So for that reason, we think THB is the perfect managed fund for investors to diversify their portfolio away from the US and Australia and into Europe and Japan.

3 stocks from the herd – WOW, REA, CGC

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In this section we provide readers with three stocks that have attracted the interest of the broking community or the ‘herd’. Broker recommendations tend to be biased and highly optimistic. We try and breakdown these barriers and give our own honest opinion. It is important to keep in mind that technical analysis is only one part of the investment process and any recommendations do not give consideration to the underlying fundamentals of each business.

Woolworths (WOW) – Current Price $26.39 – Delivered a solid Q3 with Australian Food sales up 5.1% to $9.3 billion with comparable sales growth of 4.5%. There has also been a significant ramp-up in Supermarket renewals run-rate with 49 planned for second half. New BIG W team and turnaround plan in place with tactical initiatives are underway. The business is expected to report a loss before interest and tax of $115m-135m for H2’17.

Broker View: Macquarie (UNDERPERFORM $26.20) – The broker has released a bearish view on Woolies. Despite the great sales result, BIG W and Target are concerns going forward and remains a drag on business. Macquarie also thinks the market is pricing in an unlikely earnings recovery in food in the face of increasing competition.

Unconventional View: We disagree with Macquarie. Woolworths is back baby and back with a vengeance. We’ve been staunch followers of WOW. In-fact back in July 2016 (click here) when every broker had a Sell, we said “Everything that could have gone wrong for Woolies has and all the downside risk is already baked into the price. A big transformation is at play and it’s about time.” WOW was trading at around $23 back then, it’s now up 12% since then. We definitely got that one right. The question now is whether you would continue to hold or buy? We think so. After investing more than $1 billion cutting grocery prices and delivering its strongest supermarket sales growth since 2010, Woolworths has remarkably turned its ship right around with Banducci at the helm. The grocery chain is working hard to not only steal back market share lost to Coles and Aldi but to protect it from the entry of Amazon and Lidl. The recent sales update only highlights that how successful the turnaround strategy has been. WOW posted one of its strongest results thanks to higher supermarket sales. Sure significant discounting was helping drive sales growth and investing in prices, staff incentives and training costs money. Nevertheless its positive and a big improvement. There’s still a lot of work to do in the grocery space before it can take Amazon head on. The only laggard left is BIG W. FY losses are expected to blow out to $160 million. Something needs to be done and soon.

 On the plus – Woolworths appears to have taken market share from most competitors during the quarter. Like Coles, Woolworths has lowered the number of products on promotion and moved more products to every-day low value to maintain customer trust in its prices. On the chart WOW is sitting on its uptrend support line but continuing to move up along it. On an RSI of 44 it’s not expensive either with MACD still positive. We just caution investors to be weary of a break in support. But as long as it holds this support line and makes higher highs, we think it’s an attractivebuy.

REA Group (REA) – Current Price $63.92 – This week REA announced plans to slap real estate agents with another 15% price hike. The price rise is larger than expected. Agents were preparing for a 10% price rise. The average price increase is approximately 15% for agents that are on a Premiere-All contract but for other agents, the increases are larger closer to 18%. The move will boost REA’s bottom line.

Broker View: Citi (BUY $72.50) – The broker’s observations are that the average price increase will be approximately 15% and larger increases for agents that are not on Premiere-All contracts. The increase was a lot larger than the broker expected and it increases FY18 earnings. Earnings raised by 1% in FY18 and 5% in FY19.

Unconventional View: We agree with Citi. REA have significantly upped the price it charges real estate agents. Good on them. The larger price increases for agents on lower contracts will lead to more agents taking premium packages. It’s a smart way for REA to get all agents onto the premium packages. The trend is that most agents will step up to Premiere over time. One broker is expecting a 20% rise in Australian revenue for 2018 financial year and the majority of the rise will come from residential listings. That’s quite a significant uplift. Previously volumes had been a significant headwind with the number of listings falling. There is now the potential for upgrades if volumes normalise. Even though listings are down, the uptake of the premium products will rise. All bodes well for the company’s bottom line. The only downside to REA is a big correction in the property market. We don’t think that will happen anytime soon, although markets may cool a little this year. All in all – REA is an attractive growth story that has turnedits fortunes around. Yes it’s expensive trading on a PE of 31x but its ROE is high. If listings volumes can recover somewhat and prices rise, REA will post an impressive FY earnings result.

On the chart – REA is hitting the upper end of its uptrend channel. RSI is at around 67. So on a few counts the stock is looking a little toppy. We like the story and we think there is great upside potential, but it’s a touch too expensive to buy just yet. Wait for pullback under $60. Then look to buy in.

Costa Group (CGC) – Current Price $4.33 – Held a presentation for the Macquarie Australia conference. In it the company outlined Avocados as its fifth pillar via the acquisition of Avocado Ridge based in Childers, Queensland. It also issued a positive trading update. The company reconfirmed previous guidance of NPAT growth ofapproximately 25% for the full year. Key seasonal trading in the final weeks of FY2017: Commencement of citrus season with ~100,000 tonnes forecast for the season. Far North Queensland berry season is gearing up with volumes increasing from May to fill the autumn/early winter shoulder periods– African Blue season is in full swing with harvest expected to be completed by June.

Broker View: UBS (BUY $4.80) – The broker has released quite a bullish review of the company following its trading update. CGC reiterated FY17 guidance for underlying net profit growth of 25%. This together with the company’s commitment to buy the berry, mushroom and China growth projects confirms for the broker that the company is on track to deliver earnings growth in the mid teens on a 3-5 year view.

Unconventional View: We agree with UBS. We’ve been fans of Costa for quite some time. We wrote back in December quite a positive review when the stock was trading at $3.22. It’s now 25% higher. UBS has also been on the ball. We agreed with the UBS Buy recommendation (click here). The stock has been the only star performer in the agriculture space this financial year. Some saying it has all the traits of being the next Bellamy’s. It has a dominant position and is the largest supplier of fresh fruit and veg to the big grocers such as Woolies, Coles and Aldi. The recent trading update is another big leg up. Costa reaffirming of its previous guidance only highlights its super performance. There was also no impact from Cyclone Debbie which crossed the coast south of Bowen and missed all of our Far North Qld operations. Costa is gearings up for the citrus season with ~100,000 tonnes forecast for the season and far North Queensland berry season is gearing up with volumes increasing from May to fill the autumn/early winter shoulder period. On the chart, Costa is looking expensive and toppy. Whilst we love the story and think there is massive upside potential we advise traders to be cautious. On any bad news, the stock can easily pullback towards the $3.20 support line. So in light of that. We advise traders to wait for an upside break out, before buying just yet. The upside break out will confirm the continuation of the uptrend.