The Week in Review, by Shane Oliver (AMP Capital)
Investor Signposts, by Savanth Sebastian (CommSec)
BHP’s biggest mission isn't impossible
I have known every BHP chief executive since Ian McLennan in the 1960s. I have heard them all give bullish and bearish statements, but I have never heard any BHP CEO talk like Andrew Mackenzie did on radio late in the day on Tuesday August 22 after more than 12 hours on his feet.
Andrew let his aims for BHP all hang out. Some of you will have heard the broadcast, but only if you look at a transcript does what he was saying hit home. Accordingly, I am going to slightly edit extracts from the Mackenzie remarks to help you see the significance. And I will add a few comments of my own in brackets.
Last week I think I steered you in the right direction for BHP and pretty much the daily press followed that pattern after the announcement.
But my friend Ross Greenwood on Macquarie radio went one step further with Andrew Mackenzie. Here are my extracts from that interview:
Mackenzie says: “We have used a disproportional amount of cash to create a strong BHP balance sheet and we have a dividend policy that means we can face the future with confidence, because almost anything the world can throw at us we can survive and we can probably make money.
“We made a company that actually can be very profitable even at quite low commodity prices.”
My view: (BHP has not forgotten the trial it went through and therefore wants to keep its borrowing low.)
Mackenzie: “Iron ore is trading a bit higher than what you would say was its long-term midpoint, but those price increases come with other things like higher costs of goods and services and a stronger Australian dollar that add to our costs.
“Because the company is so well run we have absorbed all of these costs via our agenda of efficiency and discipline.
“The benefits of those higher prices goes straight through to the shareholder .
“Let me give you the numbers in US dollars – we are paying out a dividend of $4.4 billion and that’s $1.1 billion more than we would have to pay out if we just followed our normal formula of paying out about 50 per cent of profits.”
My view: (BHP clearly wants to substantially increase its payout to shareholders in coming years and those payouts will come via higher dividends and capital returns. This a BHP we have never seen in my lifetime and you probably need to go back to its years as a lead and zinc miner in Broken Hill to see it duplicated).
Greenwood then skillfully drew the BHP CEO into going further by bating him with a comparison with his Australian peers. Greenwood uses Commonwealth Bank, which has seen its return on shareholders capital employed fall from 18 per cent to 16 per cent — but it is still 16 per cent. And Telstra, which also had tough times, generates returns of 13.6 per cent.
Greenwood asserts that BHP, even after a good year, has achieved a return on capital of only 10 per cent — it’s not good enough!.
Mackenzie came back with all guns firing: “Well it is not good enough but it was 2 per cent last year – we have moved it up to 10 per cent.
“If these prices carry on we will at least get to 11 per cent this year. But the drive on our return on capital that you have referred to reflects some of the issues we had with our shale business and some of the issues we have had with Olympic Dam and our copper business in Chile.
“We have a plan to substantially boost the return on capital in our copper business – up to the sorts of numbers you are talking about for Telstra and for Commonwealth Bank.
My view: (Read that again. That’s a forecast of a huge rise in BHP profit. Mackenzie has never said anything like that elsewhere.)
Mackenzie: “And remember our iron ore and coal businesses are offering returns in the mid-20s.
“Because of the way we are running this company now and because we have made it simpler and are connecting to the workforce, we are working much more productively.
“We are buying more efficiently, we are selling more efficiently and making more efficiently, so these sorts of relatively high returns will persist even at lower prices.
“And current prices are not that great relative to what we have seen in the past, yet we are making as much cash, almost as much cash, as when we had much higher prices.
(At this point Mackenzie warms up and gets really excited.)
“And I am telling you we have a plan for conventional petroleum and for copper.
“When we finished a series of investments – and we are now going to really milk those investments – we don’t have to invest anymore. Copper and conventional oil will become cash machines.
“We will drive things up to levels of return that I think have a chance of accelerating on those companies you commented on.
“Of course, it is dependent very much on price … but if we exit the business where we know it is impossible to get such returns (US shale oil and gas) … we are planning to invest in businesses that will earn returns in the 20s and 30s and beyond.
(And now he emphasises what was a big announcement missed by many in the media.)
“And we’ve got a lot of success. Today we announced potentially a very significant large oil discovery in the US Gulf of Mexico, we made a gas discovery about 12 months ago – a decent size in Tobago and we were very successful in being the first foreign company after 80 years back into Mexico to develop an undeveloped oilfield that has already been discovered.
“They are all going to help boost this return on capital and if we keep disciplined in the way I described – very quickly we are going to have a balance sheet with net debt of about of $10 to $15 billion.
“That means all the excess cash of the returns we produce will flow to shareholders”.
My view: (BHP’s past errors and the lower prices plus spin-offs caused it to lose its mantle as Australia’s largest company to the four big banks. But it’s reversing. BHP will soon rank third after CBA and Westpac.
If BHP can fulfill the predictions of its CEO, then it will challenge the CBA and Westpac to become Australia’s largest company once again. The problems of the CBA may contribute to this.
BHP is a cornerstone of most Australian portfolios. The world may turn pear-shaped, in which case BHP will disappoint, but so will many other companies.
Given that sort of statement from the normally conservative Scotsman, BHP should be part of most long-term portfolios.
Investment markets and key developments over the past week
- Share markets were mixed over the last week with good global data but ongoing concerns about US politics and mixed earnings results in Australia. Chinese shares saw good gains, US shares were up modestly, but Eurozone, Japanese and Australian shares were all down slightly. Bond yields were flat to down slightly, commodity prices were mixed with oil and iron ore down but metals up and the $A slipped a bit.
- Trump continuing to throw curve balls, adding to the risk but maybe not as bad as it looks. From North Korea, to Charlottesville, to a revolving door team in the White House and now the approaching budget/debt ceiling negotiations, the political mayhem in the US continues with President Trump at the centre of it. His comments to a rally of his supporters that he might terminate NAFTA and use the threat of a Government shutdown to get funding for his wall have naturally kept investor nervousness alive around US policy and particularly the issue of a debt default if Congress and the President fail to agree a bill to increase the debt ceiling by late September/mid-October. This is because funding to avoid a shutdown may be pared with a bill to increase the debt limit by late September. US Government funding will run out on September 30 and the debt ceiling will be reached sometime between then and mid-October. As we saw in the last US Government shutdown between October 1-16 in 2013 the economic impact was minor, so another short shutdown would not be a major problem but a failure to raise the debt ceiling in time would be: although the US Treasury would avoid defaulting on its debt initially it would be forced to stop making some entitlement payments – and this may trigger a broader downgrade to America’s credit rating which as we saw in 2011 caused a mini financial panic. However, there are several points to note in relation to this:
-- Trump should be taken seriously but not literally. He can go from Trump the populist rabblerouser to Trump the pragmatic businessperson within the same day to the point he looks schizophrenic so there is a danger in reading too much into what he says.
-- Related to this his comments on shutting down the Government and building the wall naturally appeal to his base but so did his comments about declaring China a currency manipulator and imposing 35 per cent tariffs on Chinese imports and they haven't happened. His comments on both NAFTA and the shutdown are likely both just part of a negotiating ploy.
-- Congressional Republicans (and Democrats) are well aware of the blame they will take if welfare payments are stopped. The American public tended to blame Congressional Republicans for the 2013 shutdown and debt ceiling delay and they would probably do the same again which would not be good ahead of the 2018 mid-term Congressional elections.
-- Consistent with this House Speaker Ryan has indicated that they are not interested in a shutdown, the chair of the conservative tea party group in the House has said “we will raise the debt ceiling and there shouldn’t be any fear of that” and Senate Majority Leader McConnell has said earlier this week that there is “zero chance, no chance, we won’t raise the debt ceiling.”
-- With the departure of political adviser Stephen Bannon the populist influence around Trump in the White House has been dramatically reduced (almost wiped out).
-- Finally, indications in the last week are that the White House and congressional leaders are making good progress on tax reform. The desire to achieve something by the 2018 mid-terms is a big driving force behind congressional Republicans’ in terms of tax reform.
- As a result, our view remains that the debt ceiling will be raised in time and some form of tax reform will take place. However, unlike in the 2011 and 2013 debt ceiling debates the President is no longer calm and cool and has become a third force in the negotiations. So the risk is high that there will be lots of market disturbing argy bargy and last minute brinkmanship ahead of signing a new funding resolution and an increase in the debt ceiling. The worst case could be a two-week shutdown from October 1 which focusses public pressure ahead of a debt ceiling increase just before the ceiling is reached. Just like in 2013.
- Political uncertainty ramped up a notch in Australia with the High Court unlikely to rule on the citizenship issue of five (soon to be at least seven) Federal parliamentarians until October/November with a significant risk to the Government’s ability to govern and the risk of an early election if the Court takes a literal view of the Constitution. The prospect of six prime ministerships in just over 10 years is not a good look. The risk of an early election has yet to impact Australian financial markets. But it would likely weigh on business confidence which has been surprisingly upbeat since the 2013 change of government to the Coalition which in turn could adversely affect employment and investment. A change of government would also have significant implications for banks (with the Labor Party committed to a bank royal commission) and property prices (with the ALP committed to restricting negative gearing and cutting the capital gains tax discount).
Major global economic events and implications
- US data remains solid with the composite business conditions PMI rising solidly in August to a strong reading of 56 driven by strength in the services sector. Jobless claims remain low and home prices are continuing to rise. Home sales fell in July though.
- The Eurozone composite business conditions PMI also rose in August to a strong reading of 55.8 driven by manufacturing. Consumer confidence is about as strong as it ever gets.
- Japan's manufacturing conditions PMI rose in August to a solid reading of 52.8. Core inflation remained around zero in July though highlighting that it will be a long time before the Bank of Japan can consider an exit from ultra easy money policy.
Australian economic events and implications
- Australian data was light on but skilled vacancies rose in July indicating that the jobs market remains solid.
- We are now about 85 per cent through the Australian June half earnings reporting season and results have remained a little disappointing. At a high level profits look good: they are up with 70 per cent of companies reporting higher profits than a year ago (see the first chart below) which is the strongest since 2010, 69 per cent have increased dividends from a year ago which is a good sign regarding the quality of earnings and overall earnings per share growth for 2016-17 is coming in at around 17.5 per cent which is a huge improvement after two years of declines. However, dig beneath the surface and it’s not quite so good. First, the huge upswing in earnings owes to the rebound in the fortunes of the big resources stocks with resource sector profits up around 130 per cent and there is no doubt that the turnaround here is impressive and reflecting this they have increased their dividends substantially. However, profit growth in the rest of the market is more modest at around 5-6 per cent. What’s more only 38 per cent of companies have surprised on the upside (which is less than normal and the weakest since 2012) and 32 per cent have surprised on the downside. Outlook guidance has also been a bit soft. While the market as a whole has been relatively stable through the reporting season – it’s basically flat for August to date - and a roughly equal number of companies have seen their share prices outperform and underperform the market on the day they released results, beneath the surface there has been intense volatility with some very sharp declines in share prices for companies who disappointed (eg Dominos, Telstra, Suncorp, QBE, Bluescope and Healthscope) either in terms of the result, outlook comments or dividends. The problem of course is that PEs are relatively high and so much has been factored in. As a result, expectations for earnings growth for the current financial year have been revised down a bit to 1.8 per cent, although again it’s worth noting that profit growth for the market excluding resources is expected to remain relatively stable at around 5 per cent. Key themes have been: large caps doing better than small caps; resources stocks back to strength; constrained revenue growth with the domestic economy just okay with housing still strong but retailing mixed; some disappointment from foreign earners; and dividends (ex Telstra) continuing to roar ahead.
- While profit growth for Australian listed companies ex the miners at around 5 per cent is all right – it’s well below that in the US (at around 11 per cent) and Europe and Japan (at around 30 per cent lately) so it’s another reason to maintain a bias towards global shares over Australian shares.
Shane Oliver is Chief Economist at AMP Capital
Start of Spring: a number of key economic indicators for release
- Every change in seasons is ushered in with a barrage of economic data. So with the profit reporting season coming to an end, now it is time for the Spring economic data reporting season. Business investment and home prices are the highlights in Australia in the coming week.
- The week kicks off on Tuesday with the usual weekly consumer confidence survey. Also the Australian Bureau of Statistics (ABS) releases detailed dollar estimates of consumer spending – pivotal figures for a raft of businesses.
- On Wednesday, the ABS issues preliminary construction work done figures for the June quarter. Also the ABS releases the volatile building approvals data - the collated information of approvals by local councils to build new homes and commercial buildings. The construction data covers residential, commercial and engineering construction, but it is the residential building figures which act as an input to the national accounts – that is, it assists in calculating economic growth for the June quarter.
- In the March quarter construction work fell by 0.7 per cent, driven by a 4.7 per cent slump in residential work. However engineering work lifted by 2.2 per cent. At present building sector inflation is growing at the fastest pace in eight years, but that is being driven by outsized gains in activity last year and it is likely that inflation will moderate in line with home prices over the coming year.
- On Thursday, investors and traders will have a lot to focus on with a number of indicators scheduled for release. Arguably the most important release from the ABS will be the March quarter estimates on business investment. This data is also an input into the calculation of economic growth. But also insightful are the estimates of planned investment for the coming year.
- In the March quarter investment rose by 0.3 per cent, and despite the improvement in the global economic outlook and lift in business conditions, we expect that investment fell by 2 per cent in June. The Reserve Bank will be interested in estimates of non-mining investment as well as future investment plans.
- Also on Thursday, the Reserve Bank releases data on private sector credit – or loans outstanding. And at the same time the Housing Industry Association issues estimates of new home sales.
- Private sector credit surprisingly rose by 0.6 per cent growth in June, with annual credit growth rising further from recent 3-year lows. What was most encouraging about the June result was the 0.9 per cent surge in business lending. Policymakers will be hoping the lift in lending translates to a lift in investment over the coming year.
- On Friday, CoreLogic releases the latest data on home prices together with Commonwealth Bank/Markit Manufacturing gauge.
- On current indications Australian home prices may have posted another solid rise in August, up by around 0.7 per cent. The daily data indicates that Sydney and Melbourne prices have lifted by 0.8 per cent so far in August with Adelaide prices up by 1.3 per cent.
US housing indicators to watch
- The key economic data release on international markets in the coming week is the US non-farm payrolls or jobs data to be issued on Friday. Key purchasing manager surveys in the US and China are also in the spotlight.
- In the US, the week kicks off on Monday with the release of data on wholesale inventories as well as the release of the Dallas Federal Reserve manufacturing gauge.
- On Tuesday, the CaseShiller home price series is released alongside the Conference Board Consumer Confidence index. Home prices are up 5.7 per cent over the year, driven by a lack of inventory of homes for sale.
- On Wednesday the ADP national employment report is scheduled, covering private sector jobs. The report is the forerunner to Friday’s jobs report and analysts are tipping a 180,000 lift in private sector jobs.
- On the same day the second (preliminary) estimate of US economic growth for the June quarter is released. “Advance” data suggested the economy grew at a healthy 2.6 per cent annualised pace in the June quarter.
- On Thursday the influential Chicago purchasing managers index is released together with data on personal income and spending as well as the Federal Reserve’s preferred inflation measure – the core PCE deflator.
- And on Friday the US non-farm payrolls data is issued. It is clear that the job market is in good shape with jobs up 209,000 in July and the jobless rate at 4.3 per cent. Economists are tipping more job creation of 185,000 in August. Stronger-than-expected job gains together with higher wages would lift speculation about a December rate hike.
- Also on Thursday and Friday, the surveys of purchasing managers come into focus. The surveys are released across the globe with much interest in results for China and the US. In China the official manufacturing purchasing manager’s index stands at 51.4 with services at 54.5. The US manufacturing sector appears in better shape, currently standing at 56.3. Any reading above 50 indicates expansion of activity.
Savanth Sebastian is Senior Economist at CommSec
Firstly, there’s a lot of noise around market corridors these days about an impending correction. This week HSBC Holdings Plc, Citigroup Inc. and Morgan Stanley revealed they are seeing mounting evidence that global markets are in the last stage of their rallies before a downturn.
If we are in for a market correction, a lot will come down to what happens at the epicentre of the financial universe – a place in Wyoming named Jackson Hole. It’s not only great for fishing and hiking, but it’s where global monetary policy discussions are high on the agenda.
This could be the greatest escape ever recorded. In Canada, not that far from Jackson Hole, a state of emergency has been declared after tens of thousands of Atlantic salmon broke free from captivity. One can expect a spike in salmon prices.
Meanwhile, way down here, there are other big issues on the menu. How worried should Australia’s big supermarket and department store retailers be about the impending arrival of Amazon here? The answer is very, especially if Catherine Wood, the CEO of New York-based Ark Invest, is right that Amazon is “still in its infancy” as a company. That’s what she told a group of financial media in Sydney this week at a presentation put on by Nikko Asset Management, which has just bought a stake in her business.
And how much retail clout does Amazon have? This week it sent the share prices of rival grocery retailers tumbling in the US, by slashing its food prices.
If you take this a step further, Australian commercial property owners – especially those in the retail property sector – should be very afraid. Look at what’s happening in the US, and it’s just the start of more to come.
Woolworths, not the Australian one but the South African one which owns our retailers David Jones and Country Road, is fighting battles on numerous fronts. Australia is one of its biggest battles. In an interview this week, its CEO Ian Moir spoke of “a storm of change. The customer is changing and markets are in tough places. But we are not going to wither and die.”
Moving on, what will Donald Trump tweet about this? The all-American automotive icon Jeep, the symbol of US military ingenuity made famous in World War II, could be on the market. Who’s interested? The Chinese, of course. So Jeep could soon become a Chinese icon instead.
Still on the road, you may be interested in taking a look under the bonnet at Uber. After many months of controversy, the company’s latest financials show the company’s revenue is rising, and its losses are falling.
Now, let’s head to the UK, where driverless convoys of trucks have apparently been given the green light, with the Government funding some trials for the use of vehicles piloted by computers. That’s a warning signal for truck drivers.
While there’s a long way to go on that, Brexit is definitely much closer. And UK businesses are worried about the likely outflow of labour, especially workers across the agricultural, food processing and hospitality sectors.
Australia’s renewable energy push has been well documented. A new report this week says the world is poised to give up fossil fuels for good.
Lastly, after banning its 1000 and 500 rupee notes to stamp out tax evaders, India has just released its new 200 rupee note. It’s the fourth new note to be announced since last November.
Have a good weekend.