Kreston market update week ending Friday 20th August 2010

Kreston ANZ

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News

Kreston Dormers

Kreston Dormers Financial Services Pty Ltd

The ASX 200 was 0.7% stronger this week despite today's weakness. Company reported profits have been reasonable but this news has been coupled with soft global economic data. All sectors were up with Energy the standout at 3.2%. Materials went against the trend after BHP announced its takeover bid for Canadian Potash Corporation (note BHP accounts for over 10% of the entire All Ordinaries).

Investors here and overseas are likely to remain volatile until a better understanding of how far global economies, and the US in particular, are slowing. This is likely to take some months.

	Index	Change	%
All Ordinaries	4,471	38	0.9
S&P / ASX 200	4,440	29	0.7
Property Index	869	21	2.5
Utilities Index	4,215	49	1.2
Financials Index	4,283	30	0.7
Materials Index	11,816	-227	-1.9
Energy Index	14,588	459	3.2

Bank Term Deposit rates reversed last week's rises in the 1 and 3 year terms.

Term	Rate %	Change in rate
3 months	5.65	0.00
6 months	5.95	0.05
12 months	6.11	-0.20
3 Years	6.80	-0.20
5 years	6.95	0.00

Overseas markets were generally lower again this week mainly due to weak unemployment numbers in the US. The US S&P 500 was down -0.7% while the UK FTSE fell -1.0%. In Asia, Hong Kong's Hang Seng shed -0.2% and Japan's Nikkei was 0.6% stronger.

Engineering services was the standout sector reporting this week and property trusts reported improving conditions. BHP made a bid for a Canadian potash producer and Wesfarmers and Woodside reported.

Due to the company reporting season we have not included a Feature Section this week.

Australian News

In the last few weeks I have avoided making comment on the Australian election but the temptation has become too great. A few personal thoughts from an economic view whilst trying to stay politically agnostic:

• Both parties are light on economic policy substance and talent which is concerning given global financial challenges.
• Neither party seems to recognise that significant economic risks remain and neither see a need to prepare for future downturns.
• Both parties have developed budgets that rely heavily on the resources boom continuing which means future deficits when commodity prices eventually fall (which they always do).
• Despite the rhetoric, there is very little focus on government spending efficiency.
• I am struggling to find a coherent economic philosophy and policy framework.
In summary, both parties are underwhelming on the economic front.

The election will probably have limited impact on the sharemarket. Since 1945 the Australian share market has risen an average 13.2% under the Coalition government versus 12.6% under Labor if the GFC is stripped out. However mining and the health sector would likely be stronger if the Coalition win due to their promise to drop Labor initiatives in these sectors.

Overseas News

Overseas news was relatively quiet until Thursday night when larger than expected US initial jobless claims and a disappointing Philadelphia Manufacturing Index reading pushed markets lower. An expected 0.1% gain on July's leading index data was not enough to offset the negative sentiment.

Earlier in the week, US concerns about deflation taking hold were temporarily eased as July's Producer Price Index (PPI), which measures the cost of inputs to the production process, rose by 0.2% after a 0.5% decline in June. Also Industrial Production rose by 1.0% which was above expectations and exceeded June's 0.1% decline.

In a sign that US housing will continue to struggle, building permits and housing starts were below expectations and continue at very low levels.

In Europe, CDS spreads have started to rise again which suggests an increase in stress over European sovereign debt. In a somewhat contrary trend, the TED spread (a measure of the preparedness of banks to lend to each other) has been falling, which indicates a lower perceived risk.

This could be a situation where investors are prepared to risk lending to companies but less prepared to lend to indebted governments. Some irony there – governments a bigger risk than companies?

China overtook Japan as the world's second largest economy behind the US. It is anticipated that China will be overtake the US in 2030.

The Australian Reporting Season

The Australian reporting season is well underway. Management forecasts have been cautious.

The standout sector has been engineering services where the future order books for mining and infrastructure projects are very robust. This is in contrast to other sectors that are warning of slowing conditions over the next 6 months (e.g. banks).

Engineering Services

Leightons Holdings delivered a strong $615 million Net Profit After Tax ('NPAT') and increased its dividend by 55% to 85 cent per share. However it is struggling to recoup its investments in Dubai and property assets in Australia are still producing losses. The share price rose strongly on the back of very upbeat news that LEI holds contracts on hand of $51.5 billion for 2010.

United Group (UGL) reported a 0.8% rise in NPAT although revenues were down. The news that put a rocket under the share price was management guidance of 10-15% expected earnings growth for 2010/11. They backed that forecast up by announcing next year's order book has grown 11% to $9.1 billion.

Monadelphous (MND) beat most forecasts with a rise in NPAT of 12.1% to $83.2 million. Like UGL they have a 'healthy forward workload' i.e. their order book. The one comment of caution was the possibility of delays in major resource projects that might push out revenues from next year.

Downer EDI (DOW) in contrast to UGL and MND was quite downbeat with a flat result forecast for the next year. There may well be some clearing the decks from the new CEO after the recent downgrades from DOW due to their rail project blowouts. The company also announced that its Chairman would not be seeking re-election.

Worley Parsons (WOR) is due to report next week.

Health Sector Ageing populations are a very significant issue for developed countries worldwide. As well as social security support, the growth of government health related spending is becoming a major challenge.

The current Australian government is addressing this in a number of ways but two of the major policy initiatives are having very different impacts on Australian health companies. Firstly the reduction in rebates for pathology testing and the building of super clinics has had at least a short term effect of reducing revenues to Primary Health Care (discussed below) and Sonic Health (which is also impacted by falling volumes in the US).

The other major initiative is the proposal to pay private hospitals to reduce waiting lists on public hospitals. This is having a positive effect on Healthscope (HSP), which is under a takeover offer, and Ramsey Health Care (RHC).

It is expected all of the companies will benefit from the ageing population in the long term. However, government regulated revenues is also a risk in that it is an easy target for the government of the day.

Primary Health Care (PRY) reported NPAT to $132 million and EBITDA of $331 million. While the result was in line with company guidance (albeit the low end of the range), revenues were down 3.2% due to reduced demand for services (GP and pathology) and the government cutting rebates for pathology tests from November 2009.

Management expects 2010/11 EBITDA to rise to a range of $360 to $389 million. In response to government reduced rebates, PRY has introduced customer co-payments to retain their margins. However this is impacting volumes and management were not very clear in how they would address these issues.

PRY will be hoping the natural increase in demand from ageing patients will offset the lower volumes and that patients become more willing to pay for GP consultation, Pathology testing and Imaging.

Blood plasma products provider CSL NPAT rose to $1.05 billion after a currency impact of the higher Australian $ of $187 million. Management expects profit growth of 10% for 2010/11 using current exchange rates. The strong $AUD is having a significant, negative impact on profits of CSL. A $900 million share buyback was announced.

Property Sector

Conditions have gradually improved in the commercial property sector as prices bottom. Nevertheless it is expected that sales from smaller property companies needing to sell assets to meet banker expectations will keep prices subdued. Investors remain unconvinced with this sector as share prices for many of the companies are trading at significant discounts

The biggest positive surprise was the better than expected results from US operations. There are a very large number of re-financings by US property companies occurring which was expected to have a deleterious effect on commercial property prices.

Those companies/trusts with a predominantly Australian book were generally positive on the 2010/11 outlook.

Dexus (DXS) recorded a profit of $31.4 million after a loss of $1.576 million in 2009 due to asset write-downs. Earnings (EBIT) were down 10% but excluding the impact of asset sales earnings were down a more creditable 2.3%. Property values actually rose 0.7% in the second half which is a real plus for this sector. The balance sheet is strong with gearing at a modest 30.4%.

Shopping centre developer/owner Westfield Group (WDC) had a surprisingly good $961 million NPAT. The surprisingly good part of the result was the US and UK results with respective income increases of 3.2% and 8.5%.

ING Office Fund (IOF) also returned to profit. The Australian operation performed well with income growth of 2.8% and 98% occupancy. The US operations income was down 8.7% but appears to have stabilised while the UK assets are expected to be softer in 2011. Net Tangible Assets (the value of the buildings) are $0.74 per share while the share price is 16% lower at $0.625.

Charter Hall Office (CQO), the old Macquarie Office Fund, reported a $145.8 million profit pretty much in line with forecasts. The stock is trading at a very large 42% discount to net tangible assets and the company is floating an idea to sell 50% of its US assets. The reason for the size of the discount to NTA is probably related to the number of leases that need to be negotiated over the next two years (circa 24%) and the renegotiation of its debt without having to raise more capital from shareholders. Despite those issues the discount is very hefty and probably overdone as it ascribes little or no value to the US assets.

Resources/Energy

BHP announced a $40 billion takeover offer for Canadian Potash Corporation of Saskatchewan. The board of PotashCorp rejected the offer as it was only a 16% premium to the last traded price. Potash is mainly used in fertilizers as a source of potassium. BHP's logic for the acquisition is that it can use its mining and marketing skills to efficiently develop the assets and the growing demand for food provides a strong future for the product.

This is likely to be a drawn out affair and BHP's share price has been weaker on the concern they will pay too much.

Woodside Petroleum (WPL) result was pretty much as expected with profit up 41% to $US901 million. The result included a one-off gain of $US 149 million from the sale of its Otway project which was offset by a $US95 million write-down of the Neptune asset in the Gulf of Mexico.

WPL released news of two new gas finds in the days leading up to the result, which took the heat out of the announcement of the delay in the investment decision on the second train for the Western Australian Pluto project.

Other companies

Wesfarmers (WES/WESN) adjusted NPAT increased 3.7% to $1.7 billion with revenue up 1.7%. Management was buoyant on their future prospects although, like the banks, are seeing some softness in markets over the next 6 months. The Coles turnaround is going in the right direction but still has some way to go to justify the price that was paid. Bunnings was good but Target was soft. Resources results were down but forecasts upbeat.

Prospects are positive and the diversified business model, while it has its detractors, continues to work for Wesfarmers.

ANZ reported a 37% rise in underlying profits for the quarter ending 30 June which was a 37% improvement on the previous year. CEO, Mike Smith echoed recent CBA and NAB comments that they expect conditions to be 'softer' and the 'unusually uncertain' global economic conditions.