Harbour Monthly Commentary: Theme watch in investment markets
Harbour Monthly Commentary: Economic growth is likely to remain sluggish in New Zealand next year but investing in certain secular themes such as healthcare is likely to produce good results.
Monday, December 10th 2012, 3:50PM
by Harbour Asset Management
• The New Zealand market continued its recent strength returning 2.5% in the month and now up 24% for the year to date. The successful IPO of the Fonterra Shareholders Fund was the highlight. First half earnings reports from several companies were also on balance solid. Several healthcare companies had upgrades to earnings prospects. The period was also marked by evident reinvestment of the Fisher and Paykel Appliance proceeds.
• Global markets were positive in the month, buoyed by more positive economic data and commentary suggesting that the US fiscal cliff will likely be better managed than expected. In China, leading indicators also point to signs of improvement in domestic activity. The MSCI World Index rose 1.5% in the month.
• The Australian market (+0.5% in Australian dollars) underperformed global markets, held back by weakness in the resource and energy sectors. Slowing in mining investment was reflected in the mining services and contractor sectors with many companies downgrading profits sharply.
• In contrast, the major miners signalled scaled back capital expenditure plans and Rio Tinto announced $5bn of cost savings by 2014, which was taken positively by the market. We continue to like the larger miners as confidence in a Chinese recovery improves.
• Although recent economic data in suggests New Zealand has hit a softer patch – there are also some stronger pockets of growth. Broadly speaking, 2013 looks like New Zealand will see another year of moderate expansion.
From a secular perspective, the healthcare sector continues to see profit upgrades.
Fisher & Paykel Healthcare, CSL, and Summerset all had good market updates. A special dividend announcement from Sky TV was also welcomed by the market. Kathmandu reported a solid sales start to the year with same store sales up 14%.
Secular Growth Trends Shine Through
The recent earnings and AGM season has highlighted the investment opportunity that we see in secular growth sectors such as healthcare. CSL announced an upgrade to its profit guidance to 20% constant currency NPAT growth (from previous guidance of 12%). The upgrade to earnings is underpinned by strong volume growth in its products to China, a better IVIG mix, and supply chain cost savings.
Summerset Group Holdings – an integrated retirement village operator - also provided a market update, announcing the purchase of land in Ellerslie for its 19th village. Summerset is increasing its annual build rate from 250 to 300 units per annum. The company has also entered into a conditional contract to purchase a site in Lower Hutt near the public hospital. Both purchases provide high quality sites and a land bank which is able to support the increased development plans. Both sites will have increased aged care offerings providing better economies of scale and certainty of cash-flows.
And, in the month Fisher & Paykel Healthcare provided a presentation to analysts that implied an upgrade to earnings and strong success in new nasal pillows and Optiflow Junior masks. The company is also seeing strong growth in Asian markets.
The other key secular growth trend we are observing is the emergence of the move to consumption in Asia. No other New Zealand company has a global reach on quite the same scale as Fonterra. Its large size and integrated business model gives it a unique positioning in the global dairy market. The listing of the Fonterra Shareholders Fund, and its Units, provides investors with access to earnings from this market and also signifies a key milestone in the company’s history. Investor interest was unprecedented and exceeded market expectations.
As we discussed in our recent Navigator the exposure that investors receive in the Fund is not an investment in milk. The milk collection business earns a steady cash-flow albeit at low margins, but provides Fonterra with a secure supply of milk (matched by no other global competitor) for its own higher margin consumer-focused business. The consumer brands business provides the growth opportunity for Fonterra. Leveraging the milk supply, Fonterra is able to target higher margin products for supply to the growing markets such as China and broader Asia.
Outlook
As we discussed last month, the amount of cash floating around from either return of capital (Fisher & Paykel Appliances, and stock buybacks,) KiwiSaver flows, and dividend payments has provided the market with some recent support. The success of the float of Fonterra and potential new floats outside of the utility sector may also continue to place a spot light on the New Zealand equity market in 2013.
The New Zealand equity market continues to have a neutral valuation point and in our opinion needs earnings momentum to provide a further lift to equity prices. We have seen some recent earnings momentum from the latest reporting season; however that momentum will need to continue in the New Year.
With interest rates on hold for a significant period of time and the global weight of liquidity looking for both yield and real growth, many New Zealand stocks offer that resilience. Indeed companies like Sky Network TV announcing a special dividend during November provides an example for investor attraction from a yield perspective.
We are continuing our analysis of potential investment opportunities in Australia where growth, cyclical prospects and valuation are currently under-appreciated in our view. While Australian GDP growth prospects have slipped, the Reserve Bank of Australia has stepped up monetary easing. Looking out into 2013 we expect Australian consumer and housing demand will stabilise and modestly improve. A recent lift in sentiment towards Chinese growth and a lift in iron ore prices, suggests also a lessening in negative sentiment towards some of the mining sector.
The banking sector has also reported lower than expected non-performing loans, bank CDS spreads have reduced, and funding pressures seem to have eased. Banks have taken the opportunity to hold margins by not passing on the full 25 basis point cut – although we have not seen any earnings momentum from the banking sector, strong dividends and the potential for capital management remain positive factors.
We wish everyone and their families a safe and Merry Christmas and prosperous New Year. We look forward to reporting on December and the outlook for 2013 early in the New Year.
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