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Market Indicators Week ending 1 December 2017

What we liked

A Royal Banking Commission was launched by the Prime Minister on Thursday morning after the Big Four banks asked for an inquiry into the sector. The move was done in order to end mounting speculation and restore public trust in the banking system. The Government will now act to ensure a properly constituted inquiry is made into the financial services sector is established to put an end to the uncertainty.

Black Friday Sales – Australians spent $200m on Black Friday sales last week with fashion and holidays being the big ticket items bought. Sales were up 16% from last year. It will provide some of our local retailers such as Myer, Premier Investments, Kathmandu and JB Hi-Fi a little boost to their bottom line. In the US shoppers spent US$5.03bn. It still doesn’t top China’s Singles Day which raked in US$25bn.

Iron ore continued its month long rally hitting US$67.94 a tonne. Chinese steel futures are hitting 10 week highs. It rose 8% last Thursday evening taking November’s gains to 16%. It’s good news for iron ore stocks such as Fortescue Metals, BHP and RIO.

Tech investor and billionaire Alex Waislitz who is well known for picking winning tech stocks has turned his focus onto the mining services sector. He is the founder of Thorney Investment Group his past investments include Updater and Afterpay. Waislitz says the big miners are still producing and they spend big on equipment. For that reason he says Austin Engineering, Southern Cross Electrical Engineering and MMA Offshore are ones to look at.

Julie Bishop says a Royal Bank Inquiry won’t do much but offer false hope to Australians while threatening confidence in the sector. It won’t compensate or resolve disputes. These commissions can take years and can undermine confidence in the banking sector.

Amazon founder Jeff Bezos is now worth a $100-billion as of Monday as the online retail giant raked in cash from the holiday weekend's cyber shopping spree. Microsoft co-founder Bill Gates is trailing closely behind at $89.4bn. There are reports that Amazon could be targeting the banking sector after it takes out the retailers.

Business investment spending plans have been upgraded over the last few quarters which is a positive sign for the economy. Investment plans were up 34% to $108.9bn since Feb. Next week’s accounts are tipped to show that GDP has grown during the September quarter.

The OECD is forecasting Australia to continue this period of rosy economic growth combined with resilient employment figures. They see the RBA starting to increase interest rates in the 2H18. But a major correction in house prices could upset household wealth and consumption. It expects GDP for Australia to hit 2.5% this year, 2.8% next year and 2.7% in 2019. Unemployment to hit 5.6% this year, 5.4% next year and 5.3% in 2019.

Queensland's $80bn LNG industry is set to enjoy a stellar month, with revenues topping $1.1bn.

OPEC and non-OPEC producers led by Russia have agreed to extend oil output cuts until the end of 2018 to clear a global over supply. There is no clear message on how to exit the cuts to that the market doesn’t go into deficit or so that prices don’t rise too fast and bring on the US shale gas frackers. Saudi is preparing its stock market for the Amarco listing and Russia needs to balance its budget.

ASX 200 0.11% REITS 4.49%

ALL ORDINARIES 0.20% Metals & Mining 1.74%

ASX 300 0.14% Gold 1.43%

SMALL ORDS 0.81% Cons Staples 1.43%

US DOW JONES 3.03% Banks 0.56%

S&P 500 1.81% IT 0.43%

STOXX 50 0.02% Telcos 0.40%

FTSE -1.03% Cons Discretionary 0.23%

GERMANY -0.27% Energy -0.33%

FRANCE -0.33% Materials -0.33%

CHINA -1.42% Financials -0.65%

HONG KONG -2.24% Industrial -1.16%

INDIA -1.33% Health Care -1.83%

SINGAPORE 0.54% Utilities -2.03%

NEW ZEALAND 0.78%

COUNTRY PERFORMANCE AUSTRALIAN SECTOR PERFORMANCE

What we didn’t like

Bitcoin – The bubble keeps getting bigger and bigger with the cryptocurrency hitting US$10,000 an all new high. That’s up 950% over the year and is up 54% just in the last two weeks. Domain Group have reported a Melbournian putting his home up for sale, willing to accept Bitcoin as payment. Seems like lunacy. Given Bitcoin’s extreme volatility, the seller will want to pray that the price of Bitcoin doesn’t plummet after the sale. It’s now 7 times the price of gold and its market cap is more than IBM or McDonalds. With no intrinsic value, this is the mother of all bubbles. The only way it has value is if the next guy is willing to pay you more for it – the greater fool.

The spread between the Australian 2 year and 10 year Government Bond yields is narrowing. The Australian 2 year Government Bond yield is 1.75% and 10 year is 2.50%. Banks borrow short and lend long. Therefore a shrinking gap means narrower profits for the big banks. It’s the first time in 20 years that short-term bond yields in Australia are equal to and will soon move lower than the US. Bond yields in both countries are 1.76%. This means that the prospects in the Aussie economy are expected to be softer than the US for the next few years. Here is a chart from the AFR.

Is the property boom finally over? The tune has changed and media headlines are now reading very different headlines to a year ago. Sydney is finally tipping over and the momentum has slowed in Melbourne. Here was one scary quote seen in press “Households are now trice as indebted as China’s.” With interest rates on the rise, you have to wonder how bad the impact will be on these consumers.

Amazon - The official launch date of Amazon Australia was again pushed back after a series of technical problems prevented the launch. It was supposed to go live November 24. The retailer said it “failed” to launch last week was due to glitches in its backend. Amazon Australia hasn’t disclosed any details about their launch, so it’s still up in the air.

The US has warned North Korea of absolute destruction if it doesn’t play its cards right. This week the rogue nation once again test fired its most advanced intercontinental ballistic missile which now puts the US within striking range.

Economic Insights In this section, we look at the economic news affecting global markets this week. Australia

The latest ANZ-Roy Morgan Consumer Confidence Index fell to 115 from 116.4 in the week to November 26. Its fall was blamed on doubts over ongoing future economic conditions.

Australian capex rose by 1% to $29.368 billion. The result was in line with forecasts. The fourth estimate for total CAPEX in the 2017/18 financial year rose to $108.9bn above the forecast revision of $105.4bn. It was in line with expectations.

Europe

German business confidence rose in November to a seasonally adjusted 117.5 this month from a reading of 116.7 in October, beating forecasts for a drop to 116.6.

The Euro hit a two-month high driven by a strong German business confidence reading. The Euro is trading around the US$1.19 mark.

US

US sales of new single-family homes quickened for the second straight month in October. Sales of new homes rose 6.2% to an annual rate of 685,000 units. It was a beat on an expected 2.5% fall. It’s hit its highest point since the GFC and points to a sustained recovery in sales after a soft year. The increase was bolstered by the storm-damaged southern US, which continued to see robust sales. Its good news for stocks exposed to the US housing sector such as Boral and James Hardie.

China

The Chinese PMI Index has beaten expectations coming in at 51.8 which was above an 51.4 in November, slower than 51.6 in October.

China's services sector also did well with its PMI reading increasing to 54.8 in November from the previous month's 54.3.

It seems the Chinese economy is doing better than first though and has been propped up by government infrastructure spending, a resilient property market and solid exports. It has helped China’s GDP move closer to 7% in the first nine months of 2017.

Market Insights

In this section we look at all the important announcements affecting companies this week.

RCG Corp (RCG) – Shares are on a tear rising 12.7% after retail billionaire Brett Blundy upped his stake and

emerged as the biggest single shareholder. He now owns an 11.8% stake in the footwear retailer. Telstra (TLS) – Shares fell early on in the week after the NBN said that it would halt its broadband rollout. As if

things couldn’t get any worse. The halt of HFC connections (pay TV network) is effective immediately due to poor service. The halt is to be effective until the NBN can rectify problems experienced by some users. Telstra responded to that announcement by telling investors that it would be taking a look at its full-year financial guidance as it could hit the bottom line.

Downer EDI's (DOW) – Shares rallied this week after the engineering group upgraded FY profit due to better-than-expected cost savings as it secured an 87.8% stake in Spotless this year.

Broo (BEE) – Shares were up 30.5% hitting its highest level in a year, on the back of a $120m Chinese distribution deal.

Macquarie Bank (MQG) – Shares have finally topped $100 rising almost 20% in 12 weeks from a low of $82.70 on September 8. Shares have been trading higher ever since late October when it announced an on-market buyback of up to $1 billion and a first-half profit of $1.25 billion.

Origin Energy (ORG) – Upgraded guidance for FY output from its Eraring plant. Output in 2017-18 is now expected to be between 15.5 terawatt-hours and 16 terawatt-hours, about 6% higher than its August forecast. ORG shares are hitting 26 month highs.

IOOF (IFL) – Shares rose this week after Morgan Stanley upgraded to "overweight" from "equalweight" saying the wealth manager’s increased exposure to Australia's growing super and pension system as reason for the upgrade.

Tatts Group (TTS) – 1Q profit was up 15% driven by a string of bigger than usual multimillion-dollar lottery jackpots. Revenue was up 6.8% to $743.1m. Digital lotteries which makes up 16.4% of all lotteries, was up 30% this year.

Macquarie's Australian equity strategy says 2018 will be the year of Growth to outperform Value. Its picks include: service-orientated consumer discretionary stocks such as Corporate Travel, Navitas, Invocare and Tatts Group as well as tech stocks such Computershare, Iress and TechnologyOne. Junior miners such as Galaxy, Orocobre, Regis Resources and Northern Star bring up the rear along with industrials such as ALS, CIMIC and Qube. Growth stocks such as Costa Group, CSL, Cleanaway, Domino's PIzza, Invocare, Link Administration, REA, Ramsay Health Care, Reliance Worldwide, TechnologyOne and Transurban all trade on high PE multiples, with above-average EPS growth and EPS certainty over this period.

Deutsche Bank's Australian equity strategy is to buy into consumer stocks because they are already out of favour and while households are income-poor, they're asset rich. That means they could ramp up spending for Christmas. It adds JB Hi-Fi and Scentre. Upweight Woolworths and is happy to hold Harvey Norman. Switch from Commonwealth Bank to NAB. Miners are good to own. It remains nderweight defensives. Cyclicals have better earnings revision momentum. No exposure to telcos, infrastructure or regulated utilities.

BHP Billiton (BHP) - Unit costs at its Australian mines can be cut by a further 10%. The miner said its Australian mines would deliver 80% of the US$2bn in productivity gains over the next two years. Iron ore is expected to deliver costs of around US$13 per tonne down from US$14.60 in the year ended June 30.

AWE Energy (AWE) shares hit close to +23% following a $430m takeover bid from a Chinese energy group. The company has rebuffed the offer as being

Aristocrat's Leisure (ALL) – Announced a strong set of results together with a $1.4 billion online gaming acquisition. Shares did end the day lower.

OrotonGroup – It all over. The company has called in the administrators after the board was unable to source a viable solution which could achieve a better outcome than voluntary administration. ORL was experiencing challenging trading conditions and posted an earnings downgrade in addition to the commencement of a Strategic Review. Stores will continue to trade. GAP store closure is by the end of January 2018

Isentia Group Ltd 13.99% Corporate Travel Management Ltd -8.06%

Sigma Healthcare Ltd 8.72% Syrah Resources Ltd -7.18%

Greencross Ltd 7.95% Aconex Ltd -6.14%

Primary Health Care Ltd 6.84% ALS Ltd -5.81%

Steadfast Group Ltd 6.36% Independence Group NL -5.65%

BT Investment Management Ltd 6.36% Evolution Mining Ltd -5.48%

Bega Cheese Ltd 6.27% Bellamy's Australia Ltd -5.37%

HT&E Ltd 6.02% Resolute Mining Ltd -4.66%

APN Outdoor Group Ltd 5.91% Chorus Ltd -4.51%

Australian Agricultural Company Ltd 5.91% Regis Resources Ltd -4.30%

ASX 200 MOVERS & SHAKERS THIS WEEK

Turnbull finally gives in

Watching the news yesterday left me a little gobsmacked. After standing strong for so long, the PM has finally given in and done a complete backflip. The Turnbull Government will establish a Royal Banking Commission. Well Turnbull really had no other choice after the CEO’s and chairmen of the big four banks wrote a letter to the Government asking for an inquiry in a bid to end the uncertainty once and for all. Despite his belief that it will do more harm, he admitted defeat and called the commission ‘regrettable but necessary’. The Royal Banking Commission will run for 12 months with a final report due by February 1, 2019. For months Labor, National MPs, the Greens along with some of the Government’s own party members have been pushing for an inquiry for some time. Such an interest was now in a national interest and may be the only way to restores confidence and faith in the sector after so many misconduct cases have come to light. Turnbull described it as a thorough inquiry that won’t just cover the banks but will cover wealth managers, superannuation providers and insurance companies. In this article we’ll go through what we think are the positives and negatives not only for the banking sector but to its customers and the economy as a whole. We’ll also discuss whether we think the banking sector is still attractive. Positives

The calling of the inquiry will once and for all end damage being caused by speculation affecting the banking sector.

It will end the days of banks behaving badly by addressing issues such as misconduct, rigging the BBSW rate, fraud, and sub-par customer service. It may also change the culture that has evolved in the banking industry.

An inquiry will help restore trust and faith in our banking system including in offshore markets. Because of the various misconduct cases that have occurred over the past few years, it has given the four banks a bad reputation. There is no faith.

Every stone will be turned and all the skeletons in the closet will come out. A complete rethink and clean out will help produce a better banking culture going forward.

Without an inquiry, we risk undermining the critical perception that our banks are unquestionably strong. It is in the national economic interest for an inquiry to be held. The public are dissatisfied with bank fees and costs. The inquiry could address these issues.

Negatives

A Royal Commission will expose everything. All the bad with the good. There could be some deep secrets that lay buried away that if unturned could damage our banks beyond repair both domestically and globally. The inquiry could do a lot more harm than what it attempts to solve. If there are any new issues that are of a serious nature that can undermine that bank’s reputation and profitability, especially if it’s a systemic or operational failing.

The system where by employees are paid via incentives such as the bonus structure faces a complete overhaul.

Whilst just about every arm of the bank has faced some sort of scrutiny, one division has laid dormant. That is the real estate lending arm. With Australia having the highest household debt in the world, there’s no question that bad behavior could have extended to this part of the business as well.

The commission won’t just look at the banks but also insurers, wealth managers and superannuation companies. Companies that have been operating smoothly may suddenly find themselves in hot water.

The biggest losers here will be shareholders. Banks shares are expected to remain under pressure until the inquiry is over. Shareholders could also foot the bill for any changes banks are forced to make.

Shares in insurers and superannuation companies will also face the same feat but have less to fear than their giant rivals.

The banks are already heavily regulated. This inquiry will put them through further scrutiny. That will tarnish the capitalistic way banks operate. It won’t be a free market. Banks will start to operate a lot less freely and will be more reserved.

Moody’s credit ratings agency says that if new issues emerge they will be forced to revise their assessment of the major banks. That can affect bank funding and the possible increase in costs.

One can argue that the inquiry will provide no benefit for both banks and customers affected. It will not award compensation for any wrongdoing and it will cost around $75 million.

Culture can’t be regulated or governed. The inquiry could bring about more compliance costs that will be passed onto customers. More regulation and stricter lending policies will be implanted making it harder for small business and

customers to borrow. Banks will become more risk averse. It will capture not just the banks but insurers, wealth advisers and Superannuation Funds. There is the risk

that the wealth models which exist in the Banks, AMP and IFL will be upset. Potential conflicts of interest could be targeted such as advisers selling and using in-house products. Bell Potter says “AMP faces additional scrutiny surrounding the provision of Life Insurance, with level of rejections and procedures to come under review.” The broker says it doesn’t any good to come of the review for AMP and IFL.

Unconventional View: What do we think? Well there’s no point in discussing whether the inquiry is a good thing or bad thing, it’s been decided and it’s happening. As you can see above there are both good and bad points. I think the more important question is to work out the short and long term impact and whether investors should be exposed to the banking sector.

The Royal Commission is expected to be finalised by February 2019. Until that time, its throws the entire banking sector into uncharted waters. No one can predict what will come of this. It could either be a positive thing for both the banks and customers or it could go really bad. In the short term, it will most definitely be a negative for bank shares, staff and customers. Mum and dad superannuation shareholders will cop the brunt of it. Investor confidence will sink as we all know the market hates uncertainty, so you can expect investors to reduce exposure to this sector. If nothing else comes of the inquiry and it’s mostly helps the banks to improve the way they conduct business, then great. If

however the inquiry digs up some nasty secrets… that may harm the bank’s reputation and profitability. I was speaking with a close friend who works for one of the big 4 banks in Singapore in quite a senior position. From what he was telling me, that bank’s reputation has already been hit quite hard and a lot of his global clients are distancing themselves from doing business with this major Australian bank. If anything unscrupulous is unearthed, it risks undermining the critical perception that our banks are unquestionably strong. Global clients may stop doing business with us and credit agencies may increase their funding costs. It’s a snowball effect.

On the flip side, we think the longer term impacts are positive. It is in the national economic interest for an inquiry to be held for the benefit of not just the economy but for every Australian. At the moment, we simply have no faith or trust in our banks. That really is shocking. The bad behaviour and culture that has plagued this industry after the GFC needs to be changed. This has to be done before the public can regain its faith and confidence in sector. If there problems that are unearthed and actions put in place to fix them, the banks will become even stronger. The inquiry will translate into a better banking system in the long run that will benefit customers, the economy and shareholders.

For that reason, we advise investors looking to gain exposure into the banks to hold off for the short term, just until there is further clarity surrounding the inquiry. The banking inquiry will be all plastered over the media for the next month, you’ll see it everywhere. So expect negative selling pressure to remain in the short term. We think the banks will pull back. In the medium term, provided no real nasties are uncovered, the market will revert back to earnings and profit expectations. We think banks will continue to beat earnings expectations. They are highly profitable, high ROE, have little competition and globally competitive. So expect bumper profits. It’s a buy in the medium term. If we had to choose from the big four, we’d lean towards NAB. They’ve got the least exposure to the residential mortgage market and have undertaken a massive innovation tech drive that will drive earnings going forward.

How to make money from the Santa Clause rally

What the heck is the Santa Clause rally? Well according to Wikipedia, “It’s a rise in stock prices in the month of December, generally seen over the final week of trading to the New Year.” Why you ask? That’s a good question. There isn’t really a plausible explanation. Some say it’s because of tax reasons. That’s rubbish because our tax year ends in June. Another reason is because people are happy around Christmas time. Happy people are more likely to buy shares than unhappy people? That’s rubbish too. And the other reason doing the rounds is that people tend to re-invest their Christmas bonus into the market causing it to rise. Right. If you think about it, they’re all pretty lame explanations. Either way it doesn’t really matter. We actually think it’s just another self-fulfilling prophecy similar to “Sell in May and Go Away” or “Buy in July” or the most well-known of self-fulfilling prophecies has to be, “Harry Potter and Lord Voldemort.” For those that don’t know, Lord Voldemort was destined to be killed by Harry Potter, making it a self-fulling prophecy. For what-ever reason, the message is clear, the market goes up in December. So get on board. Let’s look at some stats on the ASX 200 Index (XJO):

Over the last 11 years the ASX 200 Index has gone 8 times. That’s a 72% certainty that this month will be a winner. I like those odds. The prophecy holds true. Last year the market was up 225 points (4.1%) and the year before that 129 points (+2.5%). With a 72% chance, the odds are stacked heavily in our favour. If we drill down into these stats a little deeper, you’ll notice that the market does rally in the last week of December, but it’s not as considerable as it’s made out to be. It seems that higher gains are made by having exposure from throughout the entire month. Some of you that are still a bit cynical, need to understand that the stock market doesn’t always behave according to the textbook. It’s an emotional creature. Rallies and panic selling sometimes can’t be explained by genuine reasons

Year Dec-01 Dec-31 Point +/- % Year Dec-26 Dec-31 Point +/- %

2006 5482 5669 187 +3.4% 2006 5603 5669 66 +1.2%

2007 6533 6339 -194 -3.0% 2007 6323 6339 16 +0.3%

2008 3742 3722 -20 -0.5% 2008 3582 3722 140 +3.9%

2009 4701 4870 169 +3.6% 2009 4790 4870 80 +1.7%

2010 4584 4745 161 +3.5% 2010 4777 4745 -32 -0.7%

2011 4119 4056 -63 -1.5% 2011 4140 4056 -84 -2.0%

2012 4506 4648 142 +3.2% 2012 4635 4648 13 +0.3%

2013 5320 5352 32 +0.6% 2013 5327 5352 25 +0.5%

2014 5313 5411 98 +1.8% 2014 5394 5411 17 +0.3%

2015 5166 5295 129 +2.5% 2015 5207 5295 88 +1.7%

2016 5440 5665 225 +4.1% 2016 5627 5665 38 +0.7%

2017 - - - - 2017 - - - -

79 +1.6% 33 +0.7%Average

Month of December Last week of December

Average

because its drivers are attributable to human nature and the collective psychology of stock market investors. People do weird and wonderful things that sometimes cannot be explained by rational thinking. Remember this famous cartoon? There’s a lot of truth to it. Stock markets are at times irrational and unexplainable.

So with that in mind, we’ve decided to come up with the perfect Santa portfolio that we think you should hold to capture this upside rally based on themes that we think will play out over the month. Here is a list of themes that will impact our market this month:

US Federal Reserve interest rate rise – The Fed is on track to raise rates by 25bps mid-December. This will have an instant knock on effect here. US dollar will rise, Australia dollar will fall and Bond yields will rise. That means “rotate our of bond proxy” and “don’t fight the Fed” time. Investors can do well to have their investments aligned with current monetary policy rather than against it. So – sell bond proxies and sell gold. Buy banks and stocks that benefit from strong US dollar. Example Buys are – NAB, CBA, WBC, ANZ, CSL, BLD, JHX, RMD, AMC, COH and, BXB.

Sell Gold stocks – Will fall as rates rise. Investors tend to move out of safe haven assets when bond yields become more attractive.

RBA Meeting Tuesday 5 Dec – Rates on Hold. No changes. Watch for a change in statement. Whilst there won’t be a rate change here, the interest differential between the US and Australia will narrow. We could see banks raising rates independently to cover a rise in wholesale funding costs. All four banks are due to hold their AGMs in December.

Iron ore rally – Has continued its month long rally hitting US$67.94 a tonne. Chinese steel futures are hitting 10 week highs. It rose 8% last Thursday evening taking November's gains to 16%. It's good news for iron ore stocks such as Fortescue Metals, BHP and RIO. I

Oil – OPEC are due to meet on the 30 Nov. We’ll find out the results on 1 Dec. The market is assuming OPEC will rollover current production cuts for another 9 months, making it a formality till the end of 2018. But Citi says prepare for disappointment. At the moment the market is very bullish on oil continuing its bumper rally and a deal to continue through to 2018. Citi says if OPEC doesn’t extend through 2018, it is hard to see any other outcome than a sharp drop in oil prices. For that reason we’re going to avoid oil stocks until next year.

Electric Vehicles, Lithium, Cobalt and Nickel – The elective vehicle revolution kicked into fifth gear this month after Tesla announced its supercar Roadster 2.0 along with a spec sheet you’d associate with hyper-cars costing millions. It claims that the new Roadster will be almost as fast as a Formula One car and will use a 200kWh battery pack. The EV sector is only going to grow at an exponential rate from here. We suggest Lithium, Cobalt and perhaps a Nickel stock. Our picks are Orocobre (ORE).

Cannabis stocks – With the legalisation and relaxation of laws on imports of medical cannabis, shares involved in the cultivation, production and research have soared well over 100%. Medical cannabis can be used to treat cancer and epilepsy. We think this momentum will continue through. For that reason we think Cann Group (CAN) is a good pick.

Christmas retail splurge – According to ARA and Morgan Research, shoppers are expected to spend $50bn this Christmas period. Online sales are tipped to increase by 3.96% and Food and liquor retailers are tipping a 3.27% increase from 2016 sales. Although soft by Christmas standards, these figures remain reasonably strong. We think two stocks that stand to benefit from strong Christmas sales are Kogan (KGN) and Woolworths (WOW).

Healthcare stocks – Ones that have offshore earnings such as CSL and Cochlear (COH), are key beneficiaries of a rising US dollar. The healthcare sector has been running hot. It has been one of the best performing sectors the last few months. In this sector we like CSL and Cochlear (COH).

China facing stocks – The baby milk revolution together with anything that’s clean and green will continue to do well. We expect this theme to continue through to next year. Our two picks are a2 Milk (A2M) and AuMake (AU8).

Stay away from the NBN and Telcos – Just out this week, the NBN is halting the rollout of super-fast broadband delivered over pay television cables due to issues with service dropouts. What a mess. Customers that were to be connected to the NBNB via HFC technology face delays of up to 6-9 months. This may affect Telstra’s FY guidance. We recommend stay away from the telco sector just for December.

Trump’s Tax Plans – The Republicans have promised that the tax bill will be signed off by the end of the year. Even President Donald Trump is adamant that the bill will be on his desk “by Christmas.” We think there is a good chance it will get through. This won’t have a huge direct impact on ASX stocks. However Trump’s plans on infrastructure will be closely watched. He said plans will be submitted soon after taxes.

Industrials – A re-rating of the sector is a culmination of superior earnings and a falling Australian dollar. We expect this sector to continue to flourish with new projects on the rise. The Manufacturing PMI number remains above the 50 level. An expanding manufacturing sector coupled with strong housing construction demand should see industrial stocks do well. We like CIMIC (CIM) and Monadelphous (MND).

Utilities – These are electric, gas or water utilities companies that distribute power. With electricity prices soaring due to a shortage of baseload power, we think this thematic will continue to play into next year. We like Origin Energy (ORG).

Whilst we don’t have a crystal ball, we do have some idea of how these thematics may play out. Some are already in motion and with a bit of confidence we can assume they will carry out in to next year. If we collate stocks from the mentioned themes, we derived the Santa Portfolio below.

We’ll publish this portfolio at the end of December as well as the performance of the ASX 200 Index. It will be interesting to see if the great Santa Clause rally prophecy lives out to its expectations.

Fundie Review – Do you a large tax bill?

Code NamePrice

29 Nov

Last

Price%

Intrinsic

Value3M % PE Exposure

MQG.AX Macquarie Group Ltd $98.60 $98.60 +0.0% $123.71 13.58% 14.09x Diversified Capital Markets

NAB.AX National Australia Bank Ltd$29.75 $29.75 +0.0% $42.87 -1.91% 13.44x Diversified Banks

RIO.AX Rio Tinto Ltd $71.07 $71.07 +0.0% $104.53 4.09% 15.66x Diversified Metals & Mining

ORE.AX Orocobre Ltd $6.44 $6.44 +0.0% $4.27 64.16% 215.79x Diversified Metals & Mining

CAN.AX Cann Group Ltd $3.00 $3.00 +0.0% NULL 160.87% NULL Pharmaceuticals

KGN.AX Kogan.com Ltd $4.25 $4.24 -0.2% $3.19 27.33% 106.15x Internet & Direct Marketing Retail

WOW.AX Woolworths Ltd $26.86 $26.86 +0.0% $22.51 4.15% 24.36x Food Retail

CSL.AX CSL Ltd $145.55 $145.55 +0.0% $86.17 11.12% 37.03x Biotechnology

COH.AX Cochlear Ltd $182.40 $182.40 +0.0% $91.95 16.45% 46.44x Health Care Equipment

A2M.AX a2 Milk Company Ltd $7.58 $7.58 +0.0% $4.25 48.34% 68.59x Packaged Foods & Meats

AU8.AX Augend Ltd $0.55 $0.55 +0.0% NULL -62.84% NULL Specialty Stores

CIM.AX CIMIC Group Ltd $51.51 $51.51 +0.0% $37.66 23.58% 25.97x Construction & Engineering

MND.AX Monadelphous Group Ltd $18.62 $18.62 +0.0% $12.19 23.80% 30.52x Construction & Engineering

ORG.AX Origin Energy Ltd $9.01 $9.01 +0.0% $9.96 17.32% NULL Integrated Oil & Gas

You need the Add+Venture Fund

This week we met with Charles Williams and Christian Jensen from CVC Limited. The company is a venture capital and private equity firm that discovers aspiring young start-ups that have passed the early stage and heading into the mid venture stage. The company provides these start-ups with capital to help them grow and eventually take them to the IPO stage. Investing in Australian start-ups is no easy feat. Start-ups are fraught with danger and are usually very high risk. Trying to pick individual start-ups on your own is a very difficult task. You’re more than likely to lose all of your money if you get it wrong. That’s where the guys at CVC come in. It’s what they’re good at; cherry picking the good from the bad. And they’ve got quite an impressive track record to prove it. Here are some of their highlights:

The team have 30+ years of experience in actively investing in venture capital and have a massive network from which they can source compelling deals.

The company has made over 300 investments across all industries at varying stages of their development. Has $200m on its balance sheet. 100+ deals per year. +20% annualized shareholder return – over the last 5 years. A large team backing it – 9 investment professionals with a wide range of skills. Companies targeted must have these qualities - companies developing and commercialising a new

technology or utilising technology to create an innovative business model. Have a point of difference that can be protected while the company is growing. Trustworthy, experienced and properly incentivised management and sensible investment valuation. It must have a clear path to exit within 2-5 years.

What really caught my attention was CVC’s portfolio of early stage investments. It included one very big name, affterPay. It was refreshing to know that the team were the ones that backed afterPay in its early stages. The investment has returned the fund some 1088% in gross returns. A few of the other big names are Deals Direct, Auscred (Clickloans) and Telix Pharmaceuticals. The Fund is an Early Stage Venture Capital Limited Partnership (ESVCLP). It was launched to provide investors with the opportunity to invest in Australia’s fast moving venture capital sector. Venture capital investing involves funding companies at an early or expansionary stage in their lifecycle. The Fund invests in companies that utilise new technology, innovation or a combination of both to deliver their products or services. The Add+Venture fund offering provides investors with access to the substantial returns available from investing in Australian venture capital through an experienced manager. The Fund targets innovative, high growth Australian companies operating in an increasingly supportive early stage ecosystem. Investments are selected, negotiated and managed by Add+Venture. It looks for early stage start-ups that have a working prototype and have some revenue but are not as yet profitable. Below is a graphic representation of where the Add+Venture fund focuses its attention. Its prime area is around the Commercialisation

and Early Expansion cycles.

Did you say TAX incentives? The Fund is looking to raise $20m with the minimum investment per investor set at $100,000. The ESVCLP program was created by the Australian Government to encourage investment into start-ups by giving investors tax incentives.

Captial Gains exempt - All returns to investors from the realisation of eligible investments by the Fund will be both income and capital gains tax exempt.

Tax offset - Investors in this Fund will be entitled to a tax offset of up to 10% of the amount they invest in the Fund.

Investors will become eligible for this offset on a pro-rata basis each time the Fund makes an investment. The Management fee is 2% per annum. But the targeted return is 25% per annum, net of fees and carried interest. So the high fee is justified. The other thing to be weary of is that there will be no permitted withdrawals and no secondary market. An investment in the fund is illiquid. It’s not like investing in underlying shares that can be sold. The fund seeks a 3 year average investment holding period, which is a lot shorter period than typical VC funds. Once the investee company has grown to the point where an exit is possible, the fund will exit via: Trade sales, IPO – both ASX and offshore exchanges or via a sale to strategic investors. Capital Calls - 20% of Committed Capital is payable on application. Upon termination of the Investment Period, investors will not be required to pay further calls on their unpaid Committed Capital except for certain purposes. Unconventional View: We quite like this fund and highly recommend it to investors that have a keen interest in the start-up space. We must advise investors that the fund is a medium to long term investment with limited liquidity. It’s not a trading fund that you can pull out of with short notice. The fund is speculative and involves a high degree of risk. Yes that means you can lose your money. There are no guarantees. But going by CVC’s track record, they’re pretty good at consistently returning above the norm successfully investing capital in profitable start-ups. So as we tell all our clients, assess the risks and determine whether an investment in the fund is suitable for yourself. If you’re seeking professional advice please give our team a call at Wattle Partners.

Ferrari Portfolio - We’re selling 3 stocks today (29 Nov)

We recently introduced the Ferrari Portfolio. Just to recap – The portfolio is a challenge to turn $100k into enough to buy a Ferrari 246 GT Dino. This classic is around the $400k mark. It’s not cheap. Now this is real and it is a live portfolio. Selling – We’re locking in profits

We’re offloading both AuMake and Cann Group. They’re both highly volatile stocks and we’ve made good gains in both. Time to lock it in and run. Punching the air in delight.

Hyrdoponics Company (THC) – Hasn’t done us well. It’s hit its stop loss, so we’re out. Oh well. You win some, you lose some.

Current stocks – Actions.

Blackmores and NextDC – We’re holding onto both but ready to take profits soon. Hyrdoponics Company – Has been tracking downwards since we bought it. Despite this we’re hanging on just

for a little while longer. It is sitting on its stop loss.

Code Description Bought Price Paid Price NowTotal

ReturnStop Loss Holdings Value

AU8 AuMake Limited 10-Nov-17 $0.36 $0.58 +63.4% $0.49 56338 $32,676.04

CAN Cann Group Ltd 10-Nov-17 $2.30 $2.85 +23.9% $2.47 8696 $24,783.60

THC Hyrdoponics Company Ltd 10-Nov-17 $1.09 $0.92 -16.1% $0.93 18349 $16,789.34



BKL Blackmores Ltd 27-Oct-17 $147.09 $169.30 +15.1% $138.35 136 $23,024.80

NXT NEXTDC Ltd 27-Oct-17 $5.12 $5.95 +16.1% $4.80 3906 $23,221.17

BLD Boral Ltd 10-Nov-17 $7.79 $7.65 -1.9% $6.63 2567 $19,627.73

IPL Incitec Pivot Ltd 10-Nov-17 $3.97 $3.97 +0.0% $3.38 5038 $20,000.00

A2M a2 Milk Company Ltd 10-Nov-17 $7.99 $7.59 -5.0% $6.84 2503 $18,998.75

CASH - $122,919.40

Total $187,791.85

Profit / Loss $87,791.8

Ferrari Portfolio

Totals +87.8%Since 9th December 2016

Ferrari Portfolio – We’re buying 4 stocks today (30 Nov)

We recently introduced the Ferrari Portfolio. Just to recap – The portfolio is a challenge to turn $100k into enough to buy a Ferrari 246 GT Dino. This classic is around the $400k mark. It’s not cheap. Now this is real and it is a live portfolio. Buying – We’re buying a few more stocks today

Costa Group (CGC) – Shares have come off a little. We’re using that as an opportunity to buy in. The company recently upgraded guidance at its AGM. Its prospects are good.

Galaxy Resources (GXY) – Signed a long term off-take agreement for Mt Cattlin for a minimum 200kt pa of lithium concentrate for 5 years. We think it’s a positive announcement so we’re buying.

Origin Energy (ORG) - Upgraded guidance for FY output from its Eraring plant. Output in 2017-18 is now expected to be between 15.5 terawatt-hours and 16 terawatt-hours, about 6% higher than its August forecast. ORG shares are hitting 26 month highs. It is good news and we’re buying on the back of it.

Aristocrat Leisure (ALL) – Has announced the strategic acquisition of social gaming company Big Fish for US$990m. It is “financially attractive and expected to be EPSA accretive in the first full year of ownership”. We’re buying.



CGC Costa Group Ltd 30-Nov-17 $6.34 $6.34 +0.0% $5.39 3155 $20,000.00

GXY Galaxy Resources Ltd 30-Nov-17 $3.90 $3.90 +0.0% $3.32 5128 $20,000.00

ORG Origin Energy Ltd 30-Nov-17 $9.02 $9.02 +0.0% $7.67 2217 $20,000.00

ALL Aristocrat Leisure 30-Nov-17 $23.68 $23.68 +0.0% $20.13 845 $20,000.00



BKL Blackmores Ltd 27-Oct-17 $147.09 $169.26 +15.1% $138.35 136 $23,019.36

NXT NEXTDC Ltd 27-Oct-17 $5.12 $5.80 +13.3% $4.80 3906 $22,654.80

BLD Boral Ltd 10-Nov-17 $7.79 $7.61 -2.3% $6.63 2567 $19,537.87

IPL Incitec Pivot Ltd 10-Nov-17 $3.97 $4.00 +0.8% $3.38 5038 $20,151.13

A2M a2 Milk Company Ltd 10-Nov-17 $7.99 $7.54 -5.6% $6.84 2503 $18,873.59

CGC Costa Group Holdings Ltd 30-Nov-17 $6.34 $6.30 -0.6% $5.46 3155 $19,873.82

GXY Galaxy Resources Ltd 30-Nov-17 $3.90 $3.82 -2.1% $3.32 5128 $19,589.74

ORG Origin Energy Ltd 30-Nov-17 $9.02 $9.10 +0.9% $7.68 2217 $20,177.38

ALL Aristocrat Leisure Ltd 30-Nov-17 $23.68 $22.25 -6.0% $15.16 845 $18,792.23

CASH - $42,919.40

Total $185,589.33

Profit / Loss $85,589.3

Ferrari Portfolio

Totals +85.6%Since 9th December 2016

X-factor stocks – Two A-REITs that offer great value

Firstly what are A-REITs? Australian Real Estate Investment Trusts or A-REITS for short, are companies that own income producing real estate assets. It’s mostly commercial rather than residential property. A-REITs provide investors with a regular income stream, whilst also giving capital growth and diversification benefits. A-REITs usually pay out all of their taxable income as dividends to shareholders. This is generally at least 90% of its income paid to investors. This makes them an attractive investment. However dividends usually don’t provide franking credits as they are taxed at the investor level due to the trust structure. Shareholders pay income taxes on those dividends. A-REITS give investors the opportunity to invest in large commercial properties that would otherwise be out of reach. These assets allow investors to earn a share of income generated by tenants on the property without having to buy the physical property themselves. A-REITs generate wealth through capital growth and rental income. The fund manager is responsible for administration, maintenance and rental issues. Each A-REIT has its own features, type of properties, lease lengths and tenants. A-REITs are traded on the ASX but there are public non-listed and private A-REITs. Mortgage REITs invest in mortgage securities tied to commercial or residential properties. These are riskier. 90% of A-REITs are Equity whilst the remaining 10% are Mortgage. The underlying assets that an A-REIT can be tied to, can vary depending on the fund manager. Here is a list of properties that an A-REIT can hold. The ASX has listed A-REITS in these categories: The underlying assets that an A-REIT can be tied to can vary depending on the fund manager. Here is a list of properties that an A-REIT can hold. The ASX has listed A-REITS in these categories:

Office trusts include medium to large office buildings in and around major cities. Industrial trusts invest in warehouses, factories, and industrial parks. Hotel and leisure trusts invest in hotels, cinemas and theme parks. Retail trusts invest in shopping centres and similar assets. Diversified trusts invest in a mixture of industrial, offices, hotels and retail property. Residential trust usually invested in residential property developments - Stockland Group, Lend Lease and

Mirvac. Some A-REITs give diversified exposure such as GPT Group (GPT) which is tied to industrial, office and

retail. What moves A-REITS? The main characteristic of A-REITS is the income and capital growth, but more-so the income. Whether it’s a commercial or residential A-REIT, both generate the majority of their income from rent. If a large tenant vacates the commercial property, the rental income received will fall, lowering returns on the fund. This can be bad news for the fund if it is highly geared and fails to meet its interest obligations. That would move the share price south. The main priority for a REIT is that it has to be able to generate sustainable cash flow through the leasing of its assets. That means that a well-leased asset with long term tenants is preferred over an asset that turns over tenants regularly. There is a common misconception that A-REITS are correlated with the Australian property market. If you look at the chart below, you’ll see that both Vicinity Centres (shopping centres) and Cromwell (office) share very little correlation

with the residential property market for obvious reasons. It can be argued however that a residential property collapse will affect the overall economy and will hurt consumer spending and confidence. This in-turn may cause a tenants to pack up and vacate if business goes sour. The Amazon effect has caused huge to A-REIT’s that hold shopping centre and warehousing assets. It will have a positive effect on industrial A-REITs that build warehouses and a negative effect on those that house shopping centres. The other factor that needs to be considered is interest rates. A-REITs must pay out all of its taxable profit as a dividend to shareholders. So that makes them a stable, high yielding investment asset. It also makes them a bond proxy. A-REITs act like bonds. They are stable, safe haven and low risk type of asset that returns regular coupon bond type dividends. It also means that A-REITs have begun to move in an inverse direction to the 10 year Australian Government Bond.

A-REITS shake off Amazon effect and rising bond yields With interest rates forecast to rise and Amazon tipped to clear out shopping centres, shouldn’t we avoid A-REITs altogether? Well not exactly. Whilst US rates are forecast to rise, we’re unlike to see rates rising any time soon. In-fact the 2 year it’s the first time in 20 years that short-term bond yields in Australia are equal to and will soon move lower than the US. Bond yields in both countries are 1.76%. This means that the prospects in the Aussie economy are expected to be softer than the US for the next few years. The ASX 200 A-REIT Index is up 7% since the start of October and is in what looks like the early stages of a recovery. The Amazon effect that caused the severe sell-off is now factored in. If anything the sector sell off was overdone. The retail sector was worst hit with Westfield Corp, Scentre and Vicinity Centres losing the most. Property fund managers outperformed. These include Goodman Group and Charter Hall. We think the sell-off has created some great buying opportunities in A-REITs. Broker CLSA says the recent sell-off makes office names more attractive. Retail A-REITs offer much better value with limited downside. CLSA's pick is Scentre Group as it’s the highest quality retail A-REIT with yield of 5.3% and growth rate of 4.2%. UBS also agrees. Worries over Amazon’s arrival are well overdone. A-REITs were sold off prematurely without taking into account the shopping centre landscape in Australia. Australian landlords are well-positioned to compete, especially with favourable demographics population densities and the mix of tenants/sales.

Here are our two picks – Goodman Group (GMG) and Scentre Group (SCG).

Goodman Group (GMG) - Industrial - Is an Australian integrated commercial and industrial property group that owns, develops and manages real estate including warehouses, large scale logistics facilities, business and office parks globally. Total assets under management (AUM) of $33.9bn. Occupancy increased to 98% across the portfolio which reflects its high quality properties. GMG reaffirmed forecast FY2018 full year operating earnings per security (EPS) of 45.71 cents, up 6% on FY2017. The company very recently said “the demand drivers for high-quality industrial real estate are continuing. Increased consumerism, the rise of e-commerce and supply chain efficiencies, continue to drive the need for Goodman’s properties.” Some of GMG’s prized customers include Costco, JD.com, Keuhne + Nagel. NTA is $4.64.

Scentre Group (SCG) – Retail Shopping Australia - Is the spin-off of retail giant Westfield Corp (WFD). On June 2014 Westfield Group separated its US/European operations from its Australian/New Zealand operations. SCG holds 43 shopping centres in Australian/NZ. Since its It is Australia’s largest A-REIT and has a yield of 5.04%. The Group maintained its guidance for FY growth in funds from operations (FFO) of approximately 4.25%. The distribution guidance of 21.73 cents per security is also maintained. It also has a development pipeline of $900m.

In summary: The A-REIT sector is one that has been dismissed and overlooked by the market. It’s unloved and deserves some attention. We think now is the perfect opportunity to pick up stocks in this sector that are looking fairly attractive. The sector has an average distribution yield of 4.9% which is above the 2.51% 10 year bond yield. We believe the Amazon effect won’t have any bearing in the short term. Rental income is relatively secure, which means A-REITs’ income streams should be stable. A-REITs have always had a rather obvious inverse correlation with the 10

1 Mth

Return

Scentre Group SCG.AX Shopping +5.2% -4.3% $4.23 -4.34% 24.17x 5.09% $22.52bn

Westfield Corp WFD.AX Shopping +7.6% -7.3% $8.36 -7.29% 33.92x 3.90% $17.37bn

Goodman Group Pty Ltd GMG.AX Industrial +4.2% +24.6% $8.71 24.57% 45.74x 2.97% $15.68bn

Stockland Corporation Ltd SGP.AX Retail / +3.5% +4.9% $4.68 4.86% 35.30x 5.45% $11.39bn

Vicinity Centres Re Ltd VCX.AX Retail +4.9% -4.0% $2.78 -3.99% 18.15x 6.22% $10.76bn

DEXUS Property Group DXS.AX Office +4.5% +7.4% $10.21 7.44% 63.46x 4.45% $10.39bn

GPT Group GPT.AX Office +5.1% +8.4% $5.35 8.38% 30.85x 4.52% $9.64bn

Investa Office Fund IOF.AX Office +5.6% +1.8% $4.73 1.81% 30.13x 4.27% $2.84bn

Charter Hall Group CHC.AX Real Estate +8.3% +36.6% $6.28 36.63% N/A 4.78% $2.93bn

Growthpoint Properties Australia LtdGOZ.AX Diversified +5.1% +10.2% $3.50 10.24% 24.80x 6.14% $2.32bn

Abacus Property Group ABP.AX Diversified +8.9% +42.8% $4.14 42.81% 36.75x 4.23% $2.39bn

BWP Trust BWP.AX Retail - Bulk +2.9% +8.7% $3.18 8.74% 14.40x 5.51% $2.04bn

Shopping Centres Australasia Property Group Re LtdSCP.AX Retail / +2.1% +10.9% $2.40 10.90% 15.15x 5.46% $1.79bn

Charter Hall Retail REIT CQR.AX Neighbourhood +4.2% +2.4% $4.23 2.41% 30.60x 6.64% $1.71bn

GDI Property Group Ltd GDI.AX Office / Real +8.4% +34.1% $1.30 34.11% N/A 5.98% $0.69bn

Rural Funds Group RFF.AX Agriculture +8.1% +38.9% $2.39 38.93% N/A 4.07% $0.61bn

Hotel Property Investments LtdHPI.AX Retail - Pubs +3.2% +18.2% $3.24 18.18% 1960.00x 6.05% $0.47bn

Industria REIT IDR.AX Diversified -1.1% +31.2% $2.61 31.18% 18.00x 7.70% $0.43bn

Aspen Group Ltd APZ.AX Accomodation -1.4% +8.3% $1.06 8.27% N/A 4.36% $0.11bn

Agricultural Land Trust AGJ.AX Agriculture +90.6% +10.9% $0.06 10.91% N/A 0.00% $0.01bn

Company Price12 Mth

ReturnType

12 Mth

ReturnPrice/FFO Mkt . Cap Y ield

Year Government Bond Yield. But towards the middle of this year, that correlation seems to have changed. There are some positive factors that are at play and we think you can’t go wrong with either Goodman Group or Scentre Group.

What are the different profit metrics?

When a company announces their profit results they will usually declare a range of profit numbers such as underlying profit and statutory profit, making it all very confusing. But what do they all mean and which one should you pay attention to? In this article, we’ll try and explain all the relative numbers and which ones you need to keep an eye on. A profit and loss statement

Here are the common profit measures:

Gross Profit = Revenue – Cost of Goods Sold. It’s the profit a company makes after deducting the costs associated with making and selling its products or services.

EBITDA – Stands for Earnings Before Interest, Tax, Depreciation and Amortisation. It is used to analyse and compare profitability between companies and industries because it eliminates the effects of financing and accounting decisions. EBITDA = Net Profit + Interest +Taxes + Depreciation + Amortization.

EBIT – Is simply EBIT minus deprecation. EBITDA calculates earnings before any depreciation or amortization is determined whereas EBIT with operating income. Indeed, these values are often so closely related they can be used interchangeably without causing any accounting issues.

NPAT – Net profit after tax is one of the more important figures that a company will disclose. The NPAT is calculated from taking the operating profit after income tax, before the significant and extraordinary items. The formula is NPAT = EBIT - tax.

PBT – Profit before tax. Net Income – This is the bottom. Net income is a company's total profit. It’s what goes to shareholders and is

used for PE multiples. It is calculated by taking revenues and subtracting the costs of doing business such as depreciation, interest, taxes and other expenses.

Statutory profit - Is calculated by adding one off gains (or losses) to underlying profit. This is a once off and doesn’t happen every year. For example a company may sell some of its assets. Therefore the statutory profit isn’t the figure used by analysts to compare. Most strategic decisions are taken based on underlying profit figures.

2017 2016

Net Sales $2,000.00 $1,800.00

Cost of Goods Sold -$900.00 -$700.00

Gross Profit $1,100.00 $1,100.00

Operating Expenses (SG&A) -$400.00 -$250.00

Operating Profit $700.00 $850.00

Other Income (Expense) -$100.00 $50.00

Extraordinary Gain (Loss) $400.00 -$100.00

Interest Expense -$200.00 -$150.00

Net Profit Before Taxes (Pretax Income) $800.00 $650.00

Taxes -$250.00 -$200.00

Net Income $550.00 $450.00

Operating profit - Is the profit earned from a firm's normal core business operations. This value does not include any profit earned from the firm's investments, such as earnings from firms in which the company has partial interest, and the before the deductions of applicable interest and taxes owed.

Normalised profit - Are adjusted profits to remove the effects of seasonality, revenue and expenses that are unusual or one-time influences. Normalized earnings help business owners, financial analysts and other stakeholders understand a company's true earnings from its normal operations.

Operating Profit - Is the income earned from the core operations of a business, excluding any financing or tax-related issues. It is used to explore the profit-making potential of a business, excluding all extraneous factors.

The most important metric however is Underlying Profit. It is what analysts use to compare their forecast against. So when you hear a company has beaten profit expectations, they are comparing the underlying profit with their forecasts. When analysing a bank’s profit against expectations, the figure used is cash profit instead of underlying profit. The underlying profit shows how the business is performing. This amount is an indication of what a company may do year after year if all other parameters remain same. Australian companies are required to report statutory numbers but they will use underlying profit numbers to exclude one-off items and paint a rosier picture. The thing to keep in mind is that profit and loss figures can be manipulated to look a lot better than they really are. So as well as profit, look at free cash flow as well. Free cash flow is a measure of a company's financial performance, calculated as operating cash flow minus capital expenditures. It is the cash that a company generates after spending the money required to maintain or expand its asset base. It basically shows how profitable a business is and tells a lot better story than most of the other metrics. The profit and loss statement spreads out cash spend on long term investments over time whereas the cash flow statement has no smoothing. It’s all about the current position, what is spent here and now. Ultimately underlying profit and cash flow are just metrics and may not tell you the whole story. Just because a company isn’t generating a profit, doesn’t mean its share price won’t go up i.e. – Xero (XRO). It’s all in the expectations of future earnings that matters and whether a company will meet those expectations that matters most.

CHARTS OF THE WEEK In the below chart we have the iron ore price. As you can see, iron ore has broken out on the upside and is in bullish territory driven on optimism about Chinese demand for higher grades of the steelmaking material. The ore has risen by 16% this week to US$67.69 a tonne. It was also driven by China's push to curb pollution. The chart is from Fairfax Media in the AFR.

Charts that are attractive

3 Stocks from the herd – ORG, RCR, IFL

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. Origin Energy (ORG) – Current Price - $9.10 - Is a gas and oil exploration and production company but also deals in power generation and energy retailing in Australia. LNG operation, energy retailing and power generations. It also conducts the business in New Zealand through a 53.09% investment in Contact Energy. Production basins include SA Cooper & SWQ, Otway, Bass, Surat, Perth, and Taranaki. It also holds a 37.5% investment in Australia Pacific LNG. It is the owner and developer of gas-fired power generation in Australia and also produces renewable energy from wind farms with 6,000 MW of capacity. ORG released its Quarterly Production Report for the quarter ended 30 September 2017 this week. Origin’s quarterly production of 89.1pje was stable compared to the June quarter, reflecting a sustained level of production. Origin held its investor day this week.

Broker View: Citi (HOLD $8.97) – The broker has become a little more confident following the $500m cost-out update at its investor day. There is also upside in guidance, but Citi remains on the sidelines on Neutral. Unconventional View: We disagree with Citi. We think Origin Energy is a Buy. The company upgraded guidance for FY output from its Eraring plant. Output in 2017-18 is now expected to be between 15.5 terawatt-hours and 16 terawatt-hours, about 6% higher than its August forecast. ORG shares are hitting 26 month highs. The company will also cut more than half a billion dollars in annual costs at its APNLG JV. That’s huge. Slashing both operating and capital expenditure will help the company boost its bottom line. It is targeting $1.30 per gigajoule in 2018 and $1 in 2019. The company is trying to replicate the success the US shale gas frackers have had with the shale gas boom. CEO Mark Schubert said “We’ll unashamedly copy that and bring it back here”. We think there is merit in this strategy. That aside, ORG is also looking to hit a breakeven oil price of US$24boe below its target of US$30boe. Origin also reaffirmed its full-year earnings guidance. All very positive stuff. If the company can achieve these targets there is huge upside potential in the share price. On the chart, the stock is trading at the upper end of its uptrend channel.

ORG

$9.10

PE FY0 NULL Dividend 0.00% 52 Week High $9.09 Short term 92%

PE FY1 16.09x Gross yield 0.00% 52 Week Low $6.21 Long term 46%

ROE FY0 4.25% Franking NULL Price 1M % +12.62% RSI 70

ROE FY1 7.87% Debt / Equity 75.69% Price 1Y % +40.87% PEG Ratio 0.41

EPS FY0 -0.37c EPS FY1 0.51c EPS Growth -240.53% Market Cap $15.71bn

$9.96 Current Ratio 1.30

StockOmeter Origin Energy Ltd

Intrinsic Value

52

NO GOOD

NOT BAD

BUY

GOOD

DEEPVALUE

52

Investors may want to wait for a dip. Either way, the stock is travelling in a solid uptrend and we recommend buying now.

RCR Tomilson (RCR) – Current Price - $3.90 - Is a diversified engineering and infrastructure company providing integrated solutions to clients in the resources, energy and infrastructure sectors. RCR’s services include design, manufacture, fabrication, construction, installation, maintenance and off-site repair operating across Australia, New Zealand and Asia. RCR has three business sectors comprising RCR Resources, RCR Energy and RCR Infrastructure. These include power generation plants (solar, wind, battery and hydro), water and waste treatment systems, rail and road tunnel infrastructure, rail signalling and overhead wiring systems, mineral processing and material handling plants, integrated oil & gas services (both onshore and offshore), supply of RCR proprietary materials handling and process equipment, and property services including facilities management, HVAC and electrical services. Some of its latest projects include: The Daydream and Hayman Solar Farms in QLD and the Pilbara Minerals (PLS) Lithium processing plant. This week RCR was awarded a contract valued at $33m to design, manufacture and construct a 5km relocatable conveyor system for Fortescue Metals Group (FMG).

Broker View: Macquarie (OUTPERFORM $4.64) – RCR was awarded a $33m contract to design and manufacturer a conveyor system for FMG. The broker says it’s the first project that is between two companies that targets improving productivity and efficiency. RCR also has a massive amount of solar farm production work in the pipeline and is trading at a discount. Unconventional View: We agree with UBS. The company had a record August profit result has been ticking all the right boxes. Both profit of $25.7m and Revenue of $1.3bn beat expectations. Net debt was reduced to $25.2m with its gearing ratio remaining quite low. RCR has a strong order book of $1.4bn in work and has been awarded multiple large contracts. To add to it, the company completed a $75m capital raising @ $3.55. The funds raised will help provide balance sheet flexibility to take advantage of growth opportunities and it will support growth and development in solar and rail. This deal awarded with FMG only further highlights the company’s success. We’re impressed with the number of contracts the company has been winning. Ord Minnett says it could be in excess of $600m. This alone should drive a 7% increase in FY18 estimates. Meaning there is upside risk to FY18 forecasts. All very positive stuff.

RCR

$3.90

PE FY0 22.47x Dividend 1.50% 52 Week High $4.74 Short term 8%


ROE FY0 8.56% Franking 0% Price 1M % -7.58% RSI 25


EPS FY0 0.16c EPS FY1 0.25c EPS Growth +51.23% Market Cap $0.66bn

$3.88 Current Ratio 1.11

StockOmeter RCR Tomlinson Ltd

Intrinsic Value

69

NO GOOD

NOT BAD

BUY

GOOD

DEEPVALUE

69

With an Order Book of $1.4bn and Preferred Contractor Status of $1.6bn, RCR upside growth potential is staggering. We expect further revenue and earnings growth in FY18 just from these new contract wins. This should drive share price gains from here on in. On the StockOmeter the company pulls up OK at 69. That’s a strong Buy indicator. It trades on a rising ROE. On the chart, the stock is in a solid uptrend but has recently pulled back towards its support line. RCR is looking particularly attractive at these levels. We think investors should be buying.

IOOF Holdings (IFL) – Current Price - $11.18 – IOOF has spent up big and bought ANZ’s $975m OnePath business. The deal is massive for IFL. It not only gives IFL the ability to distribute OnePath’s wealth products through ANZ’s banking network but it will transform IFL into the second largest advice business by both number of advisers and funds under advice. The deal was of great strategic importance to the company as it now cements IOOF as a leading wealth adviser on a similar footing as AMP, who are the current leaders. The deal is expected to close by the end of 2018.

Broker View: Morgan Stanley (OVERWEIGHT $13.00) – The acquisition of OnePath is a landmark deal in the broker’s eyes. It paves that way for substantial upside and potential synergies. It also removes any major competitor and delivers scale and power. With banks retreating from the sector, it leaves IOOF in an enviable position. Unconventional View: We agree with Morgan Stanley. This deal really puts IOOF on the map. It may even take over AMP within a few years. With banks retreating from the insurance and wealth sector, it leaves AMP and IFL to rein supreme. There really is no other competition. To add to it, IFL expects the OnePath deal to be mid-single digit earnings per share accretive in FY 2019, with expectations that EPS accretion will eventually increase to around 20%. That will delivered a massive boost to the bottom line and the potential for further upside and cost savings across all areas of the business. This deal will catapult IOOF into with the big boys of advisory and wealth to become the number 2 player, just after AMP. The stock currently sits on 73 on the StockOmeter, which is a really good rating. It’s a definite buy. With ROE rising and a high yield of 6.79%, you really can’t go wrong with having this stock in your portfolio. The only negative that we can see, is headwinds coming out of the Royal Banking Commission but that’s a wait a see. That aside, the stock has

IFL

$11.18

PE FY0 28.89x Dividend 4.75% 52 Week High $11.94 Short term 84%


ROE FY0 12.36% Franking 100% Price 1M % +3.61% RSI 70


EPS FY0 0.44c EPS FY1 0.45c EPS Growth +2.50% Market Cap $3.92bn

$13.49 Current Ratio NULL

StockOmeter IOOF Holdings Ltd

Intrinsic Value

73

NO GOOD

NOT BAD

BUY

GOOD

DEEPVALUE

73

broken out on the upside and has formed a new short term uptrend. We think investors should be buying at these levels.

Wattle Partners Pty Ltd Unit 10, 3 Bromham Place Richmond Victoria 3121 Australia T + 61 3 8414 2909 www.wattlepartners.com.au

General advice disclosure

Any recommendations given in this document is General Advice only. We have not considered clients’ personal or individual circumstances. All clients and readers should seek professional advice before acting on any recommendation. You should also obtain a copy of and consider the Product Disclosure Statements for any product discussed before making any decision.

http://www.wattlepartners.com.au/

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