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1 Weekly Recommendation, Target Price, Earnings Forecast Changes

2 Broker Strategy And Stock Allocation Updates

3 UGL Shakes Up Market With Corporate Review

4 Is There Value In BHP and Rio?

5 Weekly Recommendation, Target Price, Earnings Forecast Changes

6 Newcrest Downgrades But Brokers Upbeat

7 Christchurch Clouds The Australasian Building Outlook

8 Oz Banks Suffer Weak Credit Growth

9 What Do Banks Do When They Don't Lend?

10 Dividend Strategies: Not All About Franking

11 Uranium Steady But Subdued

12 Material Matters: Copper, China's Property Tax And Coal

13 Metal Matters: Iron Ore, Thermal Coal And Gold

14 A Calmer Month For Uranium

15 Material Matters: Oil, Bulks And Platinum

16 Metal Matters: Diversified Miners, Copper, Iron Ore, Gold And Silver

17 Why The Aussie Came Back And Will Stay

18 Too Early To Give Up On Big Asia

19 Mining Investment Slowing? Mind The Gap

FNArena Weekly http://www.fnarena.com/membership/pdf_weekly.cfm

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20 Weekly Broker Wrap: Tight Budgets And Loose Money

21 Rudi's View: Amcor - Resilience And Capital Discipline

22 A Greek Tragedy

23 Weekly Broker Wrap: Cyclical Stocks Returning To Favour

24 The Short Report

25 Soon Time To Buy BHP, Rio?

26 Treasure Chest: Suncorp Re-Rating Draws Nearer

27 Understanding PE Ratios: It's About Confidence


2 of 62 05-Apr-13 11:03 AM

Stories To Read From FNArena www.fnarena.com

1 Australia

By Andrew Nelson

Brokers were a fair bit busier last week than they have been in the few weeks prior when it comes to the upgradingand downgrading their recommendations. It was also a week that upgrades outpaced downgrades, with a total ofnine recommendations pushed higher compared to eight that moved lower.

Aristocrat Leisure ((ALL)) was upgraded to Buy from Sell by Citi, the broker noting the company has done a reallygood job in bringing in some new game design talent which is already paying off in North America. Citi now expectsto see decent market share gains, especially in recurring revenue lines. FY15 earnings forecasts were lifted by 20%to reflect the better share. The higher earnings caused a big jump in the price target, giving Citi the headroom toupgrade its call. Broker sentiment for the stock is neutral according to the FNArena Database.

Last week was a busy one for David Jones ((DJS)). The stock was upgraded to Hold from Sell by JP Morgan, whileboth Macquarie and Citi downgraded their calls to Sell from Hold. JP Morgan has grown a bit more comfortable withthe company’s strategic direction and sees signs of growth for FY15. Citi didn’t much like the first result, with costpressures, weak sales and lower credit card earnings combining to make it difficult for the broker to see any kind ofgrowth over the next couple of years. Macquarie has trouble with the increasingly steep looking valuation andthinks it’ll take just about everything the company has just to keep from going backwards. Sentiment for the stockis neutral.

Macquarie upgraded its call on National Australia Bank ((NAB)) to Buy from Hold. The broker conducted a review ofthe sector and reported institutional and corporate borrowing appears to be improving in the mining states.Macquarie believes access to credit may become easier in the second half of the year and given NAB is the primarybanker to more SMEs than any of the other major banks, it is now the broker's top pick in the sector.

Perseus Mining ((PRU)) was upgraded to Buy from Hold by JP Morgan. The broker admits operating issues at Edikanand delays to the start-up of Sissingue have really put the clamps on sentiment for the stock. And while sentimentcannot be ignored, the broker ultimately believes the issues will have minimal impact and do not alter thelonger-term production upside. Given this view of significant longer term value, JP Morgan believes the currentshare price provides an attractive entry point. Sentiment for the stock is very positive.

Another stock that had a busy week was Premier Investments ((PMV)), with Credit Suisse upgrading itsrecommendation to Buy from Hold, while Deutsche Bank upgraded to Hold from Sell and Citi downgraded its call toSell from Hold. Credit Suisse thinks the outlook is finally starting to improve. The broker sees growing upside in thegroup's domestic mature brands, while international growth also looks promising. Deutsche Bank is starting to seesome positive signs for retailers in Australia, but the broker also reckons it's way too early to call a macroimprovement. A federal election later in the year further adds to the Deutsche’s cautious stance. Citi is simplyexpecting nothing in the way of earnings growth in the second half and really out through FY14. Add the flatearnings outlook to a valuation that is looking increasingly stretched and you’ve got a downgrade. Sentiment forthe stock is neutral.

Qantas ((QAN)) was upgraded to Buy from Sell by Macquarie, the broker thinks earnings margins are moving back toa more normal rate and has more confidence in the industry outlook, generally. Sentiment is positive. The brokeralso upgraded Sydney Airport ((SYD)) to Buy from Hold, noting the outlook for international remains solid, whilegrowth in domestic remains in line with expectations. Given the improving performance, the broker thinks thevaluation and general prospects are becoming increasingly attractive. Sentiment for the stock is negative.

Rounding out the air travel theme from Macquarie is Virgin Australia ((VAH)). Citi upgraded its recommendation to


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Buy from Hold, noting that Virgin is increasingly challenging Qantas' position in the business class and regionalmarkets. Sentiment is positive.

TPG Telecom ((TPM)) was upgraded to Buy from Sell by Citi, the broker finding the first half result impressive givensolid growth in broadband and mobile. Underlying numbers comfortably beat the broker and the market, whilemanagement also upgraded its guidance. FY13-15 net profit forecasts were lifted, with the broker also notingmargin pressures have diminished. Sentiment for the stock is positive.

On the downgrade side of the ledger, AMP ((AMP)) was cut to Sell from Hold. Macquarie believes most of the upsidefrom improving economic conditions is already in the price, while ongoing negative Life performance is starting topose a clear downside risk to expectations. Sentiment shifted to neutral on the downgrade.

CIMB lowered its call on Redflow ((RFX)) to Hold from Buy nothing that while the company has done the hard yardson lowering operating costs, a 60% discount was applied to the valuation case because of delays in securing astrategic partner. Any success with partner negotiations is likely to prompt a review, said CIMB. Sentiment isneutral.

Our last two downgrades come from UBS, the broker lowering its calls on both Bandana Energy ((BND)) and Orica((ORI)) to Hold from Buy. As far as Bandana goes, the market will be unlikely to pay a valuation based price untilthere is more clarity on funding and a project go-ahead can be counted on. Thus a funding solution, probably via asell down to a JV partner, is required if the stock is going to re-rate. The broker thinks the outlook for Orica is stillpositive, yet it is cautious about margins. The company also reported a number of weather-related impacts onearnings to the tune of $10-$15m, while the operating environment for Minova is not good. As well as downgradingthe stock, the broker also cut FY13-14 earnings forecasts.

There were a few significant increases to consensus price targets in the FNArena Database over the course of lastweek as well, while there really wasn’t much in the way of significant downgrades. TPG Telecom’s ((TPM)) pricetarget was up more than 15.7%, Treasury Wine Estates ((TWE)) saw its average price target lift nearly 14.3% afterBA-Merrill Lynch pushed through some higher forecasts, while David Jones’ price target was sitting 13.7% higher.

Average earnings forecasts for TPG Telecom were up by 6.8%, while average forecasts for Drillsearch ((DLS)) andDavid Jones were both more than 4% higher on the week. Earnings forecasts for APN News & Media ((APN)) weredown more than 42%, forecasts for Mount Gibson ((MGX)) were down 14.4%, Alacer Gold ((AQG)) was down 7.5%,Imdex ((IMD)) was 6.1% lower and earnings estimates for Qantas were lower by nearly 5%.

Note: FNArena monitors eight leading stockbrokers on a daily basis and the tables below are based on data analysisfrom the week past concerning these eight equity market experts. The eight experts in casu are: BA-Merrill Lynch,Citi, Credit Suisse, Deutsche Bank, JP Morgan, Macquarie, CIMB (formerly RBS) and UBS.

Total Recommendations Recommendation Changes

Broker Recommendation BreakupSecurities,Citi,Credit<*br*>Suisse,Deutsche<*br*>Bank,JP<*br*>Morgan,Macquarie,UBS&b0=99,150,84,82,88,71,116,94&h0=79,154,115,104,138,107,118,140&s0=64,23,40,46,16,48,40,27" style="border:1px solid #000000;" />

Broker Rating Order Company Old Rating New Rating Broker Upgrade 1 ARISTOCRAT LEISURE LIMITED Neutral BuyCiti 2 DAVID JONES LIMITED Sell Neutral JP Morgan 3 NATIONAL AUSTRALIA BANK LIMITED Neutral Buy Macquarie 4PERSEUS MINING LIMITED Neutral Buy JP Morgan 5 PREMIER INVESTMENTS LIMITED Neutral Buy Credit Suisse 6QANTAS AIRWAYS LIMITED Neutral Buy Macquarie 7 SYDNEY AIRPORT HOLDINGS LIMITED Neutral Buy Macquarie 8TPG TELECOM LIMITED Neutral Buy Citi 9 VIRGIN AUSTRALIA HOLDINGS LIMITED Neutral Buy Macquarie Downgrade10 AMP LIMITED Neutral Sell Macquarie 11 BANDANNA ENERGY LIMITED Buy Neutral UBS 12 DAVID JONES LIMITEDNeutral Sell Macquarie 13 DAVID JONES LIMITED Neutral Sell Citi 14 ORICA LIMITED Buy Neutral UBS 15 PREMIERINVESTMENTS LIMITED Neutral Sell Citi 16 PREMIER INVESTMENTS LIMITED Buy Neutral Deutsche Bank 17 REDFLOWLIMITED Buy Neutral CIMB Securities Recommendation Positive Change Covered by > 2 Brokers Order SymbolPrevious Rating New Rating Change Recs 1 TPM 20.0% 60.0% 40.0% 5 2 SYD - 33.0% - 17.0% 16.0% 6 3 PRU 71.0% 86.0%15.0% 7 4 QAN 57.0% 71.0% 14.0% 7 5 VAH 29.0% 43.0% 14.0% 7 6 NAB 25.0% 38.0% 13.0% 8 7 AZJ 38.0% 50.0% 12.0% 8 8HGG 50.0% 60.0% 10.0% 5 9 SGT 43.0% 50.0% 7.0% 6 10 TWE - 50.0% - 43.0% 7.0% 7 Negative Change Covered by > 2


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Brokers Order Symbol Previous Rating New Rating Change Recs 1 DJS - 50.0% - 63.0% - 13.0% 8 2 ORI 86.0% 75.0% -11.0% 8 3 AQG 75.0% 71.0% - 4.0% 7 4 GWA - 17.0% - 20.0% - 3.0% 5 Target Price Positive Change Covered by > 2Brokers Order Symbol Previous Target New Target Change Recs 1 TPM 2.594 3.002 15.73% 5 2 TWE 4.524 5.170 14.28%7 3 DJS 2.403 2.733 13.73% 8 4 QAN 1.856 1.931 4.04% 7 5 VAH 0.470 0.476 1.28% 7 6 NAB 29.339 29.581 0.82% 8 7 PRU2.723 2.743 0.73% 7 8 SYD 3.255 3.267 0.37% 6 9 AZJ 4.321 4.333 0.28% 8 Negative Change Covered by > 2 BrokersOrder Symbol Previous Target New Target Change Recs 1 ORI 28.253 27.838 - 1.47% 8 Earning Forecast PositiveChange Covered by > 2 Brokers Order Symbol Previous EF New EF Change Recs 1 TPM 16.490 17.614 6.82% 5 2 DLS8.133 8.533 4.92% 3 3 DJS 18.646 19.463 4.38% 8 4 FXJ 5.444 5.550 1.95% 8 5 SYD 13.300 13.417 0.88% 6 6 APA 26.22526.438 0.81% 8 7 CCL 77.149 77.761 0.79% 8 8 PRG 26.771 26.914 0.53% 7 9 NAB 249.488 250.425 0.38% 8 10 QBE 100.410100.783 0.37% 8 Negative Change Covered by > 2 Brokers Order Symbol Previous EF New EF Change Recs 1 APN13.476 7.726 - 42.67% 8 2 MGX 12.909 11.051 - 14.39% 8 3 AQG 49.298 45.593 - 7.52% 7 4 IMD 16.333 15.333 - 6.12% 3 5QAN 10.053 9.453 - 5.97% 7 6 PRU 14.843 14.171 - 4.53% 7 7 ORI 196.375 188.163 - 4.18% 8 8 DML 7.862 7.534 - 4.17% 4 9BLY 14.864 14.314 - 3.70% 8 10 GNC 79.313 77.750 - 1.97% 8 Technical limitations

If you are reading this story through a third party distribution channel and you cannot see charts included, weapologise, but technical limitations are to blame.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this storycontains unashamedly positive feedback on the service provided.


5 of 62 05-Apr-13 11:03 AM


2 Australia

By Greg Peel

Australia’s major equity brokers are bullish. Not that they aren’t always bullish – it’s a bit hard to make a dollar bytelling clients not to invest – but after five years of GFC gloom, successive years of earnings forecast downgrades,and a sharp rally beginning late last year, the general feeling is that the dust is now settling and things are quietlyreturning to some sort of normal.

The search for yield in a low global interest rate environment, an apparent recovery in the US economy, a lack ofhard landing in the Chinese economy, and an increasingly more ho-hum attitude toward Europe have all conspiredto provide risk-takers with the green light they’ve been looking for, at least so far. For four years the major riskswere double-dip in the US, a crash landing for China, and implosion in Europe. Even in Australia, in which thenon-mining economy has been hard hit while mining has driven the train, a quiet shift towards greater equilibriumis reducing overall risk.

The consumer sentiment survey published earlier this month showed a “noticeable uptick”, declares Citi, fromDecember to March in equities as a place for Australians to put their savings. The data confirm anecdotal evidencefrom financial executives and retail brokers, Citi notes, of an increase in retail flows and trading. New money isentering the market.

It’s early days, Citi warns, and we must bear in mind the uptick represents only a slight blip off a very low post-GFCbase, but with bank term deposit rates likely to stay low there’s little reason why the trend cannot continue. OnCiti’s numbers the average market multiple (price/earnings) has returned to a “normal” 14x. Bull markets in thepast have featured investors pushing PEs beyond normal and into “bullish” levels, ahead of expected earningsgrowth. The rally to date has transpired despite any real sign of earnings growth in FY13, but the forecast numbersfor FY14 suggest the catch-up can still eventuate, believes Citi.

CIMB notes the ASX 200 has been one of the better global performers in the rally into 2013, well outperforming theAsia Pacific ex-Japan index. Financials, staples and consumer discretionary, including a strong move from NewsCorp ((NWS)), have driven the Australian result. Large caps have performed “strikingly well”, suggests CIMB,compared to the rest of the world in which small caps have been the significant outperformers. Defensive sectorvaluations are now stretched, particularly food & beverage, the strategists suggest.

The CIMB strategists are retaining some defensive yield in their preferred portfolio, through National Bank ((NAB)),Westpac ((WBC)) and Transurban ((TCL)). The rest of the portfolio leans towards “value” as opposed to yield.Overvalued defensives have been exited or shorted. Telstra ((TLS)) is now out, while the healthcare sector hasbeen shorted. In industrials, CIMB is long Downer EDI ((DOW)), Fairfax Media ((FXJ)) and Seven West Media ((SWM)).

CIMB sees the resource sector as a “second derivative” investment opportunity. Investors sitting onunderperforming miners are no doubt bemoaning that while China may have turned around its economictrajectory, its new growth path is less inspiring than it used to be, and in the meantime it is the US economy whichis apparently firing along. Australian industrials with US exposure have provided strong returns. Do not fear, saysCIMB. If the US economy is growing, demand for Chinese exports will grow, and hence demand for Australian rawmaterial exports will grow indirectly.

CIMB has added miner Rio Tinto ((RIO)) to its portfolio along with mining service provider WorleyParsons ((WOR)),and has increased exposure to a knocked-down copper market with investments in OZ Minerals ((OZL)) and SandfireResources ((SFR)).

CIMB also runs a high conviction “long-short” portfolio. A long-short portfolio implies a degree of “pairs trading”, inwhich one stock is shorted to provide funds to purchase another, preferred stock in a similar business or at least


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similar sector. Long-short portfolios are not the domain of the small retail investor, but CIMB’s pairs at the veryleast provide readers with an idea of the strategists’ preferences on a relative basis.

CIMB is long Oil Search ((OSH)) and short Woodside ((WPL)), long Fletcher Building ((FBU)) and short Boral ((BLD)),long Downer EDI and short Leighton Holdings ((LEI)), long Goodman Fielder ((GFF)) and short Metcash ((MTS)), longStarpharma Holdings ((SPL)) and short Ramsay Healthcare ((RHC)), long Transurban and short AustralianInfrastructure ((AIX)), and long Suncorp ((SUN)) and short Perpetual ((PPT)).

The strategists are also long Seek ((SEK)) and short Ten Network ((TEN)), long Perseus Mining ((PRU)) and shortOceanaGold ((OGC)), Long Rio Tinto and short BHP Billiton ((BHP)), long iiNet ((IIN)) and short Telecom NZ ((TEL)),long Qantas ((QAN)) and short Brambles ((BXB)), long Programmed Maintenance ((PRG)) and short Navitas ((NVT)),long Hills Holdings ((HIL)) and short Imdex ((IMD)), and long Transpacific ((TPI)) and short Oakton ((OKN)).

UBS agrees with its peers that the “value” space is now the most compelling area of the Australian market, despitesome stocks now looking fairly valued. UBS’ preferences for taking advantage of the value push involve those valuestocks that have proven laggards to date, those with operational turnaround momentum, those with mid-cyclereturn on equity (ROE) upside, and those which are priced for growth.

Hence the strategists like Incitec Pivot ((IPL)) and Origin Energy ((ORG)) as laggards, Lend Lease ((LLC)), PrimaryHealth Care ((PRY)), Harvey Norman ((HVN)) and Boral ((BLD)) as those offering turnaround momentum, Sims MetalManagement ((SGM)) and Macquarie Group ((MQG)) for ROE upside, and Asciano ((AIO)) and Qantas for priced-for-growth upside.

Macquarie is also rotating its preferred portfolio out of stocks with “bond-like characteristics” and into stocks withdomestic cyclical exposure to housing and consumer demand. The analysts believe the Australian reporting seasonjust passed “strongly” suggested a bottom to the earnings cycle. They also believe a reversal in US long bond yieldsis a “critical” signal suggesting a shift away from “fear” and into “greed”.

Locally, Macquarie has added DuluxGroup ((DLX)), Mirvac ((MGR)), JB Hi-Fi ((JBH)) and Toll Holdings ((TOL)) to itsportfolio while reducing an overweight position in Telstra and exiting positions in GPT Group ((GPT)), InvestraOffice ((IOF)), Transurban and Sydney Airport ((SYD)).

Macquarie also considers Dulux to be one of its “counter consensus” calls, given the broker rates the stockOutperform when market consensus is neutral. The broker’s other counter consensus calls, for which an Outperformrating is ascribed when the market is neutral, are Echo Entertainment ((EGP)) and IOOF Holdings ((IFL)).

Goldman Sachs has introduced a new approach to recommendations for the longer-term investor by launching itsSUSTAIN focus list for Australian and New Zealand stocks. The list comprises of 15 stocks which the broker believesare best positioned to sustain industry leading returns as “long-term leaders”. This approach varies from otherbroker recommendations, such as those above, in terms of time horizon.

Goldman’s SUSTAIN list includes ANZ Bank ((ANZ)), Ausbroker Holdings ((AUB)), BHP Billiton, Brambles,Commonwealth Bank ((CBA)), Coca-Cola Amatil ((CCL)), Cochlear ((COH)), Computershare ((CPU)), CSL ((CSL)),Domino’s Pizza ((DMP)), DuluxGroup, Insurance Australia Group ((IAG)), Super Retail ((SUL)), WorleyParsons andWoolworths ((WOW)).

Moving into small caps, and back to a nearer term time horizon, Citi notes the results season just passed couldhave been worst for Australia’s small caps given reported earnings were only marginally softer than expected.Given the smalls have materially underperformed the large caps in this recent rally, the broker believes value isbeginning to appear. Relative valuations remain compelling, although a trigger for the catch-up is hard to identify,the broker concedes, while the market is keen on chasing more liquid stocks.

Nevertheless, Citi has listed its top industrial small cap Buys as Forge Group ((FGE)), G8 Education ((GEM)), iiNet,Miclyn ((MIO)), McMillan Shakespeare ((MMS)), M2 Telecommunications ((MTU)) and Southern Cross Media ((SXL)).

For small resources, Citi likes AWE ((AWE)), Gryphon Minerals ((GRY)), Mt Gibson Iron ((MGX)) and Medusa Mining((MML)).


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3 Australia

-Corporate structure review underway -Outcome may unlock value potential -But UGL has a lot on its plate

By Eva Brocklehurst

Engineering, operations & maintenance contractor and property services conglomerate, UGL Ltd ((UGL)), hasembarked on a review of its corporate structure. This may end up entailing a spinning off or possible sale ofdivisions. Who knows? At this point, as BA-Merrill Lynch describes, it's navel gazing.

The broker is among several which think the timing of such a review is not good. There is a downturn in theengineering segment and there are a couple of newer divisions in property services which are yet to realise theirfull potential. A problem for BA-Merrill Lynch in all of this is that any de-merger opens up the prospect of lowerliquidity and removal from key S&P/ASX indices. The broker understands there is potential to be unlocked in astructural separation but, also, underlines the fact that no decision has been made as yet.

Various alternatives will be considered in the review including maintaining the current corporate structure,reviewing a potential structural separation of the company, as well as the overall merger & acquisition strategy.Tax, debt and management issues that would be associated with a separation will also be examined. An update isplanned by the FY13 results announcement on August 12, 2013, if not before.

For Morgan Stanley, it is another opportunity to recommend selling the stock, with the announced review sendingthe share price up 12%. The broker think the business is under pressure and deserves to trade at a discount topeers. The list of negative aspects for this broker are a lack of cash profits, an engineering businessunderperforming peers and an unproven property strategy. The broker accepts the fact that opportunity may beunleashed by the review but, as it stands, is not confident in the underlying operations. Moreover, the weak link isnot engineering but risks from the DTZ acquisition, in Morgan Stanley's view. These include $141m of provisions thatcould be a material drag on the business and goodwill of $212m, exceeding the purchase price of $148m, as a resultof provisioning. Morgan Stanley's sums generate a potential break-up value of $8.21-10.26 per share.

Moelis sees it a bit differently. The problem is the market is valuing DTZ in terms of an engineering acquisition, notproperty. For this broker, one of the key attractions is UGL's diversified earnings stream and this is not reflected inthe multiples. Taking what Moelis believes is a more appropriate valuation of the DTZ business, there is upside tobe had. The DTZ business could also be a clear takeover target. Moreover, a more focused engineering andOperations & Maintenance (O&M) company is likely to improve market share and attract international EPCM(engineering, procurement and construction management) contractors.

JP Morgan was surprised at the timing, given the underlying operational problems. The review, in the broker'sopinion, is an attempt to reduce the discount UGL trades at against a break-up implied sum of the parts valuation,which JP Morgan has at $10.63 a share. A de-merger and/or structural separation could also make it easier for apotential acquirer to pursue a single division.

The broker believes there are two risks which are critical to assessing the benefit of any restructure. The first isdealing with the current operational issues such as lost market share for engineering and the immature roll out ofthe property business. JP Morgan is concerned that, if a restructure is pursued in the near term, this could distractmanagement from addressing these operational issues. On the second risk, restructuring is likely to incur directcosts and impact each segment's capacity to fund growth. So, ahead of further news, the broker is keeping an openmind and retains a Hold rating, one of five on the FNArena database. The other ratings are two Buys (Credit Suisse,Deutsche Bank) and one Sell (Macquarie).

Macquarie was also surprised at the timing of the review as UGL is only part way through a cost cutting programtargeted at DTZ. Taking a bullish view on valuation, Macquarie's estimates are, on FY13 price/earnings, 15-16 times


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for property and 10 times for engineering/O&M, which is in line with Downer EDI ((DOW)) and Transfield Services((TSE)). This results in a $11.76 valuation, showing 11% upside from current trading levels. It's just that UGL alreadyhas a big ask in terms of the second half, despite cutting full year earnings guidance. Macquarie notes key driversthat are required to fulfill earnings expectations include $9-10m of incremental cost savings, the non-recurrence ofa problem project in infrastructure and growth in services from recovery in the American property market, as wellas DTZ cost savings.

Credit Suisse had envisaged that UGL would consider a spin-off once DTZ was integrated and believes the timing ofthe review is to combat the downgrading of the stock that has occurred since the first half result. Credit Suissethinks the engineering/O&M segment could become an attractive target to companies intent on expandingcapabilities in the sector such as DOW, Clough ((CLO)) or Monadelphous ((MND)). Under this scenario, UGLEngineering could command higher multiples. Credit Suisse likes the stock and believes the discount to market atwhich it is trading is not warranted. Furthermore, the broker believes UGL has scope to gain market share in the USrelative to the dominant players there.

The target price on the FNArena database ranges from $10.39 (Macquarie) to $12.30 (Credit Suisse). The consensustarget price is $11.03, showing 7.7% upside to the last share price. Consensus dividend yield for FY13 earnings is6.7% and for FY14 it's 6.8%.



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4 Australia

By Greg Peel

Australia’s Big Two globally diversified “miners”, BHP Billiton ((BHP)) and Rio Tinto ((RIO)) boast resource sectorasset portfolios that are similar enough to encourage comparison, but dissimilar enough to encouragedifferentiation. BHP has a large interest in oil and gas, and Rio does not. Both are big iron ore miners, but Rio isbigger. Both have extensive copper and coal assets. Both have further interests in other base metals, uranium andso forth, but it is not these divisions which are generating the bucks at present.

Both are in the process of undertaking a major portfolio clean-out, which they hope will involve the divestment ofa lot of smaller, or more marginal businesses. Leaving aside BHP’s energy assets for now, iron ore, coal and copperare dominating earnings. Coal and copper prices are struggling, leaving iron ore, and both companies’ major ironore production expansion plans, as critical for both. Iron ore is also critical for market perception, given the greatdeal of attention now placed on spot iron ore pricing.

As noted in my most recent article with regard to BHP and Rio (Lean, Mean, Mining Machines), under respectivenew CEOs both companies are focused not just on asset sales, but also on the assiduous reduction of their costs ofproduction and maximisation of the productivity of existing projects. Stock analysts are very encouraged by thesestrategies and see the strong potential for re-rating of share prices as a result. Capital returns to shareholders, oneway or another, would seal the deal, but then both companies need to first reduce debt levels first as part of theircost reduction programs. And current expansion projects are still sucking up capex.

Brokers might be positive, and many have, and for a long time have had, Buy ratings on one or both stocks. Themarket, on the other hand, is not convinced, as the following charts demonstrate. The first is a chart of thebenchmark ASX 200 index, in which BHP and Rio are influential:

The second is a chart of the ASX 200 Materials Sector, which BHP and Rio dominate:

For many investors coming back into what appears to be a more positive Australian stock market, or for those longsuffering holders of the big miners, this chart exemplifies the disappointment and frustration shareholders arefeeling. If the stock market is positive then BHP should be positive, shouldn’t it?

JP Morgan believes there are no less than five reasons why the market is anything but positive on BHP and Rio.

The first and most obvious is iron ore price fear. Not long ago, iron ore export prices to China (and Japan, Korea etal) were negotiated annually. Commodities analysts spent all year publishing and rejigging their forecast priceexpectations, but the wider investment community really didn’t pay much attention until the annual price resetwas announced.

Today, the big producers still negotiate deals on at least a quarterly pricing basis, but more and more iron ore isbeing shipped at the margin on spot pricing. Suddenly the iron ore spot price has become a hot news topic, even inthe popular media, let alone the wider investment community. When Goldman Sachs lowered its longer dated ironore prices forecasts recently it was just about front page news. FNArena is perhaps guilty, too, of popularising spotiron ore by now publishing price movements each day on the website, from late last year. But we are simplyresponding to reader demand.

I’m surprised Tom Waterhouse isn’t running a book on iron ore. Or perhaps he is.

The bottom line is that while iron ore spot prices go up or down each day, stock analyst earnings forecasts do not.Stock analysts lay out what they call a “price deck” of average price forecasts for this year, next year, at least onemore year, and thereafter “long term”. These numbers then feed into net present value (NPV) calculations formining stocks and percolate through to share price targets. Right now, spot is around US$137/t while analysts are


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working off a near term price of around 120 and a long term of around 80 (which is where Goldman Sachs recentlydowngraded to). In other words, the trend of daily spot price movements will ultimately become important toanalysts, but daily price fluctuations are not. The same can be said for miners’ management teams. Spot prices arevolatile.

Yet whenever the daily spot price of iron ore drops a couple of percent, iron ore miners are sold down. Three yearsago the wider market would have been blissfully unaware of how iron ore prices were trending. One can see why JPMorgan considers iron ore spot price “fear” as the number one reason iron ore mining stocks have underperformedin 2013.

There has also been a lot of talk recently of a near term global surplus in copper. This is not front page stuff, butsignificant given up until recently just about every commodities analyst was forecasting higher copper prices aheadon constrained supply and a potential deficit. What they didn’t count on was such a big drop in demand, and copperprices have been suffering all year. This is reason number two for JP Morgan.

Beyond that, JPM also cites concerns of a slowdown in the Chinese property market (implying lower demand forsteel and copper). Recent news of new tax-based constraints on property development and speculation beingimposed by Beijing sent relevant stock prices plunging. Then there’s the simple issue of neither BHP or Rio beingable to reward long suffering shareholders with buybacks, special dividends or the like given their ongoing capexprograms and aforementioned need to pay down debt. And finally JP Morgan simply points to forecasts for lowearnings growth from either this financial/calendar year.

These are all, suggests JP Morgan, “near term headwinds”. Arguably the price of iron ore is not “near term” butperennial, but the point is stock analysts have already valued the shares of iron ore producers based on lower ironprice expectations. Specifically, analysts have factored in the impact of increased supply set to hit the oceans overthe next couple of years as production expansion from not just BHP and Rio, but also from Fortescue Metals ((FMG))and various aspirational juniors, along with foreign producers. In other words, the market need not panic everytime the iron ore spot price drops from 135 to 133.

On the flipside there are also “incremental medium term positives”, as JPM puts it, being ignored by the market inthe case of the Big Two. These include the aforementioned down-sizing, cost-cutting and efficiency strategies theminers are now pursuing, and the potential for capital returns down the track once these programs start paying offand debt is brought under control. Then there’s the apparent general improvement in the global economy, and thesimple fact that the share prices of both have already been knocked down some way. JP Morgan also believesinvestors in general are underweight the sector.

JP Morgan is therefore “comfortable” with its positive outlook on both stocks. Given this broker specifically ratesstocks within a sector, and not against the benchmark index, the analysts are positive on BHP, but have only set aNeutral rating given they prefer Rio, which attracts a Buy.

A preference for Rio is not uncommon among brokers, including those who set ratings against the benchmark index.Indeed, five of eight FNArena database brokers have Neutral (Hold) ratings on BHP against two Buys and one Sell.Seven brokers have Buy ratings on Rio, against one Hold.

The one Sell rating on BHP is courtesy of BA-Merrill Lynch, who downgraded from Hold in January. A glance back atthe materials sector chart above suggests this was a good move. Merrills has not yet deigned to re-rate the stock,nevertheless, despite a significant stock price retracement in the meantime. What Merrills has been doing,however, is some sensitivity analysis.

Which brings us back to the iron ore price.

The Merrills analysts, along with peers from other brokers, recently trotted out to the Pilbara to see how the ironore landscape was looking these days. Merrills spoke not just to BHP and Rio, but to Fortescue, Hancock (not listed)and the various junior miners operating in the area. What the analysts found is it is not just the market that isworried about the potential for lower iron ore prices going forward.

“On the WA iron ore field trip,” says Merrills, “a common theme was the impending pressure on iron ore prices


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going forward. Although there was no clear message as to the degree to which prices may fall from here, it wasapparent that management do not see the current levels being sustained under current conditions”.

Merrills current 2013 average iron ore price forecast is US$120/t, which includes a fall to 110 in the second halffrom current levels above 130. On a base case, the analysts have set an NPV for BHP of $26.41 (last traded price$33.13). It is important to note that while NPV is fundamental in broker target prices, Merrills’ target for BHP iscurrently $34.00. Net present value is a base value to which a premium is often added.

If Merrills assumes a 130 iron ore price for the next three years, the analysts’ BHP NPV rises to $27.97 (up 5.9%).Assuming a 70 price for three years implies $23.87 (down 9.6%).

For Rio the analysts have a base case $63.76 (last traded $57.75) and a target of $80.00. At 130 the NPV rises 5.7% to$67.40 and at 70 falls 11.8% to $56.21.

For Fortescue the analysts have a base case of $7.34 (last traded $3.97) and a target of $5.50. At 130 the NPV rises36.7% to $10.04 and at 70 falls 41% to $4.33.

Fortescue’s swings are far more substantial because Fortescue is a pure-play iron ore producer and not a diversifiedresource company. As for the junior pure-plays, as one might imagine Merrills’ analysis delivers some wild swings.

By holding all other input values equal, Merrills’ analysis is discounting one major underlying factor. If the iron oreprice were to trend downwards towards the US$80/t brokers are factoring in in the longer term, it is unlikely theAussie dollar would remain above parity for too long. Indeed, in each case of up or down in iron ore price, Aussiedollar movement is likely to be in the opposite direction, acting as a dampener on actual Aussie dollar earningsfrom iron ore sales.

UBS, for example, is forecasting a decline in iron ore price to 72 over four years. But the broker simultaneouslyexpects a decline in the Aussie to US$0.80 from today’s US$1.04. UBS has currently assigned a share price target forBHP of $40.00, for Rio of $89.00, and for Fortescue of $5.35. UBS rates both BHP and Rio as Buy and Fortescue asNeutral.

JP Morgan has a long term price assumption for iron ore of 80 and a long term Aussie assumption of 80. As notedearlier, JPM is positive on both BHP and Rio and also has a Buy on Fortescue.

Is there a moral to this story then?

It is understandable that investors in BHP and Rio in particular are (a) nervous about iron ore and other commodityprices and (b) ticked off at brokers who seem to be almost perennially positive about these stocks even as theirprices have been sinking into the sunset. The current consensus target price in the FNArena database for BHP is$38.67, suggesting 16.6% upside, and for Rio it’s $80.57, suggesting 39.2% upside. When is this upside going tomaterialise?

Well for starters these are forecasts, and not promises. But what brokers are trying to say is that the market, intheir view, has become too reactionary, too panicked, and has now sent BHP and Rio share prices down to levelswhich makes then relatively attractive, even if iron ore prices do trend down over the next few years.

Technical limitations




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5 Australia

By Andrew Nelson

Brokers were a bit busier with upgrades and downgrades last week, seemingly spurred on by the impending breakand determined to make a difference before we all headed off for Easter. The good news for the market is thatupgrades again outweighed downgrades. The score by Thursday was twelve up and eight down.

We’ll start off with Billabong ((BBG)), which was upgraded to Hold from Sell by UBS. The broker took the chance tore-evaluate the stock now that final bids for the company are expected this week. UBS does not expect the $1.10bid to become a binding offer because of the 10% earnings downgrade and $534m in asset impairments taken sincethe initial bid was made. A lower offer is expected, but the worst case scenario could be the withdrawal of bothbids. The upgrade is predicated by the assumption of a 65% probability that a bid will get up, but probably at alower price. Broker sentiment for the stock in the FNArena Database reads neutral.

BlueScope ((BSL)) was lifted to Buy from Neutral by JP Morgan, who noted the company is now leaner and morefocused and thus ready for a recommendation upgrade. The broker cites the fact that Coated & Industrial Productsis now close to break even after two years of making losses. Global Building Solutions also looks to be on a stronggrowth path. Despite a strong rally from the five-year low the shares hit last year, JP Morgan believes there's moreupside available based on the aforementioned turnaround. Sentiment is positive for the stock.

Boart Longyear ((BLY)) was upgraded to Hold from Sell by JP Morgan, the broker believing the current share pricemore than covers current downside. At the same time, JP Morgan also sees little chance its price target will bechallenged any time soon given the complete lack of catalysts. Sentiment for the stock is negative. The broker alsolifted Fortescue Metals ((FMG)) to Buy from Hold, citing the sharp fall in the share price and the belief selling hasbeen overdone. Despite the headwinds of iron ore price weakness, JP Morgan sees a good chance for some upsideonce the market returns to focus on the compelling valuation support. Sentiment is positive.

There was one last upgrade from JP Morgan. Tabcorp ((TAH)) was bumped up to Buy from Hold, the broker believingthe company is showing some promise after a period of underperformance. The improved regulatory outlook,defensive revenue growth and possible future restriction on wagering advertising all bode well, according to thebroker. Sentiment is positive.

Myer ((MYR)) also saw an upgrade to Buy from Hold, with Deutsche Bank lifting its call on the belief the market stillhas a steady appetite for discretionary retailer stocks. In this case, Myer represents the best opportunity given areasonable valuation and strong free cash flow. The company is also delivering like-for-like sales growth and isaddressing structural issues, said Deutsche. Despite the upgrade, sentiment for the stock is negative.

Analysts at Credit Suisse made two moves higher, lifting both Lend Lease ((LLC)) and Premier Investments ((PMV)) toBuy from Hold over the course of last week. For Lend Lease, Credit Suisse thinks investor concerns such as earningsuncertainty and weak operating cash flow are overstated, noting the stock's price/earnings relative to the ASX hasfallen 31% below the 10-year average. For Premier, the first half result not only pipped the broker’s forecasts andconsensus, but also told the broker the outlook is finally starting to improve. CS sees growing upside in the group'sdomestic mature brands, while international growth is also looking promising, earnings are improving and strongercash flow growth is coming. The broker says the stock also offers a good opportunity for upside from businessimprovement and some international growth protection from the current domestic economic cycle.

Analysts at Citi disagree, downgrading their recommendation on Premier from Hold to Sell. The broker notesoperating costs are building and the performances from various brands remain mixed, with Smiggle and Jay Jayscontinuing to backtrack. Citi also expects to see limited earnings growth in the second half and through FY14, while


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the valuation is starting to look stretched. Sentiment for the stock is neutral.

Our last four upgrades are all to Buy from Hold and all come from Macquarie. Qantas ((QAN)) is lifted on animproving capacity outlook, the broker believing earnings margins are moving back to a more normal rate and hasmore confidence in the industry outlook. Virgin Australia is also upgraded, the broker suspecting Virgin isincreasingly challenging Qantas' position in the business class and regional markets. Sentiment is positive for both.

The broker expects the positive earnings momentum from Qube Logistics ((QUB)) will continue into the second half,so the recent pull back in the share price is a nice an opportunity to buy. Sentiment is positive.

National Australia Bank ((NAB)) had a busier week. Upgraded to Buy by Macquarie, but downgraded to Hold fromSell by CIMB. Macquarie notes institutional and corporate borrowing appears to be improving in the mining states,with signs of improving demand for equipment finance. Macquarie believes access to credit may become easier inthe second half of the year, which means higher earnings. Meanwhile, CIMB was taking a look at bank sector netinterest margins for FY13-15 and found risks remain skewed to the downside. While NAB’s dividend yield to theAustralian government bond yield is supportive, the broker thinks the more fundamental valuations, like NAB’s,look stretched. Sentiment is positive.

JP Morgan downgraded Arrium ((ARI)) to Hold from Buy noting that despite the emergence of mining and miningconsumables as key earnings drivers, the stock is still subject to the vagaries of steel and iron ore pricing and theoutlook here is far from steady. Balance sheet gearing also remains an impediment to a more positive stance.Sentiment for the stock remains positive despite the downgrade.

Bank of Queensland ((BOQ)) is down to hold from Buy on the books of BA-Merrill Lynch, the broker noting the stock istrading in line with its long-term price/earnings ratio and dividend yield and on par with regional peers. DeutscheBank dropped DuluxGroup ((DLX)) to Sell from Hold saying that while the company may be strong and well managed,the market is still overestimating the leverage to improved housing activity and thus not worth the currentpremium. Sentiment remains positive for both stocks.

Orton Group ((ORL)) was cut to Hold from Buy by Credit Suisse. The half year results were below Credit Suisse'sforecasts and the outlook appears more challenging than previously expected. The earnings outlook is affectedmainly by the loss of the Ralph Lauren licence. Credit Suisse estimates an $18m negative earnings impact in FY14.Sentiment moves to neutral on the downgrade.

Our last two downgrades are both to Hold from Buy and both come from CIMB. The broker thinks Redflow ((RFX))has done the hard yards on lowering operating costs, although the application of a 60% discount because of delays insecuring a strategic partner sees the rating moved lower. Any success with partner negotiations is expected toprompt a review. Sentiment is neutral.

The broker also took a closer look at Whitehaven Coal ((WHC)) and came to the conclusion the issues at Narrabrimay end up lasting longer than first anticipated. There are a number of other important hurdles that soon need tobe cleared as well such as construction at Maules Creek, which hasn't even started despite off-take commitmentsalready building. The broker now sees little in the way of clear information, while first coal from Maules Creek hasbeen pushed back to 2015. Broker sentiment for the stock remains positive.

There were a handful of significant changes to consensus price targets in the FNArena Database. KathmanduHoldings’ ((KMD)) price target is up almost 15% after a well received first half report. David Jones’ ((DJS)) target is13.5% higher and Spark Infrastructure’s ((SKI)) consensus price is up 5.69%. There was only one big mover to thedownside, that being Whitehaven, down 8.12%.

There were also a few big changes to consensus earnings forecasts. BlueScope’s numbers were up 129%, helped bythe upgrade form JP Morgan. Dulux also enjoyed a better than 5% lift. On the downside, Arrium’s average earningsare down 53%, Nufarm ((NUF))’s numbers are 20.8% lower, Sydney Airports ((SYD)) 13.4% lower and Imdex ((IMD)) wasdown 6.1%.

Note: FNArena monitors eight leading stockbrokers on a daily basis and the tables below are based on data analysisfrom the week past concerning these eight equity market experts. The eight experts in casu are: BA-Merrill Lynch,


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Citi, Credit Suisse, Deutsche Bank, JP Morgan, Macquarie, CIMB (formerly RBS) and UBS.

Total Recommendations Recommendation Changes

Broker Recommendation BreakupSecurities,Citi,Credit<*br*>Suisse,Deutsche<*br*>Bank,JP<*br*>Morgan,Macquarie,UBS&b0=98,148,84,82,89,73,118,94&h0=80,157,115,105,136,106,116,141&s0=64,23,40,46,17,47,40,26" style="border:1px solid #000000;" />

Broker Rating Order Company Old Rating New Rating Broker Upgrade 1 BILLABONG INTERNATIONAL LIMITED SellNeutral UBS 2 BLUESCOPE STEEL LIMITED Neutral Buy JP Morgan 3 BOART LONGYEAR LIMITED Sell Neutral JP Morgan4 FORTESCUE METALS GROUP LTD Neutral Buy JP Morgan 5 LEND LEASE CORPORATION LIMITED Neutral Buy CreditSuisse 6 MYER HOLDINGS LIMITED Neutral Buy Deutsche Bank 7 NATIONAL AUSTRALIA BANK LIMITED Neutral BuyMacquarie 8 PREMIER INVESTMENTS LIMITED Neutral Buy Credit Suisse 9 QANTAS AIRWAYS LIMITED Neutral BuyMacquarie 10 QUBE LOGISTICS Neutral Buy Macquarie 11 TABCORP HOLDINGS LIMITED Neutral Buy JP Morgan 12VIRGIN AUSTRALIA HOLDINGS LIMITED Neutral Buy Macquarie Downgrade 13 ARRIUM LIMITED Buy Neutral JP Morgan14 BANK OF QUEENSLAND LIMITED Buy Neutral BA-Merrill Lynch 15 DULUX GROUP LIMITED Neutral Sell DeutscheBank 16 NATIONAL AUSTRALIA BANK LIMITED Buy Neutral CIMB Securities 17 OROTONGROUP LIMITED Buy NeutralCredit Suisse 18 PREMIER INVESTMENTS LIMITED Neutral Sell Citi 19 REDFLOW LIMITED Buy Neutral CIMB Securities20 WHITEHAVEN COAL LIMITED Buy Neutral CIMB Securities Recommendation Positive Change Covered by > 2Brokers Order Symbol Previous Rating New Rating Change Recs 1 SYD - 33.0% - 17.0% 16.0% 6 2 PRU 71.0% 86.0% 15.0%7 3 VAH 29.0% 43.0% 14.0% 7 4 QAN 57.0% 71.0% 14.0% 7 5 BLY - 38.0% - 25.0% 13.0% 8 6 LLC 75.0% 88.0% 13.0% 8 7 FMG38.0% 50.0% 12.0% 8 8 MYR - 25.0% - 13.0% 12.0% 8 9 SKI 43.0% 50.0% 7.0% 6 10 MGR 14.0% 17.0% 3.0% 6 NegativeChange Covered by > 2 Brokers Order Symbol Previous Rating New Rating Change Recs 1 KMD 67.0% 50.0% - 17.0% 4 2WHC 100.0% 86.0% - 14.0% 7 3 DJS - 50.0% - 63.0% - 13.0% 8 4 BOQ 25.0% 13.0% - 12.0% 8 5 BSL 75.0% 67.0% - 8.0% 6 6DLX 17.0% 14.0% - 3.0% 7 7 ARI 20.0% 17.0% - 3.0% 6 Target Price Positive Change Covered by > 2 Brokers OrderSymbol Previous Target New Target Change Recs 1 KMD 1.835 2.110 14.99% 4 2 DJS 2.446 2.776 13.49% 8 3 SKI 1.6701.765 5.69% 6 4 BOQ 8.120 8.283 2.01% 8 5 QAN 1.899 1.931 1.69% 7 6 SYD 3.255 3.295 1.23% 6 7 MYR 2.929 2.954 0.85%8 8 VAH 0.470 0.474 0.85% 7 9 PRU 2.723 2.743 0.73% 7 10 BSL 5.043 5.078 0.69% 6 Negative Change Covered by > 2Brokers Order Symbol Previous Target New Target Change Recs 1 WHC 3.879 3.564 - 8.12% 7 2 FMG 5.214 5.179 -0.67% 8 3 BLY 1.899 1.893 - 0.32% 8 Earning Forecast Positive Change Covered by > 2 Brokers Order Symbol PreviousEF New EF Change Recs 1 BSL 3.667 8.380 128.52% 6 2 DLX 22.971 24.129 5.04% 7 3 DJS 18.646 19.450 4.31% 8 4 KMD14.774 15.302 3.57% 4 5 CLO 10.310 10.577 2.59% 3 6 FXJ 5.444 5.550 1.95% 8 7 FMG 44.673 44.956 0.63% 8 8 NAB249.488 250.050 0.23% 8 9 HZN 1.381 1.382 0.07% 4 10 CBA 457.513 457.813 0.07% 8 Negative Change Covered by > 2Brokers Order Symbol Previous EF New EF Change Recs 1 ARI 15.338 7.205 - 53.03% 6 2 NUF 42.004 33.241 - 20.86% 8 3SYD 13.300 11.517 - 13.41% 6 4 IMD 16.333 15.333 - 6.12% 3 5 PRU 14.843 14.171 - 4.53% 7 6 BLY 14.866 14.193 - 4.53% 87 MGX 11.051 10.664 - 3.50% 8 8 VRL 37.800 36.800 - 2.65% 3 9 SBM 14.400 14.067 - 2.31% 3 10 QAN 9.553 9.453 - 1.05%7 Technical limitations




16 of 62 05-Apr-13 11:03 AM


6 Australia

- FY13 production guidance downgraded -Autoclave failure at Lihir the main cause -Brokers remain optimistic onlong term

By Eva Brocklehurst

What was largely expected has happened for Newcrest ((NCM)). Australia's largest gold miner has downgradedproduction forecasts for FY13. The problems inherent in being a gold miner were flagged in Could NewcrestDisappoint, Again? on March 4 and one of the concerns has come true just a month later. The potential forproblems that are never far from the surface reared up, with a failure of the brick lining in one of the autoclavesat the plant on Lihir Island, PNG. The cost of repair has not been estimated yet but it adds another layer to theongoing two-year remediation of the old plant. Newcrest has downgraded production estimates for FY13 to 2.0-2.15million ounces against the previous guidance of 2.3-2.5m ozs.

As our previous story notes, the company has a history of under delivering on guidance, so brokers weredisappointed but generally not too surprised. Most had foreseen the company would be hard pressed to achieve thelow end of the prior guidance range. Deutsche Bank noted this is the first real downgrade to FY13 productionguidance since the FY12 earnings report last August, when guidance for FY13 was first delivered.

No broker on the FNArena database has pulled back on recommendations as a result of this guidance downgrade,with target prices revealing plenty of upside potential.There are no Sell ratings on the database, just four Buy andfour Hold. CIMB did predict a production guidance downgrade a month ago after reviewing the Lihir asset, andadjusted the target price down a jot. A Buy rating was retained. Citi justifies a Hold rating thus: remain cautious onNCM's growth profile. The broker then elaborates on the stock's potential: it is leveraged to a positive goldenvironment through a large, world class reserve with high quality exploration opportunities. In the case of broker'starget prices on the database this ranges from $22.10 (Deutsche) to $29.25 (Credit Suisse). The consensus targetprice of $25.77 shows 28.3% upside to the last traded share price.

Citi calls it growing pains, and longer-term believes the recent investment in upgrades at Lihir should providepotential for strong cash flow. Near-term operational risks, such as that just encountered, are in place. FY13 isviewed as a transitional year while major capital expenditure is undertaken and production comes on stream.Deutsche Bank has now estimated FY13 production at around 2.05m ozs. Moreover, the risks extend to FY14 and thisbroker's estimates for that year are reduced by 4%, to 2.7m ozs. The refurbishment of the Lihir plant is still a yearaway from completion and Deutsche Bank finds it hard to be comfortable with the operating capability that isrequired in order to achieve the 1m ozs expected from that operation in FY14.

Macquarie expected a downgrade but was surprised by the quantum. The broker had thought that lifting Lihir toreach nameplate in February would be a tough ask and had forecast production of around 2.15m ozs. The brokernow expects 2.06m ozs for FY13. The bigger issue for Macquarie, as for Deutsche Bank, is the impact on FY14.Newcrest has not issued guidance for FY14 but expects to grow production to 3.1-3.5m ozs by FY17 and the majorityof this is expected from Lihir and Cadia Valley. Macquarie has taken a conservative tack and forecasts 2.73m ozs inFY14. Besides Lihir, which was the major contributor to the downgrade, there were more conservative estimatesoffered for Gosowong. Management had warned of the need to return to high grade sources there to achieveguidance. While grade has been restored, ground conditions have prevented a more permanent access to thefootwall. Other mines are affected by smaller downgrades. Hidden Valley's performance has been poor, DeutscheBank notes, and the company has downgraded guidance to 80-90,000 ozs from 90,000 ozs. Deutsche Bank has optedfor the middle of the range, forecasting 85,000 ozs. Telfer has lost some mining days as a result of Cyclone Rustybut there's been no change to production guidance, while Cadia East is performing as planned.

For BA-Merrill Lynch it is a reminder of just how tough Lihir is as an operation. The broker has downgraded FY13earnings forecasts by around 15%. Despite the downgrade, Merrills is comfortable with the approach the company


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has taken at Lihir. In this broker's view the ramp up with the new Million Ounce Production Upgrade (MOPU) hasprogressed reasonably smoothly and once it is fully integrated it will alleviate legacy issues associated with the oldplant. Nevertheless, it will be around six months before the market can become more confident that productionwill be consistent.

Credit Suisse notes the earnings impact would be equal to the revenue loss from the production loss. On the basisof spot gold assumptions, this could mean a $177 million impact on earnings. So, the broker estimates a 20%downgrade to FY13. Note though, the broker's assumption for foreign exchange is below the spot price and abovespot in the case of the gold price. Marking to spot would indicate a further decline in earnings.

Management's guidance for Lihir is now conservative and reflects pro rata autoclave capacity loss. The plant isseen operating at around 80% capacity, equivalent to three out of the four autoclaves. Credit Suisse notes, on theoptimistic side, that surplus oxygen could enable the other autoclaves to operate at higher rates. Again, on thepositive side, Credit Suisse cites the historical reliability of the autoclaves and the increasing redundancy ofautoclaves and oxygen plants should reduce the impact of future autoclave outages.

Newcrest may have disappointed the market with the new production guidance but, as Merrills notes, the companyhas the longest reserve life of mine (25 years) among its peers (around 18 years). Newcrest trade at a premium onearnings and cash flow multiples and improves on this for 2014/15, based on the production ramp up at Lihir andCadia.



18 of 62 05-Apr-13 11:03 AM


7 Australia

-NZ building heavily reliant on Christchurch -Oz building spurred by lowered cash rate -What balance can FletcherBuilding find?

By Eva Brocklehurst

Building activity in Australia and New Zealand looks set to ratchet higher. This spells good news for those stocks inthe sector, particularly Fletcher Building ((FBU)) which strides both countries. The difference between the twocountries is that the recovery is more regional in New Zealand, led by the rebuilding of Christchurch after theearthquake and a recovery in Auckland's housing market. Credit Suisse notes, in contrast, Australian home buyersand builders are responding to the significant reductions in the Reserve Bank's cash rate to date. The analystsbelieve weak business confidence will hold back non-residential building activity in Australia.

New Zealand housing consents rose 24% in the year to February and this improvement is a key indicator for housingstarts and, ultimately, demand for materials. CIMB believes the recovery reveals increased momentum inChristchurch's reconstruction. Christchurch building consents rose 104% in February and for the six months toFebruary were up 242%. Excluding earthquake related consents, NZ residential construction activity was up 22% inFebruary. Fletcher is the broker's preferred pick in the building materials sector. CIMB cites the "three Cs" asunderpinning Fletcher's outperformance. These are Cycle, Christchurch and Cost-out. Nevertheless, the brokerviews the sector as fully valued and considers Fletcher a relative rather than absolute opportunity.

Credit Suisse is a bit cautious about the breadth of the NZ housing recovery beyond Auckland and Christchurch,while capacity constraints may loom by 2014 in terms of the rebuilding. Moreover, identifying just how much ishousing related, Credit Suisse notes NZ non-residential building consents were down 17% in the year to February.Based on several factors, including stock-to-sales ratios, economic activity and employment prospects, the analystsat Credit Suisse do not believe the strength of the Auckland housing market will spill over into other regions in thenear term. UBS sounds another note of caution, flagging statistics which show the cost of NZ dwelling constructionis rising at the fastest pace, 3.1% year-on-year, since 2008. UBS also notes that spending on house building andfit-out in Christchurch is underpinned by insurance payouts. Fewer implications can be drawn in terms of overallhousehold confidence.

In Australia, residential building approvals have trended down slightly over recent months, notes UBS. The analystsconcur with Credit Suisse that low interest rates will prod housing sentiment and, indeed, this has surged to athree-year high. UBS looks for a 1% month-on-month bounce to a 157,000 annualised pace of building approvals.Again, the question is non-residential building and whether that can recover too. Citi has been bothered by thedepressed construction market in Australia and, noting that half Fletcher's earnings come from Australia,downgraded Fletcher recently to Sell. The good news is that the post-earthquake rebuilding should underpin the NZearnings for the next decade, at least in Citi's opinion.

Credit Suisse finds Fletcher worthy of a Hold rating, expecting NZ will underpin the company's building volumes inthe next 12 months. Credit Suisse joins two others including UBS with a Hold rating on the FNArena database. Thereare three Buy ratings (including CIMB). Those with Sell ratings include Citi and JP Morgan.



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8 Australia

- Bank share prices remain solid - Oz credit loan growth hits past lows - RBA cuts not yet spotted - Prices divergingfrom fundamentals

By Greg Peel

“Another month, another soft credit report in Australia,” sigh the economists at JP Morgan.

It is fair to say stock brokers have underestimated the attraction of Australian bank shares to both local and foreigninvestors these past few months, being diverted by the realities of the business that is banking rather than lookingat bank shares through investors’ eyes as relatively safe, high yield investments. Bank shares have run and run, tolevels which are considered too expensive under normal circumstances, and then run again.

There are clearly few countries in the world in which bank shares would be considered a “safe” investment atpresent. You can write off Europe and the UK for starters. US bank shares have had a good run in Wall Street’s pushbeyond past all-time index highs, but US banks are still harbouring some degree of government investment andhave yet to work their way through the GFC toxic debt fallout. And the US is not an AAA-rated economy.

Australia’s is an AAA-rated economy, even without a budget surplus, and Australia’s banking sector is among themost carefully regulated and thus respected. Australian banks are now much better capitalised than they were in2007, yet even then they did not need direct government intervention post-GFC, aside from the assistance ofdeposit protection. And the bottom line is: Australian banks pay handsome dividends in a low interest rate world,and those distributions are fully franked for local investors.

With the cost of offshore credit now retreating, the bank deposit war is waning. Having not passed on the fullamount of last year’s RBA rate cuts, bank net interest margins are, for the time being, looking very healthy. Therisk of bad debt write-offs has eased since the heady days post GFC, and the global appetite for risk is returning.Cost cutting and IT upgrades are improving efficiency. Australian banks almost look like they’re in a sweet spot.Except for one thing.

Their actual business is not growing.

Bank analysts had warned even a year ago that credit growth through 2012 and into 2013 was likely to be subdued,and not really apparent again until perhaps 2013-14, which is why they’ve been caught out by strong share pricegains. Under normal circumstances, if your business isn’t growing your share price won’t be either. The banks havemanaged to improve earnings on the back of the abovementioned list of positives, but upside from here needsbusinesses and households to come back into the market looking for loans. Of course, slow loan growth is not simplythe fault of businesses and households – the banks are still shell-shocked and have not yet eased the lendingrestrictions they quickly tightened up after the GFC.

For a little while there it looked like credit loan growth might just be sneaking back, but the figures for Februaryhave shot down that hope. Overall private sector credit grew a mere 0.2% in February, and the six month(annualised) run rate now sits at 1.8%. JP Morgan points out the run rate has “only previously plumbed thosedepths” in the GFC fallout of 2009 and in the nineties recession.

BA-Merrill Lynch notes within the 0.2% net growth figure, housing credit grew 0.4% in February but the annualgrowth rate fell to 4.41%, “another 36-year low”. Business credit growth turned negative, to minus 0.2%, resulting inannual growth falling to 2.3%. Personal credit grew by only 0.1% for minus 0.3% growth annually. Notes Merrills:

“Having improved for much of 2012, credit growth has now dropped back to levels witnessed 12 months ago.Aggressive interest rate cuts by the RBA appear to have done little to stimulate a major turnaround yet”.


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This is a point not lost on the central bank, yet not enough to encourage the RBA to provide another rate cutyesterday. As the policy statement noted:

“There are a number of indications that the substantial easing of monetary policy during late 2011 and 2012 ishaving an expansionary effect on the economy. Further such effects can be expected to emerge over time. On theother hand…The demand for credit has also remained low thus far, as some households and firms continue to seeklower debt levels.”

Weakness in the particular housing credit sentiment is exacerbated by the split between owner-occupier loandemand and property investment loan demand. Property is again becoming attractive to investors as Australia’stight rental market offers solid, negatively geared yields against borrowing costs which have fallen with the RBArate cuts. Investors are thus pushing houses prices up once more, as was evident in yesterday’s housing data. In themeantime, mortgage holders are using lower rates as an incentive to pay down debt more quickly, rather thanup-scale. “Potential owner occupiers appear to be either priced out of the market,” suggests UBS, “or put off bythe large amount of debt required to buy a home”.

Investment property loan growth suggests to JP Morgan that the RBA rate cuts are “getting some traction in theusual pockets,” but that so far the trend looks “far too subtle to have broader macro significance, and clearly is notsufficient to lift overall credit growth”.

Merrills is worried the market is “over-extrapolating” what for the moment is a “purple patch” for the Australianbanks of aforementioned positives. There is little Merrills can see in the near term which might derail bank sharepopularity, saving some further global-political shock (even eurozone woes are being shrugged off at present), butover-extrapolation into perpetuity without considering the underlying risks of any bank “is concerning,” say theanalysts.

“We are concerned prices are disconnecting from fundamentals.”



21 of 62 05-Apr-13 11:03 AM


9 Australia

-Banks are not lending much -Consumers not borrowing much -What will banks do with excess capital?

By Eva Brocklehurst

"We've got the money. We're in the money..." goes an old advertisement. Granted, it wasn't a bank singing the songbut today it should be. Australia's banks have the money so why aren't they lending? Is it because borrowers are notfronting up in droves to beg for funds like they once did? Are the banks still keeping a tight leash on credit, eventhough their books are sound, impairments are stabilising and low interest rates have restored margins? Analystshave pondered the situation at length.

As our story earlier this week revealed, Australian banking shares are sought after, high yielding investments so theshare prices have gone up and up ... and up. Many brokers believe they may now be too expensive and losing sightof the fundamentals. Banking business is not growing. The time is right for households and business to start askingfor money but so far they've been reluctant. Witness the February lending figures from the Reserve Bank. If banksare not lending then there is little growth to be had from that quarter. Maybe banks have to keep more money onhand these days.

Macquarie cites remarks about capital requirements by the Australian regulator's (APRA) John Laker recently. Hesaid the appropriate level of capital needs to be more nuanced and forward looking than just covering prudentialrequirements. Perhaps the banks fear they're not out of the GFC woods yet. Dr Laker made the point that this needshould be kept in mind when the market starts clamouring for special dividends, buybacks etc. So, be warned.Macquarie also notes the banking sector globally is being required to be more conservative and be morecomparable across jurisdictions. In Australia's case it may be a case of when the going gets conservative theconservative get going.

A further look at capital adequacy and risk weighting has Macquarie pondering inconsistencies among Australia'smajor banks. Looking at the risk weighting for mortgages the broker finds Westpac ((WBC)) has 58% of mortgageswith a risk weighting less than 15%, followed by National Australia Bank ((NAB)) with 61%, Commonwealth Bank((CBA)) with 66% and ANZ Banking ((ANZ)) with 74%. Citing Sweden and Hong Kong, which have set minimum riskweightings of 15%, Macquarie looks at what would be required to lift the risk weighting throughout to that levelhere and finds the majors would fall short on minimum capital levels as defined by APRA. Amidst an ongoing debateon this subject, the broker concludes that a capital return by the banks at this point would not be prudent.Macquarie suggests a 'wait and see' approach to the banks' excess capital intentions but believes this perceivedexcess capital has supported the share price appreciation in recent months.

Macquarie has divided the four pillars of Australia's banking system into two divisions based on their book mix - thepredominantly retail bankers are CBA and WBC and predominantly business bankers are NAB and ANZ. In doing so,the broker believes the premium that the retail banks generally command has peaked. There are now moreopportunities for business banking as home mortgage growth remains slow and there is little room for re-pricing.The price earnings premium peaked at two points recently (usually averaging one point) as mortgage margins wererestored, but the broker thinks this will erode as impairments stabilise and business rediscovers debt. Hence, NABand ANZ become the brokers favourites, for now.

UBS notes households are still afraid of being in hock, citing housing finance credit at a record low in February.Digging into this the analysts found that the weakness was all to do with owner occupiers. Investors were startingto borrow to invest in housing again, attracted by the low interest rates and a tight rental market. Maybehouseholds just need more time. Some would be priced out of the mortgage market by rising house prices but, inBA-Merrill Lynch's analysis, the debt burden is still pretty high. The broker notes falling interest rates have steadiedthe escalation in household debt and it has returned to late 2004 levels. Moreover, in terms of house prices Merrillsnotes, while they are recovering, they're not back to previous highs. The house price to household income ratio has


22 of 62 05-Apr-13 11:03 AM

improved. So, maybe it's all about a much more level-headed market.

Another hindrance to a willingness to borrow could be the looming federal election. UBS believes businesses havelikely put off borrowing until the political backdrop is more predictable. For BA-Merrill Lynch broad corporatehealth indicators are favourable but stresses in the system can rise up quickly. Tensions remain in the eurozoneand this still has potential to develop into another financial crisis. Is this a reason for business caution? Merrillsacknowledges the valuation of banks reveals low risk perceptions but then, when it comes to the broker itselfpicking preferred stocks, the UK connection (weakness) for NAB is cited as a reason for preferring ANZ and WBC.Moreover, Merrills finds shades of the past still hang over NAB in terms of asset quality and executing on itsstrategy. CBA is fourth in line and here the broker, too, has a problem justifying the valuation premium, given thelow earnings growth.

Conservative banks, cautious households, subdued businesses ...maybe it's all just a brave new world. A last wordon whether the banks are overvalued. Macquarie notes, for the year-ending 28 March 2013, the major Australianbanks outperformed the S&P ASX 200 by 16%. Yearly share price performance showed WBC up 40.6%, CBA 34.8%, NAB23.4% and ANZ 21.6%. The S&P ASX 200 was up 14.5%.

See also Oz Banks Suffer Weak Credit Growth on April 3 2013 and Are Oz Banks Overvalued? on March 25 2013.



23 of 62 05-Apr-13 11:03 AM


10 Australia

By Rudi Filapek-Vandyck, Editor FNArena

****

Three types of Australian listed stocks have proved an absolute boon for loyal shareholders and investors in thepost-2008 era: reliable dividend payers such as Telstra ((TLS)) and the Big Four Banks, All-Weather Performers suchas Woolworths ((WOW)), Amcor ((AMC)) and CSL ((CSL)) and stocks experiencing an operational sweet spot,generating strong profits and shareholder returns along the way. All three categories have one key characteristic incommon: they are able to generate satisfactory returns even when risk appetite retreats or economic momentumwanes. Four weeks ago, we opened this new series with an inaugural update on All-Weather Performers, see story"All-Weather Stocks: MND And BKL In The Red". The following week we took a look into stocks we think areexperiencing an operational sweet spot. Note that we intend to make this an interactive exercise: readers areencouraged to nominate stocks they believe should be added to our updates. Send your nominations [email protected] and we will follow up and consider. At the basis of all this lays my research since late 2007 whichearlier this year led to the publication of "Make Risk Your Friend. Finding All-Weather Performers", an eBookletwhich to date is exclusively available to paying FNArena subscribers (if you haven't received your copy as yet, sendan email to [email protected]). The eBooklet argues that successful investing is closely correlated to minimisingand managing risk. Hopefully the framework we are creating with these regular updates will assist subscribers inexecuting successful, long term investment strategies.

****

Most investors in Australia had largely ignored the importance of dividends prior to the market sell-down of 2008.This, if you think about it, is quite extraordinary given Australia is one of only a few countries with a favourabletax system ("franking credits") that only taxes once and, as a direct result of this, Australian companies pay muchhigher dividends than companies elsewhere. (Thank you, Paul Keating). Yet, Australian investors still largelyfocused on what the share price would do. At least they did prior to 2008.

A second observation is that most investors start focusing on dividends when retirement is approaching, which istoo late. It means there's pressure to go for high yield only and thus investment options become limited by default.It's very difficult to seek out lower dividend stocks with a higher growth profile when the need for sufficient cashflow is tapping on one's shoulder at the start of each new fiscal year.

Taken from this perspective, the world really has changed, and a lot, for most investors in Australia since 2008.Dividends have pretty much proven the only consistent winning strategy in the share market over the past fiveyears and this has become even more pronounced during the latest share market rally which has been pretty muchabout sustainable dividends and little else.

Gone are the days when my appearances on Sky Business's Lunch Money triggered phone calls from irate viewers totell me they'd been investing in shares since the early nineties and never once bothered about dividends, so whywould they do so now? Or what to think about the multiple phone calls I received to remind me that "WarrenBuffett has never paid a dividend in his whole life and he's the world's most successfull investor". Those were idealsituations to point out that Berkshire Hathaway doesn't pay dividends, but it collects them happily and in spades.

Those phone calls have stopped, by the way. I haven't heard anyone trying to negate the importance of dividendsin a long while now.

Instead, I walked into a local coffee shop earlier today and was greeted by two funds managers who grabbed theopportunity to ask me about my view on why investing in the local share market has been all about dividends andlittle else. (Apparently another well-known market commentator has declared it has all to do with the trend


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towards Self Managed Super Funds).

My answer was essentially a summary of the opening paragraphs. I know most investors focus on dividends onlywhen it is too late. I also know many investors have lost a lot of money post-2007 and with portfolios stacked withChina-leveraged resources stocks there has been little, if any, catch-up since. Add the fact the baby boomergeneration is now starting to move into retirement and it is not difficult to see why dividends have all of a suddenbecome the be all and end all, in particular with interest on term deposits falling sharply.

History shows, however, that investment strategies built around high dividends only are poised to underperformand to generate suboptimal investment returns. This is because it is very difficult to combine high dividends withhigh growth. Plus, of course, in the share market a high dividend is often a reflection of excessive risks. Analysts atABN Amro Australia, before the Dutch bank had to retreat from Australia, left a legacy of many market researchreports that concluded just that. The third handicap is the pressure for income forces investors to focus ondividends that come with 100% franking. This is why opportunities such as Amcor ((AMC)) and Ardent Leisure ((AAD))in years past have been largely ignored.

In my view, investors should always pay attention to dividends, regardless whether they need the cash flow or not.Dividends are among the most accurate tools the share market offers investors. Whereas earnings and growth canbe fabricated through accountancy tricks and obfuscations, dividends have to be paid with hard cold cash, which ismuch harder to play tricks with.

A few market observations that can come in handy at any time:

- companies that increase dividends usually see their shares outperform the broader market. This is not necessarilytrue for resources companies, but then resources stocks and dividends are, in most cases, a bit of an awkward anduncomfortable combination anyway - share prices of dividend paying companies tend to find support at solid yieldlevels for as long as the market believes those dividends won't be cut - never make the error of combiningseemingly high dividends with high risks or operational weakness. If the dividends are cut, the damage to the shareprice is usually very, very serious - combining growth with dividends makes for a very powerful investmentstrategy. It's why David Jones ((DJS)) shares beat the return on Rio Tinto ((RIO)) shares by more than 100% over theeight years from 2003-early 2011(*) - there's a widespread misconception that dividend strategies are by defaultdefensive. They're not. It's simply another way to seek out better investment returns - history suggests largediversified commodities companies tend to find dividend support at 4% yield

Given the sharp falls in resources equities in recent weeks, I thought this might be an opportune moment to spendsome time, and do some calculations, on where BHP Billiton ((BHP)) and Rio Tinto sit on the dividend scale afterthe recent market beatings.

As anyone can see via Stock Analysis on the FNArena website, BHP shares currently offer 3.5% forward looking yieldwhile Rio Tinto shares still only yield 3.1%. This suggests there could be a lot more weakness in store before bothreach that historical support level, at least from a dividend-oriented viewpoint (and all else remaining equal). Thisseems even more so with Credit Suisse updating estimates and projections for commodities this week whichresulted into severe cuts to below market consensus but with the analysts commenting they believed marketconsensus would follow their move in time.

The good news in the Credit Suisse market update (published on Thursday morning) was that CS has penciled in ahigher than consensus dividend payout for BHP in FY14. Assuming CS numbers are correct, the projected payout of129c next financial year puts BHP's FY14 dividend yield at around 4% at the current share price. As marketconsensus still sits at 118.7c for next year, this might well translate into further weakness. All this suggests supportshould be approaching fast from here, unless investors anticipate a cut in dividends which I believe is not whatanyone is thinking right now.

For what it's worth: projecting next year's consensus dividend payout of 118.5c to calculate the 4% dividend supportlevel generates a share price of circa $29.50. The closing price on Thursday was $31.75.

BHP shares also feature in this week's global market strategy report by Citi. Analysts in London had decided to add"dividend momentum" to their stocks selection criteria and with better investment results, reports Citi. Four


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Australian stocks feature on the global list of preferred stocks; apart from BHP Billiton, there's also Telstra ((TLS)),Wesfarmers ((WES)) and Woolworths ((WOW)).

The good thing about investors' obsession with yield these days is that stockbrokers have re-discovered dividendstoo. Citi analysts in Australia, for example, have been running a so-called "Yield Model Portfolio" in recent times.Citi is taking a much wider approach to the theme than most investors ever would, as witnessed by the fact thatthe latest portfolio update, released at the end of March, included the removal of Iluka ((ILU)) and LeightonHoldings ((LEI)). In their place Citi analysts added UGL ((UGL)), Cabcharge ((CAB)), Commonwealth Property ((CPA)),M2 Telecommunications ((MTU)), Woodside Petroleum ((WPL)) and Troy Resources ((TRY)).

In total, Citi's Yield Model Portfolio comprises of 30 stocks, including DuluxGroup ((DLX)), Platinum AssetManagement ((PTM)), NRW Holdings ((NWH)) and Invocare ((IVC)). As said, the portfolio clearly takes a broad viewon the subject of "yield". Proud Citi analysts reported the performance of their portfolio remains significantlybetter than the index.

Within this wider approach it's probably worth repeating that UBS analysts three weeks ago pointed out the end ofmajor LNG investment over the next two years provides scope for the major oil & gas stocks in Australia to payhigher dividends to their loyal shareholders. UBS' analysis and projections seems to suggest that WoodsidePetroleum and Santos ((STO)) may have the biggest and earliest "surprises" in store. Oil Search ((OSH)) should followin 2015.

(*) Remarkable but true David Jones shares beat Rio Tinto by a wide margin fueled by growth and steadily growingdividends. See addenda in recently published eBooklet "Make Risk Your Friend. Finding All-Weather Performers".This eBooklet is for FNArena subscribers only (6 and 12 months). If you haven't as yet received your copy, send anemail to [email protected]

P.S. FNArena subscribers have access to dividend specific data via FNArena's Sentiment Indicator and via R-Factorand via Stock Analysis which are all available on the website.

DO YOU HAVE YOUR COPY YET?

FNArena has published my latest e-Booklet "Making Risk Your Friend. Finding All-Weather Performers". Thise-Booklet (58 pages) is offered as a free bonus to paid subscribers (excl one month subs). If you haven't receivedyour copy as yet, send an email to [email protected]

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculationsare provided for educational purposes only. Investors should always consult with their licensed investment advisorfirst, before making any decisions. All views are mine and not by association FNArena's - see disclaimer on thewebsite)

****

Rudi On Tour in 2013

- I will present and contribute during the 2013 National Conference of the Australian Technical Analysts Association(ATAA) at the Novotel in Sydney's Brighton Beach, June 21-23 - I will present to members of AIA NSW North Shore atthe Chatswood Club on Wednesday 11 September, 7.30-9pm



26 of 62 05-Apr-13 11:03 AM


11 Commodities

By Greg Peel

The only nuclear reactors operating in Japan today are units 3 and 4 at Ohi. They restarted generation in June lastyear a following the government’s reassessment of its nuclear power industry but preceding the establishment of anew Nuclear Regulatory Authority in the country. The NRA has now introduced new safety requirements to comeinto force in July.

New safety requirements are comforting, but the restarted Ohi units do not comply. Rather than lose nuclearpower altogether, Ohi has been granted an extension for compliance to September. The news is not earthshattering but it does imply that the restart of Japan’s other many reactors is not something that will happenovernight. Prime Minister Abe has already made such a warning despite his new government being pro-nuclear. Inthe meantime, Japan is spending a lot of money importing excess levels of LNG for electricity generation.

Uranium prices continue to languish at the bottom end of their range, with utilities not queuing up to exploit whatwere only recently considered bargain prices. Last week saw 600,000lbs of U2O8 equivalent change hands, reportsindustry consultant TradeTech, with speculators and producers the major participants and utilities barely spotted.Buyers and sellers remain price sensitive, TradeTech suggests, hence there was little movement in spot prices overthe course of the week. The consultant’s spot price indicator thus remains at US$42.25/lb.

There were no transactions in the term market but TradeTech reports one utility seeking 2mlbs for delivery 2014-20and another 8mlbs worth of deals are being assessed for 2015-25 delivery. In the meantime, TradeTech’s term priceindicators remain unchanged at US$46/lb (medium) and US$57/lb (long).



27 of 62 05-Apr-13 11:03 AM


12 Commodities

-Copper surplus likely to worsen -Chinese property tax will widen -The tax will affect copper consumption -GalileeBasin coal rail and port in view

By Eva Brocklehurst

A proper cup of coffee from a proper copper coffee pot. If you can get a handle on that saying you probably canhandle the fortunes of the copper price of late.

Copper's price rose 1% over the last week to US$7,622/t and inventories also went up at the London Metal Exchangeby 0.9% to 5,025t. Macquarie, citing these facts, believes the copper surplus that's now in frame has all to do withsluggish demand, not surging mine supply. The analysts note that all the mine supply growth from last year wasexported to Chinese smelters via copper concentrates. Seasonality and improving demand should enable theinventory to fall in the second quarter but that may be temporary. Without a stronger lift in Chinese consumptionthe surplus is expected to worsen by the end of the year.

Macquarie argues that weaker demand, not higher production growth, is the reason for the surplus. Overall, theanalysts believe copper consumption contracted in the last six months. Moreover, the largest driver of inventorychanges on the LME is Chinese refined copper trade, prone to large stocking up and then de-stocking. Macquarienotes Chinese refined copper imports have been falling for a year, leaving producers to export refined copper tothe US or Europe, despite a drop in demand from those quarters.

China has also exported refined copper, driving an increase in metal availability outside China. Since October,China has been exporting over 20,000t of copper per month, because of a combination of lower tolling export taxesand a negative price arbitrage, Macquarie maintains. These exports have driven the increase in LME inventory inAsia, with warehouse operators paying higher physical premiums to secure volume and rental yield. Macquariethinks Chinese industrial data and bonded warehouse stock levels will be the most important factor for copperprices in the coming months, with other major consuming regions unable to rebalance the market.

Citi also thinks China has a significant surplus of copper, far more than just a build up in warehouse inventory.Primary and secondary copper unit availability in China in 2012 was 10.96 million tonnes, comprising 3.4mt inprimary copper imports, 1.6mt copper in scrap, and domestic refined production of 5.96mt. The Chinese propertysector accounted for 20% of Chinese refined copper consumption in 2012 and has been a substantial source ofcopper consumption growth.

Citi expects increased government restrictions to speculative property purchases will contribute to softness inmanufacturing growth rates. The analysts had expected Chinese copper consumption to grow by 7.5% in 2013 butnow expect that to be more like 5.9%. Citi believes weak manufacturing, strong Chinese primary copper exports,rising copper inventory and improving mine production will weigh on the copper price short term.

Speaking of China's property market. BA-Merrill Lynch expects a roll out of a property tax nationwide from 2016/17and this should be a long-term negative for the market. The government's stated desire is to cap excessive propertydemand. Shanghai and Chongqing are testing a property tax at present. In the analysts' view, the current scheme iscumbersome and difficult to implement.

The proposal suggested by Vice Minister of Land and Resources, Hu Cun-zhi, at a recent forum has the Merrills' tick.He suggested a property tax on home ownership beyond two units, seeing the way to address property inflation bydampening investment demand rather than increasing supply. Merrills suspects the government is connecting majorcity property ownership databases ahead of doing more on this front, noting excessive savings is the main problem,as there is a huge desire to save via owning properties. The analysts believe a well-designed property tax would beone of the more productive reforms the new government could make.


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On the subject of coal, Aurizon Holdings ((AZJ)) and GVK-Hancock are investigating a 60Mtpa rail and port projectto develop the Galilee Basin, Queensland. The rail would be located within the state government's preferred railcorridor and provide open access. The companies estimate the rail and port infrastructure will cost $6bn anddeliver capacity of 60Mtpa. UBS has taken note of the plans and estimates an incentive price of $111/t forNewcastle benchmark coal is needed for the project to be economic. The coal is expected to attract a 5-10%discount to Newcastle benchmark, in the analysts' view. UBS notes, while Galilee may have economies of scale,stripping ratios and washing yields are similar or worse than other areas. Should the rail and port go ahead, theanalysts believe the commercialising of the basin would be positive for those companies that possess a resourcethere.

Coal stocks UBS flags for watching are Bandanna Energy ((BND)) and Guildford Coal ((GUF)). Bandanna's 50% interestin the South Galilee project comprises 589Mt. Crystallising any value for Bandanna's South Galilee project would bepositive for the stock, as the broker believes the market is attributing zero value to the South Galilee resource atthe moment. The take is much the same on Guildford Coal, which has projects in the northern part of the Galilee.Guildford is unlikely to take advantage of Aurizon/GVK-Hancock's rail network but is actively investigatingtransport solutions, along with Asciano ((AIO)). Guildford has a total resource of 1,678Mt in Galilee. Again, thishasn't been factored in to the broker's base case valuation on the stock.



29 of 62 05-Apr-13 11:03 AM


13 Commodities

-Iron ore bears may be overdoing it -Future looks bearish for thermal coal -Gold may hit US$2000/oz next year-Gold finds are diminishing

By Eva Brocklehurst

ANZ Bank analysts believe some of the more bearish calls on iron ore are overdone. Having looked at the numbersthey believe prices could rebound US$5-10 per tonne in the short term as the seasonal construction program inChina begins. The bearishness appears to be coming from the plans to curb property inflation in China andexpectations of rising iron ore supply in the face of lower demand. Okay, iron ore is the most leveraged of theseaborne commodities to Chinese growth so the ANZ analysts have trimmed forecasts for the second half of theyear by 6.5%, to average US$132/tonne compared with US$141/tonne.

Nevertheless, they don't buy a slump in Chinese property demand. In fact, they see the latest 20% tax on capitalgains from the sale of a second property as forcing down sales of such investments and crimping the housing stock.What they see unfolding to address rising housing prices is increased supply in areas of strongest demand. Theanalysts expect this will boost raw material demand and keep iron ore prices from arriving at the most bearishscenarios.

In terms of the increased supply dynamic, this has been on the cards for some time with ongoing expansion ofcapacity among the major miners in Australia. Two factors are paramount, in the ANZ analysts' view. Fortescue's((FMG)) jump in 2013 capacity looks big but is merely a return to the status quo, after the King's project was haltedlast year and re-started three months later. The other is that the slide below the US$100/tonne price of iron orelast year could be a one-off, characterised by sustained high production of steel in China amidst uncertainty overthe political changes that were about to occur. The analysts also maintain the view that over 50% of China's 1.5billion tonnes of annual iron ore output is loss making under US$110-120/tonne.

BA-Merrill Lynch expects the iron ore price to trade around US$120/tonne on average for the year, split asUS$130/tonne for the first half and US$110/tonne in the second. The lower price in the second half is predicated onexpectations of increasing supply, particularly from Australia. BA-Merrill Lynch agrees that this new supply is wellflagged. Longer term, the broker expect the price to be around US$97/tonne in 2019 money (around US$84/tonne incurrent money terms).

Deutsche Bank also believes the iron ore price will move modestly higher over the next few weeks, supported byopportunistic buying from Chinese mills and short covering. The analysts view the pricing in the fourth quarter lastyear as close to fair value, around US$120/tonne. They note that little physical material is being transacted on thespot market at the moment, exacerbated by high steel stocks and low iron ore inventories at ports. Longer-term,these analysts are also bearish on the price and expect iron ore to gravitate towards US$110/tonne over the nextseveral years, as a function of decelerating steel demand in China. Longer term they too envisage a price aroundUS$80/tonne.

Thermal coal prices are under pressure. According to Deutsche Bank, the evidence shows producer hedging athigher forward prices, cost reductions through efficiencies, burden for Australian producers from fixedinfrastructure expenses and distressed sales of Appalachian coal through eastern and southern US ports. Globalgrowth is improving and the analysts expect the price of thermal coal will pick up near term. The analysts forecastthe price at around US$100-105/tonne by the end of the year. A key statistic here is that 95% of thermal coaldemand in the US and 87% in China is for power generation. Over the next two years the growth story augurs wellfor thermal coal. Beyond that, the analysts are concerned that coal-fired generation is falling out of favour inseveral centres of demand including the US, Europe and China for environmental reasons. The price outlook istherefore bearish in the longer term.


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BA-Merrill Lynch analysts believe the worst is not yet over for thermal coal. Colombian exports are recovering andincreasing and low-cost producer Indonesia is increasing product and exports. Even in Australia productioncontinues to ramp up. The only country that has cut thermal coal exports is the United States. The analysts don'texpect the recent recovery in China's thermal coal imports to absorb all of the oversupply this year. They havelowered price expectations to US$92/tonne for 2013 and US$88/tonne in the second quarter.

BA-Merrill Lynch has marked down gold price expectations for 2013 to a more modest US$1670 per ounce. Theanalysts remain positive on the gold outlook but do not believe gold will reach the US$2,000/oz price target until2014. Meanwhile, IntierraRMG has produced a report on gold discoveries and found a 45% decline in newdiscoveries. Not unexpected? The rate of decline has accelerated over the past four years. That's the chief finding.

The year 2003 to 2004 was the best in the study range, with over 400 million ounces of new gold discovered. Thisincludes inferred, indicated and measured ounces with an average grade of 1.65 grams per tonne. In comparison,2005 to 2006 had the lowest number of discoveries, with just over 150m new gold ozs at a similar grade. Then,discoveries increased significantly during 2007 to 2008 with more than 390m ozs and the average grade was up to2.65g/t, the highest in the 10-year period under view. After that, the next two years produced just over 250m innew gold ounces with a declining grade of 1.25g/t. This deterioration has continued to the present. The amountdiscovered in 2011 to 2012 dipped below 225m ozs with a reduced grade of 1.17g/t.

Where was the gold found? Primarily, in Africa. Africa led the way with new discoveries of 479m ozs of gold with anaverage grade of 2.8g/t. Next was North America at 290m ozs, and with a much lower grade of 1.3g/t. Europe wasthird in new discoveries with 240m ozs at 2.0g/t. Australasia recorded 74m ozs of new discoveries with an averagegrade of 1.4g/t. Global drilling activity is waning and IntierraRMG expects that the next few years will continue thetrend of fewer new gold discoveries.



31 of 62 05-Apr-13 11:03 AM


14 Commodities

By Andrew Nelson

March was a mild and somewhat positive month for uranium, with producers hoping TS Elliot is wrong in his claimthat April is the cruellest month.

It was a slow month, activity wise, with the 19 deals in March a bit less than the 21 transactions booked in themonth prior, while volumes of 2.6 million pounds of uranium fell well short of the 3.2 million pounds of U308equivalent changing hands in February.

Industry consultant TradeTech notes that year to date volume is at 10.5m pounds, well up from the 3.6m poundsreported in the first quarter of 2012.

The market simmered down quite a bit after the uncertainty and price volatility seen at the end of February afterit was rumoured that Japanese utilities were considering selling down stockpiles. By the end of March, TradeTech'sExchange Value was up US$0.25 to US$42.25/lb.

Activity in the term uranium market was even slower, with only one transaction reported for deliveries beyond2015. Although, TradeTech does report there are a number of utilities expected to enter the term market in comingweeks.

Until then, prices will stay exactly where they are and where they have been over the course of the month.TradeTech's Mid -Term U308 Price Indicator is at US$46.00/lb and the Long-Term Price Indicator is unchanged fromlast month's value of US$57.00/lb.

The last week of the month was especially light on given the interruption of the Easter holiday and spring break inthe US. Just three transactions were reported last week accounting for 400,000 pounds. The spot uranium priceremained unchanged, making for three flat weeks in a row.

TradeTech notes that demand remains highly discretionary. There are several buyers poised to enter the market,although sellers themselves aren’t really chasing sales and continue to shown little willingness to drop prices forthe moment.

And as can be gathered from the above commentary on term markets, there were no transactions reported lastweek. There is one non-US utility looking for around 2 million pounds for delivery between 2014 and 2020, butthat’s about all that’s kicking around at present expect for a few more utilities that may be looking at purchasestotalling about 8 million pounds for delivery between 2015 and 2025.



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15 Commodities

-Oil prices retreat. For how long? -Iron ore, coking coal underpinned -Thermal coal under most pressure -Platinumsupported

By Eva Brocklehurst

Average oil prices retreated in March after several months of rises. Brent and Tapis fell around 6% and are nowUS$110/bbl and US$115/bbl respectively. West Texas Intermediate dropped 2% to finish March around US$97/bbl.National Australia Bank analysts have noted that the spread between Brent and WTI is at the narrowest since July2012. This is the result of the relative strength in WTI, while Brent prices were affected by less European demandand a surge in North Sea production.

So what is in store for prices as 2013 progresses? The analysts are optimistic. Technical and economic indicatorspoint to demand being more robust compared with last year. Production is improving in non-OPEC nations, whichshould offset the reduction in supply from areas of geopolitical tension and help keep a lid on prices. The austeritymeasures in Europe continue and should also keep prices contained. WTI prices may be boosted by a drop in oilreserves at the US delivery point at Cushing. Hence the spread to Brent could narrow even further. Overall, theanalysts see the price of WTI lifting to around US$103/bbl over 2013, while the price of Brent is expected to lift toaround US$117/bbl.

Further down the track, Citi believes oil prices should keep falling, given the push to substitute natural gas for oil.Ongoing improvements in fuel economy could mean oil demand levels off sooner than expected. Citi analysts cite ashift already underway in the US where shale gas production is gaining pace. Higher prices, the removal of fuelsubsidies and rising fuel economy mandates have all contributed to make gas more compelling. The analystsbelieve structural bull market of the previous decade was a result of surging global oil demand and consistentdisappointment in non-OPEC supply, compounded by a collapse in Iraqi and Venezuelan production. The outlook foreach of these factors has now reversed, reinforcing Citi's long term view that by the end of the decade Brent pricesare likely to hover within a range of $80-90/bbl.

Back from the future and the rally in bulk commodity prices has also stalled. National Australia Bank analysts haverevised near-term price forecasts slightly lower for bulk commodities, reflecting adequate supplies in the marketand a slower-than-anticipated recovery in Chinese steel demand. Nevertheless, an anticipated turnaround in globaleconomic prospects later in the year should underpin prices. The average price for iron ore (62%) is estimated tohave been around US$131 per tonne Free On Board in March, down from US$142 in February. The spot price iscurrently around US$137 per tonne. Although there could be some near term tightening in the iron ore market fromre-stocking, the analysts do not expect prices to return to recent highs.

The analysts believe global steel production has grown at a good pace in recent months, driven by increasingChinese production despite pressure on margins from easing steel prices, record high inventories and the elevatedcost of inputs. In contrast to steel, reports show that the stockpiles of iron ore at steel mills have been depleted,particularly at small and medium sized mills. The National Australia Bank analysts suggest this running down of ironore stockpiles will only lend temporary support to prices, as supplies of seaborne ore are increasing and there willbe a running down of steel inventories as well.

Despite a similar end use in the steel industry, plentiful supplies of coal have prevented the same degree of pricerecovery that was seen in the iron ore market. Average spot prices for premium hard coking coal rose almost 4% inFebruary, but have fallen by around 6% in March; the spot price is currently around 9% below its recent peak in midFebruary, note to the analysts. Conditions in the steel market are expected to remain subdued for some time, andstockpiles of coking coal may limit demand for imports. Any delayed impact of the investment stimulus in Chinashould assist prices back toward US$175 per tonne by late next year.


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Thermal coal prices for this Japanese fiscal year will be settled shortly and are expected to be set at a premium tomarket prices at or slightly below US$100 per tonne FOB. Over the longer term, the analysts believe shifts towardsalternative energy sources, including caps on Chinese coal consumption, will likely limit potential price gains.Similarly, increasing coal supplies will restrain prices, particularly if planned port expansions in the US North Westcome to fruition. This would expand export capacity to Asian markets. On this note there is a common theme withthe aforementioned view from Citi. Competition from natural gas is expected to reduce demand in the US marketfor thermal coal.

ANZ commodity analysts find a preference for growth over risk aversion is supporting the platinum complex.Looking at the speculative positions suggests most of the upside is priced in. The analysts believe downside risksare weighing on the near-term pricing and any improvement in South Africa's industrial scene could simply trigger about of profit taking. Standard Bank analysts believe platinum, approaching US$1,550, provides value but needsmore speculative long positions before they contemplate the possibility of a rally. Moreover, price improvement isheavily dependent on the European economy, an important region for platinum demand. Without Europe in theequation the outlook in terms of demand is bleak.On palladium the Standard Bank analysts find a crowded marketand therefore the price at US$760 does not provide value from a long-term perspective.



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16 Commodities

-Diversified miners constrained -Copper prices cannot hold up -Iron ore should be underpinned -Gold trending down-Silver rallies to be sold

By Eva Brocklehurst

Commodity prices drive mining earnings, ultimately. UBS notes that a widely subdued outlook for commodity pricesdeters investors. Other factors rate, such as operational expenditures, but are secondary in that they may notmanifest until the next reporting season. So, where is the upside in terms of commodity prices at the moment? Theanalysts cite uranium, platinum group metals, nickel, aluminium, mineral sands and coal as offering prospects. Allthese are up from the lows in price of 2012.

So, maybe it's time to count the impact of commodity prices so far this year on diversified miners. Credit Suisse hasasked whether the likes of BHP Billiton ((BHP)) and Rio Tinto ((RIO)) will be constrained by tepid demand andincreasing supply of several commodities. The analysts have reduced forecasts for 2013 by 7-9% for gold, thermalcoal, copper and nickel prices and for 2014 by 11-14% for gold, thermal coal, copper and alumina. As a result oflower price expectations on the aforementioned commodities the broker has downgraded FY14 earnings estimatesfor BHP and Rio by 11% and 5% respectively. The broker notes gearing levels for both giants remain elevatedthrough the forecast period and should act to constrain potential capital management if the commodity priceforecasts hold.

In terms of copper, Credit Suisse expects a peaking in the price in the second quarter at around current levels andslippage to occur in the second half as a surplus builds. Here, the downward pressure is likely to be milder than inthe case of iron ore, as marginal copper supply remains more difficult to get to market. Copper has shifted from adeficit to a surplus market this year and Credit Suisse is forecasting a moderate surplus over 2013 and a larger onein 2014. So, copper prices are viewed falling to US$7,000/tonne by the end of the year and US$6,400/t by the end of2014. The analysts concede their view is more pessimistic than the rest of the market but believe others will followin the same direction, because prices cannot hold up at a premium to marginal costs of production when supply ismore than meeting demand.

For CIMB iron ore prices should stay supported. Underpinning iron ore is strong cost support levels and supplyoutages, or disruptions, outside of Australia. What downward pressure there is will come from weak Chinese steelproduction and higher Australian exports. In the second half of the year the analysts believe prices will hover in therange of US$110-130/t. In the case of iron ore supplies outside of Australia, CIMB views a large proportion of India'siron ore production as uneconomic, or constrained by increasingly stringent environmental and regulatory issues.As well, there has been a significant increase in cash costs there from export duties and haulage rates. CIMB seesAustralia's BHP, Rio Tinto and Fortescue ((FMG)) providing the bulk of the iron ore supply increase in the next 18months.

Chinese steel production indicators are not all that bad, according to CIMB. Fixed asset investment and otherindicators signal growth momentum is occurring and any stalling is likely to be short term. The analysts believestrength and maturity of the Chinese steel industry means that China will remain reliant on sourcing iron units fromoverseas. They note the imported iron ore share of total consumption has been increasing steadily over the pastfive years. As the market has moved back to a more balanced position, CIMB sees the use of imported ore on therise. This is because not only are lower prices pushing out the marginal Chinese producer but Chinese steel millsare looking to higher grade iron ore to maximise efficiency. Even in a market that is likely to move into surplusover coming months the demand for imported ore should remain high, if not move higher, thus supportingbenchmark prices.


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Credit Suisse expects the price of gold to keep trending lower as the risk to the financial system from Italy andCypress is reduced. The analysts have cut forecasts for both gold and silver prices significantly. Quarterly gold priceforecasts for the remainder of the year have been reduced by 13% to 18% as the reasons to be bullish havedisappeared, or had minimal short-term impact. The analysts expect gold will average US$1580/ounce over thisyear and US$1500/oz in 2014. Silver, although having a larger industrial component, is likely to be weighed down bygold. Silver price forecasts have been reduced accordingly and the analysts now expect the metal to averageUS$28.50/oz in 2013 and US$27.20/oz in 2014.

Standard Bank notes silver prices have fallen and could be subject to a further sell down to test US$26.16/oz. Thisexpectation is based on weak underlying supply/demand dynamics and growing inventories. Rallies should provokeselling in the foreseeable future. Standard Bank notes the rise in open interest on COMEX was particularly strong inthe July contract as the price fell. There is still the risk of short covering pushing the price back to US$29/oz. Herelies the selling opportunity. The rise since the beginning of the year in ETF (exchange traded fund) holdings in silveris in contrast to the liquidation of gold. The lack of silver liquidation, silver ETF holdings are up 4% and gold ETFholding down 7%, underscores the analysts concern for the silver outlook.



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17 Currencies

- Aussie To Stay Strong This Year - Greenback gains to moderate - Yen will weaken further - AUD rangeboundbetween 1.04-1.06

By Andrew Nelson

If you want to know why the Aussie bounced right back to the 1.04s from the pressure that pulled it down to 1.01syou’ll need to know a little bit more about recent and not so recent history.

From pretty much the beginning of this year the Aussie started to feel the weight of increasing pressure and therewere two main contributing factors: a dramatic weakening in the JPY and a big rally in the USD right at the sametime.

The yen freefall we’ve seen over the past few months put most of the rest of the non-Japan Asian currencies undersome downward pressure as well. This was in part due to the fear of losing competiveness against one of theregion’s major export competitors, Japan.

Currency analysts at Commonwealth Bank point out that the AUD/USD maintains a very tight relationship withnon-Japan Asian currencies. In fact, CBA notes it is often used as a proxy for Asia because of the better liquidity inthe AUD and because of Australia’s very close trade links with the region. Thus, concludes CBA, the AUD/USD wasweakening in tandem with weakness in the JPY and by extension, the decline in non-Japan Asian currencies.

At the same time there was a big run in the USD on the back of improving economic data, capital inflows intoequities on improving markets, and Italian election concerns also lent plenty of support.

And while US markets continue to rise, providing even more support for the greenback, CBA sees no way Asiancurrencies can continue to underperform, while the yen alone just can’t drive the AUS/USD anywhere. The bankthinks the cross has already come back to dancing to its own tune.

The reasons why are numerous. Firstly, CBA points out that AUD/USD option volume during the drop began todecline from already low levels. When there are limited volumes, relative economic health drives exchange rates.Australia’s terms of trade also remain at quite elevated levels. This provides significant support to the Aussie andwill also help in preventing a big drop in the AUD.

Next, while central bank buying of AUD government bonds has started to slow, there are still large substantialforeign direct investment (FDI) inflows into Australia. This is now providing increasing support, with the bankthinking the trend of rising FDI inflows will have continued into Q1 2013.

The Australian economy is also nowhere near bad enough to support the prospect of multiple interest rate cuts bythe RBA. In fact, the RBA said at their March 5 policy meeting that the substantial amount of easing that hasalready been undertaken was starting to work in the domestic economy.

Lastly, the Fed has made it patently clear that the push of current open-ended quantitative easing is not likely tochange any time soon despite the signs of economic improvement.

CBA’s current expectation is for further depreciation in the JPY, mainly on the back of the collapse in Japan’scurrent account surplus. The beginning of the new Japanese year could also see some JPY depreciation as Japaneseinvestors look to increase offshore investment. The bank also thinks that the new monetary policies from the newgovernment and new BoJ head may also contribute to further JPY weakness.

Given this backdrop, Commonwealth expects the AUD/USD to remain pretty much range-bound between 1.0200 and1.0600. The bank also sees further upside in both USD/JPY, pushing from 93.55 now to 100 by September, while the


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AUD/JPY is expected to push from the current 97.8 to 104 by September.



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18 Economics

By Andrew Nelson

The focus has started to shift from Asia to the US as the hoped for driver of economic momentum, but Asia is by nomeans dead yet. Economists from Denmark’s Danske Bank point out that not only is growth from Asia still expected,but it should also improve in the quarters ahead.

Let’s not jump to overly optimistic conclusions, warns Danske. While a moderate recovery in China and a strongrebound in Japan are certainly expected, the bank’s expectations for 2014 look a little more challenging.

Danske fully expects the recent resurgence in Japan will taper off into next year on the back of what has beensubstantial fiscal tightening. There are also more question marks with China, the bank noting the ultimate pace ofthe deceleration in China’s long-term growth rate is still a great unknown.

Recent data from China seem to indicate that what was starting to look like a steady recovery actually began tofalter over the first quarter of this year. It’s far from dire news just yet, Danske reporting that leading indicatorssuch as money supply and credit growth are still strong, so there is still some acceleration left.

Getting a tight read on China’s economic direction over the first few months of any year is always difficult giventhe disruption caused by the nation’s New Year holidays. Still, the slowdown that is evident from the last quarter of2012 is enough for the broker to revise its GDP forecast for 2013 down to 8.4% from 8.6%.

What seems to have become clear to the bank is that the impact from last year’s fiscal stimulus is starting to wearoff and with the People’s Bank of China now seen to be gradually moving to a tighter footing, a rate hike in the lastquarter of 2013 is a little more than merely possible.

There have admittedly been some solid signs of improvement in investment demand, but Danske notes this hasreally been driven by healthy infrastructure spending. Otherwise, housing construction, up until quite recently, hasremained subdued. The bank sees this picture reversing, noting signs that infrastructure spending may havepeaked, while housing is finally starting to respond to the strong house sales data that have been posted since themiddle of 2012.

So with money supply growth steady, credit growth being supported and cyclical investment demand seeming tohave remained relatively firm, China should be able to progress with a steady, if moderate, recovery, thinksDanske.

While China can be described as a slow burn, or a fire that doesn’t show much sign but grows increasingly hotter,Japan could best be described as a flash fire: violent, fast, bright and then gone. The new government under PrimeMinister Shinzo Abe has outlined an aggressive focus on growth, which is readily expected to ignite a strongrecovery over the next few months, with GDP growth exceeding 3%.

After the burn, in 2014, Danske expects the Japanese economy will be staring down the barrel of some significantresistance from both the fiscal tightening that will be needed and a slow but steady unwinding of thereconstruction boom post the 2011 earthquake. In fact, Danske thinks Japan could be at the brink of recession againover 2014. That is, of course, if the economy can’t find any support from a weaker yen and a global recovery,which is admittedly possible.

In the meantime, there is only the life support being provided by what is very accommodative monetary policy.And with no imaginable end to current woes in sight, Danske expects it will be a long time before Japan challengeseven its new 2% inflation target, meaning asset purchases will remain aggressive next year.

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19 Economics

-Mining investment is slowing -Focus now on operations -Where will the bigger impact be?

By Eva Brocklehurst

Australia's big question recently is: what will fill the gap in prosperity when the resources boom slows down? Thenational euphoria which greeted the ramp up of coal and iron ore exports some years ago as China appeared everhungry for these resources has now subsided to a point where, in some quarters, the doom and gloom merchantsare being ushered in. What will fill the gap? What will provide the export dollars?

For analysts at Commonwealth Bank it may be that we are looking in the wrong place for this "gap". Currently,what is happening is more of a reduction in mining construction than exports of mine output. The theory has alwaysbeen that a bust surely follows a boom.

Expansion of mining has meant capital expenditure in that area has reached a record high share of GDP (8%).Usually, during the "bust" there is a retraction of capital and, given the size of this boom, this bust could also besizeable. The analysts cite recent RBA research which concluded that around half mining capex was met throughimports. That is, large, complex parts and machinery being sourced offshore. This has led the analysts to surmisethat there should be an automatic 50% offset in GDP growth from lower imports. If exports continue to increasethen this should fulfill the need for more of a balance in exports/imports.

The analysts believe the sort of export growth rates required to achieve this look easy, given the huge growththere has been in mining capital stock. That's another part to the story. A rise in mining capital stock over recentyears has boosted the consumption of fixed capital. The mining depreciation share of GDP lifted to 2% from around0.8% between 2005 and 2012. This means more stock is being depreciated and more capital is required to maintainit.

The analysts describe the "pothole" that may emerge in a downturn in mining investment as labour related. Thestock of projects being worked is moving to completion at a faster rate than new projects are starting up. Inprevious research, the analysts had suggested that the heavy weighting of large LNG projects in the mining pipelinecould produce a plateau rather than a peak in resource projects. There are some big investment decisions to bemade this year such as the Browse LNG project which, if they go ahead, could produce this plateau effect.

Nevertheless, the investment phase is coming to an end, miners are cutting costs and the focus on operations isbecoming sharper. Again, turning to RBA research on the labour market implications of the resources boom, theanalysts cite this statistic: nearly 10% of the workforce is associated with resources activity. Within thispercentage, resource extraction, the more typical mining employment, accounts for 3.2%, while business activitiesrelated to resource extraction add 3.9%. Construction, at 2.7%, brings the total to around 10%.

All components of resources employment are above levels previously regarded as normal. This leads toexpectations that a winding down of resource investment will bring job losses. So, the analysts maintain thatalternative means of employment are needed to offset any downturn in resources. As they remind us, the resourceinvestment phase is typically more labour intensive than the operational phase. The analysts have crunchednumbers, looking at the impact of a 20% fall in mining investment spending from 2013/14 onwards. Over three yearsthat fall could halve the mining capex share of GDP to about 4%. The chart below shows the impact of the halvingof GDP share to 4% from 8% and implies a potential job reduction equivalent to around 1% of the workforce.




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20 FYI

-Oz federal fiscal austerity to continue -Oz business borrowing plans improve -Oz retailers restructuring asset bases-Global equities allocation highest in 2 years -Global growth improving

By Eva Brocklehurst

There may be an election in September which will change the government but there's a federal budget due in May.In the current economic climate, the government will have no choice but to hand down a fiscally conservativebudget. BA-Merrill Lynch believes, if the Coalition takes over the reins from September, it will run a tight fiscalpolicy as well. Key policies will probably include abolishing the carbon and minerals resource rent taxes andabolishing the 'School Kids' bonus. A modest cut to the company tax rate may be proffered when circumstancesallow. The analysts at BA-Merrill Lynch do not expect GDP or cash rate forecasts will change much under aCoalition government.

In terms of the impact on a sector basis, a Coalition government is likely to be positive for healthcare, BA-MerrillLynch contends. The analysts expect less frequent reform/more certainty or consultation would be a positive foroperators in the industry such as Sonic Healthcare ((SHL)), Primary Health Care ((PRY)), Sigma Pharmaceuticals((SIP)) and Ramsay Health Care ((RHC)). On the telecommunications side the Coalition could replace the NBN with alower cost fibre-to-the-node proposition. This may accelerate lines migrated to the NBN and a de-commissioningpayment in FY16 and could be seen as positive for Telstra ((TLS)).

BA-Merrill Lynch views abolishing the carbon tax as a longer-term positive for AGL Energy ((AGK)), for a lack ofcarbon tax compensation would reduce earnings in FY15 and FY16. It would also modestly support Boral ((BLD)),Adelaide Brighton ((ABC)), Arrium ((ARI)) and BlueScope ((BSL)), in the analysts' view. The implications of aCoalition government for banks, insurers and others are a bit more mixed. The Coalition intends to initiate abanking review and this may culminate in a deposit guarantee levy. The Coalition's preference for privatisingMedibank Private could impact on the health insurance market.

Macquarie's first report from collaboration with East & Partners shows business borrowing intentions are on the risein Australia. The key question revealed the majority of sampled firms (58%) are not expecting a significant increasein stress levels over the next six months. On that basis, Macquarie believes the environment is improving enough towarrant an increase in business lending. Those banks lending to the small-medium enterprise and corporate sectorshould be able to finance the demand.

In detail, corporate and institutional respondents which expect stress levels to stay the same or decline total61-75%, while the micro and SME sectors have a much more muted response, 48-50%. Those that were expecting tocontinue being stressed were less confident in the outlook and maintained concerns about availability of debt.Despite a slowdown, investment in mining and demand for equipment finance continues and, with a broaderrecovery in the economy, Macquarie believes this warrants the banks driving the next leg of growth. On the back ofthe survey, Macquarie has upgraded earnings forecasts for the banks by 1-3% and put National Australia Bank((NAB)) at the top of the ranking among the big four, given a strong SME customer base.

The latest results from David Jones ((DJS)) reaffirmed Macquarie's view that the retail sector is undergoing astructural resetting of its base. The broker expects store roll outs will slow, rents will generally decline on renewaland space will be cut back. David Jones has six expiries in FY15-17 and this will allow the company to review itsleases. Macquarie believes, despite an improving environment for retailers, a re-evaluation of poor performingstores will occur as leases expire. This will result in above-average store closures over the next couple of years.This is already revealed in the lower tenant retention rates that real estate investment trusts are reporting. It ispossible landlords can re-lease the space at more attractive rents. Macquarie is of the view that internationalretailers still want space at the larger regional shopping centres.


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Macquarie notes that in September 2012, Cushman & Wakefield valued DJS' Sydney and Melbourne CBD propertiesat $612m. David Jones is exploring options to unlock value at these properties. If these assets were indeed broughtto market, Macquarie believes demand would be strong, factoring the relatively attractive yield spreads still onoffer. Nevertheless, David Jones has stated a preference to realise value via development rather than to sell andlease back the Sydney stores.

BA-Merrill Lynch has found, through the monthly Global Fund Manager Survey, that a net 57% of investors globallyare overweight equities, the highest allocation in two years. Investors are long on assets which are being driven byUS growth, such as consumer discretionary, banks, equities, real estate and the US dollar. Investors are short onthose assets driven by inflation and China such as cash, energy, materials and commodities. So, the biggestdownside risk to positions is anything weakening the US domestic demand story, or a rise in commodity prices andinterest rates. The favoured currency is the US dollar and a record number are bullish on the greenback. For thefirst time in six months, investors are most worried about the EU sovereign debt crisis.

Merrills notes investors believe liquidity is the best it's ever been. When asked how soon the Fed would exitquantitative easing, only 3% expected a sale of all the Mortgage Backed Securities, while 24% believed some saleswould occur and 42% believed the Fed would never sell. Technology is now the world's favourite sector again.There was a big monthly rise in exposure to banks and a drop in materials. The lowest weightings are energy,utilities and telcos. If you were a contrarian what would you do? For BA-Merrill Lynch that would be selling USfinancials and buying resources and commodities. You'd be long on telcos and short on technology, long on energyand short on banks, long on materials and short on industrials.

Citi has taken a look at global growth forecasts and expects growth of 2.7% in 2013 and 3.1% in 2014, rising to 3.6%in 2015. China appears to be stabilising at around 8% year-on-year. At the same time, the uptrend of inflationappears to have become a concern for China's central bank and Citi expects broad money growth will be broughtdown to about 13% year-on-year. While the easing bias of monetary policy will be removed gradually, the policystance is not likely to turn tight and should be supportive of the 7.5% growth target. Meanwhile, the analysts findUS private spending is improving and at a rate to offset the domestic impact of federal fiscal tightening. The USFed is expected to probably start tightening monetary policy in 2015.

On Australia, Citi has a mixed outlook but believes the RBA is unlikely to enact further monetary easing in the nearterm. The analysts find widespread forecasts of a rise in the jobless rate to 6% as too pessimistic and a peak around5.5% is considered more likely. There remains a notable disconnect between consumers and business. Consumersentiment has rebounded but business confidence is weak. Citi suspects another rate cut is still possible, given thehigh Australian dollar and if inflation remains as low as forecast, but notes markets have priced out another cut.

On a more sombre note, the euro region remains in recession and Citi does not believe the crisis is over in theEuropean Monetary Union. This is not just because of the recent stand-off over Cyprus. Revenues have been hit byeconomic weakness in Greece, Italy, Spain, Portugal and Ireland. These countries should all continue to have risinggeneral government debt/GDP ratios for the next couple of years. Citi expects that some form of restructuring ofsovereign debt and/or official loans and/or bank debt will eventuate but a euro crisis could re-emerge. Citi expectsthe UK will likely be downgraded from AAA in coming months in response to the stagnant economy and weak fiscalposition.



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21 FYI


The secret, so to speak, was printed prominently in the 2010 Annual Report: Amcor ((AMC)) is well positioned byhaving a substantial growth opportunity that is not dependent on economic recovery (emphasis mine).

At that time, only a few were genuinely paying attention. So painful remains the memory of Amcor's disaster yearsamong investors and stockbrokers that up to this day many refuse to even reconsider the company as a potentialinvestment option. I know of one stockbroker who persistently shows the palm of his hand while turning away hishead whenever someone dares to mention the company's name in his presence.

Most funds managers and stockbrokers are straightforward and honest about it: they missed the Amcor turnaroundstory and by doing so their clients have missed out on one of the better investment opportunities the Australianshare market has had on offer between 2009-2012. Consider this: while the Australian share market in generalwasn't going anywhere until mid-2012, Amcor shares continued posting double-digit gains, every year, of which alittle less than half stemmed from steady dividends. When the Big Rally announced itself in mid-2012, Amcor sharesfurther extended their market-beating performance.

The table below shows the performance of Amcor shares post 2007 (add circa 5% in non-franked dividends to eachyear's return). Note also the relatively modest fall in 2008 when margin calls and panic selling had become a dailyphenomenon in the share market:

To grasp the essence of what makes "Amcor", and to fully understand its internal dynamics, it's best to think of aninternational conglomerate. Investors in Australia have in recent times fallen in love with Wesfarmers which isofficially an industrial conglomerate combining retail outlets with coal mines, insurances, fertilisers, investmentbanking and listed warehouse retailing properties, but in practice conglomerate Wesfarmers is predominantly aconsumer (retail) oriented story. Most conglomerates ultimately cease to exist as during times of troublesmanagement teams find it too difficult to successfully manage different types of operations that often have little incommon, let alone any operational synergies.

In the US, Sara Lee has abandoned tobacco and women's underwear to solely concentrate on food products. InAustralia, Mayne Nickless and Pacific Dunlop no longer exist (though spin-offs like Mayne Pharmaceuticals, Cochlearand Ansell still do). Amcor has many conglomerate-alike characteristics, with 300 plants located in 42 countries,producing all kinds of packaging, from metal screw tops to cardboard boxes to PET bottles to transparent films forfood and medicines. As stated in the opening paragraph: Amcor too has had its rough times.

The difference is, however, inside Amcor are a lot of natural synergies between divisions and across geographiesthrough common customers and distribution channels. Another difference is that Amcor's problems didn't havemuch to do with its conglomerate-like character, but more so with the break-neck speed at which acquisitions werebeing announced and executed at the turn of the century. One journalist wrote at the time: No-one, not evenAmcor itself, knows exactly how many businesses have been acquired in years past. Before mid-decade thatstrategy had come unstuck and Amcor quickly turned from market darling into fallen angel and then it descendedfurther into a grizzly bad memory from the past. One that cost a lot of investors a lot of money.

Warren Buffett once said the trouble with most turnaround stories is they never actually turn around, so what hasmade the difference for Amcor? By 2005 new management and the Board acknowledged Amcor had lost its way. Arestructuring was undertaken with the aim of improving core competencies and shedding underperformingbusinesses. The program was called "The Way Forward". In 2009 the program's principles were embedded within anew operating model; "The Amcor Way". Then Dame Fortuna smiled upon the company.

Heavily-indebted Rio Tinto was struggling for survival amidst lower commodity prices after having overpaid for the


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acquisition of Alcan in a bid to fend off suitor BHP Billiton. As Rio Tinto became a forced seller of assets, Amcorsnapped up Alcan Packaging for a bottom of the cycle price tag of US$1.948 billion, representing 5.1 times calendaryear 2009's profit before interest, tax, depreciation and amortisation (PBITDA). Amcor instantaneously becametwice as big but also with (at least) twice as many growth opportunities. Management certainly hasn't disappointedby extracting more synergies than originally suggested, ahead of schedule.

All this allowed the 2010 Annual Report to declare that Amcor had by now become a "substantial growthopportunity", regardless of what happened in the global economy. There are not many companies in the Australianshare market that are ever able to make such a bold statement, let alone in the midst of a raging bear market.

It's not all related to Alcan Packaging.

With a geographical reach that is virtually unmatched in Australia (except, maybe, by News Corp) Amcor'sworldwide operations are a reflection of what is going on the world; always a problem somewhere despite upsideelsewhere. At the same time, with some 85% of products and customers related to the food, beverage, tobacco andhealthcare sectors, Amcor's operations have a strong built-in resilience. Note that profit growth and dividendincreases in recent years have occurred despite a deep and nasty recession in Europe which just happens to beAmcor's most important market!

The conglomerate-like character has been further emphasised by two very tough years for operations in Australia(just like every other local manufacturer) and management has responded with restructuring and cost cutting. Theyears ahead should see a jump in profitability for these operations as closures of the Petrie recycled cartonboardmill in Queensland and a plant in Thomastown, Victoria should see a material boost in margins and earnings from2014 onwards.

Don't also forget Amcor is leveraged to better economic momentum in the US, the group's second largest market,while 65 plants and more than 8,000 workers in 24 Emerging Markets now represent some 19% of total grouprevenues. Since 2000, sales into emerging markets have grown at a compound rate of 18% per annum. As theaverage consumer in emerging countries grows wealthier by the day, this underpins an increasing demand forpackaging. Amcor is already, according to its own assessment, in possession of an unrivalled footprint across Southand Central America, Eastern Europe, Russia and Asia, including India and China.

Amcor's operational diversification is strikingly illustrated in the following chart (thanks to BA-Merrill Lynch):

An additional luxury is that the businesses generate a lot of cash flow and now that the bulk of restructuring andintegration of Alcan Packaging is done, management will have plenty of shareholder friendly options available,apart from reducing the company's debt ($3.8bn). The past years already saw a $150m share buyback plus a newdividend policy that should pull future increases in line with profit growth. There should still be plenty of growthpotential inside the existing operations as margins remain below competitor's levels. Acquisitions, including AlcanPackaging, typically depress margins, which offers room for improvement.

Acquisitions remain firmly on the agenda. Amcor spent some $920m over the past twelve months but managementhas declared it will remain a responsible investor. This is not a throw-away statement, given the company's failurein the past. There is an investment hurdle of 20% Return on Funds Employed (ROFE); if no suitable investments canbe found, the company will seek to return excess cash to shareholders by way of increased dividends and/or sharebuy-backs.

Admittedly, the drivers behind larger profits in the years ahead are different for the operations in developedeconomies where product innovation and cost reduction remain key ingredients, while growth will be easier toobtain in emerging markets.

Is there nothing that can disrupt this forecast?

Oh yes, there is. In fact, there's plenty! And outside control of Amcor's management too. With 85% of all profitsgenerated in foreign currencies, predominantly euro and USD, currency fluctuations can have a significant impactfor Australian shareholders. Amcor estimates that every euro 1c move impacts net profit by A$5m and every US1cmove impacts net profit by A$3m. The good news is, of course, that in case of AUD weakness, Amcor will be a


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major beneficiary.

As a global manufacturer, rising input costs are always a threat as any pass-ons to customers happen with a delay.Raw materials are typically 30% to 60% of the total cost of production. Important thus. The largest categories ofraw materials for Amcor are resins, resin-based films, aluminium, cartonboard and inks.

Another negative is that Amcor's Price-Earnings (PE) ratio has now risen to the upper level of its historical PE range(see chart below). Investors not yet on board might want to wait for share price weakness or to buy on dips in orderto avoid disappointing returns in the short term.

In summary: Amcor's All-Weather(*) characteristics which include resilient revenues, pricing power and a widegeographical and product diversification are at this point in time complemented with several drivers that shouldensure strong growth lies ahead. These profit-drivers include recent acquisitions, growth in emerging markets, costreductions, and ongoing operational improvement. Virtually every analyst covering the stock acknowledges there'splenty of room for unaccounted positive surprises, regardless of further acquisitions. Amcor may well be cruisingtowards an operational sweet spot in the years ahead.

Ignoring any further upside potential, below are present projections on the basis of FNArena's consensus estimates:

In 2012, Amcor launched a new program "Journey to Greatness" with management explicitly stating: "The objectiveis to deliver consistent improvement in returns to shareholders, measured as growth in earnings per share andincreases in the dividend."

Investors should always consider weaknesses and strengths when assessing investment opportunities. In the case ofAmcor, I believe these are:

Weaknesses: - currency fluctuations can heavily impact on profits for Australian shareholders - so can rising inputcosts were commodities to experience another bull market - acquisitions remain firmly on the agenda and theycome with specific risks - Amcor carries $3.8bn in debt which will create headwinds from the moment interest ratesstart rising

Strengths: - fast growing emerging markets on top of a resilient customer base in developed economies - Amcoraims for top three positions in all markets in which it operates which should guarantee pricing power - multipleprofit drivers in years ahead - excess cash virtually guaranteed (which can also turn into a negative in case ofmishandling by management)

Bottom Line: shareholders should continue to enjoy growth in the years ahead, while positive surprises in marketslike the US, Europe and/or Australia will only add extras to the upside potential.

Trivia: Amcor's annual sales four years after the purchase of Alcan Packaging are still below the implied $14bn atthe time of the acquisition, but its profits are much higher and so are dividends for shareholders, showing thesuccess of successive restructurings and operational improvements put in place by management over the years.

(*) Amcor was nominated an All-Weather Performer in my recent eBooklet "Making Risk Your Friend. FindingAll-Weather Performers". This eBooklet was published earlier this year and has been made exclusively available topaying subscribers of FNArena (6 and 12 months).

This is the third in a series of analyses on individual companies. Previous stories:

- Rudi's View: CommBank, The Most Consistent, Reliable Performer (14 December 2012)

- Rudi's View: Newcrest's Production Ace (25 October 2012)

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculationsare provided for educational purposes only. Investors should always consult with their licensed investment advisorfirst, before making any decisions.)

P.S. I - All paying members at FNArena are being reminded they can set an email alert for my Rudi's View stories.Go to Portfolio and Alerts in the Cockpit and tick the box in front of 'Rudi's View'. You will receive an email alert


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every time a new Rudi's View story has been published on the website.

P.S. II - If you are reading this story through a third party distribution channel and you cannot see charts included,we apologise, but technical limitations are to blame.



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22 FYI

By Tim Price

“In money management what sells is illusion of certainty. The truth (i.e. we don’t know much) is a more difficultsale, but a better investment.”

- Tweet from Piet Viljoen of RE: CM asset managers.

“A woman was trying to read If deposits were still guaranteed If her bank would consign To Frankfurt am Main OrCyprus would have to secede.”

- Tweet from Dr. Goose

“..a quite outstanding week’s work by the Troika [ECB, EC, IMF]. Take a moment to realise the scale of what’s beendone here. No human agency has achieved so much economic destruction in such a short time without the use ofweapons.”

- Pawel Morski, ‘Cyprus: the operation was a success. Shame the patient died’.

“Alright, people just need to chill. Cyprus is a tiny country. To put things in perspective, its GDP is roughly the sizeof.. Lehman.”

- Tweet from Jesse Livermore.

Like Lehman Brothers before it, Cyprus may well come to be seen not so much as the cause of further crisis but asyet another symptom of the ‘long emergency’ that continues to suffocate the western economies. We woulddescribe this emergency as, fundamentally, an inevitable crisis triggered by an unsustainable explosion of credit.No progress or improvement has been or will be possible in the underlying condition because both the bankingsector that collectively lost its mind and the governments that permitted it to are fatally dysfunctional and equallybankrupt, literally and morally. Western banks and western governments are now like Macbeth’s

“two spent swimmers, that do cling together And choke their art.”

The prime minister of Luxembourg, Jean-Claude Juncker, has provided two clear insights into the world of deceitthat the modern politician inhabits:

“We all know what to do, we just don’t know how to get re-elected after we have done it.”

And,

“When it becomes serious, you have to lie.”

This is what we now have by way of parliamentary democracy: a self-serving elite who cannot be trusted,operating to a timetable defined by, and limited to, the electoral cycle.

This democratic deficit is possibly more severely damaging than the supposedly intractable fiscal one that liesbeneath it. One of the most outstanding discussions of these twin deficits was made by John Lanchester in May2009. It’s a long piece but well worth the effort. Because it conveys the genesis and resultant scale of the bankinghorror story in terms that a layperson can understand, it may be one of the standout accounts of our ‘longemergency’. As Lanchester points out, western governments for five years now have been going to tremendous,Basil Fawltyish lengths to avoid taking insolvent banks into public ownership. Whatever emerges from the disasterthat is now the Cypriot economy (with euro zone policy making nicely described by Dan Davies as “Laurel andHardy carry a piano upstairs”), Cyprus has reminded us of a couple of awkward truths that most politicians and


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bankers would prefer to keep off balance sheet:

1) A deposit in a bank is not a riskless form of saving. We may not see eye to eye with the FT’s Martin Wolf on manyaspects of modern economics and central banking in particular, but he described banks well last week: “Banks arenot vaults. They are thinly capitalised asset managers that make a promise – to return depositors’ money ondemand and at par – that cannot always be kept without the assistance of a solvent state.”

2) When states become insolvent, the piper must ultimately be paid. Fatally embarrassing insolvency is not aproblem that can be perpetually or painlessly deferred.

Cyprus matters not because of the size of its economy or even because it is, for the time being at least, a memberof the euro zone. It matters because the inept handling of its banking crisis last week threw one facet of modernbanking into sharp relief: if a deposit guarantee scheme is seen to be fraudulent or sufficiently fragile to be easilysmashed by politicians, then confidence in banks per se, and at a wider level confidence in unbacked papercurrency itself, will be vulnerable to an unpredictable run. CLSA strategist and financial market historian RussellNapier writes as follows:

“..the Euro is the progeny of political desire and is succoured by the political elite. If, however, the people of thesystem believe that the Euro’s sustenance necessitates the use of arbitrary power resulting in unequal treatment[i.e. the abandoning of bank deposit insurance for retail savers] then they will conclude that the Euro system is notworth having. The loss of democracy and the rule of law will outweigh whatever economic benefits Euromembership may bring. The citizens of the PIIGS [Portugal, Italy, Ireland, Greece and Spain] have shown incredibleresilience to the economic sacrifices they have been asked to make, but will they be as resilient to the loss ofdemocracy which the creation of the Euro necessitates and which the Cypriot bank levy clearly illustrates? ..thebending of the rule of law to prevent its economic collapse brings arbitrary and unfair outcomes which peopleshave always rebelled against. There will clearly be short term consequences from the sequestration in Cyprus butthe key impact will be long term as the citizens of the Euro, like the citizens of the Soviet Union or the Americancolonies before them, eventually reject the sacrifice of political rights necessary to support the system. When thehistory books are written, the Brussels-imposed sequestration in Cyprus will be seen as the tipping point when thecitizens of the Euro system realised that the socio-political sacrifice needed to sustain a single currency was justtoo great.” [Emphasis ours.]

As the earlier quotation from Piet Viljoen makes clear, the ‘illusion of certainty’, in asset management, sells. Wehave taken great pains to point out our own limitations in predicting the future, and in turn to establish an assetmanagement process that reduces dependency on those predictions, by means of rigorous asset class diversification(which we continue to maintain represents the last free lunch in finance). During a debt crisis it may seem perverseto hold debt instruments at all. But in our defence we hold bonds of unimpeachable credit quality issued byobjectively creditworthy sovereign and quasi-sovereign borrowers. That those bonds yield more than bonds issuedby heavily indebted/insolvent western economies naturally adds to their attractiveness. We also hold broadlydefensive and otherwise attractively valued listed equities – but because we cannot foresee the future, we have anatural interest in protecting client portfolios against market shocks, so our equity exposure is always likely to bemore moderate than most of our ‘boy racer’ peers with their ‘here today, gone tomorrow’ herd-like and casualattitude towards risk. We hold uncorrelated managed funds. And in light of current events in Cyprus, we have aparticular interest in holding tangible, non-financial, currency hedges like gold and silver, which unlike euro zonebonds offer no credit or counterparty risk whatsoever. Actions have consequences. Cyprus may end up being astorm in a teacup. Like Russell Napier, we fear it may well be the start of something altogether more sinister. Ifyou have yet to consider the sanctity, stability, ‘store of value-ness’ and true safety of the paper currency you holdwithin the banking system, now might be a good time to start.

Tim Price Director of Investment PFP Wealth Management

Email: [email protected] Twitter: timfprice

Weblog: http://thepriceofeverything.typepad.com Group homepage: http://www.pfpg.co.uk

Bloomberg homepage: PFPG


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Disclaimer: The views expressed are the author's, not FNArena's (see our disclaimer)



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23 FYI

-Cyclicals returning to favour -Beware the second half, margin risks -Asia needs an earnings recovery -Shift to longsin US interest rates

By Eva Brocklehurst

Recent official rate cuts in Australia are still working their way through the economy and should underpin companyearnings in FY14. That's the opinion of analysts at Deutsche Bank. Cyclical industrial stocks should benefit fromcurrent conditions and the valuations are attractive. Deutsche Bank notes the earnings revision ratio for cyclicals isnow around neutral, after several years of heavy downgrades, and this should ensure superior growth vis-a-visdefensive stocks. The broker is also comfortable with US-exposed cyclical stocks. Transport companies shouldbenefit from re-stocking while a recovery in housing should support related stocks. The soft sector is retail, andgiven spending has not been substantially weak the broker does not see scope for a large bounce there. Therefore,good price/earnings growth rates are envisaged for cyclical industrials, with the exception of retail and miningservices.

In light of this Deutsche Bank likes Toll Holdings ((TOL)), Asciano ((AIO)), Boral ((BLD)), Stockland ((SGP)), BlueScope((BSL)), Brambles ((BXB)), News Corp ((NWS)), Aristocrat Leisure ((ALL)), Westfield ((WDC)) and Crown ((CWN)).

Some caution is still required. BA-Merrill Lynch also suggests the risk of sizeable earnings downgrades is now low,but there are individual exceptions. With valuations nudging multi-year highs, there could be a disproportionatefall in share prices if the risks eventuate, the broker warns. In summary, there are two stock-specific risks thebroker encounters. The first is relying too much on the second half, particularly if there are unusual expectationsof a higher proportion of sales in the period. Stocks cited for a watch in this regard include Computershare ((CPU)),Harvey Norman ((HVN)), UGL ((UGL)), Ansell ((ANN)) and Sims Metal ((SGM)).

The second risk is margin. Some stocks received a reprieve in the latest reporting season but Merrills is cautiousabout extending the expectation of margin improvement too far. This is the case for domestic sectors wherestructural headwinds are intense and demand is soft. The broker finds consensus margin forecasts appear optimisticfor Harvey Norman, Metcash ((MTS)), Echo Entertainment ((EGP)) and Toll.

Working capital deterioration could also suggest more deep-seated problems, according to Merrills. The brokernotes Ansell's inventory is turning over at the slowest rate for some time. Among consumer stocks, Coca-ColaAmatil ((CCL)) and Super Retail ((SUL)) have enjoyed an improvement in cash conversion which should still driveshareholder value. The broker accepts that holding quality stocks has been detrimental to portfolio performanceover the past six months. Nevertheless, low-quality stocks that do not cover the cost of capital are now viewed asexpensive.

Taking into account earnings risk and valuations, Merrills is most wary of domestic cyclicals such as David Jones((DJS)), Harvey Norman, Toll and Tabcorp ((TAH)) and some industrials such as Ansell, BlueScope and Sims Metal.The broker's advice is leaning towards inexpensive resource stocks such as Newcrest ((NCM)) and Iluka ((ILU)) andquality stocks where earnings growth appears less risky such as News Corp and Brambles.

Merrills' Asia-Pacific strategy is positive. The broker notes the improved performance in Asian equities over the last12 months has been mainly driven by a re-rating of stock, rather than earnings upgrades. Merrills believes Asianeeds an earnings recovery to justify a continuation of the stock rally and this could be at hand. The strategistsrecommend positioning for an economic upturn and favour China and India, and financial and motor vehicle stocks.Out of favour at this stage are expensive defensive stocks such as Hong Kong utilities and late-cycle sectors such asmaterials.

On Australia specifically, Merrills finds the market has pushed up quality defensive stocks with reliable earnings.


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Now these appear expensive. The strategists think the time is right to rotate away from these sectors. Merrills isunderweight energy, which has been underperforming over the last two years, and neutral on materials, which isalso underperforming coinciding with weak iron ore prices. The broker is comfortable with expectations of flatearnings overall for FY13 and growth around 12% in FY14. This judgement is derived from the broker's earningsmodel, which gives some sight on earnings growth over the next 12 months. The model uses global purchasingmanager and consumer sentiment indexes as input, and currently suggests bottom-up forecasts are reasonable. Afinal word from Merrills: equity markets usually perform well in the first half of the calendar year, underperform inthe third quarter, and finish the year strongly.

Further to the macro view, Citi's GRAMI (Global Risk Aversion Macro Index) is back in positive territory this week,despite the Cyprus debacle. Nonetheless, investors are not overly confident. Citi's NISI (News Implied SentimentIndicator), which aims to capture investor sentiment via news stories containing the keywords bullish and bearish,deteriorated slightly last week and remains in bearish territory. Citi has also monitored fund flows and rotation isnot yet a theme. Flows are going into both equities and bonds. From foreign exchange position indicators Citi hasobserved net long positions in US dollars versus other G10 currencies and also on a global basis. Euro positioning isshort and British pound short positions have been extended, while Japanese yen positioning is back to neutral.

On US interest rates Citi's monthly measure reveals a sharp shift to net long positions in March, outnumbering shortpositions by 32%. This is the largest net long bias in three years. The analysts do emphasise that 40% of investorsremain neutral. Citi's global credit survey shows a correction in leveraged positioning to neutral from long, whilereal money inflows are at their lowest since 2008. After unwinding sharply recently, Citi's measure of commodityappetite shows non-commercial net long positions on the rebound last week. Citi’s latest US survey reveals cashbalances have increased and 84% of respondents are looking to allocate capital to equities.



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24 FYI

By Andrew Nelson

The week from the eighteenth to the twenty fifth of March was a slow one as far as shorting and short covering onthe Australian market went. There was a bit more action when looking over the month to the twenty fifth, butmost of that was on the back of moves from weeks past.

Just one stock saw its short position move up or down by one percentage point (ppt) or more and that was AtlasIron ((AGO)). Shorts increased by 1.17ppt from 1.81% to 2.96% over the week. Credit Suisse upgraded its call to Buyfrom Sell in mid-March. Other than that, sentiment remains slightly positive, the same as it was at the end ofFebruary when the company reported what were fairly disappointing first half numbers.

Atlas also sits atop the monthly increase list, with shorts up 2.44ppt from 0.54% to 2.96%. Next comes UGL ((UGL))it’s shorts up 2.29ppt from 3.74% to 6.03%. The company said last week it was undertaking a review of its corporatestructure and is only part way through a cost cutting program. Analysts speculate this could mean a restructure ora de-merger is on the cards. The FNArena Sentiment Indicator is positive.

Shorts in Transfield Services ((TSE)) are up 2.19ppt from 1% to 3.19%. The company reported interim results at theend of February that came in a bit short of most brokers. Sentiment for the stock remains neutral on five Holds inthe FNArena Database, with brokers torn between longer term value and a difficult outlook nearer term.

Our last 2ppt or move increase over the month was posted by Iluka ((ILU)), with shorts up 2.07ppt from 14.07% to16.14%. JP Morgan noted at the beginning of March that despite the near term woes of poor pricing conditions itstill sees upside, noting a number of industry participants are talking up improving market conditions. The brokerthinks as soon as we see some evidence of a pickup in zircon prices, short-covering in the stock will start toaccelerate. Sentiment for the stock remains positive in the meantime.

SingTel ((SGT)) continued on with its short-covering march in March, its shorts coming off 5.8ppt from 5.51% to0.71%. BA-Merrill Lynch noted a few weeks back that the company had announced a strategic review for Optus'ssatellite business, with optimising share holder value the stated goal. BA-Merrill Lynch pointed out this could endup turning into a 2%-6% special dividend if the holdings are sold down or listed. Sentiment for the stock remains inpositive territory.

Gryphon Minerals ((GRY)) has seen its short position pull back by 3.45ppt from 6.61% to 3.16% over the month inquestion. Both CIMB and Credit Suisse noted in mid-March that despite a sub-par interim report, Banfora remains ontrack and that’s where the value is. Sentiment is perfect on straight Buys in the FNArena Database.

Sundance Energy ((SEA)) comes next, with shorts down 3.07ppt from 3.44% to 0.37%. BA-Merrill Lynch lifted its pricetarget mid-March after the company's acquisition of 7,812 acres in the volatile oil area of the Eagle Ford. Thebroker said this asset will now become core to Sundance's ramping up of production to 5,000 boepd over the next 15months. The broker believes the asset has significant upside potential and was secured on attractive terms.Sentiment is positive.

Our last short position shift of note was posted by Boral ((BLD)), with shorts down 2.07ppt from 4.79% to 2.72% overthe month in question. Deutsche Bank noted earlier in March that the company plans to combine its BoralConstruction Materials and Cement divisions into one, vertically integrated unit. Information on cost savings andsynergies wasn't provided at the time, but Deutsche reckons we'll see savings in excess of the $105m alreadyannounced. Sentiment is positive.

Despite the slow week in terms of the magnitude of short position changes, there was quite a bit of a change to theTop 20 Most shorted list. David Jones ((DJS)) moved from twelve to seven on the list, Harvey Norman ((HVN)) from


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eleven to fourteen and Cochlear ((COH)) from fifteenth to eighteenth position. There was also a bit ofcompositional change, with both Western Areas ((WSA)) and Sims Metal ((SGM)) falling off the list, with Cochlear((COH)) and The Reject Shop ((TRS)) joining at eighteen and thirteen respectively.

Top 20 Largest Short Positions Rank Symbol Short Position Total Product %Short 1 JBH 17699183 98947309 17.89 2 FXJ403719024 2351955725 17.17 3 ILU 68321806 418700517 16.32 4 PDN 105324703 836969286 12.58 5 MYR 72784154583384551 12.48 6 MTS 101791942 880704786 11.56 7 DJS 58015876 531788775 10.91 8 FLT 10575169 100344792 10.54 9LYC 198939672 1960801292 10.15 10 CSR 49236177 506000315 9.73 11 MND 8496010 90940258 9.34 12 KCN 13628913151828173 8.98 13 TRS 2291301 26092220 8.78 14 HVN 88172707 1062316784 8.30 15 BKN 13172590 168176418 7.83 16WSA 14571789 196843803 7.40 17 WTF 14886185 211736244 7.03 18 COH 3909294 57040932 6.85 19 BRU 18707916273912685 6.83 20 ACR 11243008 166521711 6.75 To see the full Short Report, please go to this link

IMPORTANT INFORMATION ABOUT THIS REPORT

The above information is sourced from daily reports published by the Australian Investment & SecuritiesCommission (ASIC) and is provided by FNArena unqualified as a service to subscribers. FNArena would like to makeit very clear that immediate assumptions cannot be drawn from the numbers alone.

It is wrong to assume that short percentages published by ASIC simply imply negative market positions held by fundmanagers or others looking to profit from a fall in respective share prices. While all or part of certain shortpercentages may indeed imply such, there are also a myriad of other reasons why a short position might be heldwhich does not render that position “naked” given offsetting positions held elsewhere. Whatever balance ofpercentages truly is a “short” position would suggest there are negative views on a stock held by some in themarket and also would suggest that were the news flow on that stock to turn suddenly positive, “short covering”may spark a short, sharp rally in that share price. However short positions held as an offset against anotherposition may prove merely benign.

Often large short positions can be attributable to a listed hybrid security on the same stock where traders look to“strip out” the option value of the hybrid with offsetting listed option and stock positions. Short positions may formpart of a short stock portfolio offsetting a long share price index (SPI) futures portfolio – a popular trade whichseeks to exploit windows of opportunity when the SPI price trades at an overextended discount to fair value. Shortpositions may be held as a hedge by a broking house providing dividend reinvestment plan (DRP) underwritingservices or other similar services. Short positions will occasionally need to be adopted by market makers in listedequity exchange traded fund products (EFT). All of the above are just some of the reasons why a short position maybe held in a stock but can be considered benign in share price direction terms due to offsets.

Market makers in stock and stock index options will also hedge their portfolios using short positions wherenecessary. These delta hedges often form the other side of a client's long stock-long put option protection trade, orperhaps long stock-short call option (“buy-write”) position. In a clear example of how published short percentagescan be misleading, an options market maker may hold a short position below the implied delta hedge level andthat actually implies a “long” position in that stock.

Another popular trading strategy is that of “pairs trading” in which one stock is held short against a long position inanother stock. Such positions look to exploit perceived imbalances in the valuations of two stocks and imply a “netneutral” market position.

Aside from all the above reasons as to why it would be a potential misconception to draw simply conclusions onshort percentages, there are even wider issues to consider. ASIC itself will admit that short position data is not anexact science given the onus on market participants to declare to their broker when positions truly are “short”.Without any suggestion of deceit, there are always participants who are ignorant of the regulations. Discrepanciescan also arise when short positions are held by a large investment banking operation offering multiple stock marketservices as well as proprietary trading activities. Such activity can introduce the possibility of either non-countingor double-counting when custodians are involved and beneficial ownership issues become unclear.

Finally, a simple fact is that the Australian Securities Exchange also keeps its own register of short positions. Thefigures provided by ASIC and by the ASX at any point do not necessarily correlate.


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FNArena has offered this qualified explanation of the vagaries of short stock positions as a warning to subscribersnot to jump to any conclusions or to make investment decisions based solely on these unqualified numbers.FNArena strongly suggests investors seek advice from their stock broker or financial adviser before acting upon anyof the information provided herein.





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25 Technicals

By Michael Gable

Last week didn’t see the market do much, but it still resulted in a bit of a sell-off last Thursday leading into thelong weekend. Chinese manufacturing PMI came in at 50.9, the largest we’ve seen for 11 months, and bucking thatsmall downtrend from the last few months. The figure was below expectations but it still confirms that theeconomy is expanding – at a sustainable rate. I think that is key. If we received a figure well above expectations,then the market could interpret that as the need to tighten the screws again.

On that note, I finally think that it is worth dipping the toe in the water with BHP Billiton ((BHP)) and Rio Tinto((RIO)). I can’t rule out some medium term weakness, but at the very least I expect some sustained buying to startany day now with those two. Have a look at pages 5 & 6 for the upside targets.

ASX 200

My targets remain the same on the XJO (ASX 200) with support down at 4880, and the next level down at 4570. Thisweekly chart highlights the text book reversal signal that is now evident. Unless we get an amazing rally this weekto take us to new highs for the year, the probabilities are clearly still to the downside.

Content included in this article is not by association necessarily the view of FNArena (see our disclaimer). VisitMichael Gable's website at www.michaelgable.com.au/.

After leaving Macquarie Bank's Securities Group in 2008 after many years of service, Michael has gained a highlyregarded reputation in the financial services industry. As a Private Client Adviser with Novus Capital, Michael hasbecome a popular live commentator and analyst for Sky News Business Channel’s “Your Money, Your Call” program.He is also the author of the weekly stock market report “The Dynamic Investor”. Michael assists investors toachieve their goals by providing advice ranging from short term trading to longer term portfolio management.Michael deals in all ASX listed securities and specialises in covered call writing to help long term investors protecttheir share portfolios and generate additional income. Michael is RG146 Accredited and holds the following formalqualifications:

• Bachelor of Engineering, Hons. (University of Sydney) • Bachelor of Commerce (University of Sydney) • Diploma ofMortgage Lending (Finsia) • Diploma of Financial Services [Financial Planning] (Finsia) • Completion of ASXAccredited Derivatives Adviser Levels 1 & 2

Disclaimer

Michael Gable is an Authorised Representative (Rep. No. 376892) of Novus Capital Limited AFSL 238168 ACN 006 711995. Michael Gable and Novus Capital Limited, their associates and respective Directors and staff each declare thatthey, from time to time, may hold interests in securities and/or earn brokerage, fees, interest, or other benefitsfrom products and services mentioned in this website. This website may contain unsolicited general information,without regard to any investor's individual objectives, financial situation or needs. It is not specific advice for anyparticular investor. Before making any decision about the information provided, you must consider theappropriateness of the information in this website or the Product Disclosure Statement (PDS) or Financial ServicesGuide (FSG), having regard to your objectives, financial situation and needs and consult your adviser. Anyindicative information and assumptions used here are summarised and also may change without notice to you,particularly if based on past performance. Michael Gable and Novus Capital Limited believes that any informationor advice (including any securities recommendation) contained in this website is accurate when issued but does notwarrant its accuracy or reliability. Michael Gable and Novus Capital Limited are not obliged to update you if theinformation or its advice changes. Michael Gable and Novus Capital Limited and each of their respective officers,agents and employees exclude to the full extent permitted by law, all liability of any kind, in negligence, contract,


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under fiduciary duties or otherwise, for any loss or damage, whether direct, indirect, consequential or otherwise,whether foreseeable or not, to the extent arising from or in connection with this website.



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26 Treasure Chest

By Greg Peel

As half bank, half insurance company, Suncorp ((SUN)) took a sizeable bath share price-wise in 2008 as the GFC bitand the company’s banking exposure to tenuous South-East Queensland borrowers scared investors away. Theshares recovered half their loss in 2009, and up until mid last year bungled along going nowhere as investorsscorned an operation which was half this, half that and not apparently all that good at either.

QBE Insurance ((QBE)), which also has its roots in Queensland but by the GFC had expanded nationally andinternationally with well-received acquisitions, fell sharply but briefly in 2008 before recovering most of its lostshare price ground through 2009. Yet up until the beginning of this year, the QBE share price has done nothing buttrundle lower.

Both companies were hit by fire and flood catastrophes in Australia and for QBE the catastrophe score surgedfurther with disasters in the US. In this latest rally, nevertheless, both share prices have performed very welldriven not just by a return to “risk on” attitude but by premium increases following the run of catastrophes andbelief that a fresh, less catastrophic cycle must now be upon us.

For BA-Merrill Lynch, QBE is a “very different business” to that of its pre-GFC, market darling heyday and despite arecent substantial rally, Merrills notes neither analysts nor fund managers are convinced of QBE’s recoverypotential. The company now features much lower growth, is more cyclical, higher risk and has a weaker balancesheet. Merrills’ analysts suggest QBE can no longer be valued against earlier valuation models. A transition plan outof the hole QBE has found itself in is in place but will take a long time to deliver, the analysts suggest, and in themeantime earnings remain highly leveraged to interest rates.

On the other hand, Merrills suggests “catalysts for a re-rate of SUN seem to be nearing”.

It is increasingly believed Suncorp will move to divest of large slabs of its non-core banking operations now thatsome value has returned to previously distressed assets this far out form the GFC. Given Suncorp under-provisionedfor this distress, a sale now would still prove costly on the balance sheet. But Merrills believes the move would bewell received by the market given the removal of the cloud, an increase to future earnings certainty and a lift tofuture earnings per share and return on equity. Investors may also become more confident with respect to futurecapital returns, the analysts suggest.

Suncorp will hold a Strategy Day on May 29th and Merrills believes an opportunity will then be provided formanagement to lift the market’s confidence in the capacity of the life insurance business to generate betterreturns. The broker has a Buy rating on SUN with a $12.00 price target but if the company can “pull all theselevers” a valuation of $13-14 would be more appropriate, the analysts suggest.

The FNArena database shows five Buy, two Hold and one Sell rating on Suncorp with a consensus $11.75 price targetsuggesting minor upside. By contrast, QBE scores only one Buy and seven Holds with a consensus target of $13.12,suggesting 4.4% downside.



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27 Weekly Analysis


Assuming no unforeseen scenarios, Australians will vote on September 14 to either keep the present Laborgovernment in power or to replace it with a conservative coalition of Liberals and Nationals. As things stand rightnow, conservative Tony Abbott is a strong favourite over Labor's battle-hardened Julia Gillard.

You don't have to necessarily agree with Abbott's favouritism, and certainly Gillard would like a few things to sayabout it between now and September 14, but current sentiment is unmistakably leaning towards a change ingovernment. This general sentiment is also reflected in the odds offered by bookmakers and betting companies.According to a recent press release, bookmaker Tom Waterhouse is taking on election bets with odds at $1.16 foran Abbott win and $4 in the case of a Gillard victory.

These odds will change as new developments take place and maybe sentiment can still shift in favour of Gillard,but as things stand right now there's not much to gain for punters backing the general favourite. Betting on JuliaGillard winning the contest seems so much more lucrative, but there's a very good reason for this: only true Laborsupporters and unionists think she can pull it off.

I usually don't like drawing parallels between gambling and the share market, as I do believe there's a BIGdifference, but in this case I think the comparison is apt and very much to the point, because the same principlesthat govern today's gambling odds for an Abbott or Gillard win apply every day in the share market.

Take Aristocrat Leisure ((ALL)) as an example. Shareholders in the poker machine manufacturer haven't had muchjoy post-2007. Profits and dividends had kept on declining year after year and this was reflected in a gradualde-rating as investors' confidence evaporated along the way. Aristocrat became the target of short sellers and itsPrice-Earnings (PE) ratio fell from around twenty to less than ten. What this effectively meant is the company hadstarted to look more like Gillard than Abbott and the low PE was a reflection of this. Low PE means low confidence,thus high risk.

Some gamblers might argue that $4 against $1.10 in the contest Gillard-Abbott is too wide, and that might well bethe case, but unless something feasible happens that shakes up the political landscape, Tom Waterhouse is unlikelygoing to substantially change his odds. It's no different in the share market where, arguably, valuing Aristocratshares at less than $2.40 per share (August last year) was too low a valuation for a company whose fortune wasturning around. Usually, investors want to see some evidence, no matter how flimsy, that things are indeedimproving and that general low confidence is no longer warranted.

In recent months general sentiment towards Aristocrat has improved, and quite a lot, as the market started torealise the company's profit profile was about to turn for the better. This view was confirmed in February with a35% growth in earnings per share for the year to December. Today investors are convinced this company is lookingtowards much better times ahead than what has transpired between 2008 and mid-2012 and this confidence isreflected in today's PE ratio of 19x times prospective earnings. On current consensus estimates Aristocrat willachieve 14% growth in earnings per share this year and growth of 19% next year.

Aristocrat's PE of 19 shows there's little doubt in investors' minds these growth projections will be achieved. What ifprofit growth is likely to be even better? Expect the PE to rise above 20 if the market grows confident this will bethe case.

Most of the time investors hear from market commentators and other financial experts that PE ratios show whatthe value is of shares and thus certain shares are overvalued while others are undervalued. This is only true as asecond derivative from the market's confidence that is primarily responsible for these PE ratios.


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It can easily be argued that, because of current expectations about who's likely to win the elections in September,Tony Abbott is more valuable than Julia Gillard. Imagine yourself a business owner who's about to lobby for animportant future project. To whom would you direct most of your attention?

It's the same in the share market: were Tony Abbott a listed company, his PE ratio would now be well above 20(possibly around 30) and Julia Gillard's would be well below ten (unless she promised to pay a big dividend). $1.10against $4 is simply another metric for showing the same thing.

Being confident is not the same as being right. As a matter of fact we, the people behind these PE ratios,sometimes become absorbed by our own confidence; that's when we become over-confident and risks startaccumulating in the opposite direction.

The Australian Open tennis tournament earlier this year provided one such fine example. When the world's numberone, Novak Djokovic, was to play Swiss challenger Stan "The Man" Wawrinka in the fourth round, nobody believedDjokovic would not advance to the quarter-finals. As a result, betting odds were similar to Abbott-Gillard's. Atleast, that was the case before the game had started. Once Wawrinka unleashed his super-form on Djokovic thoseodds started changing rapidly. Ultimately, Djokovic still managed to win, but it had been a tight contest overall; itcould easily have gone the other way. By the time the world's number one won the final set in 12-10 after fivehours of high quality tennis, betting odds had narrowed substantially.

In the share market, online real estate portal REA Group ((REA)) is growing annual profits by 25% or more perannum. This is quite rare in an overall environment whereby banks grow in single digits and profits for resourcesstocks are extremely volatile and uncertain. In such an environment, it shouldn't surprise investors have flockedtogether into REA Group shares. Not one of the stockbrokers covering the stock has a price target above today'sshare price, but that still doesn't deter investors. Is a PE of 32 too high?

It depends. If REA Group continues growing at 25% per annum then today's PE of 32 will drop to 26 on FY14 prospectsand even lower on estimates for later years. If the only option is between Gillard and Abbott and you must place abet, you probably still put your money on Abbott, unless Gillard's chances genuinely start improving, after whichyou might re-consider (see Djokovic-Wawrinka earlier).

Sometimes investors' confidence changes focus. At the peak for the Australian share market in 2007, CommBank((CBA)) shares were trading on a PE above 15, which is historically as high as PEs go for an Australian bank. Inhindsight, it turned out investors weren't confident at that time, they were dead right complacent, punch-drunk,over-confident and maybe even a little bit delusional. Fast forward to today and CBA's PE has again risen above 15.This time, however, investors' focus is on the bank's dividends and one can only acknowledge there doesn't appearto be much of a threat to those dividends.

Today's PE thus reflects a high level of confidence those dividends will be paid. Should the market become moreconfident about an extra-bonus for CBA shareholders in 2014, this will translate into an even higher PE.Alternatively, were Gillard's chances for re-election to genuinely improve in the months ahead, more gamblersmight consider backing her odds instead of the low profit-generating Tony Abbott.

This shows us as to why resources stocks haven't been able to catch-up with banks and industrials thus far. They'restill at Gillard-Wawrinka odds and investors' confidence is too low to shift away from backing Abbott and Djokovic.

Any comparison between the share market and gambling is incomplete without pointing out the major differencebetween the two: a gamble on Wawrinka, despite his epic battle, would have still resulted in a 100% loss. Unlessyou really don't know what you're doing, this is virtually never the case in the share market.

Shares in BHP Billiton ((BHP)) were approaching a PE of 15 on FY14 consensus estimates in February. It is clear themarket wants to believe BHP's earnings growth will resume next year and management might even surprise withcost cutting and other shareholder-friendly initiatives, but it's difficult to keep confidence up when spot iron oreappears unsustainable, crude oil prices are going nowhere and serious question marks are being raised aboutsupply-demand prospects for copper.

(This story was written on Monday, 25 March 2013. It was published on the day in the form of an email to paying


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subscribers).

DO YOU HAVE YOUR COPY YET?

FNArena has published my latest e-Booklet "Making Risk Your Friend. Finding All-Weather Performers". Thise-Booklet (58 pages) is offered as a free bonus to paid subscribers (excl one month subs). If you haven't receivedyour copy as yet, send an email to [email protected]

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculationsare provided for educational purposes only. Investors should always consult with their licensed investment advisorfirst, before making any decisions. All views are mine and not by association FNArena's - see disclaimer on thewebsite)

****

Rudi On Tour in 2013

- I will present and contribute during the 2013 National Conference of the Australian Technical Analysts Association(ATAA) at the Novotel in Sydney's Brighton Beach, June 21-23 - I will present to members of AIA NSW North Shore atthe Chatswood Club on Wednesday 11 September, 7.30-9pm


62 of 62 05-Apr-13 11:03 AM

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