- David Thodey and his team at Telstra have positioned the company to capture the structural growth in mobile data.
- The bond market is pricing in at least another interest rate cut, which is good for residential property and the banks.
- Fairfax could be in for an earnings surprise when it announces interim results on 19 February.
It’s only February 5 and what a year of expectation change and price movement it has been globally and locally. Bond yields have plummeted, commodity prices have plummeted, commodity currencies have plummeted, Central Banks have responded with rate cuts and further QE, while any equity with bond like characteristics has been re-rated.
Applestra
In Australia in the ASX top 20, Telstra (TLS) has led the way as global and domestic income seekers bid down its yield. Thankfully, the first thing I did in 2015 was upgrade my Telstra price target to $7.00 and after seeing Apple’s blowout quarterly numbers I remain even more convinced Telstra is an earnings and dividend upgrade cycle.
I have previously written numerous notes on the ‘Apple effect’ on Telstra. My simply thesis is Apple is enabling mobile data addiction (MDA). What is interesting is, since Apple introduced large screen iPhone models, of which yours truly uses, sales have gone through the roof (74.5 million in the quarter plus 22 million iPads). Large models are clearly more effective for heavy mobile data users. The table below charts Apple’s quarter on quarter iPhone sales growth.
[1]This is all good news for Telstra, which dominates mobile data in Australia. It’s a little known fact that over 1 million Australians now use two mobile phones: one for work and one for personal use. I forecast further product penetration per household and Telstra’s 4G network advantage (see also reliability advantage) will see Telstra add more customers than its lesser competitors.
So despite the sharp move up in Telstra shares in January, I encourage you to stay the course. David Thodey and his team have this company very well positioned to capture the structural growth in mobile data. Below is a chart that confirms Apple and Telstra shares are joined at the hip. I call it Applestra.
Apple (APPL) vs. Telstra (TLS)
[2]Interest rate outlook
Clearly, Telstra shares have been a short-term beneficiary of changing domestic interest rate expectations, expectations I think are correct. As you know, I have been forecasting two 25 basis point rate cuts in Australia in the first half of 2015. I did forecast Tuesday’s 25 basis point cut as a “100% certainty” and I expect another 25 basis points before June. It’s quite basic that a 2.25% cash rate is still too high and remains behind the ever lowering global and domestic yield curve. All my currency and Australian equity strategy is based off a 2.00% cash rate in 2015.
The table below confirms that despite Tuesday’s cut, the RBA remains well “behind the curve”.
[3]Every Australian Government Bond (AGB) yield out to five years is below the current RBA cash rate. At one stage this week, the 3yr bond was almost 50 basis points below the new cash rate and the 10yr was at the new cash rate.
My point is that my forecast of two 25 basis point rate cuts in 1H 2015 remains and the current AGB yield curve is trying to tell me I am on the right track. The bond market has been well ahead of the equity market in pricing in lower cash rates, lower growth and lower inflation and I continue to take key macro signals from the bond market and yield curves.
Property power
That brings me to Australian residential property where I get endless questions from investors. I also get endless phone calls from local real estate agents after a couple of big sales in my street.
To my way of thinking, residential property prices are driven by a combination of the cost of money, the availability of money, affordability, population growth and the Australian dollar.
The residential property market has often been characterised by a tug-of-war between first homebuyers and investors. At the moment, it appears that investor activity remains the dominant force in the current cycle. Yet, although investors and first homebuyers are often in competition for the same property, their reasons for home ownership can vary.
Investors are invariably in search of yield and capital gain, while first homebuyers are more driven by family and affordability issues. While the reasons for property purchases may differ, a major driver of home ownership by both investors and first homebuyers is affordability. The two main determinants of affordability are the level of interest rates (mortgage rates) and the price of residential property.
There is little doubt that affordability, in the form of multi-decade lows for mortgage rates, has provided a major contribution to the strong gains for residential property over the last two or three years. Therefore, it would appear logical, that an understanding of the future direction of interest rates over the next few years is absolutely crucial for any prospective property buyers whether they be investors or first home buyers.
Considering, the cash rate is the primary determinant of variable mortgage rates, and the 3, 5 and 10 year Commonwealth bond yields remain the benchmark for fixed interest only loans, the outlook for mortgage rates for at least the next 18 months or longer, is lower. Importantly, this represents a significant change to expectations last year when the consensus view was for interest rate rises beginning June this year.
As a result, it appears that residential property affordability, based on interest or mortgage rate criteria, should be supported again this year. This is good news for both investors and first homebuyers. It is worth remembering however, that affordability is also a function of property prices. In this regard, the majority of forecasters are expecting further gains of around 5% this year for East Coast residential property. My base case is for 5% median house price gains in 2015, yet that could easily be 10% as record low mortgage rates meet strong population growth and the Australian dollar brings in expat and international buyers of Australian residential property.
This view on further Australian residential property price gains is one reason I recently upgraded the major banks, Macquarie Group (MQG) and Bank of Queensland (BOQ). Other leveraged derivatives of this view would include the property developers Lend Lease (LLC), Mirvac Group (MGR) & Stockland Group (SGP). REA Group (REA) will also be in an upgrade cycle.
Fairfax
[4]This brings me to Fairfax Media (FXJ), which could well prove the forgotten but leveraged way to play residential real estate. Fairfax has not been “killed”. It’s like a cockroach scuttling round your kitchen. In fact, if my analysis is right, that cockroach has been breeding and the worst is behind Fairfax.
I feel Fairfax earnings have bottomed as both cost-out and revenue growth beats expectations. The reinvigoration of the Domain brand is driving the renewed revenue growth. You can see below that FY15 consensus EPS estimates have been sneaking up and I feel FXJ is a positive earnings surprise candidate in the pending interim reporting season. Yes, you read that right, I used the words Fairfax and positive earnings surprise candidate in the same sentence. Fairfax reports interim FY15 earnings on February 19.
FXJ consensus FY15 estimates (red line): sneaking up
[5]Interestingly, if the Fairfax share price had matched the consensus EPS upgrades it would be trading at $1.05 (compared to today’s $0.91).
Fairfax will generate over $1.8 billion of revenue in FY15, EBITDA over $300 million and EPS above 7c in my view. This debt free company trades on an EV/EBITDA of 6.59 times, EV/sales of 1.09 times, price to book of 1.02 times, price to cash flow of 12 times and P/E of 13 times. Dividend yield is forecast at 4.7%fully franked in FY15.
On the basis of macro drivers meeting bottom up , I recommend Fairfax as a “trading buy” up to 93c. If I am proved right at the interim result, Fairfax shares will break the five-year technical downtrend and the medium-term price target would be $1.50. This whole situation reminds me of Qantas (QAN) a year ago.
FXJ: 5yr downtrend break approaching
[6]Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.