Over the last few years I have strongly urged you to “lose the home bias” in terms of asset allocation.
Part of that was a view on the Australian dollar declining and the other part was greater growth was to be found in the rest of the world. I coined the phrase “Australia for income, rest of world (ROW) for growth”, but I’d have to say even after forecasting that correctly I am now surprised just how badly Australian equities as measured by the ASX200 are performing.
I thought I’d start by reminding ourselves of 2015 year -to -date performance of major world equity indices in home currency first and then in US dollar terms.
[1]
In US dollar terms, the ASX200 has underperformed the US S&P500 by -19%. That is monumental underperformance and wider than any underperformance I can remember in my career.
Quite clearly, the ASX200 has had the perfect storm against it in 2015, suffering not only from losses in its heavyweight index components, but also the double whammy fall in the AUD/USD cross rate.
The ASX Twenty Leaders Index (XTL) has been leading the broader market lower. BHP & RIO in the miners, WPL, ORG, STO in energy, the four major banks, WOW and TLS has played the major role in our index underperformance of the world.
Some of those falls are driven by earnings downgrades and others by large scale equity raisings/dilution. Some by both.
In the last month alone we have seen another earnings downgrade from WOW, equity issues from ORG, STO and WBC and a very unfortunate dam collapse for BHP in Brazil, which saw BHP fall to a fresh 6-year low.
Quite frankly the description of “perfect storm” is correct in large cap Australia, but it is always darkest before the dawn and I am trawling through the damage looking for contrarian large cap ideas in Australia to add to my portfolio. I think the ASX200’s 19% underperformance of Wall St in US dollars is now too wide and I expect the equity issuance pressure on the ASX200 to ease a few notches into calendar year end.
As you know my fund has been running pretty high cash levels but I am starting to see specific opportunities in Australia where I can see a prospective total 12 month return well better than cash, remembering the risks to the RBA cash rate remain to the downside in 2016.
One of those opportunities is Telstra (TLS), where I’ve started to build an investment position on down days.
Telstra has been absolutely poleaxed and I am of the view the correction in TLS is now overdone.
To put this into context, TLS hasn’t issued new equity, hasn’t had an earnings downgrade and didn’t have a dam collapse. The earnings and dividend forecasts for FY16 are marginally lower from March this year, yet the share price is down from a high of $6.67 to $5.23 currently.
The share price has fallen -21.5% in six months, yet FY16 consensus EPS has fallen from 37c to 35.8c (-3.2%) and consensus DPS forecast from 32.2c to 31.7c (-1.5%).
So in the 21.5% pullback we have seen FY16 P/E come down from 18.5x to 14.6x and the FY16 dividend yield rise from 4.78% to 6.07%. You’re basically just paying –21.5% less for all but the same EPS and DPS estimates.
I think buying Telstra on 14.6x FY16 earnings, with a dividend due in February, and a 6.07% fully franked yield is a good risk adjusted total return idea.
TLS is trading on an 8.67% grossed up annualised yield. To an Australian tax-payer, getting paid over 4x the cash rate to take the “risk” of buying the dominant telecommunications industry player seems a good risk/return equation to my way of thinking.
Even if TLS goes nowhere from here, you will receive an 8.67%pa pre-tax dividend income stream. I also think TLS shares could easily add a “p/e point” from here, which would equate to +36c in capital growth, or +6.88% from current levels. That, if it proved accurate, would equate to a total pre-tax return of +15.5% over the next 12 months.
I think new TLS CEO Andy Penn will do a good job. I know Andy personally and I am happy to back him as he attempts to position TLS for regional growth, while maintaining the dividend stream to investors.
At the end of the day, we are in a digital economy. The Australian economy quite simply can’t open for business each day without TLS’s mobile networks. TLS controls absolutely critical infrastructure, yet trades on a 10 P/E point discount to other “infrastructure” stocks, such as ports, railroads and toll roads. Note well there is a contested bid for AIO right now.
All I ever observe is people using their mobile phones and more and more mobile data. My own daughter now sends me text messages! I can’t see the risks to TLS EPS or DPS in the years ahead and feel this deep pullback in TLS shares is a chance to add a reliable fully franked dividend income stream that also offers the potential for capital growth.
In summary, I did cop a bit of heat for being cautious on Australia late last year and earlier this year. I’ll probably now cop heat for being more constructive on Australian equities around the 5000 index level. You simply have to be a measured contrarian to capture the maximum available performance. You actually do need to “buy in gloom”.
This week we have seen broker upgrades to ANZ and WBC, which helps the ASX200 index bottoming process. A lot of this is about sentiment and I believe sentiment is bottoming out.
I now believe Australia’s underperformance of the equity world is overdone and I am adding exposure where I am confident my investors will be rewarded with a double digit total return over the next 12 months. I’ve started with Telstra (TLS) and I am looking for others to put in the portfolio alongside our global exposures.
I am also adding exposure to new IPO’s that offer growth at a reasonable price. Broadly I do think it’s time to deploy some cash at the right prices in Australian equities.
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.