I didn’t think I’d actually see the day a Federal Liberal Government introduced an extra tax on the banks, but here we are. At the top of the commodity cycle, Canberra introduced a mining tax, and at the top of the housing cycle Canberra introduced a new bank tax, which really is a banks super profit tax. It also appears there was absolutely no consultation with the major banks.
And just look how offshore investors reacted to unexpected regulatory change: exactly as they did with the mining tax. They dumped the sector.
On Tuesday, the big four Australian banks lost a combined market cap of $14.1b. This was solely driven by a leaked news story that the new bank levy would generate $6b of revenue over four years.
Scott Morrison needs to understand that with this single pen stroke he has driven bank profits down (-5% according to analysts), bank dividends down, and share prices down. He has INCREASED the cost of bank capital and will INCREASE the cost of mortgages, as banks will end up passing on this new tax. This decision will lead to LOWER Australian GDP growth and a LOWER ASX200 than would otherwise have occurred. The ripple effects will be widespread.
He has hit all your retirement savings by single-handedly causing serious falls in Australian bank share prices with a basic piece of short-sighted populist politics. Politicians simply DON’T understand the cause and effect of their actions in financial markets. It’s that simple. At least the USA has a bunch of ex Goldman Sachs alumni running the Treasury.
Morrison needs to understand very quickly that Australia is in a global competition for investor capital. We are only 2% of the world and it’s very easy for a global fund manager to go zero weight Australia. He just gave them that excuse with the bank levy. He also gave the world’s hedge fund community the green light to short Australian banks and wholesale investors the green light to charge Australian banks more for their offshore funding. And that’s exactly what they have done.
The clear problem is not bank profits. They are a good thing. The clear problem is Australia and Australians living beyond their means. The government and households are simply spending more than they are earning, and financing the difference from an ever-increasing pile of government and mortgage debt.
The Australian government is now “reclassifying” debt between good and bad debt. That only happens when you have TOO MUCH DEBT.
The Australian government raised the “debt ceiling”. That only happens when you have TOO MUCH DEBT.
Similarly, a record number of Australians are paying interest only loans. This generally happens when you have TOO MUCH DEBT.
We are all borrowing from the future and that means growth will be lower for longer than anyone believes and the Federal Budget will remain in deficit for decades. Is it then any surprise that Australian retail sales have been NEGATIVE for three straight months? People aren’t spending because they have so much mortgage debt, rising living costs and flat wages. You can see hedge funds are already shorting Australian retailers because they can see what is happening. This isn’t all about Amazon arriving in Australia.
I basically think we reached the point of maximum gearing in Australia, at the government and household level. If I am right, you will start seeing a savings culture emerge, which appears to be starting in the household sector. Australians will service their mortgage debt pile and have not much else to discretionarily spend. This probably means you should buy the dip in Australian banks, but be very careful in discretionary retailers, supermarkets, property developers, retail landlords and anything consumer facing.
This will mean it will become harder and harder to find earnings growth from domestic exposed Australian companies. In fact, if the Australian dollar continues to fall, the best earnings growth in the ASX will come from industrial companies with a very high percentage of offshore earnings.
I should thank Scott Morrison for driving my fund’s performance in stocks like Treasury Wine Estates (TWE), Aristocrat (ALL), IPH, Henderson Group (HGG), EML Payments and CYBG (CYB) to name a few. I should also thank him for making investors aware of the risk of owning too much Australian exposure in a period where Australia simply has too much government and household debt, as it drives the outperformance of Australian-based Global funds.
But as an Australian and a capitalist, I genuinely hate decisions that do damage to Australia’s international reputation. Australia and Australians are genuinely WORSE OFF from what is the most short-sighted revenue grab since the mining tax at the top of the mining cycle. It’s simply poor populist policy.
However, it is what it is and we, as investors, need to deal with consequences. They are material consequences as you’ve seen this week in bank share prices, retailer share prices etc.
What I think this ensures is a period of underperformance from Australian banks and the ASX200. The bank tax has also come during the seasonally weak period for commodity prices and commodity equities. In previous weeks, there had been rotation from resources to banks, but that all ended with the bank tax and now both sectors are underperforming.
I encourage investors to look for large cap offshore earners, which will continue to outperform as global GDP and global earnings growth accelerates.
One I like is Henderson (HGG), which is in the process of merging with another large fund manager in US based Janus (JNS).
This looks to me a stock that should be $5.00 in 12 months’ time, as investors warm to the mathematics of the merger. I think it’s a cheap stock versus its growth prospects and will be a great way for domestic investors to effectively buy exposure to the Eurozone and US equity markets.
HGG is cheap, has solid growth ahead, an excellent balance sheet, excellent management, rising ROE, consensus earnings upgrades and growing dividend yield. It has every attribute I seek in a medium-term investment.
UBS this week upgraded HGG to “buy” with a $5.00 price objective. Below I quote directly from the UBS report because I think it’s a very good summary of the HGG investment case.
Four reasons UBS like HGG
- Stock is too cheap
- 13x 1-year f P/E (pro-forma) and forecast to deliver 9% three-year EPS CAGR with upside via better cost/revenue synergies.
- That’s an 11% discount to US peers…7% discount to UK peers…and a whopping 23% discount to Australian peers.
- JNS has traded at an average P/E of 14.8x over the past three years…that’s despite its terrible FUM flow and fee performance.
- I don’t think anyone will disagree that HGG has been a better run biz + deserves a higher multiple than JNS…similarly I don’t think anyone will disagree that a combined JNS/HGG (JHG) has greater prospects than a standalone JNS…on that basis, it seems logical to assume that JHG should trade at >14.8x P/E over time with upside to the 16-21x P/E multiples afforded to the Australian fund managers.
- FUM flows should normalize (market is pricing in negative flows forever)
- JNS has had a particularly difficult time with FUM flows in recent years (-1.9% p.a. over past three years)…HGG has performed much better but struggled over the past few quarters due to a bout of softer performance + Brexit impacts.
- The merger will significantly enhance both HGG and JNS’ distribution capabilities…HGG has historically struggled in the US/Japan, while JNS has never had much traction in EMEA, LatAm or Australia…We also think the market is underestimating the Dai-Ichi relationship…Dai-Ichi was a significant help in growing JNS’ Japanese biz (HGG hardly has one) + have committed to taking their post-merger stake in JHG to 15% (from 9%)…that could also absorb a chunk of the UK passive selling.
- On top of that, while recent performance for HGG/JNS funds has been softer, three-year metrics remain solid…73% of HGG’s AUM has outperformed benchmarks over the past three years…while 83% of JNS’ complex-wide mutual fund AUM sits in the first or second quartile.
- HGG’s monthly retail flow momentum is already improving with £800m insto mandates already funded in 2Q + improved investment performance across both HGG and JNS.
- The market is pricing too pessimistic an outcome for group FUM flows…current share prices imply -0.5% FUM flows p.a. going forward…we think JHG should see flows lift to +1.5% p.a. by FY20.
- Performance fees should normalize
- Risk skewed to the upside, with HGG performance fees near historic lows…while JNS’ fulcrum performance fees are approaching negative limits (JNS earn negative performance fees during periods of underperformance though these are capped at -$61m p.a.vs. annualising at -$53m p.a. currently).
- FY16 saw HGG performance fees fall to 13.5bps (vs. historic avg 25bps).
- We assume a recovery in performance fees for both JNS and HGG…but still assume negative fees for JNS going forward.
- US$110m cost out targets are realistic…and potentially conservative
- Targeting US$110m cost synergies = 9.3% of combined cost base…that’s in-line with cost-out achieved from other large global asset management deals (we’ve looked at the 10 largest).
- Post-synergies, JHG cost:income will sit at ~64%…that’s still 310bps above similar sized peers = realistic + offers upside if they can do more.
Story in pictures
- HGG and JNS FUM flows have been impacted by softer performance + Brexit related sentiment issues + structural headwinds.
- But we see this improving, thanks to enhanced distribution capabilities post-merger + still strong three-year performance metrics.
- Performance fees are tracking at historic lows…we see this improving going forward.
- US$110m synergy target appears realistic in the context of other mega-mergers.
- Most importantly, the stock is cheap! Chance to buy a world-class fund manager at a significant discount to peers.
And finally after a big period of underperformance, HGG is breaking long-term downtrends technically. HHG has broken up through its 50,100 and 200 day moving averages.
HGG is a cheap stock with plenty of medium-term upside to be released. There will be index change liquidity later this month, as HHG leaves the UK and re-lists on the NYSE, but I think any short-term pullback driven by one-off index changes is a buying opportunity. It may well be your last buying opportunity at discounted prices.
All in all, I am hugely disappointed by the Federal Budget. I think it ensures the ASX200 underperforms the world due to the attack on our major banks, but on the other hand, I think it ensures the further outperformance of global earning stocks and global investment strategies.
I encourage you to consider an investment in HGG, which should continue to be re-rated in the months ahead.
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.