One thing I have learned in terms of contrarian value investing is that value alone is not enough to generate outperformance. You need value with a near-term catalyst for that value to be released.
BHP Billiton
In terms of BHP Billiton, I think the near-term value release has three concurrent potential drivers. I think the US natural gas price will bottom (happening), the company will wind back some of its more ambitious capital expenditure (capex) projects and they will rebase the dividend payout ratio higher at the full-year result.
Getting these type of contrarian value calls right basically means picking a sentiment bottom and the road to that sentiment improving. In the case of BHP, sentiment doesn’t have to turn positive; it simply has to get less negative.
Over the past 10 years, I don’t remember there being such a negative consensus sentiment towards BHP, which is one of the key reasons I have put the stock in my high-conviction buy list.
It’s worth remembering BHP generates over 50% of its EBIT (earnings before interest and tax) from iron ore. Export iron ore prices (at about $150 tonnes) continue to rise. If I am right and the natural gas price bottoms, alongside the other strategic developments required from BHP, then the market will go back to focusing on BHP’s earnings and cash flow strengths, not the capex spend and natural gas negatives. The market will go from glass three-quarters empty on BHP to glass half full. In share price terms, that will be up around 20% in my opinion. So that’s my thesis on BHP, with the stock still trading at eurozone-crisis lows due mainly to US natural gas prices.
National Australia Bank
So where else can we see large cap value with a near-term catalyst for value release? National Australia Bank (NAB).
The upside in NAB shares is substantial. The very simple fact is NAB trades at a discount to its peers due to its capital consumptive, yet return-on-equity constrictive, UK legacy businesses. On May 10, NAB are having a strategy update, and if you join the dots in media speculation about private equity interest in NAB’s UK branch network, I think it’s fair to come to the conclusion that NAB will announce a UK exit strategy. That would be very much welcomed by equity investors.
NAB is undeniably cheap. The earnings matrix below shows NAB trading on nine-times fiscal 2013 estimates with a 7.9% fully franked yield.
These numbers DON’T include the uplift from exiting the low return UK businesses or the £2.9 billion in capital that would return to NAB’s capital base. There is even a fraction of earnings growth, which you wouldn’t expect on those price-to-earnings ratios and yields.
I want to be long NAB into the May 10 analyst briefing (and beyond).
While there are many commentators telling investors to switch to fixed interest, I just fail to believe NAB offering a 7.9%FF yield is going to underperform (in after-tax terms) an unfranked Australian government 10-year bond offering 3.80%pa over any reasonable investment period. I can’t think of a time where NAB’s dividend yield premium (pre franking credits) was at such a large premium to an Australian government long bond. On that basis, you are being paid a monumental premium over the so called ‘risk free rate’ to buy NAB shares. That monumental equity risk premium is ahead of a clear path to value release and that is why NAB is the only bank in my high-conviction buy list.
BHP and NAB represent 16.12% of the ASX200 index. By becoming bullish on these bigger cap names, you can see why I am now bullish on Australian equities. For the market to outperform the region and Wall Street, which it is starting to do, you need the big index weights to see support. You also need the Aussie dollar to correct, which is slowly happening.
Go Australia, Charlie.
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