- A lower Aussie dollar is good for ASX-listed US dollar industrial earners, ASX-listed offshore fund managers, ASX-listed international equity LIC’s and ETFs, and ASX-listed inbound tourism beneficiaries.
- Some stocks to watch include Westfield Corporation (WFD), CSL (CSL), Resmed (RMD) and Brambles (BXB).
- Servcorp is a classic GARP stock when GARP is getting much harder to find.
The clear winner of last week’s blowout US payrolls number was the US dollar. The US Dollar Index (DXY) at 98.61 is now within sight of my long-held target of 100, a target that will need positive revision in the weeks ahead as more and more global capital flows back to the world’s reserve currency, most notably from the euro, yen and Aussie dollar.
US dollar power
I have been and remain a very firm US dollar bull. I believe this is the infancy of a major US Dollar move, which clearly has ramifications for anything denominated in US Dollars.
There should be now no doubt at all that the Federal Reserve will start raising cash rates, albeit slowly, mid-way through this year. The Fed will be the ONLY central bank raising rates globally this year and the ramifications for the US Dollar are large as we have argued in these notes for many years.
Here’s some trivia for you all. On which date did the Fed first take the Federal Funds Rate (FFR) to 0%? Answer: 16th of December 2008.
The S&P500 subsequently bottomed on March 9 2009 at 676, and despite the current pullback, is 204% from that point, reminding you of the old adage “don’t fight the Fed”.
We are into our seventh year of ZIRP (zero interest rate policy). It’s actually quite amazing. I don’t think many people believed US cash rates would be 0% 7 years later, but here we are and the Fed’s policies have clearly worked, with US GDP growth outpacing the world and US employment growth outpacing the world.
Similarly, who would have thought seven years ago that the US unemployment rate would be 1% below the Australian unemployment rate? At one stage in 2009 they were 5% apart in Australia’s favour!
I have been bearish on the Aussie dollar since 106 US cents. It’s been one of my key macro calls. A few weeks ago I lowered my Aussie/US dollar cross rate target further, from 75 US cents to 68 US cents. I want to reiterate today that I remain extremely comfortable with that 68 US cent Aussie dollar/US dollar target and feel it could be hit far quicker than anyone currently believes. The pure technical target would be 64 US cents, which could also be hit on a rout.
On that basis I am redoubling my strategic focus on ASX-listed US dollar industrial earners, ASX-listed offshore fund managers, ASX-listed international equity LIC’s and ETFs, and ASX-listed inbound tourism beneficiaries. I also continue to urge you to “lose the home bias” in terms of overall asset allocation.
Resource bear
One of the reasons I remain bearish on the Australian dollar is falling commodity prices. Unfortunately for commodity prices they are facing the perfect storm. Chinese GDP growth is slowing. The supply response has arrived in all commodities. Commodities are priced in US dollars. Major producers are showing NO signs of curtailing production.
To make it worse, the case for diversification into holding physical commodities has fallen apart and losses in commodity equities are stacking up. You can feel a complete and utter capitulation coming and that is why the ONLY comment I made on Australian resource stocks this year was warning you NOT to buy them for yield. You simply don’t buy ANY stock for yield when its earnings base is falling. That is just dangerous.
I don’t think we are at the bottom in commodity prices yet or the bottom in terms of sentiment towards resource stocks. We haven’t seen the baby thrown out with the bathwater yet.
I am watching all this closely, however, falling commodity prices and our collapsing terms of trade are key to my domestic interest rate view (2.00% or lower) and bearish Aussie dollar view. In terms of commodity equities I am basically letting the knife fall strategically and waiting for the capitulation moment when the momentum knife sticks in the deep contrarian value floor. I do not think that is yet because that event requires complete analyst capitulation at the consensus forecasting level and as you can see in the table below, the consensus view on major Australian resource stocks remains positive in terms of BUY/HOLD/SELL ratios and 12-month price targets.
The price targets above have been a “death buy a thousand cuts” as earnings get revised down monthly. To put this in context, the current BUY/HOLD/SELL ratio on Telstra is 5/12/4 and the median 12-month price target is $5.94. In an iron ore crash there is only one sell recommendation on Rio Tinto versus four sell recommendations on Telstra. Enough said.
Who knows, we might be three years into a 10-year bear market in commodities. From the resource companies, through to the analysts, everyone is throwing darts. Nobody has a clue what comes next. Nobody predicted that iron ore would have a “5” handle and oil a “4” handle, that is why I think setting an Aussie dollar/US dollar target of 68 Us cents is not even a big call. It’s just a matter of how quickly it gets there.
The winners
If I am proved right on my Aussie dollar/US dollar bearishness then these below stocks will be the winners. Winners keep on winning in that scenario. Currency cycles are long cycles.
US dollar leverage
- Westfield Corporation (WFD)
- Servcorp (Servcorp)
- CSL (CSL)
- Resmed (RMD)
- Brambles (BXB)
- Macquarie Group (MQG)
- Mesoblast (MSB)
- Treasury Wine Estates (TWE)
- Platinum Asset Management (PTM)
- Magellan Financial Group (MFG)
Inbound tourism
- Crown Resorts (CWN)
- Sydney Airport (SYD)
- Auckland Airport (AIA)
- Air New Zealand (AIR.NZ)
- Sealink Travel Group (SLK)
- For the highly risk tolerant Virgin Australia (VAH) is arguably worth a punt
Servcorp
In August 2014 I wrote a note on Servcorp titled “Boutiquefication Leverage” and set a $6.50 price target. Servcorp shares were around $5.00 then and we’ve collected the 11-cent final FY14 dividend and 11-cent interim FY15 dividend. It’s been a solid total return mid-cap industrial idea. It’s given us the leverage I hoped for.
Today I want to update that note to include analysis of the FY15 interim result.
Servcorp (Servcorp) delivered one of the best results of the reporting season. These earnings and dividend trends will continue in the years ahead. Just have a look at this slide: most industrial companies would be very pleased to print this set of numbers.
Servcorp is a leveraged play on the global structural trend to “boutiquefication”. Ok, that’s not a word, but it means the trend of professionals learning their trade in a big incumbent firm then branching out in early middle age to start a boutique business. The vast majority of the working world has worked out you can’t get rich in a big firm and you can’t control your destiny.
You need to “hang your own shingle out” if you want a private jet. This is a structural trend, aided by technology, that will continue. Servcorp is superbly placed to provide a variety of services to small and medium sized entrepreneurial businesses.
The trick to any start up business is to look stronger than you are. Servcorp, via offering small scale serviced offices on high floors in the world’s most premium office buildings, clearly facilitates that ability to look stronger than you are at competitive rents and without the long tail liability of extended leases/make-goods etc that come with direct office leasing. Servcorp clearly does offer “the world’s finest service offices”. The slide below summarised Servcorp’s global footprint.
In terms of earnings/dividend growth total floor space, occupancy rates and margins are all heading in the right direction ie up. With head office/management costs stringently watched, the leverage to revenue growth and cash flow conversion is very strong.
The office of the future
Growth is also starting to come from “virtual office”. To my way of thinking “virtual office” is a low cost growth option of Servcrp with the technology required simply piggybacked onto the existing office hardware/software backbone. Clearly the EBITDA margins in “virtual office” are highly attractive.
Back to the core business and Servcorp has more than doubled in size over the last 5 years, signing long-term floor leases when conditions post GFC were very favourable. Now, as the world economy starts recovering, they fill those floors and reap the revenue and margin harvest.
But the growth doesn’t stop here for Servcorp with intentions to open a further nine floors and expand three existing floors in FY15, which will add approximately 10% to group office capacity. In terms of earnings and valuation I think Servcorp is an undervalued structural global growth stock.
The yield is a nice bonus but to me, Servcorp is about GROWTH. With the usual caveats about “unforeseen circumstances”, Servcorp has guided to net profit before tax (NPBT) to “improve by NO less than 15% in FY15”. No less than 15% NPBT growth vs. the ASX200, which offers prospective EPS growth of 5% in FY15 at the aggregate level.
Servcorp ticks all my boxes. Organic global growth in a structurally supported sector, earnings growth, extremely strong balance sheet, strong management, dividend growth, tight register and clear valuation support. It’s a classic GARP stock when GARP is getting much harder to find.
It’s also a great example of an Australian company getting offshore expansion right. I continue to rate Servcorp a high conviction mid-cap buy and reiterate the 12-month price target of $6.50.
Go Australia, Charlie
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