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Dividend Stocks Technical Picks

Rio Tinto Ltd- Shares Remain Overvalued

Aluminium should constitute a substantially larger share, given the USD 40 billion that Rio Tinto controversially paid for Alcan in 2007, but Rio overpaid. Rio Tinto and BHP have the lowest operating costs of the iron ore players, but despite this being the bulk of company earnings; adjusted excess returns were destroyed by procyclical overinvestment during the China boom.

Key Investment Consideration

  • Rio Tinto is only mildly diversified. Iron ore generates most of the company’s value, and aluminium and copper nearly all of the rest. It’s highly leveraged to China’s steel demand.
  • Rio Tinto’s procyclical capital investment was poorly timed. The invested capital base grew from USD 16 billion in 2005 to USD 105 billion in 2015, after adding back write-offs. Subsequent cost deflation, and lower commodity prices, exposed the folly.
  • Rio overpaid for Alcan and the large acquisition was the first in a number of serious missteps. However, current management is rebuild Rio’s reputation and is favouring cash returns to shareholders.
  • As a commodity producer, Rio Tinto is a price-taker. The lack of pricing power is aggravated by the cyclical nature of commodity prices. Rio Tinto lacks a moat, given that the bloated invested capital base doesn’t permit returns in excess of the cost of capital. The firm’s assets are large, however, and despite being overcapitalised, generally have low operating costs.
  • Rio Tinto is one of the direct beneficiaries of China’s increasing appetite for natural resources. ORio’s cash flow base is somewhat diversified, and is less susceptible to the vagaries of the market than single-commodity producers.
  • The company’s operations are well run and are generally large-scale, low-operating-cost assets. OCapital allocation is likely to be significantly improved following the China boom. Competition for inputs will reduce substantially, while the reduction in cash flow available for investment will mean only the best projects are approved.
  • Mining is seen as a sin activity, and governments may use it as a source of tax revenue to plug shaky budgets.
  • The global economy is cooling. Demand for natural resources in China has peaked, and commodity markets are starting a painful structural decline.
  • Rio Tinto is being viewed as a high-yielding income stock, but resource companies are notoriously unreliable dividend-payers, with cyclical commodity prices often bringing attractive yields undone. ORio Tinto’s investment track record through the boom was woeful. The company paid too much for acquisitions and expanded when it was expensive, permanently diluting returns.

 (Source: Morningstar)

Disclaimer

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Global stocks

Healthy demand for value stock funds, tepid demand for bonds as the reflation trade kicks in

× Index funds continue to increase their market share at the expense of actively managed funds because of higher inflows (size adjusted).

× Global large-cap blend, US large-cap value, ecology, and financial equity funds saw the highest inflows on a Morningstar Category level in March.

× Corporate bond and US growth equity funds were highly unloved, as were multistrategy products.

× BlackRock topped the list of the asset-gatherers by branding name in the active spectrum; Xtrackers in the passive world.

× Allianz Income and Growth benefited the most among Europe’s largest open-end funds from the demand for risky assets. Conversely, the largest trackers of the S&P 500, IShares Core S&P 500 and Vanguard S&P 500 ETF, continued to bleed.

Long-term fund investors in Europe increasingly fell into line with the dominant global market trend in March as the reflation trade kicked in. This was reflected by a virtual standstill in the net sale data for bond funds, which only took in net EUR 1.2 billion, thus making last March the weakest month in 12 months. This reflects the heavy losses multiple bond segments have suffered over the past months as yields for government bonds rose sharply in the first quarter. The rising optimism of investors for the prospects of a post-coronavirus economy is also reflected in the high inflows of 47.3 EUR billion sent to equity funds. Cyclical sectors and value categories benefited the most from this trend. Conversely, precious-metals funds suffered a rout in March, shedding EUR 1.9 billion, another indication that gold has lost its allure in the current market environment. These outflows were only partly offset by inflows to broad basket and industrial commodity funds, and thus net sales for commodity funds were pushed into negative terrain in March.

Allocation funds enjoyed the highest one-month inflows since February 2018, while alternative funds returned to the red zone, suffering outflows of EUR 400 million after a two-month positive-flow intermezzo. In all, long-term funds garnered healthy inflows of EUR 60.2 billion. Money market funds saw modest outflows of EUR 430 million. Assets in long-term funds domiciled in Europe rose to EUR 10,952 billion from EUR 10,608 billion as of Feb. 28, 2021. This marked a new historic record for Europe’s fund industry.

Active Versus Passive

Long-term index funds posted inflows of EUR 16.9 billion in March versus EUR 43.3 billion that targeted actively managed funds. (The table below only includes data for the main broad category groups.) On the active side, equity funds enjoyed the highest demand, pulling in EUR 29.5 billion, while demand for actively managed fixed-income funds trickled down to EUR 493 million. Equity index funds enjoyed inflows of EUR 17.8 billion, and bond index funds drew in close to EUR 800 million. The market of long-term index funds rose to 20.9% as of March 2021 from 19.5% as of March 31, 2020. When including money market funds, which are the domain of active managers, the market share of index funds stood at 18.5%, up from 16.9% as of March 31, 2020.

Fund Categories: The Leaders

A look at the top-selling long-term fund categories reveals the continued strong demand for global equities. Global large-cap blend equity funds enjoyed an outstanding EUR 11.9 billion of net inflows last month, marking its 10th consecutive month of positive inflows. Passive and active funds shared the spoils, even though the two top sellers within the category were two index funds: HSBC Developed World Sustainable Equity Index Fund and BlackRock ACS World ESG Equity Tracker Fund, with almost EUR 2.0 billion and EUR 1.7 billion, respectively (both are distributed in the United Kingdom only).

US large-cap value equity funds took in EUR 4.8 billion in March, making its best month with regard to flows on record. This arguably indicates that value investors, after a decade in the wilderness, anticipate the so-called “great rotation”: a major turn in the investment cycle from growth to value stocks. The iShares Edge MSCI USA Value Factor UCITS ETF was the most sought-after product of the category, with EUR 1.5 billion attracted.

The equity sector ecology category continued to benefit from the huge demand for environmental, social, and governance and climate-focused funds, garnering inflows of EUR 4.0 billion. ACS Climate Transition World Equity Fund was the fund with the highest demand, with net inflows of EUR 524 million each.

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Property

Tabcorp Holdings– Equity Raise Shores Up

Management is admirably transitioning the company into the digital world, with significant investments in online infrastructure and product, while leveraging its incumbent status and physical reach. Further, the addition of Tatts’ near-monopoly lotteries business should help smooth the earnings volatility, and facilitate stronger cash flow generation. This should provide the company with additional financial firepower to reinvest and strengthen its digital wagering offer.

Key Investment Considerations

  • Market infatuation with defensive earnings and yield has propelled Tabcorp’s trading multiple to lofty levels, leaving little margin of safety for investors.
  • While there is a degree of resilience to the company’s earnings, their long-term sustainability is clouded by structural factors because of digital disintermediation and proliferating competition.
  • The critical investment issue remains Tabcorp’s ability to maximise returns from its dominant (and licence-backed) physical distribution channels while managing customers’ migration online.
  • Tabcorp operates three segments. The ostensible spread belies the fact that the wagering (providing betting services) and media (providing racing pictures to complement betting services) division generates more than a third of the group’s earnings.
  • Long-life wagering, lotteries and Keno licences furnish Tabcorp with a stable earnings and cash flow profile, underpinning a relatively high dividend payout ratio.
  • Tabcorp’s retail exclusivity and extensive brick-andmortar distribution presence place the company in a strong position to migrate its wagering customer base to a multichannel environment.
  • While Tabcorp Gaming Solutions is relatively small, it boasts solid growth potential, not just in the core Victorian market, but especially in the New South Wales electronic gaming machine servicing space.
  • The company’s multichannel strategy may fail to stem the spillage of its traditional customers to more nimble and innovative online betting operators, diminishing the value of Tabcorp’s vast physical retail network. OA protracted impact of the COVID-19 pandemic could weigh significantly on Tabcorp’s earnings.
  • Pressure on Tabcorp from structural headwinds could have a downstream impact on the racing bodies (lower product fees), lead to lower-quality races (because of less prize money), and devolve into a negative economic loop for the whole wagering industry.

 (Source: Morningstar)

Disclaimer

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Dividend Stocks

Lumen Technologies The Best Dividend Payer

“We think the market has overly punished Lumen’s stock and is overlooking the substantial free cash flow generation and margin expansion opportunities.

Lumen Technologies owns an extensive communications network of over 450,000 route miles of terrestrial and subsea fiber in over 60 countries and 900,000 route miles of copper. Three fourths of Lumen’s revenue is from business customers; the remaining fourth is from the consumer business. Both businesses have posted declining sales in recent years, and we expect that trend to continue.

Prices in the enterprise market are deflationary, as technological advances make data transport cheaper and allow software-defined solutions that cannibalize higher-revenue services. Lumen’s copper-based consumer business offers lower quality than cable alternatives, and it has been bleeding customers. We expect both trends to moderate but not cease, as the firm is upgrading its consumers to better speeds and legacy enterprise technologies will gradually make up a lower portion of sales.

“For income investors, the biggest knock on Lumen is the 54% dividend cut the company made in 2019, though Morningstar analysts believe the current dividend is secure: “We project free cash flow to remain fairly steady throughout our five-year forecast and cover the dividend by more than 2.5 times, on average…given the coverage we forecast, we don’t expect another cut in the near term.”

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Property

Simon Property Group Highest yield

Backs of men in uniform looking at new building

In their Best Ideas report, the analysts wrote: “Simon Property Group trades at a steep discount to our fair value estimate. We think the shares have traded down on short-term issues that are already accounted for in our estimates. Investors are worried that the corona-virus will have a dramatic impact on brick-and-mortar retail, which would negatively affect the rents for mall REITs.

Many retailers are likely to declare bankruptcy due to the lack of sales, which will reduce occupancy across Simon’s portfolio.

“However, we believe that Simon’s Class A mall portfolio will recover and show solid growth over the next decade. We recognize that e-commerce will continue to apply significant pressure to brick-and-mortar retail, particularly after the majority of America was forced to do nearly all shopping online for several months. Still, we believe that there will be a continued bifurcation of physical retail performance, with the highest-quality assets continuing to produce strong sales growth and the lower-quality assets experiencing declines in foot traffic and sales.”

The remaining three stocks not in the portfolios are all constituents of the Income Bellwethers watchlist.

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Shares Technology Stocks

Technology One Ltd – Critics With Cash Flow Jump

Digital tablet display the stock market data

Since the firm turned profitable in 1992, earnings growth has been impressive, as is the track record of client retention. All this testifies to the quality of the company’s products, the benefits of its consistent research and development spending, and the strength of its staff and management. Critically, the nature of enterprise software and its intricate embedding into clients’ technology infrastructure are such that switching costs are very high, something that Technology One has further enhanced through its end-to-end solutions offering and track record of quality delivery.

Key Investment Considerations

  • Technology One offers enterprise software solutions that are deeply embedded in clients’ information technology, or IT, infrastructure, resulting in high switching costs for users.
  • The company generates revenue from software development and implementation, along with subsequent upgrades and ongoing support, providing revenue resilience and an impressive client retention rate. OAlthough the company operates in a highly competitive industry, its earnings growth track record since turning profitable in 1992 has been exemplary and testifies to the quality of the company’s products and staff.
  • Technology One is a provider of Enterprise Resource Planning, or ERP, software in Australia and the United Kingdom. The company has an excellent track record of consistent revenue, NPAT, EPS, and franked dividend growth over the past 30 years, and the asset light nature of the company has supported strong cash generation and a consistently strong balance sheet.
  • Technology One’s business model captures value in the entire software development and implementation chain. It develops and markets the software, implements the solution for clients, and offers ongoing subsequent support.
  • The company’s software products are embedded in customers’ business operations, locking in existing clients and underpinning recurring revenue streams in post-sales support and licence fees.
  • Cross-selling opportunities remain, as products taken up per customer are low at three, compared with 12 available in Technology One’s enterprise product suite.
  • Skills shortages in the information technology sector mean the loss of key personnel can be costly, and bidding for talent may drive up labour expense.
  • Development delays with new products and failure to keep pace with technological changes could significantly affect Technology One’s ability to compete in the fast-moving enterprise software industry.
  • Failure of the international expansion strategy in the United Kingdom could dent the company’s longer-term growth profile.

 (Source: Morningstar)

Disclaimer

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Shares Small Cap

Kellogg Company Benefited From Pandemic-Related Gains

Stock market information

Kellogg’s dividend growth has been modest over the past five years, at an annualized rate of 2.9%. However, Morningstar analysts anticipate a higher rate going forward: “We forecast Kellogg will raise the shareholder dividend in the mid-single-digit range annually on average during the next 10 years.”

In their Best Ideas report, the analysts made the following case for the stock, which trades at an 18% discount to fair value: “Kellogg has benefited from pandemic-related gains in the retail channel (which drives 90% of its sales) as consumers continue to spend more time at home. Even before the pandemic, we thought Kellogg was taking steps to profitably reignite its top-line trajectory: abandoning direct-store distribution in favor of warehouse delivery, divest-ing noncore fare and stock-keeping units, and upping investments in its manufacturing capabilities and brands.

Although we expect more muted gains over a longer horizon, we think the company is using the current backdrop to sharpen its edge.

“We believe actions to expand its category exposure beyond cereal (with 50% of sales now from on-trend snacks versus 20% from North American cereal) will prop up its sales growth potential longer term. Further, we like the changes to its pack formats to include more on-the-go offerings, which should allow for increased penetration in alternative outlets. We also think recent acquisitions (including smaller, niche startups like RXBAR) afford the opportunity to grease the wheels of Kellogg’s innovation cycle to more nimbly respond to ever-changing consumer trends as they relate to health and wellness and taste.”

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Commodities Trading Ideas & Charts

NiSource Accelerated Investment Should Lead to Growth

From the Best Ideas report:

“Natural gas utility share prices have lagged the Morningstar US Utilities Index as the economy recovers from COVID-19, due in part to environmental con-cerns about the long-term use of natural gas. However, we believe the electrification of building space and water heating has significant technical and economic obstacles and the market’s misperception of the future of nature gas results in an attractive price for NiSource shares.

“The fully regulated company derives about 60% of its operating income from its six natural gas distribution utilities and the remaining 40% from its electric utility business in Indiana. NiSource has accelerated the pace of gas pipeline restoration investment following a tragic natural gas explosion in 2018, and this will reduce risk and cut methane emissions. Its electric utility will close its last coal-fired power plant in 2028 and replace the capacity with wind, solar, and energy storage.

As a result of favorable regulation and renewable energy investments, we expect NiSource to step up its capital expenditures to almost $12 billion over the next five years, almost 40% higher than the pre-vious five years. The accelerated investment should result in better than 7% EPS growth, strong dividend growth, an improved ESG profile, and reduced risk for investors.”

NiSource Inc. is one of the largest fully regulated utility companies in the United States, serving approximately 3.5 million natural gas customers and 500,000 electric customers across seven states through its local Columbia Gas and NIPSCO brands

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Dividend Stocks Shares

Telstra Corp – Show Off Infrastructure Strength

The strategic intent is taking shape: segregate the AUD 200 million EBITDA-generating InfraCo Towers for potential monetisation (akin to Optus’ current moves to do the same), maintain the optionality of keeping the AUD 1.5 billion EBITDA-generating InfraCo Fixed stand-alone (as NBN mulls its future ownership), and continue refocusing the AUD 5.7 billion EBITDA-generating ServeCo on its transformation to become a more simple, efficient, and digital-centric competitor.

Rather than having investors obsess over the ebbs and flows of Telstra’s near-term earnings still suffering from the margin-crunching impact of NBN and competition, the restructure is likely to shift investor focus to the group’s underlying asset values. We expect a flurry of favourable sum-of-parts asset valuations to hit the market over the coming months, underpinned by the current low-interest rate environment and possibly “inspired” by the lucrative investment banking and advisory fees on offer.

The cloud surrounding Telstra’s near-term earnings is also clearing. Management not only reiterated fiscal 2021 earnings guidance (second-half-weighted and driven by cost-cuts, COVID-19 recovery, mobile earnings growth), but also provided encouraging signs for beyond. Return to underlying EBITDA growth in fiscal 2022 (excluding one-off NBN receipts) and an upgrade to fiscal 2023 return on invested capital, or ROIC, to 8% (from 7%) are all broadly in line with our unchanged estimates. But they are still comforting, especially after the shock of the August update when management (too conservatively) trimmed fiscal 2023 ROIC target to 7%-plus (from 10% previously).

As an illustration of the type of sum-of-parts valuation that investors may see in the coming months, traditional infrastructure entities typically trade at low-to-mid-teen EBITDA multiples. We see no reason why Telstra’s InfraCo Towers and InfraCo Fixed won’t attract similar multiples, given their recurring, predictable and indexed earnings growth (at margins of well over 60%) and likely long-term contracts with Telstra and NBN as anchor tenants. Applying, say, a 12 times multiple to both InfraCo Towers’ fiscal 2020 pro forma AUD 200 million EBITDA and InfraCo Fixed’s AUD 1.5 billion EBITDA, and 8 times to the still-rationalising ServeCo’s AUD 5.7 billion EBITDA produces total enterprise value of AUD 66.0 billion. Subtract AUD 16.8 billion in net debt and one can come up with an asset-based valuation of around AUD 4.10 per share for Telstra. And we are likely to witness much more creative ways to boost this value from the investment community in the future. Our unchanged AUD 3.80 fair value estimate for Telstra will remain based on a discounted cash flow methodology.

 (Source: Morningstar)

Disclaimer

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Property

Transurban Group – Recovery Is a Little More U-Shaped Than Previously Expected

Portrait of Vietnamese young stock broker talking on the phone with coworker

The weighted average concession life of the portfolio is around 30 years. Under the leadership of Scott Charlton, Transurban has aggressively expanded its portfolio through a combination of acquisitions and greenfield projects. Toll roads have high barriers to entry and benefit from rising traffic volumes and tolls, which increase in line with the consumer price index or higher. Traffic volumes are recovering strongly from COVID-19 lockdowns. Nonetheless, distributions fell 20% in fiscal 2020 and are not expected to fully recover until fiscal 2023.

Key Considerations

  • Cash flow is typically defensive and increases strongly, as solid revenue growth is leveraged over a fixed cost base. Profitability benefited from falling debt costs because of low global bond rates, but we think rates are likely to trend higher. Coronavirus remains a headwind.
  • The core Australian roads generate strong returns on initial investments. Upgrades, such as widening these assets, should also generate good risk-adjusted returns.
  • Finite life concessions require the firm to add new roads to extend its existence, introducing high forecasting risk for developments and leading to the need for ongoing equity issues.
  • Core Australian roads generate defensive revenue that grows with traffic volumes and toll price increases, which are at a minimum pegged to inflation.
  • Solid revenue growth and a high fixed-cost base translate to strong cash flow and distribution growth.
  • Transurban owns high-quality infrastructure assets with limited regulatory risk.
  • There are attractive organic growth opportunities, such as potential widening of roads.
  • Building and acquiring new roads can destroy equity value as a result of overbidding and overly optimistic traffic forecasts.
  • Transurban faces risk from the coronavirus outbreak, given high financial leverage coupled with a major hit to revenues as countries go into lockdown to prevent the spread of the disease.
  • Bond yields are likely to trend higher, detracting from profitability and the attractiveness of its distribution yield.
  • Transurban is expanding aggressively late in the cycle, increasing risk.

 (Source: Morningstar)

Disclaimer

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.