IG Markets - Australian Market Wrap August 18 2010

IG Markets - Australian Market Wrap

Across Asia, regional markets were mixed this Wednesday despite good overnight leads from the US. Stronger-than-expected industrial production numbers and results from Walmart and Home Depot helped the major indices post their biggest gains in two weeks. The Nikkei and Kospi are higher by 0.9% and 0.4% respectively while the Hang Seng is down 0.2%. The Shanghai Composite is flat.

Locally, the ASX 200 finished the day modestly lower, declining 0.1% to 4474.9 having oscillated in and out of positive territory for most of the session. After yesterday’s outperformance it wasn’t surprising we underperformed global leads, especially given the selling in BHP following its bid for Potash. The material, healthcare and consumer discretionary sectors did most of the damage while energy, financial and consumer staples names saw gains.

The recent outperformance, as well as the heavy selling seen in BHP held the local market back. Obviously there are some concerns as to how BHP will fund the deal, as well as implications for its balance sheet and ongoing financial flexibility. Having said that, the fact that BHP has been willing to make such a move is a big positive and investors should take comfort in the miner’s noted financial discipline.

There’s no way BHP would jeopardise its financial strength and flexibility if it didn’t see massive upside potential in the transaction. Many market pundits had been looking for the next catalysts – perhaps this move from BHP will be the trigger for a raft of M&A activity over the remainder of the year. The reason being many corporates are sitting on large hoards of cash earning very little return and may feel better returns can be generated through corporate activity.

Turning our attention to the market and most of the attention was on the materials sector today. The sector fell 1.8% as BHP Billiton (-4.4%) succumbed to heavy selling pressure.

In a comment from Deutsche Bank, it said BHP Billiton’s takeover of Potash appears accretive for an offer up to US$155/share from the current US$130/share, or US$38.6 billion bid. The broker said that while the bid for Potash detracts from BHP's build-over-buy strategy in Potash, the deal appears 4% - 7% earnings per share accretive for BHP, with gearing likely to increase to 55%, ruling out any capital management plans near term.

In a separate note from Macquarie Group, it said BHP's bid is the opening shot with the miner willing "and clearly able to pay more". Nonetheless, Macquarie believes that notwithstanding BHP's extremely strong balance sheet and robust forecast cash flow, this is a big bite in anyone's language. Macquarie continued, saying even with potential non-core asset sales out of the Potash structure, such an acquisition will likely limit BHP's ability to do sizeable opportunistic deals over the next 2-3 years. The broker also sees it as a directional move into soft commodities while leveraging two core BHP competencies - deep, bulk tonnage underground mining and marketing nous. Macquarie also sees diversification benefits stemming from developing country end market exposure that is slightly different from the more traditional industrial cycle exposure of metals and energy

Elsewhere, Bluescope Steel and Newcrest Mining fell 2.6% and 0.7% respectively while Rio Tinto and Fortescue did their best to limit the losses, both adding more than 2.6%.

The healthcare sector was another big detractor, losing 1.4% for the session as sector heavyweight CSL declined 2.7%. The company announced plans for a $900 million share buyback, which failed to offset investor concerns about a weak net profit outlook for FY11. The company announced it expects FY11 net profit of $980 million - $1.03 billion at FY10 exchange rates. That's down from $1.05 billion net profit in FY10. With the world no longer in phase 6 of an influenza pandemic alert and now in a post-pandemic period, pandemic influenza vaccine sales that gave a strong boost to CSL FY10 earnings will be absent in FY11. The firm also said that sales revenue was likely to be impacted by US and European healthcare reforms and austerity measures.

The consumer discretionary sector also came under pressure, losing 06%. Fairfax, Ten Network, Tabcorp and News Corporation were all down more than 0.7%. However, it wasn’t all bad news with David Jones having a good session, rising 2.8%.

It turns out the Mark McInnes scandal hasn't kept shoppers away from David Jones stores in recent months as some might have feared. The group reported 4Q10 total sales up 7.3% and like-for-like sales up 1.7%, an impressive result considering shoppers had stimulus money to spend in the prior year's 4Q, so it was hard to grow sales off that base. To compare, rival Myer reported 4Q total sales down 1.4% and like-for-like sales down 0.9%. The retailer reaffirmed its 2H10 after-tax profit, FY10 after-tax profit and FY11 after-tax profit guidance, with all pointing to growth. New CEO Paul Zahra gave optimistic commentary, saying sales in June and July were on an upward trend and that the first half of fiscal 2011 is looking more positive. The stock has rallied on the back of the result, currently up 2%, an impressive performance considering it has gained 16.5% since early July.

On the upside, the consumer staples, financial and energy sectors all added points, rising 1.2%, 0.8% and 0.8% respectively. Wesfarmers and Woolworths led the staples names higher, both up more than 1% ahead of tomorrow’s results from Wesfarmers.

Westfield Group topped the financials, advancing 2.2% while the big four banks were all up between 0.3% and 1.1%, with National Australia Bank the best.

Macarthur Coal and Santos led energy names higher, rising 2.9% and 26% respectively. Woodside Petroleum managed a gain of 0.6% after reporting its results this morning.

The two recent gas discoveries haven't given Woodside enough confidence to sign off on an expansion of its Pluto LNG project by the end of the year, with the company instead saying work will continue on the investment case into 2011. However, the disappointing news looks to have been offset by the energy giant posting a bumper underlying 1H profit of US$813 million, smashing the US$714 million average forecast. Woodside this week reported discoveries at Alaris-1 and Larsen Deep-1, but both weren't perfect, with the bigger find Alaris-1 over 500 kilometers off the WA coast and the less remote well, Larsen Deep-1, only striking a 50 meter gas column spread over separate intervals

The discoveries could still support the expansion but Woodside may need a few bigger discoveries closer to the coast to give it the confidence it needs. There's still 16 wells left to drill in the exploration campaign and third party gas supply talks continue. Following the result, Macquarie kept its neutral rating on Woodside and noted that the 1H result beat expectations and that the Pluto LNG expansion was delayed, as it had expected. The broker said this was undoubtedly a solid financial result. However, it saw little to really arouse either the bulls or the bears, especially given the growing excitement generated by the two discoveries in the run-up to today’s result.

Ben Potter
Market Strategist
IG Markets

ENDS

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