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Sustainable Upside: Not For Everyone


At the time when my name started appearing in the business section of newspapers in Belgium and The Netherlands (we are talking mid-nineties), there was one iconic story about investing in the share market that was repeated time and time again by just about everybody who had a little bit of affinity with the subject: there had been one smart secretary at Reed-Elsevier who'd used her monthly salary to buy a few shares in the company, every month, and she kept doing exactly that throughout her career at the publisher of scientific and legal periodicals (in print).

The short and the long of this story was that she retired a wealthy woman, multi-millionaire if the rumour mill was to be trusted, while the company had only paid her a moderate wage.

For many years in both countries this was the most told story about investing in the share market. It's easy to see why, but after two major meltdowns within the space of less than eight years last decade, I very much doubt whether anyone -and I mean: anyone- ever again refers back to that loyal secretary at Reed-Elsevier.

I don't think so.

I am pretty certain there are plenty of alternative stories to be told in Australia, about shareholders in Macmahon Holdings and in Macquarie Group who held on too long to their shares in the company they worked for, and that has ultimately cost them dearly.

A few months ago one financial planner told me about a heart-breaking experience when one elderly lady walked into his office with the request could he please calculate the exact value of her retirement funds which consisted mostly of a large ownership of shares in wealth manager and insurer AMP ((AMP)).

Just like the secretary at Reed-Elsevier, this lady had started accumulating AMP shares at an early stage, and her loyal self had taken up all invitations from the company to subscribe to additional shares. AMP is a good company, she ensured the financial planner.

The latter may well hold true outside the share market, where AMP enjoys a solid and premium reputation among Australian consumers, but in the context of the local share market a different reality rules. AMP has been quite the opposite of the Reed-Elsevier story throughout the eighties and nineties. In this particular instance, the financial planner had to break the unpleasant news that steadily accumulating AMP shares over a prolonged period had ultimately led to a 50% loss of all sums invested.

Yep. That's right. Fifty percent had gone lost without a trace. One can only imagine the shock on the old lady's face.

It raises the question whether successful, long term accumulation stories such as the one about the secretary at Reed-Elsevier belong to a different era. Sure, the eighties had the crash of 1987 and there were recessions in the early nineties, a banking crisis in the US, and two Gulf Wars, but there was no TMT/Nasdaq meltdown and there was no GFC.

Then again, not that I have heard any such stories, but it is well possible that employees at three of the four major banks in Australia have a Reed-Elsevier alike story to tell. As I have pointed out in the past, investments made in Australian banks tend to double just about every decade. Given the strong share price performance post 2009, and the market's focus on dividends which is likely to keep support ongoing, there's no reason to assume this time will be materially different for bank shareholders.

There's no doubting the eighties and nineties generated more success stories like Reed-Elsevier, while this time around such experiences are merely the exception. Australian banks are prime examples of the benefits of investing in a cosy, government protected oligopoly. Their significant market power has allowed the banks to turn themselves into All-Weather Performers when (most) international peers have no such track record or reputation at all.

And herein lies one of the key ingredients for picking solid long term investments: choose supportive industry dynamics.

Reed-Elsevier still is the absolute market leader in most of its publications. Customers such as lawyers and medical practitioners do not have a credible alternative at hand. Plus, and this is not to be underestimated, those were the years before the Internet started causing significant disruption to traditional media and other sectors.

I do also believe the Reed-Elsevier story is symbolic of a corporate era that is no longer with us. Companies are always facing battles and challenges. If it's not about outsmarting the government or the competition, it's about entering new markets, producing new products and finding that next leg of accelerated growth.

This time around, I think there are more disruptions than usual, affecting more sectors on the share market than investors might realise. And it's probably a fair comment to make that the Internet has never had as big an impact as it has today, while mobile is working its way into prominence fast.

Investors looking for the next solid, long term investment opportunity may want to take the following considerations on board:

Gaming sector:

It wasn't that long ago when market commentators referred to Australia's gaming and gambling sector as "effectively consumer staple stocks", as if the likes of Tabcorp ((TAH)), Tatts ((TTS)) and Echo Entertainment ((EGP)) had become peers of Woolworths ((WOW)) and Wesfarmers ((WES)). Not so, of course.

If this year's price action has proved anything, it is that not every stock in this category is equal, and a lot of it has to do with specific industry dynamics. Packer's Crown ((CWN)) effectively ruined the outlook for Echo Entertainment and this has resulted in significant underperformance for Echo shares this year. Crown is riding the ever-so-buoyant momentum on Macau and its own share price has been sitting on a rocket.

Pokie machines manufacturers Aristocrat Leisure ((ALL)) and Ainsworth Gaming ((AGI)) have the wind in the sails because of renewed momentum in the US market, but for household tote and wagering monopolies here in Australia, Tabcorp and Tatts, there could be trouble around the corner. International competitors are using the Internet to aggressively chase market share, and profits, over here and it is yet to be determined who's going to end up being a winner or loser.

Note that shareholders in Tatts have not participated in this year's rally, while expert opinions on Tabcorp are divided. This story is poised to generate a lot of newspaper copy in the years ahead, mark my words.

Gas Consumers on Australia's East Coast:

New South Wales is facing a shortage in natural gas at a time when demand is projected to spike while Queensland is likely to feel the brunt of several internationally oriented LNG projects ramping up, initially sucking gas from the domestic market. Experts have no doubt about what's going to happen in the coming years: domestic gas prices on the East Coast are going up, and they might well go up by a whole lot.

The major beneficiary should be Santos ((STO)) and shareholders in the company. Major losers on the consumers' side of this story are likely to include companies such as Incitec Pivot ((IPL)), Orica ((ORI)) and Adelaide Brighton ((ABC)).

Higher gas prices won't kick in immediately, due to longer term supply contracts, and they won't prevent these companies from growing, but higher costs will have an impact and one that is largely unknown and unquantifiable today.

Mining Services Providers:

It is easy to declare the worst is over for this once highly popular segment of the share market. Many companies in the sector are banking on a recovery in the second half of 2014. But what if spending drops dramatically in 2015? And again in 2016?

I remain of the view the underlying trend for spending on mining projects remains to the downside, just ask the likes of BHP Billiton ((BHP)) and Rio Tinto ((RIO)). In my view, it would be rather imprudent to assume things can only get better from here, simply because the share market (always a short term focus) is suggesting this might possibly be the case.

Traditional Media

Apparently we are about to witness the return of Channel Nine as a listed entity on the Australian share market. Nine Entertainment is believed to make its come-back from private equity ownership with a valuation of between $1.9bn-2.2bn. It will be the largest IPO this year in Australia, but is it worth owning the shares?

Granted, the impact from new technologies on newspapers and magazines is many times more fierce for print publishers such as APN News & Media ((APN)) and Fairfax Media ((FXJ)), but that doesn't automatically make TV operators immune. I'd argue quite the opposite and see ongoing challenging times ahead. Structural decline, as we are witnessing for TV, is a process that unfolds over many years and in Australia the transformation has arguably only just started.

Imagine what readily available, fast broadband can do to the sector?

Bricks and Mortar Retail

Consumer confidence is on the rise and bricks and mortar retailers have been among the best performers on the Australian share market. Gone are the days of widespread doom and gloom predictions and analysts and commentators are now talking "bottoms" and "upside" again.

Really? So that whole story about foreign competition and the increasing shift to online shopping was just a passing fad?

Please allow me to retain some healthy doubts. I remain a believer in a permanent lower growth pace for retail spending in Australia, even though a pick up next year seems feasible.

This doesn't mean that all retailers are the same as competition and Internet/mobile are not impacting on all market segments equally. Similar to the gaming and gambling sector (see above) investors will have to distinguish the No-Nos from the Go-Gos (even though there may not be a difference in short term share price movements).

The successful management team at Super Retail ((SUL)), now widely regarded as probably the best retailers in the country, has been justifying its own success with the observation that most of the group's operations are in segments where consumers have not held back in their spending: automobile accessories, sports, and leisure.

On this basis, there are some good arguments in favour of RCG Corp ((RCG)) and of Reece Australia ((REH)) instead of Westfield Retail ((WRT)), Harvey Norman ((HVN)) or David Jones ((DJS)). Others like Super Retail, The Reject Shop ((TRS)) and Breville Group ((BRG)) remain solid performers, but this is reflected in today's share prices.

Also, one would have to question the viability of Metcash ((MTS)), and the sustainability of its dividends, in an arena so dominated by bullies Coles/Bunnings and Woolworths/Masters?

The irony of today's share market ebullience is that IPOs are lining up to hit the market, looking for investors who seek diversification. Some of these about to list newbies are in sectors mentioned above: Nine Entertainment (traditional media), Dick Smith (electronics retail) and BIS Industries (mining services providers).

The promoters of these companies are partially relying on the recent successful floats of Virtus Health ((VRT)), OzForex ((OFX)) and SeaLink Travel Group ((SLK)) to sell their offerings. Apart from the fact all these companies are new listings, or about to become so, they don't genuinely seem to have much else in common.

(This story was originally written on Monday, 4 November 2013. It was published on that day in the form of an email to paying subscribers).

P.S. I haven't checked the details or calculations for the AMP story and am solely relying on the story told by this financial planner, but it should be clear to everyone that AMP has not been a good investment in the past decade and I believe what is currently working against the company is consumers focusing on costs of insurance in combination with a demographic shift as Babyboomers are retiring.

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena's - see disclaimer on the website)

By Rudi Filapek-Vandyck, Editor FNArena

Rudi Filapek-Vandyck is the editor of online news and analysis service FNArena, which offers investors proprietary consensus data and various unique tools and applications that can assist in researching the Australian share market. In addition, the service provides insights into the views and expectations of major stockbrokerages in the market.

FNArena Editor Rudi Filapek-Vandyck has been credited with accurately predicting the end of the bubble in crude oil prices as well as the largest correction ever in commodity prices in 2008. He offers his unique analyses and views on a regular basis to subscribers.

Click here for a free 14 day trial

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena's - see disclaimer on the website)


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