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Lonsec Australian Market Outlook November 2009 William Keenan Snr Equity Strategist

Lonsec Australian Market Outlook November 2009 William Keenan Snr Equity Strategist. Disclaimer. IMPORTANT NOTICE: The following relates to this presentation prepared by Lonsec Limited ABN 56 061 751

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Lonsec Australian Market Outlook November 2009 William Keenan Snr Equity Strategist

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  1. Lonsec Australian Market Outlook November 2009William KeenanSnr Equity Strategist

  2. Disclaimer IMPORTANT NOTICE: The following relates to this presentation prepared by Lonsec Limited ABN 56 061 751 102, AFSL No 246842 ("Lonsec") and should be read before making any investment decision about the product(s). Warning (General Advice Only): Today’s presentations will provide information about investment process, economic conditions and outlooks for investment markets. The views, opinions and recommendations included in the information today are all “General Advice”. That is, they do not take into account the question of their personal suitability for any particular attendee and where a specific financial product is referred to, attendees should not act on the advice without first consulting their financial planner or advisor about its appropriateness to their investment objectives, financial circumstances and needs. Past performance is not reliable indicator of future performance. Disclaimer: No representation, warranty or undertaking is given or made in relation to the accuracy or completeness of the information being presented, which is based solely on public information that has not been verified by Lonsec. The conclusions and recommendations contained in this presentation are reasonably held at the time of completion but are subject to change without notice. Except for any liability which cannot be excluded, Lonsec, its directors, employees and agents disclaim all liability (whether in negligence or otherwise) for any error or inaccuracy in, or omission from, the information contained in this presentation or any loss or damage suffered by the recipient or any other person directly or indirectly through relying upon the information. Disclosure:Lonsec’s directors, officers, representatives, and their associates, may hold the securities referred to in this presentation, which may change from time to time, but none receives or gains any other benefit as a consequence of the recommendation or advice presented in this presentation. Lonsec considers such holdings not to be sufficiently material to compromise the recommendations or advice, and the Analysts at the time of preparing this presentation are not aware of any holdings. Lonsec receives brokerage or other benefits (e.g. application fees) for dealing in financial products and its associated companies or introducers of business may directly share in the brokerage or benefits.

  3. Agenda • Australian economic outlook - Positives - Negatives • Australian share market outlook • Market conclusion • Lonsec Core Model Portfolio

  4. Australian economic outlook Positives • The Banking system is stable and credit is flowing • Financial markets are on the mend and volatility has eased • Monetary policy has been effective in lowering interest rates • The Gov’t is in a relatively strong financial position to provide fiscal stimulus • House prices have proven resilient • Net Exports have held up well • China (our main export partner) is still growing • Retail sales have been robust over 2009 • Employment has also been surprisingly resilient (unemployment rate 5.7%) • Consumer and Business sentiment has experienced a V shaped recovery • The rising AUD is deflationary in the short term

  5. Australian economic outlook Negatives • The GFC has induced a Global recession in the developed world • Global Private sector looking to deleverage • Global Public sector is re-leveraging as a result of fiscal stimulus • Global demand and trade has fallen sharply but now seems to be gradually recovering • Australian sharemarket down ~ 35% ($500bn in wealth lost) • Aust. Export income declining in the short term due to lower coal and iron ore prices • Aust. Private sector debt levels high (170% of GDP) with A$678bn borrowed offshore • Underlying inflation is proving resilient at 3.5% • Interest rates are on the rise • A rising AUD will hurt our export competiveness in the medium to long term

  6. Australian sharemarket outlook • The Australian market is up 40% since 2001 whereas the US market is still under water • Resource and Energy stocks have outperformed because of demand from Asia and weak USD

  7. Australian sharemarket outlook • The 07/08 bear market was similar to 1973 in severity but note that after each fall, the market has recovered all losses within 3-6 years • Daily share market volatility peaked in 2008 but is settling down in 2009 to <1.0% again

  8. Australian sharemarket outlook • The recent market rally has increased the trailing PER to > 20x which looks expensive • However, the market expects earnings to recover by at least 20% over the next year

  9. Australian sharemarket outlook • The market dividend yield is around 4.2% - closer to 4.8% if excluding low yielding resource stocks • Secondary market capital raisings increased markedly to $90bn or about 9% of total market cap over FY09 • This is significantly larger than the 1995-2008 average of 3.8% of market cap • Investors will need to keep an eye on EPS growth rather than NPAT growth

  10. Australian sharemarket outlook • The cash rate has been slashed but is on the way back to more “neutral” levels • Bond yields are also on the rise • Rising bond yields increase the cost of debt and in turn equity capital • Investors need to keep an eye on this trend

  11. Conclusion • The Global economy seems to be stabilising and gradually recovering • The Australian economy has proven remarkably resilient over FY09 • Consumer and Business sentiment has recovered • Financial markets have improved • The Australian market has rallied 45% from its March 09 lows but is still down 35% from its 2007 peak • There are encouraging signs that the worst has past • Nonetheless, significant challenges lie ahead for the developed world with growth likely to remain subdued for some time due to the deleveraging process that has now begun, post credit crisis • Asia looks to have much cleaner prospects for growth • Lonsec expects the Australian market to move towards 5,000 over FY10, as investors rediscover their appetite for risk • Lonsec recently increased its Australian Equity weighting to overweight

  12. Lonsec Direct Equity Model Portfolios

  13. The Lonsec approach to direct investing • Construct and manage virtual model portfolios • Focus on absolute returns over the medium to long term • High conviction, low turn-over, active portfolios • Four-step investment process • Strong focus on “top-down” macro-economic and industry themes • Risk mitigation at the portfolio and individual stock level

  14. Lonsec investment process Return Income v Capital Step 1 Investment Objectives Client Risk Profile Timeframe Risk Controls – Min. no. of IndustriesMin. no. of StocksStock universe restriction Stock weighting limits Portfolio turnover rules Macro-economic view Sector view - Growth, Cyclical, Defensive, Value Step 2 Portfolio Construction ICVR x 4 Stock Filters Industry Ratings Company Quality Company Valuation Company Risk Rating • Step 3 • Stock • Selection Daily monitoring Monthly performance measurement Attention to Corporate Actions Quarterly Investment Committee Review Implement any changes Regular Reporting Step 4 Portfolio Management

  15. Lonsec stock selection filters • Each of our stocks is selected after a rigorous qualitative and quantitative analysis involving four stock filters – Industry, Company Quality, Valuation and Risk • A Lonsec model portfolio stock will rank highly in each category (ICVR) based on our analysis and experienced judgement. • Not necessarily looking to find the best stocks in the best industries but the best value stocks in the best industries. • The Valuation and Risk filters are there to minimise our downside. • Examples: HSP and PRY instead of SHL and RHC, CBA and WBC instead of ANZ and MQG, ORG instead of AGL (major decision at the time), BHP instead of RIO

  16. A closer look at Step 3 – ICVR stock filters COMPANY QUALITY Industry positioning Barriers to entry Recurring- revenue Growth rates Margins Return on Equity CCompanyQuality Free Cash Flow Dividend history Management- experience and track record Management- incentives and stake in equity Corporate Strategy Corporate- Governance Balance sheet- strength VALUATION Enterprise Value / EBITDA Market Cap. / Free Cash Flow VCompanyValuation Stock Price / Cash EPS Stock Price / Dividend PS Market Cap. / Book Value RISK RATING Key macro-economic & weather- sensitivities Key customers and suppliers Government influence Level of recurring- revenue Barriers to entry RCompanyRisk Rating Balance sheet- strength Free Cash Flow Corporate Strategy Corporate -Governance Market –Capitalisation Share liquidity Major shareholders INDUSTRY Products Supply & Demand Key Macro-economic variables Growth Rate Structure Barriers to entry Return on Capital Government intervention Sustainability I Industry Rating

  17. Core Model Portfolio Objective To deliver strong absolute returns, over the medium to long term, through a diversified “blue-chip” portfolio invested across a number of industries. Portfolio Rules Investment universe ASX TOP 150 Benchmark ASX TOP 100 Accumulation Index Min. no. of stocks 10 Min. no. of industries 8 Individual stock limit 12.5% Cash weighting 0% LPT weighting 0% (refer Property Asset Allocation) Targeted portfolio turnover 20-30% pa

  18. Core Model Portfolio Portfolio Profile Current no. of stocks 12 Cash weighting 0% Top 3 sector exposures Financials 31.25% Energy 18.75% Mining 12.5% Top 50 exposure 87.5% Ex Top 50 12.5% Current forecast cash yield 3.9% (5.4% gross) Inception date 17/04/2000

  19. Core Model Portfolio Performance

  20. Case Study – recent change to Core portfolio • While TLS looks attractive from a bottom up view (PER 10x, Div yield 8.8% ff) the top-down outlook is very uncertain • Govt plans for a National Broadband Network and the structural separation of TLS creates great uncertainty over TLS’ future earnings and capital structure • TLS does not pass the Industry and Risk filters • Private healthcare industry has strong fundamentals (ageing and rising population, rising participation rates, 4 major players) • PRY well positioned in Medical Centres and Pathology • PRY valuation is attractive (PER 13.4x, Div yield 5.7% ff) • Risk has been significantly reduced after recent capital raising

  21. Lonsec Direct Model Portfolios Summary • Investment Philosophy - Active, focused on absolute returns, top-down process, high conviction portfolios • Investment Process – Four-step, top-down process with four stock filters (ICVR); risk mitigated at the portfolio and stock selection level • Two model portfolios – Core and Income • Seeking strong absolute performance over the long-term

  22. Lonsec Australian Market Outlook November 2009William KeenanSnr Equity Strategist

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