Good afternoon,

A crappy old week on the markets, 8 negative sessions in a row saw us fall from 6350 to 6125, 3% over the last week. The cause of the pullback? Trade wars, and the elevated risk that Trump’s geopolitical pissing-contest actually escalates into something meaningful but so far, it’s a lot of bluster and noise without much actual policy.

The other thing to consider is commodity prices. We’ve seen pretty savage declines over the last 3 months. Copper, a typical lead indicator for economic activity, is down 20%, whilst Aluminium is down 12%. Steel and it’s raw inputs (met coal, manganese, iron ore) have held up ok or rallied in some cases (particularly Rebar, +17.5%).

This hasn’t prevented a significant sell-off in our local resource company stock prices. RIO is down 20% in the last 3 months whilst BHP is down only 10%, FMG down 23% and Western Areas (WSA) down 35%. Woodside (WPL) up 7%. If we take out oil/energy stocks, the ASX 200 Resources companies are down 12.43% in the last 3 months.

Afterpay (APT)

APT shares are down 28% from the high of $23 back on the 24th of August and in my view, the shorts are about to take hold of this company’s share price. The chart is certainly starting to resemble many disasters that came before it. I can see APT breaching $17.50-$18.00 before falling to new recent lows, sub $14.00.

Why now? As this is certainly not the first time I’ve written about my distrust of Afterpay’s reported results, my concerns around the opacity of their financials and the quality of the people they are offering credit too (make no mistake, “buy now, pay later” is credit.) I think there’s more media-momentum this time, there’s been a bunch of articles in the AFR and other mainstream media questioning various aspects of Afterpay’s reporting, legitimacy and regulatory compliance.

I think with a market cap of nearly $4bn, its liquid and large enough to make the short trade viable and lucrative for hedge fund managers of scale and significance.

I also think the recent capital raising of $117m at $21.65 is a short sellers wet-dream. Darling stock status (and valuation), not actually profitable, buying an asset with stock yet still raising $117m (seemingly opportunistically) whilst management continue to sell stock. Plus you’ve got a regulator sniffing around…

I might be wrong (again) but, I’m yet to have a fund manager or broker actually explain or justify their long position in a way that would change my mind. Time discloses the truth!

Ideas, Ideas, Ideas

As you guys know by now, I try and be as open and transparent as I possibly can in this weekly email. I work really hard to try and uncover a few hidden gems for you (GRB +50%, SPOT +25%, BRG +25% spring to mind) and I’ve spent some time last week digging with a little bit of success.

Large-cap value is hard to find in this market. Outside the beat up and down-trodden banks (which I’m still so-so/bearish/I don’t own them if I don’t have too!), there’s a lot of below-average growth, moderate quality for very high prices in my opinion.

Amcor (AMC) however sticks out like the proverbial canine genitalia. Above average forecast growth, good quality, defensive characteristics, USD denominated earnings, exposed to rising global growth. Trading 10% under consensus price target on a PEG ratio of 1.6x and a raw PE of 14x FY20, 8-10% EPS growth, steady as she goes!

A little further down the ASX is mining services business Ausdrill (ASL). Now this is a little bit off the reservation because it’s a contractor. So, we need to apply a bigger ‘margin of safety’ because contractor earnings can be volatile/unpredictable. However, this company is trading on 8.5x FY20 earnings after taking over a competitor, Barminco. ASL is now the largest pure-play mining services company in Australia and they have significant earnings accretion ahead as they merge the two businesses. It’s got a bit of debt ($643m), and they paid a lot of goodwill in the acquisition but provided the mining industry remains relatively buoyant, I think this will turn out nicely for investors as ASL will pay down debt and pick up additional work. There is material (c.40%) upside from current prices to reach consensus price targets, so it’s a higher-risk, higher-return type situation.

A bit lower on the risk profile is what feels like an old favourite of mine now, Integral Diagnostics (IDX). Trading on c.16x earnings with a dividend yield of 3.5% (and growing) IDX is a high-quality business generating near-20% ROE’s with accelerating free-cash-flow growth, as acquisitions are bedded down and synergies extracted. IDX’s new management appears unlikely to make the mistakes of the past and with a natural tailwind from increasing demand for diagnostic imaging, IDX could 20-30% higher in the near term as the stock re-rates on building market confidence and strong industry volume data.

Housing & Markets

There isn’t much reprieve from a bad week on the stock market in the property sector either. Research out from Citi last week shows investor finance and credit growth declining at faster and faster rates. Clearance rates, a nice lead indicator for future property prices, also leave little room for any near-term relief in Sydney and Melbourne. Lower credit availability leads to lower property demand. Simple.

Somewhat paradoxically, it’s the Australian housing market that to me is of much greater concern to stock market investors than anything that Trump is tweeting about. Whilst some analysts like to delude themselves with the idea of an “orderly correction” and the RBA rate rise, blind-Freddy could tell you that if house prices continue to decline, confidence gets further eroded and consumers spend less. Lower consumption leads to lower wages and lower inflationary pressure and then subsequently, lower interest rates…. unless of course, the banks (the retailers of credit) simply raise rates to protect profits, effectively exacerbating and speeding up, the above-stated sequence of events.

And post-reporting season we already saw this effect taking hold. Online drove most of the LFL sales growth and put pressure on margins. Housing exposed retailers reported softer conditions, as these rate hikes flow through the economy, expect these trends to continue.

Movers & Shakers

Nearmap (NEA) up despite raising $70m at $1.60. Not much else to talk about on the positive side.

Plenty happening on the downside with NextDC (NXT) falling 13% on the back of a Deutsche Bank sell recommendation out last week ($6.30 price target).

Kogan (KGN) continued its slide as it’s founders sold more stock and other high-growth, high PE names like HUB, ALU, APX and A2M sold off.

Have a good week,