The ASX200 Index (ASX:XJO) closed last week flat compared the previous week, creeping a mere 0.03%. This is despite covering a total range of 1.6% throughout the week.

Electricity ‘gentailers’ under pressure after ACCC report

Prices of listed energy companies suffered significantly when the ACCC released its final report into retail electricity pricing on Wednesday, 11 July 2018. AGL fell as much as 8.5% intraday and Origin Energy (ASX:ORG) fell as much as 6.6% over Wednesday and Thursday.

The Australian Energy Regulator (AER) also released its new five-year draft determination aimed at cutting gas and electricity costs by up to 13%. Markets reacted on unfounded instinct to the news by dumping shares in AGL and Origin:

  • the ACCC report is a broad-brush approach of 56 different recommendations, many of which will not affect AGL or Origin’s bottom line; and
  • the AER’s draft determination targets power grid operators like Spark Infrastructure and AusNet Services, not the electricity retailers.

AGL provided good buying opportunities during the week and PEF Capital have been long AGL since $21.30. We forecast that much of the short-term gain has materialised but expect AGL to continue to its price growth for a short while longer.

Flight Centre now priced for selling       

Flight Centre (ASX:FLT) moved to an unsustainable price point as it reached a record $67 during Friday’s trade.  breaking out of a two-month trading range.

Flight Centre is likely to report a strong performance next month, and we expect to see an increase on the current $1.54 annual dividend.

However, Flight Centre trades at a price earnings ratio of 25 times compared to the average ratio of 18.5 times for the sector and is starting to face demand hurdles, as is the nature of its cyclical industry. For example, contraction in the housing market or economy generally, significant grounding of flights due to natural disasters or war are quite not improbable.

Given the vicissitudes in the airline industry, Flight Centre is more appropriately priced in the range of $54 to $58 and is currently a good candidate for selling.

Viva Energy fails to launch          

Viva Energy (ASX:VEA) completed its $4.5 billion IPO during the week. The bookbuild price came in at the bottom of the target range at $2.50 — the company had been hoping to achieve as high as $2.65 per share. Viva Energy began trade at $2.43 on the ASX last Friday and closed the trading week down at $2.40 — 4% lower than its issue price.

Viva Energy does not fall within our coverage but we will follow it closely to see how it impacts on the performance of Caltex (ASX:CTX), a company we frequently hold positions in.

Update on recent forecasts

Since 18 June 2018, when our analysis pointed towards selling Insurance Australia Group (ASX:IAG) and buying QBE Insurance (ASX:QBE), we’ve seen IAG underperform by ASX200 by 1.6%, whilst we’ve seen QBE outperform the ASX200 by 1.5%. QBE has made a total return of 4.4%. The divergence in market performance between these two has met our forecasts (see Figure 1).[/vc_column_text]

On 2 July 2018, we examined Harvey Norman (ASX:HVN) and suggested strong upside potential in the retailer. Its price has increased by 6.3%, outperforming the ASX200 by over 5% during that period, meeting our expectations (see figure 2).

Figure 2. HVN compared against HVN from 2 July 2018

China’s credit crunch will affect Australian resource companies

Continuing on from last week’s analysis, we look at companies in our coverage which we believe might be affected by China’s current credit crunch. The Chinese government has redoubled efforts to reduce credit growth, in particular, local government borrowing. The expected result is downward pressure on infrastructure investment growth, and with that, reduced demand for steel, iron ore and coal.

BHP Billiton (ASX:BHP) is expected to take a fair hit with roughly 63% of its 2017 EBITDA coming from coal and iron ore. Rio Tinto (ASX:RIO) is also expected to feel pressure on earnings with over 45% of its earnings coming from iron ore exports.

Policy change in China is placing pressure on steel manufacturers to minimise their environmental impact and maximise productivity. Rio Tinto has been able to secure significantly higher rates on high content iron ore which is in higher demand. It noted that iron ore with 62% iron ore content was achieving up to 70% higher prices than the lower 58% iron ore content because of this policy change.

On the other hand, Fortescue Metals Group (ASX:FMG) is likely to miss out on these premium prices as the iron ore mined out of its Solomon and Chichester Hubs in the Pilbara contains the lower iron ore content (around 58%). Fortescue has been successful in cutting costs by about 17% so it is unclear where EBIT for the quarter will land ahead of next Thursday’s report.

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Stephen Arulogun           Chief Investment Officer              +61 (0) 402 255 524