[vc_column_text]We saw last week finish with $34 billion of tariffs on US imports against China taking effect. The Australian market finished at 10.5 year high with the S&P/ASX 200 (ASX:XJO) index rising another 1.2 percent.

Qantas Airways (ASX:QAN) faces increasing costs

Over the next two years, Qantas faces a number of challenges:

  • The price of oil has continued to rise. Despite OPEC agreeing to an increase of 1 mbpd, the US is moving to sanction Iranian oil supply which could reduce supply by up to 1 mbpd. With current uncertainty around supply, oil spot prices have continued to rise. Qantas Airways fuel hedges have fallen from mid-70% a year ago to around 50%, leaving it more greatly exposed to upside fuel price risk.
  • From 2020, capital expenditure is set to rise about $500 million each year. Airline businesses are capital intensive, and any fall in demand (like fewer incoming passengers from China) will have an amplified effect on the airline’s profit).

US investment bank, Bank of America Merrill Lynch has a $7.75 price target on Qantas. It believes the capacity cuts and fare increases made by Qantas ahead of the impending impact of higher oil prices will allow it to continue growing in value. We believe that Qantas is more fairly priced at $6.00.

Wesfarmers: key drivers behind the business in CY2017

With Wesfarmers shares reaching a record of more than $50 this week, it’s time to have a closer look at the drivers behind the company’s price.

Wesfarmers has risen more than 20% since it announced the demerger of its Coles business in March 2018. The demerger is slated for completion in late 2018. Coles has been capital-intensive for Wesfarmers; return on capital employed margin of 9.7% in FY17. Separating Coles from the rest of Wesfarmers’ businesses, the Western Australian conglomerate averages a return on capital employed margin of 25%. Clearly, the market is holding strong hope that any acquisitions Wesfarmers makes will fit the high return model.

Prior to announcing the demerger, the Coles component of Wesfarmers held a lower EV/EBIT multiple less than Woolworths, with market considering it valued at $18.5 billion. Analysts have projected that on its own Coles could be worth as much as $22 billion. An increase in $3.5 billion market capitalisation would have seen Wesfarmers’ share price at $44.50 in mid-March. Any value to be created by the demerger is now fully priced in.  

Wesfarmers exit from metallurgical coal well timed

In 2017, Wesfarmers resource arm contributed $400 million to the overall earnings. The resource has previously been volatile — it is strongly depending on the export price of commodities. In FY17, it made a return on capital employed of 69%. In December 2017, Wesfarmers sold off its Curragh mining operation in Queensland’s Bowen Basin to US producer Coronado Coal Group for $700 million.


Commodity prices have recovered and there’s renewed demand. So, did Wesfarmers time its exit from the coal market well?

In June, the Office of the Chief Economist published its forecast for commodity exports over the next two financial years, including the two main ingredients used in steel manufacturing – metallurgical coal and iron ore.  Export volumes of metallurgical coal and iron ore are expected to grow at a compound average rate of 4.2% and 2.7% respectively. However, the shrink price of each is likely to have the net effect a compound annual drop in value of more than 3.5%. Out of 12 commodities Australia exports, metallurgical coal and iron ore are the only two commodities forecasted to fall in export unit value (EUV) out to FY20.

Chinese’s slowing economy has a large impact on Australian companies

The Shanghai Composite Index has fallen 23% since 26 January. A reduction in new construction and manufacturing will result in reduced steel production in China.  There’s a growing credit crunch in China that is starting to have an impact on Chinese investment outside of the country. Last week,  China’s HNA pull the plug on $400 million dollar deal with Automotive Holdings Group (ASX:AHG), the automotive retail and logistics group. HNA is no small player, being a significant shareholder in Virgin Australia Holdings. Demonstrating the real impact China’s credit crunch will have on Australian companies, AHG fell over 10% within the first hour of trade last Monday, 2 July 2018, after the announcement.

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Stephen Arulogun           Chief Investment Officer              +61 (0) 402 255 524[/vc_column_text][vc_video link=”https://www.youtube.com/watch?v=tr_puu82seg”]