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Sunday 21

April, 2019 8:56 PM



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Buying on the Dip

Buying on the Dip

By Bob Kohut 04.02.2019


While stock price fluctuations are to be expected, during dire and even simply uncertain economic conditions the fluctuations can be wild, some bordering on the irrational.  Such fluctuations often present buying opportunities for investors with an appetite for risk.

In today’s market there exists ample opinion to support both a Bear outlook and a moderately Bullish outlook for stocks.

The last trading week of January saw panicked investors fleeing the likes of chip-maker Nvidia and earth-moving equipment manufacturer Caterpillar.  Both reported disappointing earnings and guidance, and both pointed the finger at China.

Later in the week aircraft manufacturer Boeing came in with a company record revenue of $101 billion and earnings that crushed earnings expectations.  Investors had been abandoning the stock in the final months of 2017, in part due to expectations of slowing growth in China.  However, in 2017 Boeing derived only 13% of its revenue from China and although some investors may be unaware, the company is the world’s second largest defence contractor.  Boeing shares were up close to 7% in early market trading.

Market reaction to Apple’s earnings release was moderately surprising, as the company’s revenues fell short of expectations.  Apple management attributed the results to its Greater China business.  For the critical fourth, or holiday, quarter, Greater China revenues fell to $13.2 billion, down from $18 billion for the 2017 holiday quarter.  Apple shares were up close to 5% in early market trading.

The Boeing story provides evidence that the Buying on the Dip investing strategy can work.


In Boeing’s case the dip may have been caused by an overaction to problems in China, given the company’s presence in other commercial markets and in the defence industry.  Assessing the cause of a stock price dip is, sadly, nothing more than an educated guess, with the emphasis on “educated.”  

Market conditions can in some cases support such guesses, when contrarian indicators to prevailing market sentiment begin to appear.

On 4 January leading financial websites from Yahoo Finance to Reuters to CNBC published the results of a proprietary Bank of America/Merrill Lynch “Bull & Bear” market indicator flashing a strong contrarian BUY signal.  The gauge measures fund inflows and outflows, with extreme signals to either side flashing BUY or SELL signals.  At the close of the 2018 trading year investors had pulled $8.4 billion from stock investment funds while putting a record $24 billion into funds specialising in government bonds.  On 4 January the gauge hit 1.8, the lowest level since the Brexit panic, triggering the BUY signal. The following graph tracking the BOML gauge is from yahoo finance.


The Top Market Rise and Falls from the market wrap appearing in the 28 January bull.com newsletter includes three stocks to consider as buying opportunities, based on their two-year earnings growth forecasts

 

The ResMed stock price was up around 425% prior to the recent dip.  The US-based company trades both here on the ASX and in the US on the NYSE (New York Stock Exchange.)  ResMed has been in business since 1989, when founder Dr. Peter Farrell bought the then revolutionary non-invasive treatment for obstructive sleep apnea (OSA) – the nasal continuous positive airway pressure (CPAP) device.  The CPAP originated right here at the University of Sydney before moving to Baxter Labs for further development.  Farrell worked at Baxter and when that company decided to abandon the OSA market, Farrell stepped in.

Today ResMed offers a host of sleep disorder treatments, ranging from CPAP devices in varying sizes to ventilation and oxygen devices as well as cloud-based respiratory diagnostic software for professional clinicians. 

The US ResMed listing had an OUTPERFORM analyst consensus rating, but some brokers have downgraded the stock following the earnings release that precipitated the dip.

The company entered into two separate joint ventures and is increasing its investment in its diagnostic software-as-a-service (SaaS) platforms.  While Q2 sales were up 8% and US revenues were up 9%, the rest of the world was down 2%, due to the costs of the joint ventures and the software investments.  However, operating profit rose 8% but analysts and investors alike chose to fixate on the future potential of rising costs eroding growth.  The share price fell 12% following the news.

While some investors would look on capital expenditures as a means of propelling future growth, others fixate on the costs.  ResMed continues to churn out new products, with the latest examples a portable oxygen device called Mobi and the second a “top of the head” CPAP mask called AirFit N30i.  An attractive feature of ResMed diagnostic software is the “out-of-hospital” offerings.  One of the acquisitions the company made recently is MatrixCare, a leader in software solutions for the aged care sector, expanding the company’s opportunities in that growing market.  MatrixCare serves more than 15,000 providers in skilled nursing centres, life plan communities, senior living accommodations and in-home private duty personnel.

Netwealth Group Limited is a newly listed “fintech” company looking to disrupt the Australian wealth management sector through its online platform.  The company listed in November of 2017, opening its first day of trading at $4.88 and closing at $5.33, up about 30% as of the $6.90 close on 29 January.

The share price plunged 9.5% following the release of its latest quarterly update. Given expected the success of Netwealth and other fintech providers in the space, Hub24 (HUB) and Praemium Limited (PPS), investors are willing to pay more for these “high growth” stocks.  Netwealth has a trailing twelve-month P/E (price to earnings ratio) of 78.1 while rivals HUB is at 104 and PPS at 157.5.  As newcomers to share market invest learn quickly, when high growth stocks fail to meet what are often unrealistic growth expectation, the share price takes a beating.

Funds under administration (FUA) is a key metric for all wealth management providers.  In the update that troubled investors, the company reported a small – negative 1.5% -- decrease in FUA, while also reporting an overall increase of 23% in FUA from December to December. 

Investors chose to ignore the year over year increase and focus on the decline, especially since rival Hub24 reported higher fund inflows in the first quarter.  Netwealth management attributed the softer than expected results to the “platform pricing wars” as traditional providers fought back against the upstart newcomers, a difficult task considering the cost savings of online offerings versus the cost of maintaining branch office networks.

Netwealth serves both individual investors and financial advisors and its suite of offerings for individuals includes far more than simple portfolio creation and management, with extensive charting, financial reports, and tax statements.  

The Royal Commission has struck fear in the hearts of traditional providers, uncovering abuses such as charging for advice not delivered and the infamous charging of the deceased.  The vertical integration business model where providers profited handsomely from pushing investment products they create is under scrutiny, with some experts pronouncing it dead.

The final report from the Royal Commission is due this week, and it could provide significant tailwinds for NWL, HUB, and PPS, particularly in growth in the independent financial advisers.  Of the three, NWL has the lowest P/E, although the 2-year earnings forecast for PPS is double that of NWL – 103.5%.

Amp Limited (AMP) also had a big drop following a trading update to the ASX and serves as a “poster child” for the troubled traditional providers.  Once a dividend powerhouse, the company slashed its half year dividend from $0.145 per share to $0.04 and issued profit guidance, expected to fall 90% year over year.  The share price has been in constant decline since the announcement of the Royal Commission on 30 November of 2017.


New Zealand-based Synlait Milk Company (SM1) is a major supplier of market darling A2 Milk Company (A2M), as well as producing and distributing its own milk, milk powder products including infant adult nutrition packed formulations.  

In business since 2000, Synlait listed on the New Zealand Stock Exchange in 2013 and dual listed on the ASX in 2016.  In its first full year on the NSX the company posted revenues of $548 million and a net profit of $18.  In its first full year on the ASX the company posted significant revenue increases since its initial listing – revenues of $714 million and net profit of $36 million.  For FY 2018 revenues climbed to $807 million while profit increased to $69 million.

The share price dropped 3.7% following an announcement, with prior warning, the company was lowering its forecast for the price of milk in FY 2019 from $6.75 to $6.25.

Interested investors should take note Synlait and A2 Milk recently revised their original supply agreement from December of 2016 upward, from five years to seven years.  Following that July announcement A2 Milk increased its ownership stake in Synlait to 17.4%.

The initial supply agreement predates Synlait’s listing on the ASX but both companies appear to be profiting handsomely from their partnership and other business operations.


>> BACK TO THE NEWSLETTER: Click here to read other articles from this week's newsletter


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