September 2015 TAE Market Review

Performance to July 2

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Markets under pressure  Australian economy remains weak.  Chinese economy remains weak – although significant stimulus is being undertaken.  US economy too strong – rates to lift.  But market factoring in significant bad news. 4

Australian Terms of Trade under pressure  Australian economy under pressure from sharp drop in terms of trade and fall in capex spend.  Confidence is down and political environment unsteady.  A$ reducing and interest rates could reduce further.  There are risks of a technical recession even if it will not feel like one. 5

What is new in China?  China has been weak for some time  Confidence undermined by authorities steps to reign in the stock market  Currency move signalled further devaluation and outflows have accelerated as a result.  Market move appears liquidity driven.  Further monetary easing likely and 6

7 Lifting rates is bad for markets?  Given value argument it is understandable markets are nervous on changes to interest rates.  But it is not a foregone conclusion.

Some offsets for the Aussie market  Currency adjustment easing the strain for exporters  Tourism, education, exports showing signs of improvement.  Service sector exports bigger than resources. 8

Gearing low 9

Better ability to stimulate 10

But dividends at highs vs bonds 11

Key Asset Allocation Considerations  A$ at fair value but will overshoot given the softness in the domestic economy.  Australian equities offer significant value relative to bonds and interest rates.  Bond rates at 300 year lows and assets with defensive characteristics have been bid up with certainty being highly sought after by the market. 12

Overview of reporting season Earnings growth  Slightly negative at -2% (Industrials was +8%)  Circa 2% downgrades  Results overshadowed by macro events and bank capital raisings Summary  Reinvesting and poorly received – Seek, Veda, Brambles  Increasing dividend and well received – AZJ, QBE, MQA  Strong results – Treasure Wines, Estia Healthcare, Myob, Supercheap, Resmed, Lend Lease  Good results but overshadowed by macro events – banks and resources (CBA, BHP, S32 and Rio) 13

Top Line Growth Difficult Summary  Resources and energy going backwards thanks to commodity prices  Banks revenue growth in circa 2% in a competitive environment but price rises will assist  General insurance revenues are flat as are a range of industrials 14

Key areas of growth Consumer stocks  Cyclical rebound? Low interest rates and an easier budget assisted.  Retailers and gambling stocks performed well.  SUL delivered 7% sales growth and strong like for like growth (2.5% auto, 10% liesure and 4.5% sports) Housing related exposure  LLC – strong performance but cycling a year where there was a large one off sale of Blue Water.  Development pipeline of $44.9b was up 19% on the prior year, construction backlog was surprisingly up 7% to $17.3b (despite losing the East / West road in Melbourne) and funds under management are up 31% to $21.3b. $5.2b of pre-sold revenue underpins outlook. Service and software industries  Economy transitioning.  MYO – beat IPO with revenue up 8% and profit up 14%. Cloud users were up 65%. 15

Key areas of growth Exporters  Lower A$ and improved competitive position assisting  TWE – Sales up 8.4%, EBIT up 25% - 10% beat.  Key highlight of the season with Asia up 53%, cost out and reinvestment in brands paying dividends. Ageing population  Stocks exposed to this area via Aged Care (Estia Health, Regis Healthcare) or via healthcare (Ramsay, Medibank, Resmed) enjoyed strong top line growth.  EHE – Beat prospectus and flagging 20% profit growth in FY16  RMD – Revenue up 17% on a constant ccy basis. 50% flow generator growth. 16

However companies reinvesting struggled Seek  Revenue growth 20% and EBITDA growth 15%.  Forecasting 15-18% revenue growth next year but only 5-8% EBITDA growth  Two factors – Adjustment to education earnings following regulation change and reinvestment in a range of new products and to cement their number 1 position in China.  Seek’s track record at investment is noted in the table and the opportunity is strong.  China – just established the lead in a market less mature than Australia.  SE Asia – opportunity to substantially increase margins following takeover of the number 2 player.  Australia – Launch LinkedIn product and two new enhancements this year.  Rollout Seek Learning across global platform.  20x given underlying growth is not expensive. 17

However companies reinvesting struggled Veda  In line result with revenue and EBITDA up 12%.  Similar levels of revenue and EBITDA flagged for next year broadly in line with market.  However flagging higher amortisation and higher capex given a range of opportunities.  Opportunities – Anti money laundering, Comprehensive Credit Reporting, KYC.  Market adds the Capex to models without adjusting revenue.  Management could have done a better job annunciating the size of the opportunity and the potential return on the capex.  Outlook appears strong, stock is on less than 20x for a very strong medium term outlook with a strong balance sheet. Brambles  Revenue growth up 8% and profit up 10% at constant CCY in line with market.  Slightly disappointment was die to higher capex being flagged next year to ensure they hit their 20% return on capital goal.  Growth forecast for FY16 6-8% was also slightly disappointing.  We understand market’s slight disappointment in this result but given weakness leading into the result, strong market position and steady growth rate the stock looks reasonably priced at 17x.  CCY provides a valuation benefit. 18

Cost out / self help remains a focus Industrial Profit Margins increasing Aurizon  Flat revenue but EBIT up 14%.  Dividend payout up to %. Dividend was up 45% over the past year.  Margin target is 30% by 2018 (up from 25% currently). 19

Cost out / self help remains a focus QBE  Flat premium growth (underlying up 2%) but cash profit up 26%.  Dividend in A$ up 33% with payout ratio being lifted to “up to 65%”.  Further cost out announced and focus is on growing top line by selectively targeting specialist business.  Strong turnaround in progress with balance sheet sound. MQA  Revenue up 3.4% and EBITDA up 8.4% ahead of market.  Dividend for FY15 will be 16 cents and 18c forecast for FY 16 slightly below market.  However cash position is very strong which will allow potential further dividend increase or a value adding acquisition. 20

Resources controlling what they can BHP  Reaffirmed dividend, demonstrated good cost and capex control.  But remains hostage to commodity prices.  Productivity gains of US$4.1b with further cost out expected. Capex down 24% to US$11b and is expected to decline further to US$8.5b. 21

Resources controlling what they can RIO S32 – US$350m in cost out and a 9% cut in capex 22

Banks CBA  5% profit growth overshadowed by capital raising  Bad debt concerns arose due to ANZ and GMA result. These fears are overplayed.  ANZ saw some deterioration in performing loans and they increased their provisions. ANZ is the most vulnerable.  We have been reducing the underweight to banks. 23

Key Australian Equity Opportunities  Banks beginning to look oversold and overhang presenting an opportunity.  Top line growth difficult to come by yet the market has been selling down those reinvesting. Presents an opportunity to add stocks with strong structural growth.  Offshore earners remain attractive.  Some macro concerns emerging on the domestic economy. Potential to look at those stocks with defensive growth characteristics (gaming, health). 24