Author: Colin Twiggs

Colin Twiggs is a former investment banker with almost 40 years of experience in financial markets. He co-founded Incredible Charts and writes the popular Trading Diary and Patient Investor newsletters. Using a top-down approach, Colin identifies key macro trends in the global economy before evaluating selected opportunities using a combination of fundamental and technical analysis. Focusing on interest rates and financial market liquidity as primary drivers of the economic cycle, he warned of the 2008/2009 and 2020 bear markets well ahead of actual events. He founded PVT Capital (AFSL No. 546090) in May 2023, which offers investment strategy and advice to wholesale clients.
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APN Outdoor (APO) – Sell

Stock: APN Outdoor
Symbol: APO
Exchange: ASX
Financial Year-end: 31 December
Latest price: $6.70
Date: August 24, 2018

Sector: Consumer Cyclical
Industry: Marketing Services
Investment Theme: Structural Trends

APO is positioned to benefit from the rise of technology, with fast-growing revenues from digital billboard advertising.

Company Profile

APN Outdoor is a leading outdoor advertising company with 28% market share in Australia and 30% in New Zealand.

Competitors & Markets

APO will rank second behind the combined 50% market share of oOhmedia and Adshel if their proposed merger goes ahead.

APO is active in billboards (55% of total revenue), transit (26%), airports (11%) and rail (8%). Digital advertising grew 18% in FY18 and contributes 42% of total revenue, with 134 large format digital panels across Australia & New Zealand. Non-digital advertising declined 5% due to loss of the Melbourne Yarra trams contract (won by JCDecaux).

Outdoor advertising sites are secured by 5- to 10-year leasehold contracts and may be subject to competitive bidding on renewal of larger sites.

Financial performance

Revenue Growth

Revenue growth slowed to 4% in HY18, compared to an average of 6.7% over the previous two years.

Revenue and EPS

Earnings per share (right-hand scale) declined slightly from FY16.

Margins

EPS decline is a result of tighter margins.

EBT Margins

Cash Flow

Cash flows declined relative to net income as APO invested in digital displays.

Net Income & Free Cash Flow % of Revenue

Dividends

APO declared fully franked dividends of 7 cents (H1 FY18) and 12.5 cents (H2 FY17), amounting to a 2.9% dividend yield.

EPS and Dividends

Capital structure

APO uses debt to fund new digital billboards, maintaining a net debt to equity ratio of 35%. This could render it vulnerable in an economic down-turn.

Net Cash/(Debt) % of Equity

Weaknesses

Outdoor advertising revenues can be volatile over the economic cycle.

Recent management changes leave APO with new leadership after the retirement of CEO Richard Herring (having led the group since 2004) in September 2017 and CFO Wayne Castle in January 2018.

Takeover Offer

French outdoor advertising giant JCDecaux tabled a AUD 6.70 per share cash offer in June 2018, to acquire 100% of APO. The offer was recommended by the APO Board of Directors and is likely to go to a shareholder vote in October 2018.

The Australian Competition and Consumer Commission’s (ACCC) cleared the proposed acquisition on August 23 but the deal still remains subject to a number of conditions, including approval of APN Outdoor shareholders, court approval, the Foreign Investment Review Board (FIRB) and the New Zealand Overseas Investment Office (OIO) approval, and the satisfaction or waiver of certain other conditions outlined in the Scheme Implementation Agreement lodged with the ASX on 26 June 2018.

APO is expected to declare a fully franked special dividend of up to $0.30 per share just before the takeover. The AUD 6.70 offer per share would be reduced by the cash amount of the dividend but shareholders would benefit from up to $0.13 per share in franking credits.

Valuation

With expected annual revenue and earnings growth of 7%, APO is projected to deliver low annual returns of 6%, or 7.6% after franking credits.

Technical Analysis

APO broke resistance at $6.00 after the JCDecaux offer. Twiggs Momentum (50-week) and Trend Index (50-week) recovered to positive territory but remain weak.

Twiggs Momentum & Trend Index

Conclusion

Sell at $6.70. Prospects of 13 cents in franking credits are not sufficient incentive to hang on to APO.
[**Note added 26/08/18: Clarification is required regarding the upcoming dividend of 7 cents plus 3 cents franking credit. Sellers prior to the ex date of September 5th will forego the dividend. Sellers after the ex date are likely to receive a price, probably 7 cents lower. They may wish to wait until September 5th for the benefit of the 3 cents franking credit but need to weigh this against the increased uncertainty.]

Disclosure

Staff of The Patient Investor may directly or indirectly own shares in the above company.

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S&P 500 volatility falls

The Philadelphia Fed Leading Index at 1.42 for June 2018 maintains a healthy margin above the 1% level that would warn of a potential slow-down.

Philadelphia Fed Leading Index

The picture reinforces a steeply-climbing Freight Transportation Index, indicating strong economic activity.

Freight Transportation Index

Concerns that the economy may over-heat, spiking inflation, are not reflected in strong growth in average hourly earnings. The Fed has done a good job of containing money supply growth, with growth in the broad money supply (MZM plus time deposits) closely tracking nominal GDP.

Nominal GDP and Money Supply Growth

Credit and money supply expansion at faster rates than nominal GDP have in the past flagged an overheating economy and higher inflation, leading to a recession when the Fed attempts to curb inflation.

We are in stage 3 of a bull market but there are few signs that the economy will slow or earnings will fall.

The S&P 500 respected its new support level at 2800, confirming an advance to 3000. Declining Twiggs Volatility (21-day) signals that market risk is low and we can expect business as usual.

S&P 500

The NASDAQ 100 continues to warn of a correction, with bearish divergence on Twiggs Money Flow. This is secondary in nature, because of the indicator’s position relative to the zero line, but could test support at 7000.

Nasdaq 100

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China threatened by loss of US trade

The threat of a US-China trade war has rattled investors, with the Shanghai Composite Index breaking primary support at 2700 to signal another decline. Trend Index peaks below zero warn of strong selling pressure. Long-term target is the 2012 to 2014 lows at 2000.

Shanghai Composite Index

Hong Kong’s Hang Seng Index is also under the pump, breaking support at 28,000 to warn of another decline.

Hang Seng Index

Copper prices, a good barometer of the Chinese economy, are also falling. Breach of $6,000 offers a target of $5,500/tonne.

Copper S1

The Yuan has fallen almost 10 percent, testing support at 14.5 US cents. Failure of the PBOC to support the Yuan (by selling some of their $3 trillion of foreign reserves) may cushion the economic impact in the short-term but only invites further escalation from the Trump administration.

Chinese Yuan/USD

There is no easy way out. Trump clearly has the upper hand in trade negotiations.

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ASX 200 breakout

Strong earnings reports and continued interest in major banks lifted the ASX 200. Rising Trend Index troughs signal buying pressure. Breakout above 6300 offers a short-term target of 6500.

ASX 200

The ASX 300 Banks index followed through above 8100, indicating another rally with a medium-term target of 8500 (long-term 8750).

ASX 300 Banks Index

But the ASX 300 Metals & Mining index broke support at 3750, warning of a test of primary support at 3400. Fears of a US-China trade war are likely to undermine commodity prices.

ASX 300 Metals & Mining

I am also wary of banks because of higher funding costs, falling credit growth and rising default risk .

So the primary trend on the ASX 200 is up but I remain cautious, holding over 30% cash in the Australian Growth portfolio.

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Gold stocks hammered

China’s Yuan continues to fall.

CNY/USD

Causing the US Dollar to strengthen. Dollar Index follow-through above resistance at 95 suggests further gains unless China intervenes to support the Yuan. Long-term target for the advance is 103.

Dollar Index

Gold plunged through support at $1200/ounce. Expect a test of primary support at $1130 but the long-term target is the 2015 low of $1050/ounce.

Spot Gold in USD

A Trend Index peak below zero warns of a strong decline on the Australian Dollar.

Australian Dollar/USD

But Aussie weakness was not enough to shield local gold miners. The All Ordinaries Gold Index (XGD) broke support at 4900, offering a long-term target of 4100.

All Ordinaries Gold Index

Local gold stocks are getting hammered, as I feared.

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S&P 500 earnings surge

Of companies in the S&P 500 index, 90.2% have reported their results for the quarter. According to S&P Dow Jones Indices:

  • Sales growth at 11.0% year-on-year (Y/Y) is close to a potential record.
  • The earnings beat rate of 78% is also historically high, compared to an average of 67%.
  • Operating margins are at a record 11.58%, compared to an average of 8.08% over the last 20 years.

Forward earnings estimates are climbing, driving the forward Price-Earnings ratio to a more comfortable 17.6 compared to its March 2015 high of 23.9.

S&P 500 Forward Earnings Estimates

Valuations based on historic earnings remain high, but P/E multiples have fallen to 22.02 from 24.16 in the last quarter. The long-term chart below compares the index price to previous highest annual EPS, to eliminate distortions caused by sudden falls in earnings.

S&P 500 Price-earnings based on Maximum Previous Earnngs

The current earnings multiple is still significantly higher than the 18.86 reached prior to the 1929 Wall Street crash and 18.69 in October 1987. But high valuations don’t cause market crashes. Sudden falls in earnings do. And there is little sign of that at present.

The S&P 500 is retracing for another test of its new support level at 2800. Respect would signal an advance to 3000. Declining Money Flow warns of selling pressure but this appears secondary in nature, with the indicator still well above the zero line.

S&P 500

The Nasdaq 100 also warns of a correction, with bearish divergence on Twiggs Money Flow. Again this appears secondary in nature because of the indicator’s position relative to the zero line. Expect a test of support at 7000.

Nasdaq 100

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ASX 200 buying pressure

The ASX 300 Metals & Mining index continues to test support at 3750. Breach of support and the rising trendline would warn of a correction to 3400.

ASX 300 Metals & Mining

The ASX 300 Banks index recovered above 8000, the false break suggesting another rally, targeting 8500.

ASX 300 Banks Index

I remain wary of banks, however, because of higher funding costs, falling credit growth and rising default risk .

The ASX 200 continues to test resistance at 6300. Rising Twiggs Money Flow troughs signal buying pressure. Breakout above 6300 would present a short-term target of 6500.

ASX 200

The primary trend is upward but economic indicators and the potential impact of a US-China trade war make me cautious. I hold more than 30% cash in the Australian Growth portfolio.

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No Silver lining for Gold stocks

A long-term chart shows Silver broke support at $16/ounce and is headed for a test of its 2015 low at $14.

Spot Silver in USD

Silver is more volatile but often indicates, ahead of Gold, the direction of the two precious metals. At present that suggests Gold is likely to test its 2015 low of $1050/ounce.

Spot Gold in USD

China’s Yuan continues to fall against the US Dollar.

CNY/USD

The Dollar Index followed through after breaking resistance at 95. Retracement to test the new support level is now unlikely unless China intervenes to support the Yuan. Focus shifts to the long-term target of 103.

Dollar Index

The Australian Dollar broke support at 73 US cents, the Trend Index peak below zero warning of a strong decline. This may cushion local gold miners, to some extent, from the falling US Dollar price but Gold is more volatile.

Australian Dollar/USD

The All Ordinaries Gold Index (XGD) continues to test support at 4900. Breach is likely and would offer a long-term target of 4100.

All Ordinaries Gold Index

Not a good time to buy Gold stocks.

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Wisetech Global Ltd (WTC)

Stock: Wisetech Global Ltd
Symbol: WTC
Exchange: ASX
Latest Price: $15.47
Date: 9 August 2018
Financial Year: 30 June 2018
Results Due: 22 August 2018

WTC was added to the ASX 200 in December 2017 and shows strong growth in revenue and earnings as well as price performance since 2016.

Wisetech Global Ltd (WTC)

We have not rated WTC as a buy signal because:

Our valuation is substantially below the current price. Assuming long-term revenue growth of 25%, while operating expenses grow at a slower rate of 23% due to economies of scale, delivers a value of $10.00 per share.

Results for the 6 months to 31 December 2017 (1H18) show declining Net Income and Free Cash Flow as a percentage of Revenue. Declining margins are the opposite of what we expect to see with economies of scale.

WTC Net Income and Free Cash Flow as % of Revenue

Free Cash Flow is also consistently lower than Net Income because a percentage of research and development costs is capitalized. While one can expect to benefit from current R&D in future years, most companies need to expend a constant percentage of Revenue on R&D in order to maintain their competitive position, especially in Software Development .

WTC looks like a great business, with strong customer retention rates, but is over-priced at present.

We will review WTC performance after FY18 results are announced on 22 August 2018.

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Appen Limited (APX)

Stock: Appen Limited
Symbol: APX
Exchange: ASX

Appen was added to the ASX 200 in June 2018 and displays strong performance in both LT technical and revenue & earnings growth.

Appen Limited (APX)

Despite this, we have not added APX to our model portfolio, or issued a buy signal, because of its market position.

We are looking for companies with a competitive advantage that enables them to defend market share against competitors, without compromising profit margins.

APX competes in a crowded, technology-driven market against a vast number of competitors (over 17,500 Content Relevance and Language Resources providers, according to Jacob Simonsen at Lincoln) and is vulnerable to technology advances by competitors that could make it difficult for APX to defend its market share.

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