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Banks and financials outlook 2013

Nicholas Grove | 20/12/2012Text size Decrease

Nicholas Grove: The Morningstar equities research team recently released the Huntleys' Forecast 2013 sector reviews. Here to give investors an idea of what to expect from the banking and financials sector in the coming year, I am joined again by Morningstar sector head David Ellis.

David, thanks very much for your time today.

David Ellis: Thanks Nick, my pleasure.

Grove: First of all David, what are going to be the key macro issues, both domestic and international, that investors need to keep an eye on when it comes to this sector in 2013?

Ellis: Well, the key domestic macro issue is economic growth and the strength or lack of strength in Australian GDP for 2013 and even into 2014, as the massive mining investment boom is slowing down, and the concern is that it's slowing down faster. And when it reaches its peak, the pressure on the non-resource parts of the economy is expected to increase, and on the high Australian dollar and the flow-on effects of that combined with the federal government tightening their fiscal position. That means the GDP growth in 2013 will probably be slower than expected, and that will have a clear impact on the financial services sector, particularly the banks.

As far as internationally, the key things we're looking for internationally of course is, first of all, the US fiscal cliff negotiations are rapidly drawing to - hopefully - rapidly drawing to a close. If that goes badly, that will probably have a quite a significant negative impact globally on global equity markets, and conversely.

So, if there is some negotiation agreed between the two political parties in the US, well then that'll probably have a short-term positive impact on equity markets. Other global macro issues, of course, are the economic growth outcomes in China, and the flow-on effect for demand and price of commodities - particularly iron ore and coal which obviously impacts the Australian economy.

Grove: David, what do you expect from the big four banks in terms of earnings and dividends in the year ahead? And do you still expect a return of surplus bank capital to shareholders in the form of special dividends, buybacks or payout ratios in 2013?

Ellis: Yeah. Our position hasn't changed since the last time we spoke and that is for moderate credit growth, which will flow through to moderate revenue growth. There is an increasing focus and emphasis on improving the cost base of the banks. So, in relative terms, we'll see costs being reduced. And margins of course - net interest margins - are a major swing factor.

And over the last month or so, we've seen wholesale funding costs actually come down. Now, that has a longer, flow-on impact on net interest margins that's definitely not immediate by any stretch of the imagination. So, margins we expect will stay relatively stable. The big swing factor for bank earnings are bad debts, and that gets back to my first point or to your first question about he economy. If we see a sharp decline in the economy, an increase in unemployment, then we will see an increase in bad debts, particularly for business and commercial loan bad debts.

If we see a sharp increase in bad debts, well, then we'll see bank profits being under pressure. That's not our central case, that's not our main thesis. We expect the economy to muddle through and we wouldn't be surprised if bad debts do increase, but not materially.

And so, getting back to thesis or forward-looking thesis of capital returns or higher dividends, at this stage we're comfortable that the banks will continue to increase their capital base. They will have surplus capital, particularly Westpac, and probably CBA. And assuming the economy doesn't deteriorate sharply, then we expect to see capital returns to shareholders in the next 12 to 18 months and it may be in the form of special dividends or it could be share buybacks.

Grove: Stepping away from the banks for a minute, what sort of performance can we expect from the big insurers in 2013?

Ellis: Well, that's a tougher question. The insurers obviously are impacted by a lot of factors, not the least being the incidence of natural disasters and catastrophes. And in 2011 and 2012, we have seen a sharp increase in catastrophes around the world, which have impacted QBE severely, and to a lesser extent IAG and Suncorp.

Insurance premiums are increasing, which is a positive for profitability. There is better underwriting discipline. Reinsurance costs are going up, but we do expect to see a solid improvement in earnings for the three insurers, particularly QBE.

Grove: Finally David, how do you expect the wealth managers and the diversified financials to perform in 2013?

Ellis: Well, the wealth managers and the diversified financials are influenced heavily by equity market activity and strength, so they are leveraged to the markets. So, if we see a continued recovery in equity market values, well it'll do two things - one it'll increase the market value of funds under management, which will increase fee income for the wealth managers. But more importantly, we want to see a return of confidence from investors to start putting more money into the equity market, either directly or through managed funds. A lot of that money is currently seeking cash deposits with the banks.

So, if we see a recovery in confidence in the market, we will see a recovery in net flows into the listed wealth managers. We see a similar sort of outlook too for the property sector. Whilst a lot of the property stocks have run quite hard over the last six months, the last 12 months, we're pretty confident in underlying asset values, property values, and we expect further investor demand for those higher-yielding, quality, income-producing property trusts.

Grove: David, thanks very much for your time today.

Ellis: It's a pleasure, Nick.

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ASX and the retail investor
10/05/2013 ASX chief executive Elmer Funke Kupper talks about the market outlook, listed bonds, and why retail investor confidence is everything. ASX and the retail investor Christine St Anne 10/05/2013 http://video.morningstar.com/aus/video/130507_asx_audio.mp4

Christine St Anne: We're at the Australian Shareholders' Association's annual event in Sydney. Today, I'm joined by the ASX's Elmer Funke Kupper to talk about the market outlook and initiatives by the ASX. Elmer, welcome.

Elmer Funke Kupper: Thank you.

St Anne: Elmer, you recently reported an uplift in revenue and it comes at a time when market seems to be gathering strength. Do you expect that momentum to continue?

Funke Kupper: I think it's been particularly strong in February, March, April. So, at the half year results we said it’s still little fragile, retail investors are sitting on the sidelines. I think some of it has come back in the last two months. So, yeah, we've had much healthier trading volumes in the equity market, and combined with strong trading volumes in our other markets, we had quite a strong third quarter, yes.

St Anne: Elmer, on that point of investors sitting on the sidelines, there have, of course, been a lot of discussions about investors remaining in cash and term deposits. Do you think that they are going to start moving more into the listed equities markets?

Funke Kupper: I think investors make their own choice. I think during the GFC, we saw a drop-off in equities and a significant increase in bank deposits. While that doesn't help my company, it probably helped the economy, as of course banks rely on those deposits. So I think it was quite healthy that that happened. What we're now starting to see with interest rates coming down and yields coming up, and we're seeing the bank results recently paying very healthy yields, people are starting to go back into the marketplace. It seems to be somewhat of a hunt for yield and returns that many corporations seem to be responding to. They make up their own minds, investors make up their own minds, but if you put the two together, you can see that happening.

St Anne: Elmer, you've had fixed income ETFs, and now the ASX is looking to list bonds. Will that change the role of fixed income in an investor's portfolio?

Funke Kupper: Well, in some ways they already have fixed income investments through deposits in banks. I think that is effectively fixed income investment. We know that when we benchmark our market to other markets around the world, that we don't have a large or liquid corporate bond market. And we know from overseas markets, like Europe, that a healthy corporate bond market is something that investors value. So we've been looking at ways to start that process and create such a market for investors. An important first step is the quoting of Australian government bonds on the exchange, because that creates effectively a benchmark price for the corporate securities, because it's the lowest risk form of investing, and corporate securities then sit above it.

There's a number of other steps that we would need to take. We would quite like to see a longer-dated government bonds, so you can create a proper price curve for longer-dated securities. We need to simplify the documentation requirements and change their director liabilities for the corporate bond market. All that work is underway. So I'm hopeful that if you add all of that up, then in next 12 months we will start to see the corporate bond market slowly develop in Australia.

St Anne: Elmer, now with listed fixed income securities, and of course, we've had listed equities, how does that compare with the traditional funds management industry? Do you think investors are going to increase their allocation more to direct investing?

Funke Kupper: Well, fixed income ETF is a fund, of course, that's listed on the exchange in which you can buy units. I don’t see a big shift, and I think part of that is driven by what I call the weight of money. So if you look at the superannuation guarantee that keeps going up. We do know that the superannuation sector and the funds management sector will continue to grow. At the same time, we see self-managed super grow and personal investment grow. So where that ends up, I don't know. I'd like all of them to grow, of course, because that's part of what we do.

But I don't think we should underestimate the forces that make superannuation grow, like the increase in the guaranteed continue to grow there. We've got some very large superannuation funds already, and they will only get larger, and that sort of – that's where most of the money, I think, will go because it's this guaranteed inflow of money. And then private investors will make their own trade-offs between fixed income, securities, and deposits.

St Anne: Elmer, in your presentation, you mentioned dark pools and high frequency trading, and of course the role of ASIC. What about the role of the ASX? What role do you play in securing investor confidence when it comes to these sorts of trading tools?

Funke Kupper: We think retail investor confidence is everything. I think we've taken a different approach than some other exchanges, such as exchange in the United States and Europe. We have taken, if you will, a high ground here, because we think it's in the long-term interest of our market, and therefore in the long-term interest of the ASX that this is well managed. So, we raised a number of issues in the last two years on this issue, on high frequency trading and dark pools. I think ASIC has been listening to us. They've been listening to other market participants, and more importantly, they have been listening to investors, and I think they've come up with a measured approach and a series of steps that will control both dark pools and high frequency trading. But, of course, you have to recognize that we can never get rid of it. I mean, its effect of life, technology is effect of life, innovation is effect of life, and in many cases it's a good thing. So, we are trying to do is allow innovation, but manage the unhelpful side effects, and I think relative to other exchanges and other markets, I think ASX and ASIC have done that very well in Australia. In fact, we're seen as the poster boy of financial market regulation these days.

St Anne: Finally, Elmer, our company Morningstar has the opinion that the ASX has strong competitive advantages. How are you going to maintain that with the new entrants in the markets, like Chi-X?

Funke Kupper: Well, I think competition is here to stay, isn't it. So, Chi-X has been growing. We believe Chi-X will grow and will compete. So, that's the world we live in today, and that will continue to be the case. So, our job is to make sure that we continuously improve the services for investors with our own trading products. We've built a new data center that allows us to generate a new form of incoming technical services, and all of that has gone relatively well. So, we've been competing I think well. But, of course, when your market share starts at 100 per cent, it can really only go one way, and I think our market share over time will decline as Chi-X grows. Our job is to make sure that we compete well and that we deliver great services to our clients, and of course, that our shareholders continue to benefit from a growing company, and that's the balance that we’re trying to find. I think so far so good.

St Anne: Elmer, thank you so much for your time today.

Funke Kupper: You're welcome.

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Can ANZ sustain its dividends?
09/05/2013 ANZ deputy chief executive Graham Hodges discusses the bank's recent dividend increase and its growth initiatives Can ANZ sustain its dividends? Christine St Anne 09/05/2013 http://video.morningstar.com/aus/video/130508_anz_audio.mp4 Christine St Anne: We're at the Australian Shareholders’ Association annual event this week and today I'm joined by ANZ's deputy chief executive, Graham Hodges to talk to us about growth opportunities for the bank and whether ANZ could sustain its dividends? Graham, welcome.

Graham Hodges: Pleasure.

St Anne: Graham, ANZ recently made a splash with its increased dividend announcement. Does this mean that the bank will focus more on shareholder returns rather than pursuing an aggressive growth strategy, for example, your Asian strategy?

Hodges: No, I don't think so. I mean, I think what we've done in the dividend is just reflected. We had a good stable earnings, and we have just sort of decided that we will payout a little bit higher payout ratio. So, we have lifted lower end of our range to sort of more of the upper end of our range, which has been consistent for long time.

And then we've also agreed to pay a little bit more in the first half as a share, whereas before we were doing 45, 55 split. We've increased our first half payout a little bit. So, it's absolutely consistent with what we are doing, expanding the Asian strategy. So, we are still investing to grow. The dividend is really reflecting the success we are having.

St Anne: Graham, you mentioned in your presentation about the credit cycle of being a particular risk for banks, therefore can you sustain your dividends going forward?

Hodges: Well, I think, the credit growth environment is slower, and slower credit environment in a competitive market can encourage or can lead banks to take on more risk in order to grow their business more quickly. The good thing for ANZ it is we do have a growth option, our Asian growth option, which allows us to both grow, but to grow safely.

So, in a way, I mean, I think having that extra option of where we can continue to see growth is a positive for us in terms of the stability of our overall earnings and our profit, and therefore stability of our dividends longer-term.

St Anne: Graham, this week the RBA also announced a rate cut and of course there was a lot of discussion about whether the banks will pass on this rate. How do you balance the needs of your customers with giving back more to your shareholders?

Hodges: I think when we look at interest rates, I mean, we obviously take into account both the environment, the customers and the shareholders. So we always – it's always a balanced decision. We haven't announced our decision yet, and we will do that on Friday. But in all of these things we look at the range of interest, and I think as we should because customers ultimately are what pays the bills to give to shareholders, so we are quite mindful of that.

St Anne: There has been a lot of discussion about share price bubbles, particularly in the banks. Graham, what's your view, and do you think that the share price can be sustained?

Hodges: I mean, I think the share prices have gone up quite a long way, and that's been also part of what I'd call globally more of what they term risk on sort of focus, where they are starting to take increased weighting into the equity markets and perhaps lightening off their exposure to the bond markets. So, I mean, that's sort of something that as the European issues have a settled a little bit and people got more confident they are seeing growth in the US economy, it is sort of a natural expectation that that will happen, fueled in some ways by the liquidity, which is being pumped up by central banks globally as well. So, I actually see the share price rise as partly reflecting that broader environment that people are prepared to take a little bit more risk and therefore investing in riskier assets, which shares are. And also reflects the fact that the banks have had strong earnings performance and the earnings are sort of – the results are pretty clean, they reflect good performance in the business. And obviously, the banks are attractive in terms of the yields that they are offering, attractive lower interest rate environment, the yields on banks. Particularly, if you are looking at the franking benefits as well as a retail investor they are quite attractive and you can see why people even at today's share prices see that as being something that is attractive.

St Anne: Graham, in your latest results ANZ also lowered its provisions for bad debts. Does this make you bit more optimistic about the economy?

Hodges: Well, no, I think we do see the economy is having some difficulty, still it is sort of – its growth is sort of moderate, I wouldn't say it's not strong growth. There are some sectors of the economy that are experiencing more difficulties, and that's typically the smaller commercial part of the book so SME. Why? Because a lot of them are focused in the service sector and consumers haven't been spending as much. The Aussie dollars being higher and they are competing against imports, which are cheaper. And also some of the bigger players have been pushing down the supply chain and squeezing their margins as well. So, the combination of factors and we therefore have seen more financial stress in that SME part of the sector.

But for the banks, overall, that's a sector which we tend to have a little bit more collateral or security around. And so we don't tend to see big losses for the banks in that sector. We tend to see the bigger losses are in the big end of town, the Institutional end, but that side of the business overall is being performing very well, which is why you're seeing credit losses at reasonably low levels. So, our expectation is that this year – that's probably going to be maintained this year.

St Anne: Your results also highlighted a massive improvement in your cost to income ratio. Are you able to discuss how that was achieved, and do you think that that can be sustained?

Hodges: Yeah, so we've been working hard at that for a number of years. We've been investing in standardizing our processes. We have actually sort of invested in our hub businesses, which are sort of our big platforms that we've got, not only in Australia but elsewhere and therefore simplifying our business, standardizing it and achieving productivity benefits as a result of that. We're using more straight through processing, which means less intervention by people and so therefore we haven't needed some of the staff to service the business. So, we're getting more volume for slightly lower cost, which is actually really good outcome, and we would hope that that is sustainable.

We've continued to invest in technology and in platforms to achieve that, digital platforms are some of the good examples of that. And I think that's an important part of why banks are responding to a lower growth on revenues, because it's a lower growth environment, overall. They've got to work a bit harder on the productivity side and we will continue to do that.

St Anne: Finally, Graham, Australia's compulsory superannuation is now over a trillion, and is only set to grow further. How is ANZ positioned to grow its wealth management in this market?

Hodges: So, our wealth business performed quite well in the last 12 months. It's been under new management with Joyce Phillips. We still see some upside for us. We're a bit – we've got a very good insurance business. We underweight in the retail funds business, but we've recently launched a new superannuation product, which is sort of easy and straight forward, it suits the current environment where simple – we've got Simple Super coming in. So, that's been competitive and it's actually sort of seeing an increase in volume of business for us. We are doing more with our own customers, where we probably weren't penetrating in that enough.

So, I think there are opportunities for us to continue to improve that, but it's going to be a steady improvement. We underweight in that sector and we see it's a good sector to grow in.

St Anne: Graham, thanks so much for your insights today.

Hodges: Pleasure. Okay.
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BHP and Rio head to head
19/04/2013 After the big two miners released their quarterly production numbers earlier this week, Morningstar's Mark Taylor give investors an idea of which company put in the best performance. BHP and Rio head to head Nicholas Grove 19/04/2013 http://video.morningstar.com/aus/video/130419_mining_audio.mp4

Nicholas Grove: The big two miners, BHP Billiton and Rio Tinto, released their quarterly production numbers earlier this week. And here to give investors an idea of which company put in their best performance, I'm joined again by Morningstar's Mark Taylor. Mark, thanks very much for your time today.

Mark Taylor: Thanks, Nick.

Grove: Mark, firstly to BHP, which commodities were the key drivers of its numbers and did those numbers contain any surprises?

Taylor: Well, the key drivers of earnings are unchanged. It's iron ore, copper and oil and gas prices, and then weren't any major surprises in prices or production numbers. If anything, that was marginally ahead of expectations despite the fact that volumes were off quite sharply due to cyclones and weather events.

Grove: Mark, how did Rio's numbers stack up and were there any surprises there?

Taylor: Very similar actually. And for Rio, iron ore is pretty much everything at the moment. Its numbers were marginally below expectations, but not meaningfully so, and in fact both Rio and BHP said that their full-year earnings projections were intact. So, while there might have been swings in the quarter itself, they will be making those up over the balance of their fiscal years.

Grove: Mark, in your opinion which company delivered the most pleasing set of figures?

Taylor: Well, I don't think there was any one area or one company that stood out, particularly in the quarter, as being more pleasing than the other, but just as a general statement, BHP's figures, I think, are more pleasing because they're just not quite so focused on one area. It's not all iron ore. Oil and gas is important for them and that did reasonably well, especially the shale gas in the States is starting to come to the fore, so that's quite pleasing.

Grove: Finally Mark, was there anything in BHP's third-quarter numbers or Rio's first-quarter numbers that are going to alter your full-year earnings forecasts, or is it all steady as she goes at this stage?

Taylor: It's pretty much steady as she goes. The one thing that did happen was the pit fall failure at Bingham Canyon in the States for Rio, but that was announced pre-quarter, so it was already factored in, but that is going to result in lower copper production for them and some added costs and lower revenue. So that has hit their earnings a little, round about 5 per cent or so, but by the time the quarterly came out, that wasn't news.

Grove: Mark, thanks very much for your time today.

Taylor: Thanks, Nick.

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A closer look at an outperforming LIC
17/04/2013 WAM’s Geoff Wilson provides an insight into the type of companies that have driven performance for the listed investment company. A closer look at an outperforming LIC Christine St Anne 17/04/2013 http://video.morningstar.com/aus/video/130322_lic_audio.mp4

Christine St Anne: While the Australian markets have experienced the ups and downs, Wilson Asset Management has managed to outperform the market since the GFC. To give us an insight into how the portfolios work, I’m joined by Geoff Wilson.Geoff, welcome.

Geoff Wilson: Thank you very much.

St Anne: Geoff, first thing; how wide is the investible universe for Wilson Asset Management?

Wilson: We look at every listed company. So, we had maximum flexibility. I really believe in investing. It's incredibly important to have maximum flexibility. We tend to focus on mid- and small-cap industrials because that's where we believe we can have a real competitor advantage, and what that is, is our ability to find companies that are undervalued. We spend a lot of time meeting with management. We would have over a 1,000 company visits a year and probably see over 800 to 850 odd companies.

St Anne: On that point about industrials, what sort of value are you finding in that sector?

Wilson: The small industrials has had a good run like the large – like the overall market, but we are still seeing value in that sector. Some companies we have been buying recently are the likes of Cash Converters, Hills Industries, Brickworks, those types of businesses.

St Anne: Geoff, you're also invested in financials, but not the major banks. So, what sort of companies do you have investments in?

Wilson: In financials, our exposure tends to be in two parts. One is we buy because we are a listed investment company and we have three listed investment companies. The large one is WAM Capital, then its WAM Research and then WAM Active. I spent a lot of time analysing the sector, and what we do is buy other listed investment companies, when they try to get sizeable discounts and our larger holdings are Century, Ironbark, Emerging Leaders, and in all those three companies there are some interesting dynamics at the moment.

Also, we look at the smaller financials, where we have had exposure there. Magellan has been a very good performer for us. We bought them at the $2 llevel. We have been selling them recently. Another one is Clime Investment Management. To me, that's a little Magellan. At the moment, they are really excited to get some good fund flows run by John Abernethy. Those types of companies make out the rest of that.

St Anne: You already mentioned a number of stocks. Are there particular companies that you're bullish on?

Wilson: Brickworks – I mean, companies would be very happy talking about that where are the holders or buyers, would be the likes of Brickworks, also Automotive Holdings. We think there would definitely be a merger with AP Eagers over the next six months, and it could be a big fully franked dividend liberated there. Another company we are buying discount assets, we bought some more today is Keybridge. They are the type of companies.

St Anne: Geoff, finally, how is the merger with Premium playing out for your business?

Wilson: It's been really good for WAM Capital. WAM Capital merged with Premium. We had about $220 million odd of assets, Premium had about $85 million of assets. In the end, about 65 per cent of Premium shareholders decided to become WAM Capital shareholders. The merger went through on the 31st of December 2012. We had a Board meeting on the 2nd of January. There the Board decided to liquidate all the premium investments, which we did, and now that money has been managed as we manage the rest of our money.

What WAM Capital shareholders have picked up is the ability to utilise $46 million of tax losses and also franking credits to allow about 40 million fully franked dividend to be paid out. So, it's been a very good merger from WAM Capital’s perspective.

St Anne: Geoff, thank you so much for your time today.

Wilson: Thanks very much.

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Woolworths versus Wesfarmers
12/04/2013 With Woolies having released its quarterly sales and Wesfarmers set to announce its figures next week, Morningstar lets investors know how these companies are faring as we head towards the end of fiscal 2013. Woolworths versus Wesfarmers Nicholas Grove 12/04/2013 http://video.morningstar.com/aus/video/130412_wesfarmers_audio.mp4

Nicholas Grove: This week saw Woolworths release its sales and revenue results for the third quarter, while Woolies' archrival Coles, owned by the Wesfarmers conglomerate, will release its results next week. Here to give investors an idea of how these two companies are faring as we head towards the end of the fiscal 2013 year, I'm joined by Morningstar's Tim Montague-Jones. Tim, thanks very much for your time today.

Tim Montague-Jones: You're welcome.

Grove: First of all, Tim, how did Woolies' third-quarter sales shape up in your opinion, and were there any surprises in the figures, either positive or negative?

Montague-Jones: It was a strong quarterly result, but we had expected that. The comparable sales number was up about 5.3 per cent, which is a strong number for group sales. The number the last quarter over the December half year was strong, because what happened over Christmas was we've had lower interest rates, rising equity values, and favourable weather as well, which has encouraged retailers to sell more products. So, retail conditions across the board have risen, and Woolworths as well as Wesfarmers are doing reasonably well at the moment, and that was apparent in this result.

Grove: What kind of performance are you expecting when Wesfarmers reports its retail sales next week?

Montague-Jones: Well, they're both doing very extremely well. The bigger are getting stronger, and the weaker are getting weaker. Both Woolworths and Wesfarmers have significant market power, and they're taking market share away from the smaller independents. So, we expect Wesfarmers also to report - or the Coles part of the Wesfarmers Group - to report strong revenue growth as well. If you look at the actual statistics of retail sales for the month of February, they've increased quite strongly since January. So the tide is coming up and it's lifting the returns of all the major groups.

Grove: Tim, what are you expecting in terms of dividends from both Woolies and Wesfarmers for the full year?

Montague-Jones: Woolworths has a payout ratio of 70 per cent, meaning about 70 per cent of its earnings are paid out in the form of fully franked dividends, and we calculate that to be about $1.30 for the full year. For Wesfarmers, its payout ratio is higher, at about 90 per cent, and on our calculation we look at a full-year dividend payment of $2 per share.

Grove: Finally, Tim, what are going to be the major themes confronting these companies in the 2014 financial year that investors should keep in mind?

Montague-Jones: That's an interesting question. Both groups are going to be, I believe, under a lot of pressure from the ACCC (the Australian Competition and Consumer Commission), because their market power is significant and they're getting stronger. There's a threat to smaller groups who want to kind of kick up a bit of political pressure for some action to be taken. So, I think that will be a concern for both groups. If we look at specifically Woolworths, for them next year a big component of the earnings growth is going to be Masters, which is a home improvement store portfolio, which is increasing, and that will be a key focus to see the performance of that group next year. For Wesfarmers, obviously, it's Target, which has not been performing that well and they've recently appointed a new managing director to the group. It would be interesting to see what their turnaround strategy is going to be and how successful it will be.

Grove: Tim, thanks very much for your time today.

Montague-Jones: You're welcome, Nick.

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Is NAB set for a turnaround?
11/03/2013 National Australia Bank is set to surprise investors with strong earnings growth, signalling a turnaround for the bank. Is NAB set for a turnaround? Christine St Anne 11/03/2013 http://video.morningstar.com/aus/video/130311_nab_audio.mp4 Christine St Anne: It was only in December when shareholders expressed anger at National Australia Bank's annual general meeting over the bank's poor results. Two months later, National Australia Bank posted some surprising numbers in its first quarter trading update. Today I’m joined by Morningstar’s David Ellis to talk about the bank’s metamorphosis. David, welcome.

David Ellis: It's a pleasure, Christine.

St Anne: David, firstly, has National Australia Bank's first quarter trading update signaled a turnaround for the bank?

Ellis: Well, being a trading update, you can't make too definitive statement or conclusion, but they look good. Margins were good, top line revenue growth was positive, and bad debts were down. So the underlying trends looked very good.

St Anne: Is the bank positioned to improve its earnings quality?

Ellis: Yes, definitely. I mean, obviously, NAB has long held the reputation for bad surprises, negative surprises, for 10 years or more. So, the last couple of years there has been major work on restructuring and repositioning the bank, particularly here in Australia, and earnings quality is improving and will continue to improve.

Margins are going to expand. Bad debts, I am expecting, will come down. And this week, the NAB is launching a major strategy update, and I expect to see some good, positive, long-term trends in their cost base; so improved productivity, which, of course, leads to improved profits.

St Anne: David, you had mentioned that the National Australia Bank was the riskier amongst the major four. Do you still hold that view?

Ellis: Yes, it is. But I’m saying that the balance of risk and return is changing, and so the riskiness factor is reducing and there is more certainty in earnings. So they've still got the risky U.K. banks, which, of course, over-pin or overhang the overall risk factor of the bank. But I can say the risks are decreasing and the quality of the management and the quality of the earnings are improving.

St Anne: David, on that point of the U.K.’s troubled operations, do you think that the Bank can finally manage to effectively offload that business?

Ellis: Not in the near term, no. Not this year. There may be some further news on that in the near term, but economic conditions, and particularly conditions for the financial services groups, for bank in Europe and the U.K. are slowly improving. Bank share prices are up significantly in Europe and the U.K. over the last six months, 12 months.

So there is – I see there is more opportunity. The possibility of an exit from the U.K. without incurring too much of a large write down, I think, is improving. It won’t happen overnight, but the chances of an exit, I consider, are definitely improving.

St Anne: David, thank you so much for your views.

Ellis: It's a pleasure, Christine.

St Anne: Morningstar subscribers could get more information from David Ellis's report on National Australia Bank by going to the website and looking at the stocks tab.
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Paying dividends in gold
08/03/2013 Evolution Mining's Jake Klein talks about the company's new dividend policy that aims to give investors greater exposure to the production of gold. Paying dividends in gold Christine St Anne 08/03/2013 http://video.morningstar.com/aus/video/130307_stocks_audio.mp4 Christine St Anne: Gold producer, Evolution Mining, has recently announced a new dividend policy that links its production with dividend payments. To tell us more about this initiative, I’m joined by the company's executive chair, Jake Klein. Jake, welcome.

Jake Klein: Thank you. Good morning, Christine.

St Anne: Jake, can you tell us a little bit about this new dividend policy and how it works?

Klein: Sure. It came in at an opportune time for us, because we are hearing consistently from investors that they want the return, they want the dividend from gold companies. Gold companies have traditionally been relatively poor payers for dividend, rather going for growth.

We're only 15 months old. Evolution was only started in November 2011. We have been through a major capital program and just this quarter we’re finishing our fifth mine and that will peak our capital requirements. So, we thought there was an opportune time to give investors clarity that they will be getting a return, and we thought that it was innovative, and we are the first Australian company to introduce a gold-linked dividend, which will mean that our dividend is really almost a royalty. Royalty companies are very well valued at the moment in the markets.

So, we wanted to give investors, exposure to Evolution plus a royalty.

St Anne: Jake, how are you able to sustain the dividend payments, if production falls or even the price of gold falls?

Klein: Well, it will, because 2 per cent – we are saying that we will pay effectively 2 per cent of our production – of our revenue to shareholders as a dividend. So, if that would occur, yes. But likewise if production expands or the gold price goes up, then shareholders will benefit from that.

So, we are linking it to the gold price and our production. 2 per cent is a start. We recognize that we need to be consistent and be able to ensure that we pay and we thought 2 per cent was a prudent number to start with.

St Anne: Jake, there has been a lot of discussion amongst investors about resource companies not giving back as much as they should. How you balance capital reinvestment with giving back to shareholders?

Klein: You are hearing it loud and clear from shareholders, angry shareholders. Look I think the gold industry is almost going through what I described as a retooling and a rethink of how it's going to operate. Just like the financial services industry in some ways went through a credit crisis in 2007 and come out healthy and stronger. The gold industry is not going through a credit crisis, maybe a credibility crisis, but I think through this rethink and relook at capital investments, clearly investors are focused on return on capital as gold companies are going to be more disciplined about capital allocation, returns on capital, dividends and returns to shareholders. I think, the gold industry will be healthier for it.

St Anne: A lot of investors are attracted to gold through gold bullion or exchange-traded funds or ETFs, what are the benefits of investing in a gold company as opposed to those other investments?

Klein: Well, I mean, that's been a theme. And in fact, gold equities have in some ways underperformed gold bullion and that's led to the belief that you’re better off in gold ETFs or bullion. I mean, I think that’s hopefully going to change.

You can't have a discovery in an ETF. In a gold company, you can have an exploration success that adds ounces that weren’t there previously. You have much better leverage to the gold price, and hopefully now with us introducing gold-linked dividend, we are giving you something again that investors cannot get from an ETF, which is a return.

So, I think gold companies need to demonstrate the discipline, which investors are asking, but I think the returns should be more leveraged and potentially higher going forward.

St Anne: Finally, Jake, could you give us a little insight into Evolution Mining, and what your plans are for the future?

Klein: We're excited about the future because in some ways Evolution was created for these times, challenging equity market, challenging investor markets. We set ourselves up 15 months ago with a view that there was an opportunity in Australia to create a mid-tier gold company. We are doing exactly that. For the last five quarters, we've delivered to our guidance. This quarter, we expect to produce between 85,000 and 90,000 ounces. We're commissioning our fifth mine this quarter. We've peaked our capital outflows. So, from next quarter or the September quarter, we will be cash generative.

So, we are extraordinarily well positioned, gearing only 7 per cent with significant headroom on our debt facility. So we don't need equity. We will start generating cash. We will start returning some of that cash to shareholders through our dividend policy, and we will look for opportunities. We think Australia has done a poor job, representing itself to international investors in the last few years. The mineral resources tax, the carbon tax, the minority government have all led to investor confidence being somewhat reduced including with international investors in Australia. I think, Australia can regain the ground as a premium mining destination, and I think that will come in the next 18 to 24 months.

St Anne: Jake, thanks so much for your time today.

Klein: Thank you. /video/transcript/2279 mailto: ?subject=Paying dividends in gold&body=http://www.morningstar.com.au/video/story/2279

Top stocks from earnings season
01/03/2013 As the curtains are drawn across the half-year earnings season, Morningstar's Peter Warnes helps shed some light on what can often be a confusing time for investors. Top stocks from earnings season Nicholas Grove 01/03/2013 http://video.morningstar.com/aus/video/130301_earningswrap_audio.mp4

Nicholas Grove: As the curtains draw across earnings season this week, many investors will be wondering which companies put in a good performance and which failed to live up to expectations. Meanwhile, many other companies' results may have simply left investors scratching their heads. Thankfully, here to shed some light on these companies' results, I'm joined by Morningstar head of equities research, Peter Warnes.

Peter, thanks very much for your time today.

Peter Warnes: Thanks Nick. It's always good to be here.

Grove: First of all Peter, let's start with the positives. Which of the big caps put in the most pleasing performances in terms of both earnings and dividends?

Warnes: Nick, I think before we get to the individual stocks, I think we have to address the situation that the reporting season overall was positive. I think the expectations were fairly low, albeit that we've had a robust reporting season. Yes, there has been some positives and some negatives, but overall the positives outweighed the negatives and that's why the market continues to push higher.

In terms of the individual big-cap stocks that delivered, if you like, strangely enough or maybe not so strange, they came from that defensive space. The retailers Woolworths and Wesfarmers via Coles; the healthcare via Ramsay, CSL, Primary Health Care; and in the banks, the only big bank that reported was CBA. And then you've got the Telstra report which didn't surprise, but it was just a great solidifier, if you like, for confidence - and it should be of no surprise. I mean, defensive stocks do always perform and should deliver in a market or an economy that is under a little bit of pressure.

Outside that, IAG, that was a very good result, and in addition to that, Leighton and Brambles we also liked. I think of the big caps, honestly, Woolworths was a very good result, strong where we thought that it would be strong, in the supermarkets, and really they have delivered where there was quite a few skeptics out there. When you've got the Australian supermarket operation with an EBIT margin of 7.73 per cent against Coles at 4.7 per cent, that was a marvelous performance.

Grove: In your estimation, Peter, which company delivered the biggest upside surprise?

Warnes: Nick, there were obviously some smaller caps that went very well. I would think from my perspective, I think CSL was an outstanding performance. Given that it's a global leader - you have big market shares and where they've really made significant ground was increasing market share in the emerging markets, small gains in the larger, more developed markets, a wonderful cost control, and when you're working off a $1-billion base, to come in with a 24 per cent increase, it's a very, very strong result. And a new CEO coming in after McNamee's departure, I think that company is in great shape, and I would think that was the highlight of, if you like, the big caps in my mind.

Grove: On the flip side, Peter, which companies' results did you find to be the most disappointing?

Warnes: Nick, there always are some disappointments. Look, I wouldn't call Rio and BHP or any of those, the major resource stocks, disappointing. People knew what was happening with prices of commodities, and there was some guidance there and what have you. So I wouldn't call them disappointing.

One stock that I forgot to mention on the positive side in the resources space, which I think was the feature of the resources space, was Woodside. That was a marvelous result as well from the positive side.

Now, back to negatives. Look, the mining services, anything mining-facing or resource-facing was under pressure as we know. Disappointments - well, I suppose Ausdrill, certainly UGL disappointed - we thought that was going to happen, because the activity was much, much slower.

Elsewhere, I think Origin Energy disappointed with a loss of customers in retail energy to AGL, strangely enough. And of course, as you know, Origin bought New South Wales retail energy assets from the government and they've lost a little bit of share there. And niggling increasing costs and their massive LNG project in Queensland offset the market. Smaller stocks - SAI Global disappointed, Billabong is a serial underperformer. But other than that, I'm just trying to think of others. There were some there, but not dramatic.

Grove: Which big-cap do you think delivered the biggest negative surprise?

Warnes: Yeah. I think Origin again. It was something that came out of left field a little bit. The other one that was a bit negative and certainly disappointed was Cochlear and that came in early in the reporting season, so you tend to forget about them three weeks later. But that disappointed. And I think it disappointed, because the market was looking for them to continue to increase their market share in the developed market if you like. And whilst the overall number of units sold was up nicely, the overall majority of those were sold in China, which was low-margin and it would appear on the surface that they did lose market share in the developed markets and that was the US and Europe.

And so that was a disappointment and that stock did come back quite sharply. So, Origin and Cochlear I think were the two that in big-cap space that were disappointing.

Grove: Finally, Peter, what themes do you think will characterize the market as we close out the final four months of the 2013 financial year?

Warnes: Nick, the economy looks like its stabilizing and there are relatively comfortable levels of activity. Yes, mining and resource activity is slowing. Investment in that area is peaking. Job creation is struggling. I would think that still there will be some focus on defensive stocks, because they have really delivered in the first half. And my gut feel is the market is just ahead of itself at the moment. I wouldn't be surprised at all to see it pull back a little bit pre-June and then strengthen going into the back half of this year.

Grove: Peter, thanks very much for your time today.

Warnes: Pleasure, Nick, always a pleasure.

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Earnings season winners and losers
15/02/2013 For the week ending 15 February, Morningstar head of equities research Peter Warnes lets investors know which companies' earnings impressed and which did not. Earnings season winners and losers Christine St Anne 15/02/2013 http://video.morningstar.com/aus/video/130215_reporting_audio.mp4 Christine St Anne: Earnings season continues this week with a number of companies including Wesfarmers, CBA and Rio announcing their results. Morningstar's Peter Warnes joins us again to give us his take on the companies that impressed him and those that did not. Peter, welcome.

Peter Warnes: Thanks Christine. It's lovely to be here.

St Anne: Peter, let's start with the banks. Did CBA's cracker result surprise you? And where there any concerns from ANZ's trading update?

Warnes: Christine, CBA's result was a great result. It ticked all the boxes, and if there was any surprise, I guess from a headline point of view, a 20 per cent increase in the interim dividend to $1.64 probably surprised people, but the Bank had already indicated that it's going to rebalance the first half, second half dividend and so let's not expect a 20 per cent hike in the second half, it won't happen. They've already guided that the second half dividend will be slightly lower than second half of 2012, but overall, we are looking for almost a 10 per cent increase in the dividend for the full year. So that was surprise number one at the head line.

Surprise number two, the 81 per cent of their mortgage customers are now on average seven months in advance of their payment requirements. That is a staggering number. It will put some shivers into the spines of bears that the Australian housing market is going to collapse and there will be a calamity in bad debts for the major banks. So Commonwealth Bank's result, honestly, it was very, very hard to fault and the market appreciated the results accordingly. In terms of ANZ, again, no negatives there. Surprises were that the bad debts were a little lower than anticipated, so that's a positive. Margins are holding at the levels of last year, about the 2.25 per cent to the 2.26 per cent mark. Overall the bank looks to me to be in line for another strong result this year.

St Anne: Moving on to mining giant, Rio. Peter, was their result what you expected and are there any immediate concerns for the newly appointed Chief, Sam Walsh?

Warnes: Rio, a few weeks ago delivered some bad news for the market in terms of some significant impairment and write-downs, and the market did pull back their forecast. So Rio did actually match expectations and as I said, only just recently downgraded. So there were no surprises there in the, underlying bottom-line which was down 40 per cent, iron ore again the feature, and a very strong result there despite weakening iron ore prices.

The dividend was a surprise, and perhaps it was a little bit of giving the shareholders back something after some bad news. So that was positive. Now Sam Walsh has – there's lot of expectation, and the weight of Rio is on his shoulders so to speak. He has got a pretty stamp on this multinational mining group, I think fairly quickly. He is already set right, slashing operating costs, cutting capex, reducing exploration expenditure. So he is going to drive the bottom-line. By driving the bottom-line, hopefully there will be some more goodies to shareholders down the track. Has he got any problems? I suspect the problems might be more to do with sovereign risk than operational. He's got Mongolia, Guinea, and Mozambique to deal with. Three places quite frankly I wouldn't want to do any business. But he has operations there of size and he will have to deal with those sovereign risk issues, whilst as I said, focusing on the bottom-line and driving it.

St Anne: What about Wesfarmers. We know Coles did very well, but how did their other businesses stack up?

Warnes: Christine, Coles did do well, and just covering off that briefly, strong performance up 14.6 per cent in EBIT, off a 5 per cent increase in sales, EBIT margin up 38 basis points to 470. Things are going well there. In terms of the other operations, Bunnings was another feature; I mean you've got a very, very competitive market. You've got Masters muscling in, you've got a rejuvenated Mitre 10 and yet, they held the margin, in fact in margin they jumped to 12.9 per cent. So EBIT up 6.5 per cent, 6.8 per cent on sales of that 5.8 per cent, a great performance in that competitive environment with deflation still even. Kmart was outstanding, I just don't know how they are doing what they are doing, but Guy Russo has got it absolutely firing. Margins of 10.7 per cent in the discount department store are heard off in Australia and he is doing a wonderful job there.

Target on the other hand didn't disappoint because you've got a massive restructuring operation and a repositioning if you like, of Target in the market between the department store and the discount department stores, they are trying to slot it in a little bit above the discount department store. EBIT down 20 per cent, sales just up a tad, look, they'll get that right, so no real problems there. The Resources clearly was a downtick but look, that's a volatile situation, earnings down 63 per cent, it will turn around, but they've got some work to do, I mean, despite the production being up, significant force in coal prices. In addition to that, clearly operating costs went significantly higher and they’ve got to start addressing those issues. Industrial and Safety was a little bit disappointing albeit that it is facing, one of their clients the major miners, so they are selling consumables to the major mining companies. So that was off a little bit because of the reduced activity in the mining space. Chemicals, Energy, and Fertilizers were a flat result and kind of as expected. Insurance was a very strong result but rebounding from this, a very elevated client in the previous corresponding period at Christchurch and a few weeks caused problems.

St Anne: Peter, the Australian REIT sector has reduced its risk over the past few years. With the announcements this week from GPT, Stockland and Dexus, have their results reflected this trend?

Warnes: Christine, the markets perceive that there's less risk in the REITs now and to a great degree they are correct, because the biggest risk in REITs is gearing. After the GFC, the gearing has been repaid and the majority of REITs now have a very, very comfortable gearing ratio. So in terms of risks, the balance sheet is in much better shape. In terms of the portfolios if you like, the diversified REITs, anyone exposed to residential has still got some higher risk. You've seen that with significant write-downs in Mirvac and Stockland. So the risk is probably, yes, it's abated because of lower gearing, but we must be aware that those exposed to residential have still got some risk.

In terms of the results GPT was in line with where we looked and we're looking forward to another wood solid second half. Dexus, again in line with expectations and no problems there. Stockland, again, they followed Mirvac with a significant write-down on the residential side, but their other exposures office and in commercial are pretty reasonable. Look, in terms of REITs going forward, we're still fairly relaxed. Occupancy is high in terms of retail office and industrial. So, we're comfortable in terms of that position. Residential has still got – we're still relatively nervous on residential, but overall not too bad.

St Anne: Peter, thanks again for your insights.

Warnes: It's lovely. Thank you, Christine.
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Earnings season winners and losers
08/02/2013 For the week ending 8 February, Morningstar head of equities research Peter Warnes lets investors know which companies' earnings impressed and which did not. Earnings season winners and losers Nicholas Grove 08/02/2013 http://video.morningstar.com/aus/video/130208_earnings_audio.mp4

Nicholas Grove: This week saw the likes of Telstra, Cochlear and Transurban release their results for the first half of the 2013 financial year, while NAB and Macquarie provided first-quarter trading updates. Here to give investors an idea of which companies impressed and which did not, I'm joined by Morningstar head of equities research Peter Warnes.

Peter, thanks for joining us.

Peter Warnes: Thanks, Nick. It's always great to be here.

Grove: First of all, Peter, let's start with Telstra. Did the company deliver as you expected and were there any surprises, either positive or negative?

Warnes: No, Nick. Telstra delivered as expected and then reaffirmed guidance for the full year in all the benchmarks - in other words, in revenue, in EBITDA, and free cash flow, and also more importantly, the dividend. So, no surprises in terms of the result.

In terms of the operations, positive certainly in mobile - what the market expected. Another 607,000 mobiles added, 14.4 million mobiles in service. They continue to take market share. It is the growth engine of Telstra now. The negatives - and the market expect them and there is nothing to get worried about - were a 10.8 per cent fall in PSTN or the traditional fixed-line operations and Sensis was under some pressure, as was expected. But importantly for Telstra, we are now less than five months away from going into 2014 financial year and that should bring a higher dividend, paying $0.28 currently. We expect it to move to $0.30, maybe $0.31 for FY14.

Grove: Peter, moving on to NAB and Macquarie, was there anything in their quarterly updates that caught your eye or was a cause for concern?

Warnes: Nick, NAB was a relief, if you like, given the bad news that came out on their downgrades earlier. Lower bad debts obviously helped good cost control. Their Australian franchise is still doing very well. I'd love to see the exit of the UK, but that probably will take a little time, but no, overall, positive from the NAB, looking like a $6-billion impact for the full year. So, no, we're comfortable there.

In terms of Macquarie, it's a little disappointing that the guidance came in at a 10 per cent increase year-over-year for their FY13 number. That was below consensus and that's not surprising given that we're going through some pretty ordinary conditions, particularly in the market-facing operations, albeit that they are improving.

And so, I would say to you that probably the worst is over for Macquarie Bank. The engine room, if you like, of their operation is the asset management and funds management operation, which is annuities-style income. That's going very well, but the market-facing operations are where you do get some leverage. So, Macquarie Equities and some M&A, they could now start really kicking some goals as the equity markets move higher. So, I'm expecting a better fourth quarter - in other words, the March quarter, which finishes the year, has some nice tailwinds.

Grove: Peter, what did you think of the results from Cochlear and Transurban, and do you have any concerns about these businesses?

Warnes: Two very, very distinctly different businesses there. Cochlear - again, it was disappointing, and mind you, the stock has had a very, very big run through the $80 mark. The disappointment was that it appears they have lost market share in the non-Chinese or excluding Chinese sales, so in the sales to the US, Europe and the rest of the world, which have much more higher margin than the Chinese sales, they seem to have lost market share. And don't forget, they are coming off a comparative period last year where there was a major recall that cost them about $130 million. That's where the market did have some concern. I would suspect that it's only of a short-term nature. The aggressive R&D is important, and I think that you'll see more innovation, more new products come on there, and we are not concerned about the long term for Cochlear overall. It's basically an immature market that still got a plenty of growth.

Transurban - the result was in line with expectations, there's nothing surprising, a couple of positives and a couple of negatives, and negatives were what was happening in the Sydney market, if you like, M2 and M5 upgrades, car parks rather than freeways, and so, therefore, the revenue was under pressure there, albeit that there was some price rises or toll increases offsetting that. Melbourne CityLink helped and they got some upgrades there in terms of both volume and some toll increases.

In the US, there are a couple of problems there that, albeit in terms of the portfolio were small, but niggling. The upgrade of the 495 Express Lanes isn't working and looks like it could have to be written down to zero. That's coming off the back of a disappointing investment in Pocahontas. And if you get a couple of those things back-to-back, the market might say: "Well, this is what you are doing." So, look, we're comfortable with Transurban. The free cash flow is still not covering the distribution, albeit, only by a small margin, but we're still okay.

Grove: Finally, Peter, earnings season can be an overwhelming time for investors as they feel like they are bombarded with information from all sides. What do you think is the most important thing investors should keep front of mind so that cooler heads prevail?

Warnes: It's a good question, Nick. They'll get bombarded and the analysts get bombarded as well. So, my advice to both the analysts and to the investor is try to keep a cool head and don't panic. Figure out why you bought the stock - why is it in your portfolio, and look at the reports that are coming at you, and say with a cool and calm demeanor, say, "Is it doing what I expected it to do?" If it is, don't worry about it. If it's not, then dig deeper. So, in the cool climate, no panic, sit back and say, "Do I stay with that stock, because it's not delivering what I expected it to do? That's the reason I bought it - should I exit?"

It's a good time to have a look at the portfolio and say: "Do I need to do anything with it?" And if you do, do it with the equipment, that is, the result just fresh in your mind. So, don't panic, look at it in a relaxed manner and maybe do some tidying up. Leave the winners - the good ones. Leave them alone, you don't have to worry about them. If they're delivering, leave them alone. Just be concerned about the ones that aren't matching what you expect them to do.

Grove: Peter, thanks very much for your time today.

Warnes: Pleasure Nick.

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Banks and financials outlook 2013
20/12/2012 Morningstar's David Ellis tells investors what issues to keep an eye on and gives them an idea of what to expect in terms of earnings from the financials sector in 2013. Banks and financials outlook 2013 Nicholas Grove 20/12/2012 http://video.morningstar.com/aus/video/121211_banks_audio.mp4

David, thanks very much for your time today.

David Ellis: Thanks Nick, my pleasure.

Grove: First of all David, what are going to be the key macro issues, both domestic and international, that investors need to keep an eye on when it comes to this sector in 2013?

Grove: Stepping away from the banks for a minute, what sort of performance can we expect from the big insurers in 2013?

Grove: Finally David, how do you expect the wealth managers and the diversified financials to perform in 2013?

Grove: David, thanks very much for your time today.

Ellis: It's a pleasure, Nick.

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Consumer, health and industrials in 2013
21/12/2012 Morningstar's Peter Rae lets investors know what to expect from the consumer, healthcare, industrials and telco sectors in the coming year. Consumer, health and industrials in 2013 Nicholas Grove 21/12/2012 http://video.morningstar.com/aus/video/121210_industrials_audio.mp4

Nicholas Grove: The Morningstar equities research team recently released the Huntley's Forecast 2013 sector reviews. Here to give investors an idea of what to expect from the consumer, healthcare, industrials and telco sectors in the coming year, I'm joined by Morningstar's Peter Rae. Peter, thanks very much for joining us.

Peter Rae: Thank you, Nick.

Grove: First of all, Peter, what are the key issues, trends and risks that you think investors should bear in mind when it comes to both the consumer discretionary and consumer staple sectors in 2013?

Rae: Nick, in the consumer sector there are a number of issues and trends that have been playing out for some time. We've got cyclical conditions facing the sector at the moment and we've got weak consumer sentiment that's been around for some time. We've had interest-rate cuts. It's probably more than 12 months since the first interest-rate cut was put in place, but that doesn't seem to have made a lot of change to consumer sentiment at this stage. People are looking to pay their down debt, people are a lot more frugal, so that's had an impact on the consumer discretionary space, retail, and media, with advertising down. We expect that that trend will probably continue. We don't see any signs at this stage of any change in that trend, but we are hopeful that the interest-rate cuts, including the latest one in December, starts to have an impact early in the new year. But we think it will probably be a little while before we start to see that flowing through to the outlook for many other players in the consumer cyclical or consumer discretionary space in particular.

Grove: Peter, broadly speaking, where do you see earnings and dividends heading for healthcare companies in 2013?

Rae: Well, the healthcare sector is very defensive sector, earnings are resilient. Sure, the sector can be subject to regulatory issues some times, but we are seeing a fairly positive outlook for that sector for 2013. CSL recently came out with earnings guidance upgraded and they are looking for pretty strong growth next year. I think most of the major players, the narrow-moat firms in particular that we cover in that sector, are expected to perform fairly well next year. So, we are looking for some good earnings and dividend growth from that sector. The only thing I would say, though, is that the share prices in that sector have run quite hard over the past year. And so, from a value perspective, there is not a lot there and most of the expectations are already priced into those stocks.

Grove: When it comes to the telco sector, what issues should investors keep front of mind and what do you expect in terms of earnings from this sector?

Rae: Look, there's a couple of big issues there. One is the potential for a change of government next year with an election due. Telstra has done a deal with the current government on the National Broadband Network. The opposition has made noises about not favouring the National Broadband Network. So, we don't really know what they would look to do if they were in government, but we think that, regardless, Telstra is fairly well-protected. There are clauses in there that would compensate them if changes may be made to the NBN legislation. So, the other big issue is the auction of mobile spectrum. We would be watching that to make sure that the bidders such as Telstra and the other networks don't pay too much for that spectrum. With the government under budgetary pressures, they'll be obviously looking to extract as much as they can from that auction. So, I would be hopeful that the participants don't pay too much because it would then have an impact on the cost base further down the track. And in relation to the earnings outlook for the sector - relatively stable. It is a mature sector, so we are certainly not expecting strong growth, particularly from the likes of Telstra, but should see good, moderate earnings growth come through. Some of the smaller players will probably achieve better earnings growth as they pick up market share and they've also got cost programs in place, which should help drive the bottom line.

Grove: Finally Peter, when it comes to the industrial space, which sub-industries do you expect to perform well and which do you not expect to perform so well?

Rae: Look, the industrials is a mixed bag. A lot of the subsectors in there have been hurt by the weak consumer environment and also the strong Aussie dollar, which has made it difficult for manufacturers in particular to compete. We are hopeful that there will be perhaps a pickup in the building sector, or with the signs there that we may start to see a pickup with interest rates now at fairly low levels, hopeful that there will be some pickup in activity in the housing and construction sector. But, again, a lot of that's already priced into the (shares). So we're sort of looking for some rebound in earnings growth from that sector through 2013. The transport sector is a sector that's also hit with weak consumer sentiment - goods not moving as fast, fewer goods moving. So it's a fairly weak sector, and again, unless we see a pickup in consumer activity, it's probably going to remain fairly weak in the short term.

Grove: Peter, thanks a lot for your time today.

Rae: Okay. Thank you.

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Huntleys' 2013 forecast
07/12/2012 Morningstar’s head of equities research Peter Warnes provides an outlook on the key investment issues for 2013. Huntleys' 2013 forecast Christine St Anne 07/12/2012 http://video.morningstar.com/aus/video/121207_forecast_audio.mp4 Christine St Anne: Volatility remained in 2012 as investors continued to navigate some very challenging markets. So, what's in store for 2013? Today, I'm joined by Morningstar's Peter Warnes to give us his outlook for next year. Peter, welcome.

Peter Warnes: Thanks Christine. It's lovely to be here.

St Anne: Peter, Ian Huntley had forecasted that the market would range between 4,000 to 5,000 this year. Was his forecast accurate?

Warnes: Christine, Ian's last two forecasts for 2011 and 2012, had the trading range on the All-Ordinaries Index between 4,000 and 5,000 and strange enough, it has proved very accurate. If you look at the performance of the ASX All-Ordinaries over that two-year period, it has traded slightly out at the top end. But for the last 11 months or 12 months it has traded in the lower end of that range between 4,000 and 4,500, but has been contained in the last two years in that band 4,000 to 5,000. So, it has been a very, very good forecast going back in hindsight.

St Anne: Peter, what sort of factors do we need to see in the market if we are to have a teens bull market for next year?

Warnes: Christine, I think we've got to be a little careful to just say that there is going to be a teens bull market in 2013. What Ian and I are saying is that bull markets develop and we are looking for a teens bull market to develop and the bull markets evolve. Yes, you get initial surge in the market, the first surge is usually very profitable. But then you get the consolidation and you move into a higher zone. So, we are looking for a teens bull market that may have some longevity pushing out to 2015, 2016.

We're looking for a more gradual trend into 2013. The market seems to be reasonably well underpinned at the current level around the 4,500 mark, underpinned by a dividend yield of the market at 4.4 per cent versus the 10-year bond yield at 3.1 per cent, 3.2 per cent. We haven't seen dividends yields on the market over the bond yield for a period of time. Since early 1970s it happened very rarely and in that circumstance, it becomes favourable for equities.

Now, that doesn't mean that the equity market is going to roar away. All it means is it's got some good underpinning as people continue to look for, if you like, sustainable income-producing stocks. The market is giving you that opportunity, as I said, with a yield of 4.4 per cent versus the bond yields of 3.1 per cent, 3.2 per cent.

St Anne: Peter, do you think you'll be able to give us an idea about how you see the market range for next year?

Warnes: Well, Christine, it's always difficult and probably a dangerous occupation to forecast where indices may or may not end up over the course of a year. I would rather get the trend right and we are continuing to say that we could see a moderately rising trend in the market. As I've said, we think the market is already underpinned at 4,500 by those yields; but if forced to have a stab at where the range would be, I would say, look, 4,500 to 5,500 on the All-Ordinaries Index for 2013 calendar year.

Could you see some downside from 4,500? Well, there's obviously always chances of that. And could you see some upside from 5,500? Yes, there's possibility that lies. But as a general theme and probably I think more realistically is that this market will just move up, if you like, one gradient, if you like, one bar from the 4,000 to 5,000 range to 4,500 to 5,500 and I'd be comfortable with that.

St Anne: Peter, how do you see the eurozone playing out? Do you think Draghi's whatever it takes policy will be solely tested?

Warnes: Christine, look, we are not looking for and I'm not looking for any help from the eurozone at all. I just hope there's no more black swans or exogenous factors out there coming from the eurozone that could disturb global financial markets. I would think that the majority of the problems that are still persistent in the eurozone are going to be there for 5, maybe 10 years and hopefully, they are not going to get any worse.

Do whatever it takes and it's conditional because the buying of those bonds that Draghi is undertaking through OMT (outright monetary transaction) is conditional upon the Italy and Spain in particular, doing something about their problems. Look, these problems, as I said, are deep-seated. Having low interest rates doesn't solve the problem because the problem is that you've got to get the deficits down and the deficits are going to stay down. And that requires some, if you like, backbone rather than what we've had from the politicians over there and probably elsewhere is wishbones. And so what I'm looking forward is a change from wishbones to the backbones and they've got to do that and that will ultimately bring competitiveness and economic activity back into the zone.

But look, we are not looking for any improvement, if you like, of a dramatic nature in the eurozone economy for quite some time. It will probably just – a lot of it is going to depend on what Germany does, but there's too many hangers on there and the hangers on have got to get serious.

St Anne: Do you see some positive signs coming out of the US despite a fiscal cliff looming?

Warnes: Christine, I wish this fiscal would just go away. I think it's a distraction. It reminds me of Y2K. Y2K, every IT platform in the world was going to implode on the 1st of January 2000 as we switched from the 31st of December. It didn't happen. There was no dislocation and I think this fiscal cliff is of the same kind of proportion.

The US economy will not hit a brick wall and will not stop operating on the 1st of January 2013. Yes, it would be nice for these politicians to show some nationalism rather than their party-driven ideas and idealism. But that's what politics is all about.

The fiscal cliff is a distraction. I'm more concerned about what's happening in the real economy except the fiscal cliff and the signs are positive. The signs in the US, the banking system has stabilised. The housing industry has certainly bottomed. You have got housing starts now running at close to 900,000, I think, 895,000 starts for October and that's way up from 470,000 back in April 2009. Permits are at four-year highs. House prices are starting rise. The inventory of existing homes and new homes is falling.

So, what's happening over there is that low, low interest rates that where Bernanke aiming, aiming to keep long-term bond rates down so they will impact on mortgage rates and you've got 15-year mortgage rates in the US now at just over 3 per cent and 30-year rates at 2.6 per cent something like that. Now, that is going to start dragging some people back into that market and that market will once it gets to like a million housing starts on an annual basis that will start to be positive for GDP. It hasn't been a supporter of GDP for the last four or five years.

So, housing is better. Order sales are very robust. The consumer confidence and consumer sentiment numbers are okay and quite reasonable at this point in time. So, the green shoots in the US economy are there. We have to make sure that we keep watering them and get them to grow a little stronger.

But I would suspect that, look, that economy is – there's what we're looking for leadership. It is the most resilient. They are the most entrepreneurial race in the globe. They have technology. Just look what's happened with your iPhones and iPads and what have you, it came from Apple it is Apple that in the last four or five years, look at the development and what that's done to the technology and communications, et cetera, et cetera. So, that's where we are looking for leadership and I think you'll find that economy looking better and better as 2013 unfolds.

St Anne: Peter, China's growth concerns is one of the key topics for 2012. Do you think that this will continue and how do you see China's move to a more a consumption-oriented economy playing out?

Warnes: Christine, it was no surprise that China slowed down. You can't run 12 per cent, 13 per cent GDP growth year-in year-out, particularly as the base starts to get higher and higher. So, a slowdown was obviously on the cards and yes, everyone said okay, well, how far is it going to come back?

Look, I would suspect that the third quarter number of 7.4 per cent is probably the low. The exit of that quarter was better. In other words, September was better than August and August was better than July. And the subsequent numbers coming out October and November were also better than September. So, I would be looking for a marginally better fourth quarter.

The new power base there, it will get to work in 2013. There is still a lot of work to be done in terms of this move from the rural to the urbanization. Another 350 million to 400 million people have got to move and they want them to move before they get that balance in the economy. It's probably at the moment around 50-50. I think what they want see it at about 70-30, 70 in the cities and 30 in the rural regions and that still requires a lot of infrastructure.

But more importantly, it will change the complexion of China's economy. It will change it from an economy that is supported by and driven by infrastructure and exports to one that is more driven by domestic demand because of the move to – the urbanization move. So, domestic demand will become more important to the overall economy and a more balanced economy.

That will be, yes, you'll see a growth in terms of the bulks as Australia provides, in other words, coal and iron ore, those rates of growth will come off, but the volumes are certainly not coming off. The volumes are still expanding, but the rate of growth is slowing. But I suspect that in the base metals you could see some interesting moves there in terms of copper and nickel and aluminium. I think interestingly the prices there could start moving. But I don't expect the bulk prices to roar away anytime soon and probably there I don't think you will see bulk prices like you saw in the first quarter of 2011.

So, China, again, if you're like supportive of a 2013 market, that will drift, I believe, drift higher and that a better Chinese performance will help our resources stock which have been the ones that have really pulled this market down over the last year.

St Anne: Peter, finally, we're now moving into more of a low rate environment. What are the key implications for retirees?

Warnes: Christine, I mean, I'm not in the camp of further cuts in official interest rates in Australia. Having said that, I don't think they're going to go up. So, what I'm saying is that 3 per cent official interest rates for all of 2013 are highly likely. That puts pressure on term deposits and then term deposits are round about 4 per cent to 4.5 per cent with 2.5 per cent inflation means the real rate of return is 2 per cent.

Retirees have really got a very, very difficult problem in terms of where do I – what do I do? Do I go up the risk curve and go on get some equities or do I stay in capital secure investments with very, very little growth potential? I would think that what they have to do is probably go up the risk curve a little bit. Each individual has got different philosophies. But if you can buy sustainable (companies) and sustainability is the key word for 2013.

St Anne: Peter, thank you so much for your insights today.

Warnes: It's more than a pleasure, Christine. /video/transcript/2262 mailto: ?subject=Huntleys' 2013 forecast &body=http://www.morningstar.com.au/video/story/2262

Is the IMF wrong on banks?
22/11/2012 The International Monetary Fund has called for greater capital controls in Australia's banking sector but are their concerns justified? Is the IMF wrong on banks? Christine St Anne 22/11/2012 http://video.morningstar.com/aus/video/121122_banks_audio.mp4 Christine St Anne: The International Monetary Fund, or IMF, has recently called for greater controls on Australian Banks. Today I'm joined by Morningstar's David Ellis to discuss whether the IMF's concerns are justified. David welcome.

David Ellis: It's a pleasure, Christine.

St Anne: David, the IMF has called for banks to hold more capital. What is your view?

Ellis: Christine, I've got a very strong view and I think the IMF is wrong. I don't think the Australian Banks necessarily need to hold more capital for the reasons outlined by the IMF. Over the last three or four years, the four major Australian banks have increased their capital level significantly for a number of reasons, but the most important was getting over the global financial crisis particularly in 2008 and then in 2009.

The capital levels now are about 1.5 times higher than they were going into the GFC. The new capital global capital rules, applied from the 1st of January 2013, these are far stricter rules and the four major Australian banks have already exceeded the new minimum requirements and the bank regulator, the Australian Prudential Regulation Authority (APRA), has required the four major Australian banks to be fully compliant on the 1 January 2013 rather than a staged process or a staged period running out for three or four years.

St Anne: David, do you think that banks should implement greater stress testing as suggested by the IMF?

Ellis: Well, the banks always, have always and continue to undertake stress tests. They have done this in conjunction with Australian Regulator, APRA, and they have the details of the testing as confidential, however, I would estimate that the stress testing has become tougher and tougher and more robust. So by itself I don't see a need to say that stress testing needs to be done by the Australian banks. They have always done stress testing. They will always continue to stress test their business models.

Of course, there is good reason to continue to make it tougher, this stress testing. So I don't disagree with the need to continue, but it's not something new. They've always done it. APRA is heavily involved in that process. I think it's an evolving concept that they will continue to do more sophisticated stress testing and that ultimately leads to better and stronger banks.

St Anne: The IMF has also suggested that banks share the cost of the government’s guarantee. Is that justified?

Ellis: Well, that's a tough one. I struggle with that. I think in the end, unfortunately, the consumer will pay, no matter whether the government forces a fee or a charge on to the Australia banks for providing the deposits or guarantee. If the Australian government does go down that path and does raise it, a fee, I would imagine that the banks would pass it through to consumers one way or the other. It may not be a specific standalone charge or fee, but the banks will recoup it from their consumers.
St Anne: Finally, David, do you think that the banks are well placed if we do have another market crisis?

Ellis: Well, the four major banks have never been in a stronger position. Never been in a stronger position. As I mentioned earlier, the capital levels are 50 per cent higher than they were pre-GFC. The funding and liquidity levels are significantly higher. The reliance on short-term wholesale funding has decreased.

Wholesale funding has become longer maturity term in wholesale funding. The proportion of customer deposits to total funding has increased. It's running now between 50 per cent and 60 per cent. So capital levels are higher. So obviously, there is no guarantee we won't have another global financial crisis, but the Australian banks are in a far stronger position. We say with increasing confidence and increasing certainty that the Australian banks, the four major banks will actually have a surplus of capital in maybe 12 to 18 months' time, and we believe that the four major banks will be returning surplus capital to shareholders in 12 to 18 months’ time, which is far, far, far different to the IMF’s position that the Australian banks need additional capitals also.

St Anne: David thanks so much for your insights today.

Ellis: It's a pleasure Christine. /video/transcript/2257 mailto: ?subject=Is the IMF wrong on banks? &body=http://www.morningstar.com.au/video/story/2257

Westpac full-year earnings snapshot
05/11/2012 Westpac has delivered pleasing earnings and dividends for fiscal 2012 and Morningstar's David Ellis lets investors know what he expects from the bank down the track. Westpac full-year earnings snapshot Nicholas Grove 05/11/2012 http://video.morningstar.com/aus/video/121105_westpac_audio.mp4

Nicholas Grove: Westpac has announced its results for the 2012 financial year, and here to give investors his initial impressions of the bank's earnings results, I'm joined again by Morningstar's David Ellis.

David, thanks very much for joining us.

David Ellis: It's pleasure, Nick.

Grove: First of all, David, were Westpac's earnings above, in line with, or below what you were expecting?

Ellis: Westpac came in with some good solid numbers. A little bit higher than we were expecting. The profit came in at just under $6.6 billion, we were sort of looking at about $6.5 billion, and the dividend was $0.01 higher than what we were expecting. But overall, a good set of clean numbers for 2012 for Westpac.

Grove: David, what were the key drivers of Westpac's result?

Ellis: The key drivers were solid loan growth, so round about 4 per cent loan growth. Quite strong deposit growth - customer deposits were up about 12 per cent, 13 per cent - and so net interest income was up a little bit. Non-interest income was up strongly, which was a pleasant surprise following a weak 2011 performance, particularly in the markets and treasury area within the bank. The cost growth was good, it was below, so it was less than the rate of revenue growth, which is a very important measure because then the cost-to-income ratio improved and Westpac has the sector-leading low cost-to-income ratio. So, for every $1 of revenue Westpac earns, they earn more profit than their three other major bank peers.

Grove: Finally, David, was there anything about the result that really surprised you or that will in any way alter your outlook for the bank?

Ellis: No. I suppose the only surprise is that it was moderately better than we were expecting, so it was a pleasant surprise. No negative surprises. Importantly, the indications from the bank and from what we can discern from the result are that the capital position is growing strongly and following our major bank investment thesis, we expect major banks to have surplus capital in approximately 12 months, maybe 18 months time. And with that surplus capital, all other things being equal, and so as long as the economy doesn't collapse, we expect the major banks, particularly Westpac and CBA, to initiate some type of capital management initiatives in 12 to 18 months time, which would more than likely be a special dividend or share buybacks.

Grove: David, thanks very much for your time.

Ellis: It's a pleasure, Nick.

/video/transcript/2252 mailto: ?subject=Westpac full-year earnings snapshot&body=http://www.morningstar.com.au/video/story/2252

NAB full-year earnings snapshot
31/10/2012 Morningstar's David Ellis gives investors a breakdown of NAB's fiscal 2012 earnings and also discusses the bank's beleaguered UK operations. NAB full-year earnings snapshot Nicholas Grove 31/10/2012 http://video.morningstar.com/aus/video/121031_nab_audio.mp4

Nicholas Grove: National Australia Bank has announced its earnings for the 2012 financial year, and here to give investors his initial impressions of the bank's results, I'm joined by Morningstar's head of Australian banking research, David Ellis. David, thanks very much for joining us.

David Ellis: Pleasure, Nick.

Grove: First of all, David, were NAB's earnings and dividend in line with, above or below what you are expecting?

Ellis: Well, they were in line, simply because NAB had preannounced a couple of key earnings drivers about 10 days ago, particularly focused around bad debts. They had also preannounced the final dividend, so there was no surprises there. They had indicated that the cash profit would be similar to 2011. So there were no surprises with that. However, the makeup of the result was a little bit surprising and a little bit disappointing.

Grove: So, David, what were the key drivers that made up these results?

Ellis: Well, the key drivers that we identified, that we were looking at, were net interest margins and they declined sharply in first half 2012 and continued that decline into second half 2012, which was a little disappointing. Bad debts, even though there has been lot of focus on that with the preannouncement a couple of weeks ago, that was still little bit worse than I was expecting. The majority of the pre-disclosure related to the United Kingdom and to National Australia Bank's banking operations in the UK, but there was bad debt weakness here in Australia.

Some of the positives, however, some of the good things in the result were operating costs. So, costs are coming down actually, so they are not growing. Costs came down in the year and in the second half, so that helped to offset some of the weakness in the revenue growth and the weakness in the bad debts.

Our non-interest income recovered strongly from the previous year. That was good, but that's a volatile number and that changes from period to period. So while it was up in this year, it may be down next year, so it's not necessarily a good quality indicator of future earnings. So, overall, there was reasonable revenue growth - nothing fantastic - but reasonable. Credit growth was okay, there was some weakness in the Australian business sector, but the major weakness for the National Australia Bank was in the UK operations and they have been a festering sore now for quite a while and unfortunately will continue to be so for all for several years.

Grove: Finally, David, was there anything about the result that surprised you or that will alter your outlook for the bank?

Ellis: Yeah, and the margins were bit softer than I was expecting. So we've had to pull back some of our forecast on net interest margins. The dividend was also was preannounced. It was still a reasonably strong result, the dividend increase for the year. That's important because our thesis, our long-held thesis, has been that the four major banks are going to continue to deliver sustainable growing dividends and that's very important. And while the profit number was a bit softer, the fact that the dividend was around 4 per cent higher than 2011, and indications that the dividend will continue to grow, reinforces our thesis and our positive view on the major banks.

Grove: David, thank you very much for your time.

Ellis: It's a pleasure, Nick.

/video/transcript/2250 mailto: ?subject=NAB full-year earnings snapshot&body=http://www.morningstar.com.au/video/story/2250

ANZ full-year earnings snapshot
25/10/2012 Morningstar’s David Ellis gives a rundown of ANZ's fiscal 2012 earnings and gives investors an idea of what to expect from the bank in terms of capital management. ANZ full-year earnings snapshot Nicholas Grove 25/10/2012 http://video.morningstar.com/aus/video/121025_ANZAUDIO.mp4

Nicholas Grove: ANZ has announced its results for the 2012 financial year and here to give investors his initial impressions of the bank's earnings, I'm joined by Morningstar's David Ellis. David, thanks very much for joining us.

David Ellis: Pleasure Nick.

Grove: First of all, David, were ANZ's earnings and dividend above, in line with, or below what you were expecting?

Ellis: $5.66 billion, that's a touch higher than what we were expecting but pretty much in line. The surprise was the dividend, which was a solid increase. They are 4 per cent higher but we were looking for about 5 per cent higher. So, the final dividend was just a touch under what we were expecting.

Grove: David, what were the key drivers of this result?

Ellis: Good top-line revenue growth made up of interest income, about 4 per cent, 5 per cent growth in interest income, 3 per cent growth in non-interest income, so it was good to see some top-line revenue growth, particularly in the economic conditions that we're in with relatively modest credit growth. Cost control was good, particularly in the second half. Second-half costs were flat on first half, and so the equation of pretty solid revenue growth with lower cost growth means good upside, uplift in underlying earnings.

Grove: Finally David, was there anything about the result that surprised you or that will alter your outlook for the bank?

Ellis: The dividends were a little bit lower than we were expecting and also there was guidance from ANZ that they're going to maintain their payout ratio at round about 65 per cent. We were forecasting a little bit higher than that, so we've had to pull back our forecast a bit to account for that. Credit growth, also credit quality, loan quality, ANZ guided for some weakness there and with expectations of higher bad debt - not much higher but a little bit higher bad debts in the next few reporting periods. So, we've increased our bad debt provisions, we've pulled back our dividend forecast a touch, but importantly, we still maintain that ANZ and all four major banks are going to continue to grow dividends and maybe in 2013 or 2014 we might see some capital management initiatives, which could be special dividends or share buybacks for the major banks.

Grove: David, thanks very much for your time.

Ellis: Pleasure Nick.

/video/transcript/2244 mailto: ?subject=ANZ full-year earnings snapshot&body=http://www.morningstar.com.au/video/story/2244

Investing in Suncorp CPS2
12/10/2012 Morningstar provides investors with its insights into the latest hybrids issue from Suncorp Group. Investing in Suncorp CPS2 Nicholas Grove 12/10/2012 http://video.morningstar.com/aus/video/121010_Hybrid_audio.mp4

Nicholas Grove: Australian diversified financials company, Suncorp, recently announced it was looking to raise around $0.5 billion through the issue of some convertible preference shares to be known as CPS2. Here to give us an idea of what these hybrids can offer investors, I'm joined by Morningstar's Nicholas Yaxley.

Nick, thanks very much for joining us.

Nicholas Yaxley: No problem.

Grove: First off the bat, Nick, can you give us a brief idea of the structure of these securities and how do they differ from other interest rate security issues we've seen on the market recently?

Yaxley: Sure. These are mandatory converting hybrids, which basically means all else being equal, these securities will pay discretionary noncumulative distributions on a quarterly basis up until 19 December 2019. These are subject to particular conditions and at the same time, Suncorp has the option to redeem that issue two years earlier at their discretion.

They are slightly different to other securities in that they - interest rates securities that have been offered recently - in that they are designed for the insurance sector of Suncorp's overall business, and therefore they are more comparable to securities such as the IAG CPS, which was issued a few months ago rather than PERLS VI, which was the most recent issue.

Grove: Nick, who is eligible to invest in these securities and how much do you expect Suncorp to raise from the offer?

Yaxley: These securities are open to all investors. We expect that Suncorp will raise at least $500 million. They are looking - they have in the past raised at least that with previous securities they have issued and that's how we expect they will go going forward.

Grove: Nick, what's the margin on these hybrids and how does it compare to where you are expecting the margin to arrive at?

Yaxley: Yeah, the margin was set at bookbuild at 4.65 per cent. It is the lower end of the range of 4.65 per cent to 4.85 per cent which was originally announced. This is above where we put in our fair margin of 4.25 per cent and therefore we think this is a reasonable offer.

Grove: What are the main features of this issue that you find particularly attractive?

Yaxley: Well, historically, we've noticed that the Suncorp hybrids that have been issued in the past have all performed in line with expectations and therefore we're reasonably comfortable that these securities will also perform in line with what the market expects. This is something that the market has been watching very closely over the last over few years, but we are very comfortable with the issuer profile and hence we think this is an attractive offer.

Grove: Finally, Nick, what are the main risks investors should be aware of when it comes to investing in these hybrids?

Yaxley: I think the primary thing that investors should be very cautious of is that these are not deposits nor are they traditional corporate bonds. Investors need to understand the terms of these securities and how each term will individually influence the performance of these securities. The performance can be negatively influenced quite substantially by some of the terms such as the non-viability trigger and hence it's important that investors understand these things and what this will actually mean if and when the circumstance arises that the trigger may actually be influenced.

Grove: Nick, thanks very much for joining us.

Yaxley: No problem at all.

/video/transcript/2242 mailto: ?subject=Investing in Suncorp CPS2&body=http://www.morningstar.com.au/video/story/2242

When mining services music stops
10/10/2012 Now that the spending spree by Australia's resources sector appears to have stopped for the time being, Morningstar takes a look at those companies that are best prepared for slower activity. When mining services music stops Nicholas Grove 10/10/2012 http://video.morningstar.com/aus/video/121009_Mining_audio.mp4

Nicholas Grove: The spending spree by Australia's energy and mining sectors appears to have reached its zenith, with the end of the boom attributable to slowing global growth, lower commodities prices and higher operating costs. But now that the music appears to have stopped for the time being, which mining services companies are left with the chair?

Here to help investors answer that question, I'm joined by Morningstar's Ross Macmillan. Ross, thanks very much for joining us.

Ross Macmillan: Thanks Nick.

Grove: First of all, Ross, in a recent special report you said that some mining services companies, particularly those with an exposure to expenditure in iron ore, coal and base metals, may be unprepared for a slowdown. What's the best way for an investor to differentiate between those companies that are prepared from those that aren't?

Macmillan: Nick, at the moment there's $250 billion worth of mining and energy projects being undertaken. Now, $170 billion of those are in the energy sector, predominantly on LNG plants, but that still means that there's $80 billion worth of construction projects occurring in the mining sector and for mining infrastructure.

Now, that means a massive pipeline of contracts and work for mining services companies. And we've really seen boom conditions over the past decade. That's made a number of companies become lazy, because they've seen this massive pipeline of contracts - they've seen endlessly growing revenue and increasing profit margins.

Now, the companies that we really are favorable on are those companies that have exposure to maintenance and operation contracts rather than the development and construction contracts that are occurring at the moment. If they are involved in maintenance and operations, we think there will be continuing demand for commodities, perhaps a little bit slower as we see China is slowing, but certainly there will be some level of demand.

There is also the maintenance of the mine sites and the infrastructure and companies that have those sort of contracts are generally there on a long-term basis. There's also companies that have got exposure to the energy sector. We're still very favorable on those.

Grove: In your report, you discussed the only five companies that have an economic moat. Can you elaborate on some of the characteristics that make these companies moat-worthy?

Macmillan: Yes, Nick. There's five companies out of the 16 in the ASX 200 that have a moat. And economic moats are very important to a firm's investment potential. Moats provide a competitive advantage over other companies and we've identified five areas where there are economic moats and characteristics that companies have. Those characteristics include switching costs; they include intangible assets; they include cost advantages; they include the network effect and efficient scale.

Now, generally in the mining services sector where companies are contracting to large mining companies, the mining companies have strong bargaining power. The market for mining services is also extremely competitive, fragmented and very cyclical. Generally, you wouldn't see companies in that type of market with moats. However, we do feel that switching costs and efficient scale are two moat characteristics that a number of companies have.

Grove: Ross, with reference to these companies specifically, when it comes to the end of the boom what does this mean for these companies' dividend profiles going forward?

Macmillan: Well, to look at their earnings and cash flow first, Nick, we think that over the next 12 months you will still have revenue increases, growing revenue and quite reasonable sort of earnings returns.

Now, that will be on the basis of contracts that these companies have won over the past year - or past two years really. Some major contracts have been won to undertake construction work in both the mining and energy sector.

So, in the next 12 months we won't see a great deal of change from what we've seen the past decade. However, as we get towards the end of fiscal 2013, I think we'll start to see deterioration in the level of revenue growth and certainly the margins that companies in the mining services sector are achieving.

A lot of companies have over this period been building up cash reserves. Some of them have been ensuring that their capital expenditure has started to slow down and have prepared themselves for the end of the mining and energy boom. Now, those companies, they won't be immune to the slowdown. But certainly, what they'll be able to do is only marginally decrease their dividend payments.

They'll have fall in revenue, they'll have a fall in earnings. But we imagine that during the period of the slowdown, dividends will only decrease by a marginal amount. Then when conditions improve, when economic conditions are stronger again and we start to see stronger demand for companies and an increase in pricing for commodities, we see those companies very quickly being able to restore dividend payments to the levels we've previously seen.

Grove: Finally, Ross, what kind of risk tolerance should an investor have when it comes to the mining services sector? And given the current climate are these companies still suitable for conservative long-term portfolios?

Macmillan: Certainly, Nick, the mining services sector is very cyclical and perhaps even more cyclical than the mining sector. There is an expression that "when the mining company sneezes, the mining services companies catch a cold". So, investors have got to be prepared for certain degree of risk in this sector.

Most of the companies we rank as having a high risk and some are very high risk.

Grove: Ross, thanks very much for joining us.

Macmillan: Thank you, Nick.

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Investing in a piece of the Patties pie
25/09/2012 Patties Foods managing director Greg Bourke gives investors an idea of what to expect from the frozen food manufacturer in the year ahead. Investing in a piece of the Patties pie Nicholas Grove 25/09/2012 http://video.morningstar.com/aus/video/120924_patties_audio.mp4

Nicholas Grove: Patties Foods, the manufacturer of frozen food icon such as Four'N Twenty pies, last month delivered a $19.5 million profit for the 2012 financial year, as well as an 8.2-cent dividend, that was slightly above Morningstar's expectations. But what does the year ahead hold for the company? To give us an idea, I'm joined by the company's Managing Director, Greg Bourke.

Greg, thanks very much for your time today.

Greg Bourke: Thanks, Nick.

Grove: First of all, Greg, in your results you indicated that you expected rising input costs and tough trading conditions in the year ahead. What is Patties doing to counter this?

Bourke: Yes Nick, well, there is two things there - the issue around tough trading conditions and the rising input costs. The tough trading conditions are well documented within the financial media and that's all around the conservatism and caution of consumers at the moment. When you add into that, the whole flight-to-value that we talk about within the business, consumers are becoming very sensitive around pricing and they are looking for specials all the time. So, what we need to do is get their minds out of the position of pricing and look at the new products. New products are certainly very important part of our business.

The other side of this rising input costs, as we have heard there is drought in the U.S. and we're seeing right now flour prices are increasing. Within the business, we have a target of zero cost increases across the business. So we are achieving that by offsetting our input costs that we get with efficiencies built within the business, and we've done that with the investment in automation in the packing room that we've got in our operations in Bairnsdale. We're commissioning right now robotic palletizing and also packing equipment and that's taking a lot of cost out of our business.

Grove: Can investors expect more of the same when it comes to dividends in the 2013 financial year?

Bourke: Well Patties does generate a lot of cash, and we have a tradition of increasing our dividends as our profits in earnings increase. The Board's got a target, if you like, of around 60% payout ratio. We're keeping to that, we see that that policy will remain in place for the next few years and that's even without expected increase capital expenditure and as we invest in working capital to support growth within the business. But we still see the dividends will grow in line with earnings as we move forward.

Grove: Also Greg, you've previously mentioned that Patties focus on some export opportunities. Could you elaborate on some of these?

Bourke: Export is an exciting opportunity for Patties. We've been traditionally domestic-only business, but we have noticed that now as we continue to reduce our cost and we have very efficient manufacturing capability, we're now finding that we are competitive in some of SKUs in a number of markets. We're looking at the U.K., we're looking at U.S. and also Asia Pacific.

A number of opportunities are there and the challenge for us is to make sure that we get the right one that meets our needs and at the moment we're certainly targeting the U.K. and we think there may be some future in U.S. as well. It could be range of products, not necessarily single-serve pies, probably going to be in our party range. Whilst the world does not have a taste for meat pies as Australia does, there is a trend toward more entertaining products and hors d'oeuvres and finger food and our party range is ideal for that market, so we're exploring that.

Grove: Finally Greg, are there any potential acquisitions on the cards for Patties this year? What sort of criteria to any possible acquisitions have to meet?

Bourke: We've got a very strong balance sheet and we have capability for acquisitions. We're very careful in what we look at and we have been looking at some over the last 12 months or so. We have a very firm process and a robust criteria for acquisitions. I suppose, typically, people think that we're probably going to expand into the pie category, that's not necessarily the case. There are opportunities in dessert range and entertainment range and we're just looking at a number of assets at any one time to see if there is something right for Patties. The right business will be something that is a branded business now or has the capability to take our brands into a new space. So, we're very careful in the way we look at these things. We're cautious and we'll get the right one over time.

Grove: Greg, thanks very much for joining us.

Bourke: Thanks, Nick.

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Are banks on track to pay good dividends?
18/09/2012 The four major banks reported only moderate earnings growth, however, they may still be positioned to sustain their high-dividends. Are banks on track to pay good dividends? Cristine St Anne 18/09/2012 http://video.morningstar.com/aus/video/120912_bank_report_audio.mp4

Christine St Anne: A recent Morningstar report looks at whether banks are able to sustain their dividends. Today, I'm joined by the report’s author David Ellis to give us an overview of some of the key findings.

David, welcome.

David Ellis: It's pleasure, Christine.

St Anne: David, the banks reported relatively moderate earnings in the last reporting season. Are they on track to sustain their dividends of the past?

Ellis: We believe so, yes. Despite moderate earnings growth the banks, in absolute dollar terms, are very profitable and lending growth is moderate, so the demands on their capital levels - their capital ratios are under control and so they're continuing to build surplus capital. As long as the general economy doesn't enter a sustained and deep downturn, we believe that the key drivers are in place to support moderate earnings growth and importantly dividend sustainability.

St Anne: David, on that point of the lending business, housing credit continues to remain weak. Is that going to have a real impact on their earnings?

Ellis: Not necessarily, certainly housing credit growth has been declining – the rate of growth has been declining for nearly eight years now. It's running at a roundabout - for the system, is running about 5% but the banks themselves are taking market share from non-bank lenders and the major banks are doing pretty well. So, overall system credit growth is declining for housing, but to offset that - partially offset that is business credit growth is increasing from, it's still at low levels, but the rate of growth is increasing, it has been for the last 18 months or so.

So, ones partially offsetting the other and whilst housing finance - housing credit for the banks, is a large part of their loan books, it's not necessarily a large component of their profit. The banks generates just as much profit from their deposit books.

They obviously have quite profitable business banking and commercial banking, markets business and personal lending, credit cards, transaction so on and so forth. So, whilst housing credit is important, I think it's overstated - that importance is overstated. As far as the bottom line profits are concerned, it doesn't have as much of an impact as a lot of people would think.

St Anne: Global markets, of course, remain in turmoil. David, will funding costs remain a key issue for banks?

Ellis: It certainly is an issue. Wholesale funding costs are - across their funding portfolios are gradually increasing and will probably increase for the next 18 months of so, 12 months. But the rate of increase seems to be easing a bit. Obtaining the funding is not a problem for the four major banks. They have high credit ratings and quite very, very profitable businesses.

So, funding costs are an issue, they are increasing. However, the big advantage of an investment in four major banks is that they have pricing power. So whilst funding costs have been increasing and will likely to continue to increase, the banks have the ability to increase their loan rates and they do, do it. The banks have the ability to increase their lending rates, to maintain their margins and over time, the banks have and will maintain their interest rate margins.

St Anne: David, what would be the key issues that banks will have to grapple within the future in order to sustain their earnings and maintain those margins?

Ellis: Well, over the last four or five years, the focus of the banks has been on ensuring they have enough capital and ensuring that their bad debts were managed, so their credit quality was improved. Looking forward, we see the next four or five years focus will be on technology and on cost control.

So, in a low credit growth environment, which we expect will continue for several years, that means low revenue growth, the focus on reducing cost or reducing the rate of growth in cost is becoming much more important and we'll expect to see more of that over the next few years.

Technology is a big issue, of course, for the big banks. It's a big issue for most businesses globally, it's not just an issue for the four major Australian banks. So, the focus is on particularly the shift from over-the-counter branch transactions to mobile devices.

So, the rate of take up or of banking transactions through smartphones and tablets and mobile devices has been rapid and of course, we expect that rate to continue. So, significant amount of management time and investment in improving technology to ensure that the banks do not lose a large part of their business to the global tech companies.

St Anne: David, thanks so much for your time today.

Ellis: It's pleasure, Christine.

St Anne: Premium subscribers could get a better understanding of some of the key drivers that David spoke about by going to the morningstar.com.au website, clicking on the Special Reports tab and then clicking on the link below.

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Investing in CBA PERLS VI
05/09/2012 Commonwealth Bank of Australia is looking to raise around $750 million through an issue of hybrids and Morningstar helps investors decide whether or not the security is suitable for them. Investing in CBA PERLS VI Nicholas Grove 05/09/2012 http://video.morningstar.com/aus/video/120905_cba_hybrids_audio.mp4

Nicholas Grove: Banking giant CBA recently said it's looking to raise about $750 million through an issue of some hybrids to be known as Perpetual Exchangeable Resalable Securities or PERLS VI. Here to give us a rundown on what these securities can offer investors, I'm joined again by Morningstar Credit Analyst, Ravi Reddy.

Ravi, thanks very much for joining us.

Ravi Reddy: Thanks, Nick.

Grove: First of all Ravi, can you give us a brief idea about the structure of these hybrids, and how they differ from other interest rate security issues we've seen on the market lately? Also, how do they differ from other CBA hybrid issues?

Reddy: PERLS VI are mandatory converting hybrids, so in December 2020 they convert into CBA ordinary shares, but that’s subject to conversion conditions or unless they were redeemed or converted earlier, or if CBA exercise an option to call them two years early. They pay franked distributions, they are paid quarterly and it’s based on the margin above the 90 day BBSW rate. Their distributions are non-cumulative and discretionary.

The recent Subordinated Note issues that we've had were pure debt securities and they don’t convert into ordinary equity. PERLS VI are like true hybrids, so they have debt and equity like characteristics. They are similar to PERLS IV and PERLS V but the terms are much stricter, so they are more equity like.

Grove: Ravi, who is eligible to invest in these hybrids?

Reddy: The offer is open to anyone. PERLS VI are replacing PERLS IV, so there is a reinvestment offer for PERLS IV investors. So, PERLS IV investors can reinvest in this offer, they can sell on market or hold on to be redeemed for cash at the end of October.

Grove: Where do you expect the margin on these hybrids to come in at?

Reddy: CBA haven’t given an indicative margin range. We expect the margin to come in above our fair margin estimate of 3.15%. Similar hybrids are trading at around 3.8%, so we would prefer the margin to be at least 3.8% or above.

Grove: Ravi, what are the main aspects of this issue that you find most appealing?

Reddy: PERLS VI potentially offer attractive distributions. They are backed by a quality issuer, CBA which is one of the four major banks. That's the attraction.

Grove: Finally Ravi, what are the main risks investors should be mindful of when it comes to investing in these hybrids?

Reddy: PERLS VI are unsecured subordinated security, so they are riskier than bank deposits. PERLS VI also have the strictest terms of any major bank hybrid on issue. These terms have been imposed by the prudential regulator, APRA. So, in our view it makes them the most equity like of any major bank hybrid on issue.

Also distributions are discretionary, say CBA doesn’t have to make-up missed distributions, but there is a dividend stopper so it stops them paying dividends on the ordinary shares. We also recommend investors seek professional investment advice before making an investment decision.

Grove: Ravi, thank you very much for joining us.

Reddy: Thanks, Nick.

Grove: To read Morningstar’s full report on CBA PERLS VI, morningstar.com.au premium subscribers can go to the Hybrids tab and click on the link below.

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Keeping faith in the big miners
04/09/2012 BHP and Rio have come under pressure amid the recent significant fall in iron ore prices but it’s crucial investors keep their long-term perspective when it comes to investing in resources. Keeping faith in the big miners Christine St Anne 04/09/2012 http://video.morningstar.com/aus/video/120903_ironore_audio.mp4

Christine St Anne: Investor unease over the mining sector has certainly increased over the past few weeks as iron ore prices continued to fall. To put this one into perspective, I'm joined by Morningstar's Mark Taylor.

Mark, welcome.

Mark Taylor: Thanks Christine.

St Anne: Mark, with the dramatic fall in the iron ore prices, would that also mean a dramatic impact on the earnings for BHP and Rio?

Taylor: Well, it will be quite meaningful, particularly for Rio Tinto where iron ore has represented the lion's share of their earnings in recent years. Lesser for BHP where it represents a smaller share of earnings overall, but you can still expect a meaningful hit to earnings on both companies.

St Anne: Now, we've also certainly got bad news from China, with the country indicating that a number of steel projects could be halted. Would that also have a significant impact for these miners?

Taylor: Look, I don't think it will be a huge impact, just one-off projects here and there. But steel is an early-stage commodity in the cycle of development for developing countries. So you would expect the steel to sort of have its big bull run and then sort of taper off later on, even with increasing volumes.

It's the extreme increase in volumes that drives the pricing impact. So, once it starts to taper off a bit, you are going to see some swings and roundabouts. But genuinely we've long expected a gradual decline in iron ore prices from, sort of well over $100 to our long-term target is $80 per ton and it has been for quite some time.

St Anne: Mark, now domestic miner Fortescue, certainly derives a lot of its revenue from iron ore. What's the outlook for that miner?

Taylor: Well, it all depends on the degree of price fall and how long it stays where it is. But as a general rule of thumb, if you're expecting commodity prices to rise very strongly then you're going to get the most leverage in the companies that sit higher on the cost curve, whose margins were perhaps narrower. You don't need much of an increase in price to get a doubling, tripling in their margins.

The reverse is true on the way down. So those companies are the ones whose margins are going to be squeezed in percentage terms the most when prices fall. So, companies like Fortescue who are slightly higher on the cost curve are going to be more at risk. It's not to say that say that they are at risk, but just obviously it goes without saying, the lower on the cost curve you are, the better really.

And then on top of the operating cost side of things, you've also got to consider the capital cost side of things and the balance sheet - the debt situation. Companies like BHP who've got very low debt overall are going to be able to weather any hiccups or storms better than companies that are very highly geared and are very reliant on what happens from month-to-month in terms of their revenues.

St Anne: Mark with falling commodity prices will the resources sector essentially be just a volume growth story?

Taylor: In some respects, yes, because you're not going to see the big increases in price. You might see some quick recovery from lows and things, but you're not going to see that long continual uptrend in prices I don't think again. So, it is going to be about volumes, who is increasing volume, who can sort of make up a little bit of the lost ground.

But really the other side of the equation is, your capital cost. Do you really want to be investing large sums of money, if you're not going to drive the returns on that investment that you have historically. So it's not all about volumes, it's about return on invested capital as well and looking after your cost side of things.

St Anne: Finally, Mark, given the subdued outlook for the sector, should investors do keep their faith in the miners?

Taylor: Well, I mean, definitely keep your faith in the quality blue chip companies. That's not to say their earnings won’t be hit, they will because they are in the business of selling commodities. But when you invest in mining stocks - resource companies, it goes without saying that there will be ups and downs and they are, by definition, more cyclical and more volatile than some of the more stable blue chip companies. You have to expect that when you buy them and if it's not something you're willing to expect then you shouldn't really be in that space.

St Anne: Mark, thanks so much for your insights.

Taylor: Thanks Christine.

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Reporting season: Harvey Norman
31/08/2012 Morningstar analysts provide investors with their earnings season insights in these concise, timely video snapshots. Reporting season: Harvey Norman Tim Montague-Jones 31/08/2012 http://video.morningstar.com/aus/video/120831_harvey_report_audio.mp4

Q: Were Harvey Norman’s earnings above, in line with, or below your expectations?

Tim Montague-Jones: Harvey Norman reported $172 million of net profit for the full year 2012, which is in line with our forecast of $172 million.

Q: Was the dividend above, in line with, or below your expectations?

Montague-Jones: The dividend was $0.09 per share, which is also in line with our expectation of $0.09 per share.

Q: What were the key drivers of the result?

Montague-Jones: The key driver of the weakness in the result, as we all know, has been the massive price deflation, particularly from the flat screen TV market, where you've seen television screens five years ago of about $5,000 or $6,000 go down to $500, $600 or $700. So the margin on the sale is a lot less. So, you're comparing a lower margin business to a higher margin comparable number. So, it's very difficult to get the relative sales and margins coming through the business.

Also the computer segment; laptops, they've also seen significant price deflation. Also, as we all know, the economic conditions are tough and electrical retailers are finding it extremely difficult because it's a discretionary expense and we've seen Dick Smith has been closing stores and liquidating stock. So, this liquidated stock also floods the market and makes it difficult for competitors like Harvey Norman to extract some good returns out of that segment of the market.

Q: Was there anything about the result that surprised you?

Montague-Jones: The market was pretty well informed of what the profit was going to be at the sales result. So, hence there's no real surprise in the performance of the business that has come to light today.

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Turning NAB around
29/08/2012 NAB chief executive Cameron Clyne talks about how the bank embraced a number of initiatives to grow its businesses and the key challenges ahead. Turning NAB around Christine St Anne 29/08/2012 http://video.morningstar.com/aus/video/120829_NAB_clyne_audio.mp4

Christine St Anne: National Australia Bank, Chief Executive, Cameron Clyne recently spoke at the Australia-Israel Chamber of Commerce lunch in Sydney this week. Among key things such as business reputation, Clyne also spoke about how the Bank has managed to turn around its Personal Banking division over the last 3.5 years. This included the Bank's radical strategy for cutting its fees announced back in 2011.

Cameron Clyne: If you go back 3.5 years ago, when we outlined our strategy to the market, what we clearly had - and bear in mind our Personal Bank is still relatively small in proportional terms. It gets a lot of focus, but it’s only 16% of our earnings.

What was very clear to us that our Personal Bank was not performing. It was going backwards in terms of market share. It was 8 percentage points behind the third in customer satisfaction, now in a four-horse race that is a hell of a gap.

What was becoming quite apparent to us was that if did not turn that around then we would have a number of issues. The first would be that we would not be sourcing deposits because obviously the Retail Bank, the Personal Bank is a good source of customer deposits and they are increasingly becoming important in trying to get to a much more stable funding ratio.

We would increasingly, potentially threaten the growth of our business bank, because you have to manage your balance sheet to certain concentration limits. What we wanted to do, of course, was to continue growing in business and often what people don’t always realize is that in the same time we’ve added those million customers, we’ve added 300 basis points of market share in business. So it’s not as though we’ve been just only focusing on that issue.

The only way we were going to do it was, in fact, to do something quite radical, because you'd had a number of in-market mergers here in the Sydney market that it made the - arguably the bigger retail banks even larger. So you had to do something organic and to do something quite quickly and we wanted to really push out on reputation. So we initially dealt with dealing to a range of fees and other things.

Now, I can present two arguments, both of which support the strategy. So, obviously, when we did that - took those fees, we took a hit to our earnings. Since we took that hit to our earnings, the personal bank has grown 21% compound annual growth. That is pretty, pretty strong by any measure. If you say, well that doesn’t count, I don’t like that measure, I’ll give you another one, which is to say we are now back to the earnings we had before we rebased, yet we have a million new customers and we’re number one in customer satisfaction. So that’s not a bad situation either to turn a business that is, basically in the space of three years from going backwards to being back to where it was in three years and gives us a platform to grow and…

St Anne: As one of the country’s key mortgage lenders, Clyne was also upbeat on the outlook for Australia’s residential property market.

Clyne: It is unquestionably the first question you get asked by overseas investors, when is the Australian housing market going to collapse? Because if you look at traditional metrics like affordability, it does look at the difficulty end of the scale but there are a whole series of factors in the Australian market that put a bit of a floor under property prices. We still do a net intake of migrants, which provides some genuine source of demand and that demand is concentrated into a few number of urban centres. There is also a genuine supply constraint. It still takes a long, long time to get housing approvals developed - developments approved, which obviously constraints supply.

Finally, we have this unique situation in Australia, where 85% of mortgages are variable. So the capacity for interest rates to move rapidly to improve affordability in a crisis is significant. Whereas one of the big problems, of course, in foreign markets is people are trying to get out of fixed mortgages and those sort of things. So when you put it all altogether, it does provide a bit of a floor under property prices. So we're relatively comfortable about them.

St Anne: In its last trading update, National Australia Bank reported subdued outlook for its U.K. businesses. A topic also raised by Clyne at the lunch. He said while it was hard to predict the outlook for Europe, National Australia Bank’s U.K. businesses were doing well given the uncertain environment.

Clyne: The English economy is struggling, and by definition our banks are, and they are in still many respects probably amongst the better performing banks in that market, but that’s cold comfort when you’ve got a very difficult economic environment.

St Anne: Funding pressures were, of course, another key theme to the Bank. Clyne also spoke about the particular challenges the Bank now faces under the new capital requirements.

Clyne: Part of the regulatory regime we're moving towards is that Banks by 2018 need to be one, what’s really termed, 100% stable funded, which really says that your funding basis needs to be either customer deposits or term funding with greater than 12 months to maturity. The logic behind that is that you're not subject therefore to the vagaries of the short-term market that at the moment probably make up 10 to 15 odd percent of how the Bank funds itself.

Interviewer: That’s a good thing, it’s a good…?

Clyne: I think on balance it is, but there are implications because long-term funding is more expensive than short-term funding. So there's going to be issues around that, and whether or not we can continue to fund credit at a high level.

The task will be made harder, of course, when we have a rebound in confidence, because money will flow out of deposits. Now, some people misinterpreted the view that that means that the money doesn’t disappear from the economy. That’s not the point we were making when we - certainly when we mentioned this in a recent trading update. The point we’re making is that under that regulation, all deposits are not created equal. So the regulator clearly places a greater premium on deposits they think are stickier.

So, if the consumer has the money in their bank account that is considered by the regulator, one of the safest form of deposits, because they feel its risk of flight is less. If the consumer becomes more confident and goes and buys equities, then the money still exists in the system, it just moves from out of the retail deposit account into the wholesale deposit account, which carries less of a weighting.

So that’s the real issue is at the moment we’ve got flattering set of numbers because it’s mostly parked in retail and retail is well rated by regulators. If the economy improves and all that money is either spent or purchase equities, it moves into wholesale deposits and wholesale deposits have a lesser weighting. So it’s not that the money disappears, it's still the same pool in the economy, but it will actually carry less weight for the banks and that will be a challenge for us.

St Anne: Christine St Anne for Morningstar.

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Reporting season: BHP Billiton
23/08/2012 Morningstar analysts provide investors with their earning season insights in these concise, timely video snapshots. Reporting season: BHP Billiton Mark Taylor 23/08/2012 http://video.morningstar.com/aus/video/120823_BHP_report_audio.mp4

Q: Were BHP’s earnings above, in line with, or below your expectations?

Mark Taylor: Well, they were below my expectations, but I was quite ahead of market consensus and that turned out to be the wrong tact. Petroleum prices were lower than expected and metallurgical coal costs were higher than expected and those were the two key reasons why we were overly optimistic.

Taylor: Underlying earnings was 21% to just over U.S. $17 billion, which was in keeping with lower commodity prices. The headline result included about $1.7 billion after tax charges relating primarily to Fayetteville shale gas assets, a $300 million charge for Olympic Dam impairment, because it's no longer going ahead, and a minor offset of $600 million odd gain, a tax credit, in response to the introduction of the Mineral Resource Rent Tax.

Q: Was the dividend above, in line with, or below your expectations?

Taylor: It was below expectations and would have disappointed a number of people in the market because there was some hope that BHP pulling back on the capital expenditures might translate into higher dividend, but it wasn't to be. The final dividend is basically just been kept in keeping with BHP's progressive policy.

Q: What were the key drivers of the result?

Taylor: Well, lower commodity prices, but also some higher costs, particularly as I said in metallurgical coal. Possibly some issues with the U.S. shale gas assets leading - trying to sell gas into historically low U.S. gas prices. So those were the key things.

And then of course, the other big announcement was that BHP won't be progressing with its Olympic Dam expansions plan in its current form. So, that seems to be a common sense decision that they've made, no sense flooding the market with new product and building something at the height of the capital cost boom.

Q: Was there anything about the result that surprised you?

Taylor: Well, despite the P&L being a little bit worse than we are expecting in a cash flow sense this was a very strong result, over $25 billion net operating cash flow was a bit ahead of expectations, boosted by a favorable working capital moves, but nonetheless a very pleasing result in a cash sense.

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Reporting season: Origin Energy
23/08/2012 Morningstar analysts provide investors with their earning season insights in these concise, timely video snapshots. Reporting season: Origin Energy Gareth James 23/08/2012 http://video.morningstar.com/aus/video/120823_origin_report_audio.mp4

Q: Were Origin’s earnings above, in line with, or below your expectations?

Gareth James: Origin Energy reported an underlying net profit after tax of $893 million in 2012, that's 33% higher than the prior year. The net profit was pretty much in line with expectations. It was just 4% below consensus estimates and 2% above our forecast.

Q: Was the dividend above, in line with, or below your expectations?

James: Origin Energy announced a final dividend of $0.25 per share fully franked. That brings the full year dividend to $0.50 a share, which is in line with our forecast. The shares will trade ex-dividend on the 27 August, 2012. A dividend reinvestment plan will be in place, but no discount will be offered as part of the plan.

Q: What were the key drivers of the result?

James: The main reason for the rise in underlying net profit after tax was the full year’s contribution from the retail energy businesses acquired from the New South Wales government in 2011. Other businesses, including Contact Energy, their New Zealand based energy retailing business, as well as exploration and production contributed similar results to the prior year.

Q: Was there anything about the result that surprised you?

James: Origin Energy lost 160,000 retail customers in 2012, which represents around 4% of their entire customer base. This is quite disappointing to see, especially when considering the AGL Energy acquired 180,000 customers in 2012. This is obviously a little concerning for the market and we hope to see a stemming of this outflow in 2013.

Underlying net profit after tax in 2013 is expected to be similar to 2012 levels. This is below market's expectations and possibly explains the 5% fall in the share price on the day of the announcement.

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Wesfarmers keeps long-term focus
24/08/2012 Wesfarmers chief executive Richard Goyder talks about the importance of keeping focused during tough times. Wesfarmers keeps long-term focus Christine St Anne 24/08/2012 http://video.morningstar.com/aus/video/120824_wes_goyder_audio.mp4

Christine St Anne: Fresh from last week’s profit results, Wesfarmers Chief Executive, Richard Goyder, spoke at a recent Financial Services Council lunch. Goyder spoke about managing a Group that operates eight businesses and employs over 200,000 people.

Richard Goyder: So, I think it's a testament to the leadership that's been at Wesfarmers, the Board, but also to the fact that we operate in a country where free enterprise has been supported and rewarded and that's enabled the Company to grow.

St Anne: Goyder drew on the Company’s rural heritage. He said the farming roots behind the Company allowed Wesfarmers to maintain its long-term focus.

Goyder: There has been one really important aspect to Wesfarmers over the years and that's that we've taken a long-term view of things. We’ve tried not to become hostage to short-termism. Although we report sales quarterly, we report results on a half yearly basis, and there are things that - fads and things that come through from time-to-time, we've tried to look through cycles and we’ve tried to invest and run the Company for the long term, and I think our rural heritage has helped enormously on that.

When I joined the Company in ’93, the Board consisted – the non-executive directors were entirely farmers, and now we have no farmers on the Board, I think. We still have a culture, which goes back to those farmer cooperative days, and that is we know things bad can happen in the short-term, but we run the business for the long term.

St Anne: He also spoke about the key aspects that made Wesfarmers a successful business.

Goyder: We have three key inputs; access to capital, which is so critical, and that's from our shareholders and from our providers of debt. Incredibly important is superior people resources, and just as investing in capital is a really key decision, so is investing in people, and we invest heavily in people and I invest a lot of my time in people.

Every company says this, but we really do think that our employees provide a long-term sustainable competitive advantage, if we get it right, and clearly we are in some businesses at the moment and others we've got some work to do. And then we have this thing called strong corporate infrastructure, so we let the businesses get on and run the businesses. We have strong governance over the businesses, we have a strong say on things like people, capital and our reporting systems and obviously around integrity, but we let the businesses get on. We are very financially focused.

St Anne: Goyder was also confident with the growing number of its core businesses.

Goyder: We’ve got, you know, I would say this, a portfolio of quality businesses. We think we can grow them. We look to value add to the group through transactions like buying and selling businesses and, as I said, we look to do it over the long term.

The outputs that we're hoping to get are superior long-term financial performance for our shareholders and we measure that through a total shareholder return and a reputation as an admired Company, and that obviously depends on your financial performance, but then it depends on the way you can operate within the communities as well, and we take that pretty seriously.

St Anne: Consistent with the long term focus, Wesfarmers would also continue to invest through all market cycles.

Goyder: As I said, investing in people is important, but investing in the business is important, and we do invest through the cycle. This chart just shows you what our capital expenditure has been, and basically we've been spending in gross, this is net, in gross terms over $2 billion per annum. Our depreciation runs at about $1 billion. So we're spending well over $1 billion in growth capital in the business over the last few years.

So, if you think about that over three years, that will be somewhere between $4 billion and $5 billion of new growth capital invested in the business, which on its own, would be a sizeable acquisition. Now we're doing it through investing in our existing businesses, which we like doing, but we haven't pulled back at all on our investments and in fact a good example of that would be the Curragh expansion.

We just now commissioned our new wash plant at Curragh and we've got an operating capacity there of up to 8.5 million tons of export coal. This is our coal mine in the Bowen Basin in Queensland. And we made that decision in 2009 and we quite deliberately went to the Board and we said we want to spend a few hundred million dollars. And this is a time when everyone was negative on the outlook of coal, but we actually think longer term, the outlook for metallurgical coal is good.

St Anne: He labeled market criticism that the Company was not getting any return on its new investments as being too focused on the short-term.

Goyder: The problem with that is if you’re going to spend $550 million building an ammonium nitrate plant, it takes you about three years to build it, two to three years to build. You don't get any return until you start producing that ammonium nitrate. Actually, you do have to invest upfront to get a return down the track. We’re confident we’ll get a return down the track and people who are impatient for returns are just going to have to wait.

St Anne: As a favored income stock, Goyder also remained committed to growing the Company’s dividends.

Goyder: And the other thing we've tried to do on the yellow charts here is growing our dividends over time, and no doubt one of the reasons our results last week were received in a positive sense was the increase in our final dividend to $0.95 fully franked, and we're endeavoring to give our shareholders a lot of the profit we generate.

St Anne: Christine St Anne for Morningstar.

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Reporting season: Woolworths
24/08/2012 Morningstar analysts provide investors with their earning season insights in these concise, timely video snapshots. Reporting season: Woolworths Peter Warnes 24/08/2012 http://video.morningstar.com/aus/video/120824_wow_report_audio.mp4

Q: Were Woolworth’s earnings above, in line with, or below your expectations?

Peter Warnes: The Woolworths' FY '12 result of $2.183 billion from continuing operations, was 2% below our expectations and 2% in nearly $2.5 billion to $2.2 billion is neither here nor there. This is a solid result and there is no need for alarm bells.

Q: Was the dividend above, in line with, or below your expectations?

Warnes: As with the earnings, which were just slightly below our expectations, the dividend was also $0.01 below our expectations at $1.26 a share. Again, a strong payout of 70%. Strong cash flow, negative working capital will ensure that Woolworths will continue to be a robust payer of dividends and around 70% is likely.

Q: What were the key drivers of the result?

Warnes: Key drivers of the result - a very strong performance in New Zealand and continuing good progress made in the Australian Food and Liquor operations, which is the engine room of the business. Margins there continue to expand up from 7.41% to 7.50%, which is not really Woolworths like. Woolies usually coming with 15% to 20% basis point improvement, so this was a little bit lower than history has shown.

But, with the aggressive rollout of supermarkets, 38 new supermarkets and 20 new Dan Murphy big box stores, that does increase the cost of operation, the cost of doing business and has an effect on the margin. Surprisingly, as I said, New Zealand was very, very good. It was up 59 basis points with EBIT margin widening to 5.3% on a 16% increase in EBIT and only a 3% increase in sales. So that was a very, very pleasant surprise.

Q: Was there anything about the result that surprised you?

Warnes: Another surprise in the result was the good performance by the expanding liquor operations, driven by Dan Murphy clearly, and now including Cellarmasters for full year. But sales for the liquor operation were up 11.9% and the EBIT growth was higher than that, which obviously means it was a positive influence on the margin of the Australian food and liquor operations.

Again, pleasingly from that operation, the sales of the liquor group now accounts for 17.5% of Australian food and liquor, up from a 16.3%. That is a very, very positive influence on the overall operations of Australian Food and Liquor and that growth is expected to continue.

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Reporting season: Wesfarmers
17/08/2012 Morningstar analysts provide investors with their earning season insights in these concise, timely video snapshots. Reporting season: Wesfarmers Peter Warnes 17/08/2012 http://video.morningstar.com/aus/video/120817_wes_report_audio.mp4

Q: Were Wesfarmers’ earnings above, in line with, or below your expectations?

Peter Warnes: The Wesfarmers FY '12 ENPAT of $2.126 billion was slightly below our expectations of $2.172 billion, but it was tinged with conservatism. There is a $40 million provision - restructuring provision for Target and in the insurance division there was $108 million increase to reserves following the February, Christchurch earthquake. So those are non-recurring and let's say a conservative number $2.126 billion, but just slightly below our expectations.

Q: Was the dividend above, in line with, or below your expectations?

Warnes: Dividend was in line with expectations. We were looking for $0.95 in second half to take it to $1.65 for the full year and that’s exactly where it came in. The pay-out ratio are relatively high at 90%, however the excellent shape of the balance sheet and strong cash flow generation should see Wesfarmers continue to have a pay-out ratio between 85% and 90% in future.

Q: What were the key drivers of the result?

Warnes: Key driver of this result, which was up 10.6% year-on-year was the continued resurgence of Coles, food and liquor, with the emphasis on food. Coles head line sales were up 4.6%, but the EBIT jumped 15% with a very, very strong performance in margins up 42 points from 4.28% to 4.7%. But the exit margin if you like the second half margin broke new ground at 5.18% and that’s’ an excellent performance.

Coles have really starting to fire on the volume side, in other words, foot traffic, basket size is pushing volume along and the supply chain has really started to become significantly more efficient right from sourcing all the way through to the cost of getting the goods on the shelf that is now driving their margin nicely.

Elsewhere, Kmart was a very, very good performance and strong EBIT growth up almost 30% and the margin moving from just over 5% to 6.6%, which is excellent in a very, very difficult discretionary retail environment. Elsewhere industrial and safety was nicely up as was the chemicals, energy and fertilisers and Bunnings whilst not spectacular was very solid.

Q: Was there anything about the result that surprised you?

Warnes: Surprises were all on the positive side. Wesfarmers, as we know, is a conglomerate and conglomerates are very, very difficult to manage and control and Wesfarmers do it very well. All the operations had underlying positive growth and that is testament to very strong management and good cost control.

There are eight individual divisions, if you like, but there are many, many more businesses within some of those divisions and to get them all reporting underlying growth in both revenue and profit is an excellent performance and that was a very, very pleasing surprise.

Surprises, as I mentioned earlier, were certainly Kmart and Coles, and the Coles food operations in particular because the liquor operations are a drag on Coles food and liquor - the opposite the case in Woolworths, but that really highlights the excellent performance of the Coles food operations, and we do anticipate with liquor we’ll pick up going through into FY '13.

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Reporting season: Brambles
16/08/2012 Morningstar analysts provide investors with their earning season insights in these concise, timely video snapshots. Reporting season: Brambles Peter Rae 16/08/2012 http://video.morningstar.com/aus/video/120816_brambles_report_audio.mp4

Q: Were Brambles' earnings above, in line with, or below your expectations?

Peter Rae: Well, the result was pretty much in line with expectations, but given the guidance for EBITDA to be within a certain range based on currency rates as at 30 June, 2011, they're towards the lower end of that guidance. But nonetheless, they did meet expectations. From our perspective, the net profit after tax was pretty much in line with our forecast.

Q: Was the dividend above, in line with, or below your expectations?

Rae: The dividend of $0.26 per share was below our forecast of $0.28 per share, so that was a little disappointing, but given that they declare the dividend in Aussie dollars, the Aussie result had been impacted by the rise in the Aussie against the U.S., and Brambles' reports in U.S. dollars, so that's been partly behind their thinking of keeping the dividend flat. Also they've got a higher share count following the entitlement offer that they made a few months ago. So, there is a higher share base too. So, that was taken into consideration when maintaining the dividend flat.

Q: What were the key drivers of the result?

Rae: The key drivers from a positive perspective were the continued growth into new and emerging regions. Brambles has been growing into Central and Eastern Europe, Turkey, and in the Americas, Latin America. They've been achieving good growth in those new regions, and also in the U.S. they've continued to have some good new business wins. They've picked up business that they had lost to a competitor, IGPS, so they continue to grow quite well in the U.S. from that perspective.

So, those positives helped to more than offset the weaknesses in the core businesses in the U.S. and particularly Europe, there their existing business is not performing well, and that's no surprise really given the state of the economies particularly in Europe. Brambles is a big player in Spain and that economy as we very well know is not performing well at all.

Q: Was there anything about the result that surprised you?

Rae: Look, probably the biggest surprise and it was a disappointment was that their guidance for FY'13 is not as strong as we had expected it might be. We had expected that they'd continue to achieve some good growth from the emerging regions, but just the weakness in the developed economies seems to be having a greater impact on them then what we were forecasting for FY'13.

Also, they're continuing to invest to grow the business in the developing regions, and that will have a negative impact on earnings next year. There's also some expenses in relation to their attempt to get some efficiency guidance from their core businesses in Europe, so that also will be a drag on earnings.

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Reporting season: CBA
15/08/2012 Morningstar analysts provide investors with their earning season insights in these concise, timely video snapshots. Reporting season: CBA David Ellis 15/08/2012 http://video.morningstar.com/aus/video/120815_CBAreport_audio.mp4

Q: Were CBA's earnings above, in line with, or below your expectations?

David Ellis: CBA's 2012 full year result was $7.1 billion net profit after tax, and that was pretty much in line with our expectations and also the market.

Q: Was the dividend above, in line with, or below your expectations?

Ellis: CBA's dividend for 2012 was a real standout. It's a strong point for the bank. It was higher than expected, the final dividend was $1.97 per share, and the full year - the total dividend for the year was $3.34. As I said, the surprise was the increase - the extent of the increase in the dividend, but that also agrees with our thesis, and our thesis with the major banks is that we expect to see increasing dividends with upside potential for each of the four major banks.

Q: What were the key drivers of the result?

Ellis: Well, the key drivers of the result were pretty much the moderate credit growth, strong deposit growth. Cost growth was a little bit higher than expected, but still pretty tightly managed, and there was a reasonable fall or decrease in bad debt expense, which was a little bit higher - the decrease was a little bit higher than what we're expecting, so no major standout driver. There were three or four items that contributed to the solid overall result for the Bank for the year.

Q: Was there anything about the result that surprised you?

Ellis: The result, as I said earlier, was in line with our expectations, and possibly even a little bit higher or in line with consensus, so there was no real standout item within the result. Other than the dividend, which was, as I said was a positive surprise.

At the analyst briefing, again we were pretty impressed with the performance of the new CEO of the bank, Ian Narev. He provides a very confident and comforting leadership style and made it quite clear to the analyst that the bank continues to be conservatively managed, and the management made no apology for that conservatism, and that's one of the reasons why CBA has outperformed over the last six months in particular, and over the last few years as well.

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Reporting season: Newcrest
13/08/2012 Morningstar analysts provide investors with their earning season insights in these concise, timely video snapshots. Reporting season: Newcrest Mat Hodge 13/08/2012 http://video.morningstar.com/aus/video/120813_newcrest_report_audio.mp4

Where Newcrest’s earnings above, in line with, or below expectations?

Mat Hodge: So the result was just - it was basically in line but slightly below. Basically, costs were bit higher than we're expecting. Corporate costs have gone up quite a lot in the last little bit. That was the primary reason otherwise operationally it was pretty much in line.

Was the dividend above, in line with, or below expectations?

Hodge: The dividend was bit less than we expected. I guess, the company has given a better explanation on the roll of the special dividend. We were kind of expecting Newcrest to be able to hold the dividend steady, but it hasn't done that and it's basically saying we're spending more CapEx at the moment, so we won't have specials at this time. But in the future if we're spending less on capital expenditure and operating cash flow is strong then we'll look to pay that out as special.

What were the key drivers of the result?

Hodge: If we take a step back and look at the 2012 for Newcrest, pretty soft year. They had some interruptions from weather and things like that. Basically the earnings, well the ENPAT was flat year-on-year, earnings were less and that's because there was more shares on issue over the year with the full year of Lihir. So, basically the result was slightly down and it's a pretty weak result for them. And things will start to improve once the two big projects Lihir Expansion and Cadia East kick off.

Was there anything about the result that surprised you?

Hodge: The change in the guidance is the big thing with this result and it looks like Newcrest is going to be much more scrupulous when it comes to future capital expenditures. They've kind of reined in growth expectations quite a bit. Some projects have gone beyond the five year outlook period - they have sort of dropped off. The company said they can bring them back if they want to, but basically they're just trying not to spend too much money while capital expenditure costs are at the peak and that seems fairly sensible to me. So, it looks like probably large dividends but off of a small base are going to be a focus for a little while.

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Reporting season: Telstra
10/08/2012 Morningstar analysts provide investors with their earning season insights in these concise, timely video snapshots. Reporting season: Telstra Peter Warnes 10/08/2012 http://video.morningstar.com/aus/video/120810_report_telstra_audio.mp4

Where Telstra’s earnings above, in line with, or below expectations?

Peter Warnes: Telstra's FY '12 results, the ENPAT of A$3.566 billion on an adjusted basis was right in line with our expectations of A$3.575 billion. Pleasingly, EBITDA at A$10.4 billion was also right in line with our expectations and the EBITDA margin at 40.6%, which was steady, but up nicely from 38.3% in the first half.

Was the dividend above, in line with, or below expectations?

Warnes: The dividend of $0.28 a share for the full year, fully franked, is in line with our expectations and the guidance given by Telstra. It will be $0.28 again in 2013 and before we see capital management initiatives boosting that dividend in 2014, and we expect that to be upwards of A$0.31 a share.

What were the key drivers of the result?

Warnes: Key drivers of the results were mobiles and more mobiles. There is an insatiable demand for mobile connectivity and that's what's driving the Telstra results and the mobile operations in particular. Another 1.6 million customers are added in the year and it takes the new additions over the last two years to 3 million, pushing the mobile customer numbers to 13.8 million. That is the driver of the mobile operation. Very, very strong growth in customer numbers in mobile broadband, up another 808,000 customers to 3.1 million.

Pleasingly, sales up 8.5% to A$8.7 billion and the EBITDA up 21% to $3.1 billion. The margin improving from the first half 34%, second half 39% for a year total of 36%. It's very robust and up sharply from the EBITDA margin of 2011.

It really is all about mobiles. Network and applications and systems, also was pleasing. Revenue up 10.5% with some several new major contracts signed and expectations of another double-digit increase in revenue in the coming year. But the driver really was mobiles and that is going to continue going forward as Telstra continues to investment in their network operation.

Was there anything about the result that surprised you?

Warnes: Well, the surprise was really continued strong operational cash flow and free cash flow and it's the free cash flow that shareholders should be cheering, because that's where the benefit down the track is going to come from. Free cash flow was robust at A$5.3 billion but there is an additional or excess A$1 billion worth of cash flow that will be boosted by the sale of TelstraClear in New Zealand and that will allow Telstra in FY '13 to invest A$1.2 billion in its 4G or Long Term Evolution mobile network. That will drive future growth. That will maintain or expand their advantage over the competitors.

This 4G network now has been switched on in 89 regional centers and 16 major cities and airports way in advance of the competitors opt this in Vodafone and this gap will probably widen. The handset sales, for example, in FY '12 were robust, obviously, but 88% of the sales were smartphones, and smartphones and tablets mean data, and data is where the future of the mobile connectivity is going, and so Telstra in a very, very strong position in that situation. So that was a surprise and it holds Telstra in very, very good state going forward.

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Reporting season: Rio Tinto
09/08/2012 Morningstar analysts provide investors with their earning season insights in these concise, timely video snapshots. Reporting season: Rio Tinto Mark Taylor 09/08/2012 http://video.morningstar.com/aus/video/120809_report_rio_audio.mp4

Where Rio Tinto’s earnings above, in line with, or below expectations?

Mark Taylor: Well, the result was in line with most recent expectations, but it's got to be said that we brought those expectations down quite dramatically in recent times due to the persistence in high cost in the Aluminum division. But subsequent to that, I don't think there would have been any surprises.

Was the dividend above, in line with, or below expectations?

Taylor: The dividend was precisely in line with expectations and in line with Rio's progressive dividend policy, which is to pay at least half the previous year's full-year dividend for the first half of the subsequent year.

What were the key drivers of the result?

Taylor: The key drivers - a 34% decline in profit, were chiefly lower commodity prices across the commodity spectrum. Volumes and exchange rates had very minor impact around the fringes but it was chiefly a reflection of lower commodity prices.

Was there anything about the result that surprised you?

Taylor: A couple of things about the result that was surprising. The first was the strength in the aluminum results. We were expecting a considerable loss. In fact, they reported breakeven, and that had a lot to do with the Canadian currency, which was favorable versus the U.S. dollar. So costs were a bit lower than expected. Although it must be said that Rio has hived off a lot of its Rio assets into a separate vehicle ready for sale, so there could be some costs lurking in there that were hidden.

The other thing that was quite surprising was the CEO, Tom Albanese's very bullish outlook in the near-term for the Chinese economy. We've been used to seeing some quite subdued outlook commentary about the near-term. This time it was quite bullish, and he is forecasting 8% growth in China this year and an uptick in demand.

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Reporting season: Leighton
07/08/2012 Morningstar analysts provide investors with their earning season insights in these concise, timely video snapshots. Reporting season: Leighton -- 07/08/2012 http://video.morningstar.com/aus/video/120807_report_leighton_audio.mp4

Where Leighton’s earnings above, in line with, or below expectations?

Ross Macmillan: Basically Leighton’s half-year result was in line with my expectations. Leighton’s has moved to a December year-end in line with its 54% majority shareholder ACS of Spain. Leighton’s had previously given guidance to the market that their half year, net profit after tax result, would be between $100 million and $150 million.

Company came in with a net profit after tax of $115 million before minority interest or $106 million after minority interest. So is at their lower end of guidance and we were certainly at the lower end of guidance as well. We were expecting a $102 million, so just marginally above what we were expecting, but at the lower end of guidance.

Was the dividend above, in line with, or below expectations?

Macmillan: We were expecting a $0.25 dividend. Leighton’s paid a $0.20 dividend, which was unfranked. Company has a policy now of paying 60% of its earnings as dividends to shareholders. Therefore, we are still expecting a $0.50 final dividend for the six months ending 31st December.

What were the key drivers of the result?

Macmillan: Certainly the key drivers of Leighton’s result was the mining service division. The company is winning a number of strong contracts here in Australia and in Indonesia. We expect this part of the Leighton’s operations to continue to perform very strongly over the next 12 months. Certainly, there is uncertainty after that period with a number of domestic mining companies suggesting that marginal projects might be deferred or delayed at this stage.

The other thing that really impacted Leighton’s over the past six months was their two key infrastructure projects; that was the Brisbane airport project and the Victorian desalination project. Each one of those projects had accumulated losses of about $600 million. The Brisbane airport link project was completed on the 23rd of July, so Leighton’s only has the final Victorian desalination project to complete. Now that should be completed in December and we're not expecting any further losses from that operation.

Was there anything about the result that surprised you?

Macmillan: Yes, we were surprised that the Middle Eastern joint venture operation that Leighton has called Habtoor Leighton is still performing quite weakly. Leighton equity accounted a $32 million loss for this business and wrote down the value of the business from $380 million down to $350 million. Now this business originally was valued at $1.4 billion, so there has been significant write-downs, impairments, and losses with this business over the past four years, and they continue to impact the Leighton result.

The other thing that is surprising in Leighton’s result is that we know that they recently sold their Waste Management operation for A$218 million. Now the CEO of Leighton, Hamish Tyrwhitt, has indicated that he will be undertaking further divestments of non-core assets and businesses over the next 12 months. We’d see that they will be - Leighton currently operates business in the aviation, IT and telecommunication sectors. We're seeing that those businesses probably will be divested in the next 12 months. That would bring Leighton a further between $100 million to $200 million of funds to strengthen the balance sheet and fund any growth opportunities that the Company sees coming.

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WOW & WES: Sales war intensifies
27/07/2012 Both groups released impressive fourth-quarter sales numbers this week, but competition remains intense. WOW & WES: Sales war intensifies Christine St Anne 27/07/2012 http://video.morningstar.com/aus/video/120727_wes_wow_audio.mp4

Christine St Anne: Woolworths and Wesfarmers both released their sales figures for the fourth quarter this week. Morningstar's Peter Warnes joined us to get the truth behind the numbers.

Peter, welcome.

Peter Warnes: Thanks, Christine. Good to be here.

St Anne: Peter, the strong sales growth by both companies were attributed to the government stimulus payments. Because of that, do you think that the sales numbers are sustainable?

Warnes: Christine, those government payments were of significance in the fourth quarter, and more importantly in June, but they weren't the only positive influences on the sales figures - and don’t forget two interest rate cuts prior to that quarter are filtering through. And of course the majority of people who have mortgages are on variable rates, and that increases immediately the household disposable income.

So, if you put interest rates together with those government payments, then that makes a very solid boost and gives a solid boost to those sales. But both companies indicated that the trend was positive prior to June and June was the icing on the cake, if you like. So, are they sustainable? Well, the interest rate cuts are still filtering through and who knows there could be another interest rate cut in August, but I suspect not.

But the payments have a one-off situation. I would think that the more of the problem is what's going to happen to household disposable income when they start receiving their electricity accounts, and gas accounts, and water accounts in June - in July, August and September and they are very, very big increases. And so that might just take the edge off the positive trend, albeit there just seems to be that people are starting to spend a little bit more now and I would expect that probably to continue.

St Anne: Peter, Coles achieved higher sales growth than Woolworths and yet Woolworths has increased its floor space more than Coles. Is the growth strategy for Woolworths paying off?

Warnes: Christine, both companies have a different strategy in terms of how they are trying to increase foot traffic and therefore increase sales. Woolworths has decided to go on the front foot and aggressively open supermarkets. In FY'12 they opened 38 supermarkets, that is the highest number of supermarkets ever opened on an annual basis in Woolworths' history. It will peel off a little bit in 2013.

Of course, that really does impact - it impacts your headline sales, because you've got more stores and say you're getting some sales, but it also suggest that there might be some cannibalization of their existing stores. I would suspect that Woolworths - the momentum was favorable in the fourth quarter, disappointing in the third quarter and I would think that they are really starting to try to reinvent themselves, if you like, more initiatives, more loyalty programs et cetera, et cetera. So, look Woolworths, I think, will probably gradually improve going through 2013.

Coles on the other hand have decided to not open too many stores, in fact they opened 19 and closed 11 for a net 8, but they very, very strongly pushed into refurbishments. So, they are getting more bang for their buck in refurbishments and that is helping their comparable store growth, because they are not opening new stores and so those stores they're refurbishing are already opened for a year and so that's why they're getting better comparable store sales.

So, what's happening is that the growth of the headline rate for Coles is still outperforming Woolworths, but the comparables are still outperforming Woolworths as well, albeit that Woolworths did close the gap in both metrics in the fourth quarter.

St Anne: Target and Big W also both lifted their sales. Is there a little bit of optimism creeping back into the discretionary side of retailing?

Warnes: I wouldn't call discount department stores really discretionary. So, we've just got to be a little bit careful there. Look, the government payments that did hit when households do get an injection of money, they're going to look after the kids normally. So, both Target and a Big W had very, very good sales in, strange enough, in soft goods, in other words apparel, some homewares were much better, getting a new pot and pan and what have you, and also Target brought their toy sale - brought it forward.

So, those things were definitely impacted by the government payments. There is no doubt, in fact Richard Goyder had indicated that government payments really were worth about 1% of sales in the fourth quarter. I wouldn't think that there is a great turnaround in discretionary spending just on the back of fourth quarter sales of those two discount department stores.

St Anne: Peter, finally with the earning season coming up next month, what are your expectations for Woolworths and Wesfarmers?

Warnes: Christine, of course a lot will depend obviously on what's happening with margins. I mean they've got the volume up and the dollar sales are up. It comes back to margins. I would expect that the margins will be at least maintained and probably improved slightly. The reason for that is that it's all to do with volume growth and when you take into account the deflationary pressures that are in the supermarket space and across the other areas as well. Coles had real growth in the fourth quarter of 7% and over 6% for the full year and Woolworths was 5.3% in the fourth quarter and about 4% in volume terms for the full year.

Now, that volume growth it's how efficient the distribution networkers are, Woolworths is very, very efficient, Coles is catching up. So, the supply chain efficiencies, the productivity loop, if you like, they are the critical things that will impact margins favorably. So, I expect the volume growth to dictate what happens to the margins. So, I'm looking for pretty reasonable growth in EBIT and ENPAT comfortably above the headline sales growth numbers.

St Anne: Peter, thanks so much for your insights today.

Warnes: That's a pleasure, Christine.

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Investing in Westpac notes
24/07/2012 Morningstar's Ravi Reddy helps investors weigh up the pros and cons of the recent debt offering announced by Westpac. Investing in Westpac notes Nicholas Grove 24/07/2012 http://video.morningstar.com/aus/video/120723_westpac_notes_audio.mp4

Nicholas Grove: Banking giant Westpac recently said it's looking to raise about $0.5 billion through the issue of some debt to be known as Westpac Subordinated Notes. Here to give us a rundown on what these securities can offer investors, I'm joined again by Morningstar Equities Analyst, Ravi Reddy.

Ravi, thanks very much for joining us.

Ravi Reddy: Thanks, Nick.

Grove: First of all, Ravi, can you give us a brief idea about the structure of these securities? Also how do they defer from other types of interest rate securities?

Reddy: Westpac issues are similar to recent issues by ANZ and NAB. It's a debt security, which is subordinated and unsecured. It's got a 10-year term. It can be redeemed early at the 5-year mark or at any subsequent interest payment date or following a trigger event, like a taxation or regulatory event. But note holders do not have an option to request early redemption.

The notes pay quarterly interest and it's based on a margin above the 90-day BBSW rate. The expected margin range is between 2.75% and 2.95% and there is no conversion into Westpac ordinary shares. So on redemption repayment is by cash. The notes are also higher ranking than other Westpac hybrids and ordinary shares, so which means in a wind-up scenario these note holders stand ahead of holders of these other securities.

Grove: Ravi, who is eligible to invest in these notes, should they wish to?

Reddy: There is no general public offer. The offer’s open to Westpac security holders, clients of participating brokers and certain institutional clients. The other offers by ANZ and NAB were open to the general public, so it's a little bit different.

Grove: Roughly where do you think the margin on these notes will come in at, and do you also think the size of the offer may increase?

Reddy: We think the margin will come in at 2.75%, which is at the bottom of the indicative range. The recent offers by ANZ and NAB came in at 2.75%. We think the final offer size will be higher than the initial offer size of $500 million, maybe around $1 billion. ANZ and NAB raised $1.5 billion and $1.2 billion respectively, so that gives you bit of a feel for what we expect.

Grove: Ravi, what are the main aspects of this particular issue that you find appealing?

Reddy: We like this issue because it's a pure debt security. It's got a relatively simple structure. The interest payments are mandatory, but they are subject to a solvency test and there's no conversion into equity. They're also higher ranking than other Westpac hybrids and ordinary shares.

Grove: On the flipside, Ravi, what are the main risks that investors should bear in mind when it comes to this type of security?

Reddy: Investors need to be aware this is a subordinated, unsecured investment, so it's riskier than a bank deposit. Investors should also be aware that its floating rate security, which re-prices quarterly, so in a declining interest rate environment interest payments are likely to fall and the opposite is the case in a rising interest rate environment. We also suggest that investors seek independent advice from a professional advisor before making an investment decision.

Grove: Ravi, thanks very much for joining us.

Reddy: Thanks, Nick.

Grove: To read Ravi's recent report on Westpac subordinated notes, Morningstar.com.au premium subscribers can go to the hybrid's tab and click on the link below.

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Rio and BHP under pressure
20/07/2012 Morningstar’s Mark Taylor makes sense of the latest production results from Rio and BHP. Rio and BHP under pressure Christine St Anne 20/07/2012 http://video.morningstar.com/aus/video/120720_BHPRio_audio.mp4

Christine St Anne: Rio Tinto and BHP both put out their June quarter production levels, with BHP posting its 12th consecutive iron ore production record. To make sense of the numbers I'm joined by Morningstar’s Mark Taylor.

Mark, welcome.

Mark Taylor: Thanks, Christine.

St Anne: Mark, so these production numbers, were they inline with your expectations?

Taylor: Overall, marginally softer. Very, very strong iron ore numbers, higher than expected, up about 10% for BHP and about 15% for Rio, so very strong. But that was more than offset on balance by a slightly weaker than expected copper output, and some of the other lesser divisions; BHP Petroleum was a little bit softer than expected too. So, the overall impact was about a 5% hit to our earnings forecast for fiscal 2012.

St Anne: Mark, on that point of iron ore production, Rio Tinto’s levels were softer than BHP and the markets seem to be concerned. Are those concerns valid?

Taylor: I don't believe so. I mean, I'm not sure that that's taking into consideration the growth path that each company has got. Rio has got very, very strong iron ore growth path, expansions are underway and iron ore is far more important to Rio than it is for BHP. It made up 85% of group earnings before interest and tax for the last half, so very, very substantial.

So, the markets probably scrutinized Rio's numbers more closely because it's more meaningful to that company, but I think that both companies, the growth in volume is in line with their expansion plans.

St Anne: Mark, are the production levels of these two big miners reflective of their earnings outlook?

Taylor: Yes and no, I mean they are in the sense that they’re pretty much in line with the expectations of their iron ore numbers, but the big issue is the pricing. I mean, that's where all the sensitivity is and the iron ore price has come off a bit of late from about $160 a ton down to about a $130 a ton. It doesn’t sound like a lot, but it will impact margins. So, it swings and roundabouts.

St Anne: Mark, when the two miners put out their production levels, their share price is fell, with the mining index falling to its lowest level in three years. Is the market concerned about the companies or it's about more the macro issues?

Taylor: I don't think the response has been into what's - anything that’s been announced in the quarterly reports. I mean the numbers were mildly soft, but nothing to write home about. I think the market is just looking forward - looking to all the negative commentary coming out of Europe and China, and has been for some time, and is in a frame of mind to jump on anything that's not hugely positive. So, I think that's just a sign of the times rather than anything that could be gleaned specifically from the reports.

St Anne: Finally Mark, we're coming into the earnings season, are you expecting any surprises from Rio or BHP?

Taylor: Not any surprises as such, but there will be some negatives to come out, particularly in an abnormal sense. I mean from Rio you’re likely to see more aluminum write-offs. I'm expecting a similar sort of thing from BHP with respect to petroleum, with their shale gas acquisitions. I think these things are sort of – particularly with BHP, are sort of marking-to-market, rather than a genuine long-term negative, but those sorts of things, but nothing that's unexpected.

St Anne: Mark, thanks so much for your time today.

Taylor: You're welcome Christine.

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Will M&A activity increase?
17/07/2012 Morningstar’s’ Mat Hodge outlines possible merger activity in the Australian market and whether takeovers will increase. Will M&A activity increase? Christine St Anne 17/07/2012 http://video.morningstar.com/aus/video/120716_MandA_audio.mp4

Christine St Anne: Morningstar recently put together a report on mergers and acquisitions or M&A activity in the Australian market. Today, I'm joined by the report’s author, Mathew Hodge, to discuss the findings.

Mathew, welcome.

Mat Hodge: Pleasure to be here.

St Anne: Mathew, do you expect M&A activity to pick up?

Hodge: Well, it's hard to say. The external environment is pretty poor at the moment. The global economy is pretty weak. Europe is looking pretty poor. The U.S. is starting to slowdown, and China has obviously been slowing as well. So that's not a very good backdrop for M&A.

What tends to happen is that managers get pretty bullish when everything is quite favorable and tend to make acquisitions at the top of the market. There may be some who have got solid balance sheet, who can come in and take advantage of some of the depressed prices. But if you take commodities, for example, it's going to be difficult in the mining space to get deals up because prices are a lot lower than where they were and they are falling. So, it just makes it more difficult to get finance in place.

St Anne: Mathew, you mentioned the mining sector, what about other sectors that are more prone to M&A activity?

Hodge: You might get a little bit of bargain-hunting in the mining sector. There is a bit of stuff happening in the media sector. People are anticipating changes across media ownership laws and obviously you’ve got the decline of old media. So, there are going to be new companies emerge or perhaps private equity come in and look to strip out costs and change the business model in there, because obviously some of those companies have struggled to change their business model after decades of operating the way they have been.

In the gambling sector, you’ve got a bit of activity around Echo, but that seems to be more about control and getting licensing for Crown, for a second casino in Sydney. So, we're not sure a full takeover would necessarily be needed in that case.

It doesn’t appear like there's much happening on the surface, but when you look underneath there's quite a lot of little bits and pieces and resources, as you said, the big deal at the moment is Whitehaven. But as I was saying before, that's increasingly looking difficult because the coal price has fallen so much, so it's going to be hard to get the debt to make the numbers work.

St Anne: Mathew, Rio Tinto and BHP recently made announcements that they were going to cool off in some of the project expansions. Are they in a position to make any acquisitions?

Hodge: Well, Rio has still gone ahead with its iron ore, but basically the market was expecting that expansion to go ahead anyway. So I think that's probably - you can basically say that's stuff that was almost in train anyway.

BHP has definitely cooled, and I think that's a reasonable thing given the price of capital expenditure is just extortionate relative to mines that have come before it. So it means that new mines that are built, their returns won’t be as attractive. So definitely there is a motivation to buy existing assets, and BHP and Rio’s balance sheets are pretty good. They might hunker down for a little while now, but I could see them spending money on sort of smaller bolt-on acquisitions.

St Anne: Singapore’s Genting Group are already making a play for Echo Entertainment. Do you expect an increase in overseas companies coming into the Australian market?

Hodge: Well, private equity, particularly I guess, the obvious opportunity is probably in retail or some of these sectors that are under severe threat from the Internet and their business model has to change. There aren’t many examples of management being able to negotiate those kind of changes well. So when management doesn’t act, that's where these guys come in. So, media, retail, these kind of sectors you could see some activity particularly from the private equity types.

St Anne: Mathew, thanks so much for your views today.

Hodge: Pleasure.

St Anne: Premium subscribers can access the report by going to the Morningstar.com.au website, clicking on the Special Reports tab, and click on the link below.

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Huntleys' 2012-13 forecast
09/07/2012 Huntleys' Your Money Weekly’s Ian Huntley talks about a possible bull market and his outlook for interest rates, China and commodity prices. Huntleys' 2012-13 forecast Christine St Anne 09/07/2012 http://video.morningstar.com/aus/video/120626_huntley_fcast_audio.mp4

Christine St Anne: The markets never ceases to surprise us as volatility continues. Today, I'm joined by Your Money Weekly's Ian Huntley to give us his forecast over the next six months. Ian, welcome.

Ian Huntley: Hi.

St Anne: Ian, over the last three years, you've held the view that the market would zig-zag ranging between 4,000 to 5,000, that view has pretty much been accurate. What makes you think that we're going to see the start of a market bull run?

Huntley: Volatility doesn't particularly trouble me, I think it's a crazy word. It means the market goes up and down, right? Hey, what's new? It always does. But, what I've looked for is, over the last three years following the GFC, is a workout period. I have compared it initially to structure that strategy with this workout period following the 1987 crash, when we actually had three years of a zig-zag market, which is exactly what I've looked for over the last three years, and I have said it crudely between 4,000, 5,000, with a bit slippage to 3,800 and last year, I thought there was a 20% chance of it going up and breaking through 5,000, 5,500. At 20%, the major chance was it didn't, and it didn’t.

But I've also look for, around this year - later this year for the beginnings of a new - a teens decade bull market. If you look at the history of the market, decade bull markets are there every year - every decade over the last 100 years. Why should this one be different? But the launching pad for a bull market can be a very messy corrective phase. The bear market’s got to suck the majority of the people in, before it launches the next upside, and interestingly that first leg up can be very, very powerful indeed. If you looked at the run up from the March 2009 crisis low, there was a pretty powerful market there, and there was a lot of money to be made in that particular period. Sure, that it came after a period of a major horrendous mess, particularly in property trusts and over-geared companies, but that's the way it is.

St Anne: Ian, do you expect interest rates to fall and if that's the case, what sort of strategies do you think retirees should look at?

Huntley: It's very interesting that quite a few people have - equity inclined people have around about 30% of money in the sidelines and bank deposit, some people obviously have more. In fact some financial planners have been describing bank deposits as a new asset class. Well, I'm an equity investor and I simply regard money on deposit just as a short-term thing, while I wait to find a better opportunity in the market. I think this market has got lots of opportunities. It's cheap. It's actually a much safer market to buy-in than the top of 2007 by definition.

So, there is a lots of things that can go up over next three to five years. Now over the next few months, our market is going to continue to be roiled by the looks of it, by the European stuff, but it's going to be a low interest rate world. That could mean a bit of strength in the Aussie dollar, that's hard to pick. There is downside in Australian interest rates, but not massive from here. We've got a very powerful resource investment boom, something the United States simply doesn't have that underpins our employment picture and that underpins our household's ability to repay their mortgages and that underpins our banks stability. So, I think the banks offer good yields. I prefer to have my money in the bank rather than on deposit, but I don't mind particularly if the shares go up and down. I bank the dividends.

Now, if I'm buying them relatively cheaply, it's not fussing me if they go down 10%, 15%, 20%, they'll get back up. But I've sort of lived through a lot of volatility. As long as I'm happy that the stock is not going to go out the back door or something like that or be permanently damaged, I'm quite happy to hold.

I'm used to my stocks fluctuating often, usually on a long-term trend going up. As long as I’ve got the available liquidity, let's buy more. I think that's a wonderful strategy, but I tend to be a long-term investor and I absolutely love the dividend income. It's not hard to generate 6% fully franked in this current market in quality stocks.

Some of them are extremely high quality. A company with a good business and a good balance sheet - at Morningstar, we broadly describe a quality company as having a moat, either a wide moat or a narrow moat, which is a good definition of a competitive advantage, which will underpin that company's earning power at a reasonable level for many years to come.

My own personal best definition of a company with a moat is, with a great thank you to Warren Buffett; will this company still be around in 10 years? It's a great question. If you can understand that that company will still be there in 10 years and growing and doing well, then you sit down and look at a few more figures. If it's got a good dividend yield and that dividend yield is growing, then I just fall in love. The damn bank deposits I prefer that, but I'm me, and that's the way I look at it.

St Anne: Ian, what's your view on commodity prices?

Huntley: Currently, there is the biggest resource investment boom in our history, that's massive. Now that's feeding through into the rest of the economy and that's underpinning employment. Now, the commodity prices are now well and truly off. Iron ore and copper and metallurgical coking coal to my mind are still excellent prices.

They’ve come off their peaks, but metallurgical coking coal, there was a massive flood in Queensland a year ago, and they are still excellent long-term prices. I would think that - personally I think that iron ore was stay up at a very reasonable price for the next few years, and I think copper will surprise the bears and be at very good prices, probably in the next decade. But that doesn't mean that they are at record prices. Copper is now about $3.30 a pound, and not so long ago it was over $4. But you got to remember five or six years ago people thought $1.20 a pound for copper was extraordinary.

Now, these are excellent prices that copper and iron ore and metallurgical coking and coal are very much driven by Chinese demand, and I'm not a China bear.

St Anne: There has been a lot of talk about the growth in China. Do you think that the slowdown will be substantial?

Huntley: I think that's a load of garbage. Look, you've got to understand the newspaper business, I grew up in it. Fear sells a lot better than good news. There is nothing like a good murder, right? Now, if you sit down and say, hey in Australia there is 23 million people are still alive today. Guess what, you won't sell a newspaper, but if you say, so and so was murdered last night, they’ll want to read it and saying (urrrrrrr…).

Now look, China is going to still be growing over the next 15 to 20 years. There is 1.3 billion, 1.4 billion people still earning - their earnings have really grown since Deng unleashed the economy right back there in the early 1980s, after 100 years of absolute strife in China, most of all under Mao, his predecessor. They wrecked the country with a cultural revolution. The leaders of China don't want that again, and they sit down and work very hard and they study very carefully, they listen to criticism, and they're really trying to continue to grow that country. Do not underestimate them.

Now, some of the suppositions that you see in the headlines to my mind are absolute garbage. The impact of Europe on Chinese exports, at most I can figure out would drop, that's very much the worse case, would drop Chinese GDP by 2%. This is something that in recent years has been running at 10% or 11%. Now I'm quite happy with a figure of somewhere between 7% and 8% this year. Now, if you want to be bearish you can allow for failures and drop 1.5% off it. But I always focus on iron ore demand and that's continuing. The major driver in China will continue to be, for quite a long time, investment in infrastructure.

Look, this is a country that’s the same size as the U.S. or Australia, it’s a continent. They've got to make up for 100 years of doing nothing. They've got put in rail lines, power lines, it's massive, and that drives jobs. Their consumer is growing at 15% per annum. They’re selling more motorcars in China than they're doing in the States. This business about no consumer growth, and all the rest of it in China, I don’t know how much more do you want, 13% to 15% per annum? It just defies me.

China is turning around at the moment. I would expect that 2013 would be quite a buoyant year in China. Look, real estate is starting to pick. They are starting to drop interest rates. Our Reserve Bank has described this particular downturn in China as a policy-driven downturn. Interesting phraseology. The downturn in Europe and in the United States is not policy-driven. It's driven by a 70-year build up in debt, which is now being written-off, or repaid.

St Anne: Ian, what about gold? Do you think that would continue to be a safe asset?

Huntley: You reckon gold is a safe asset? Good luck. I'm far more interested in quality income earning assets, especially when they're paying me good income. You've to remember gold does not pay you a dividend. It's an asset and where you win is if it goes up.

Now, I have lived in African countries and I do understand, in a situation of turmoil, it's rather lovely to have gold, funnily enough U.S. dollars. I once stuffed a fishing rod full of U.S. dollars and left a country, that was the only way I can get my money out. I spent six months getting the U.S. dollars, but that's a long time ago. The amount of U.S. dollars I put in the fishing rod was quite important to be at the time.

Now, gold is that type of asset that runs across borders. Now, yes, I remain positive in gold because there is so much drive. There is so much need to resort to the printing press, and in many ways gold at the present time is relating as an alternative currency.

So, all I can say, I think that Europe is going to be currency turmoil and money printing. I don't think gold is going down. Now in the United States, there is another two or three years of debt run down by households, the economy is going to be sluggish, and the Fed is going to be quite correctly, to my mind, trying to keep the place on an even-keel.

So I remain positive on gold. I think gold shares are selling at too much of a discount to the earnings they've got to be making over the next few years, but it's not a place where I put a great deal of assets.

St Anne: Ian, thanks so much for your time today.

Huntley: Okay.

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Gambling on control over Echo
06/07/2012 Morningstar’s Michael Wu provides an insight into the competing bids for control over the Echo Entertainment Group. Gambling on control over Echo Christine St Anne 06/07/2012 http://video.morningstar.com/aus/video/120705_echo_audio.mp4

Christine St Anne: The battle for Echo Entertainment continues between the key players; the Genting Group and Crown. Today, I am joined by Morningstar's Michael Wu to give us his perspectives on the tussle.

Michael, welcome.

Michael Wu: Thanks. It's nice to be here.

St Anne: So Michael, the Singapore's Genting Group has lifted its stake in the Echo Group. Do you think a takeover is imminent?

Wu: Not right now. I think the main hurdle is that Genting do require regulatory approval from the gaming regulator in New South Wales and Queensland to lift their stake above 10%. From Echo's return perspective, we don't think Genting is going to make a full takeover. This is an opportunity for Genting, but Genting itself does have plenty of opportunities around the world, so this is just one of them.

St Anne: The other key player, of course, is Crown which has also lifted its stake. Where does the Genting bid now leave Crown's involvement?

Wu: Crown's intention is quite clear, with what they want to do there. I think Genting's stake will act as a blocking stake for Crown. So, any deals that Crown does will have to involve Genting. Crown's regulatory application was ahead of Genting's, so we do expect an early decision for Crown.

St Anne: Investment manager Perpetual also was given regulatory approval to lift its stake. Michael, does this scuttle any takeover plans between Crown and the Genting Group?

Wu: Perpetual did receive a regulatory approval to lift their stake in Echo above 10%, but they have since reduced and sold their stake in Echo and are no longer substantial shareholders. At current share price, we don't see them increasing their stake. I think one implication from this announcement is that it might take some time for Crown and Genting to receive regulatory approval given that Perpetual needed - the regulator needed seven months to decide on Perpetual's submission.

St Anne: Michael, given that the Genting Group is based in Asia, do you think that they are better positioned to boost the VIP market for Echo?

Wu: Genting does have a good understanding of the Asian VIP market, but at the same time Crown does have a good network with the VIP business with their joint venture in Macau. So, we see both Genting and Crown are able to lift the VIP business in Echo.

St Anne: Finally Michael, the Star is the jewel in Echo Entertainment's crown. What is your outlook for the business now?

Wu: The recent trading conditions and the update was slightly weaker than expected, but it's too early to draw any conclusion from that. I think a lot of those gaming facilities and entertainment venues were opened in the second half of last year, so we do expect a better performance at the Star as well as some operational efficiency that should flow through. In the shorter term, I think that the events that would open up in the early next year could be a driver, and the longer term driver would be the revamp of the Darling Harbour precinct.

St Anne: Michael, thanks so much for your time today

Wu: Sure. Thanks, Christine.

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Consumer and industrials outlook
05/07/2012 Morningstar’s Peter Rae shares a few thoughts on what qualities investors should be looking for in consumer, healthcare, telecoms and mining services companies. Consumer and industrials outlook Nicholas Grove 05/07/2012 http://video.morningstar.com/aus/video/120704_consumer_fcast_audio.mp4

Nicholas Grove: A team of Morningstar equities analysts recently completed their consumer and industrial stocks outlook as part of the Huntley's 2012 to 2013 forecast. Here to discuss what investors can expect from these stocks down the track, I am joined by Morningstar's Peter Rae.

Peter, thanks very much for joining us.

Peter Rae: Thank you very much Nick.

Grove: First of all Peter, let's talk about the media sector. There seems to be a tectonic shift occurring in the media space similar to what we've seen occurring in the retail space for some time. Broadly speaking, what kind of companies should investors be leaning towards in this space?

Rae: Yes. Well, we certainly have seen a lot of structural change in the media sector and that’s going to continue for some time we think. We've seen the likes of Fairfax and News come out with significant restructuring and efforts to cut costs and change the direction of their business.
So, we tend to steer clear of that sector and in the online space, we'd have preferences for stocks that have growth businesses, those that have benefited from the shifting classifieds to online.

We see those as providing better opportunities to investors, but I'd also caution that in the online space things can change quite rapidly and even though some of these names who have very strong brands, it's not against the realm of possibility that the new players can come in and steal share from these existing players.

Grove: Peter, what kind of attitude should investors take and what sort of qualities should they be looking for when it comes to the healthcare and telecommunications sectors in 2013.

Rae: In healthcare we'd be looking for stocks with good strong businesses, larger companies, those with economic moats that have competitive advantage in the industries that they are in. Healthcare is not a homogenous sector. There are a number of different areas of healthcare in which to invest, but yes we'd focus on those stocks with good businesses, strong competitive advantage and economic moat.

In telecommunications, look there is really only one player there that has done very well this year and offers a good dividend yield. It's hard to go past that particular stock.

Grove: Peter, in the aforementioned report you described the outlook for most companies across all the industrial subsectors, so manufacturing, transport, housing and building related companies, you described this as being weak. What’s behind this outlook and is there a silver lining?

Rae: There are a number of factors behind that, the strong Australian dollar is one factor, it's affecting manufacturing in particular and we've seen a lot of job losses occurring in the manufacturing sector. It's just tough for many manufacturers to compete on a global stage given the strength of the Aussie dollar.

Also, in the building and construction sector, housing construction is down given the weakness in consumer sentiment and we think that’s likely to stay that way for little while. Ultimately, the interest rate cuts that have occurred recently and we think there will be some further interest rate cuts, they will drive demand for housing and housing will pickup. So, we will see pickup in that sector. It's a little bit hard at this stage to say just when that will occur.

And also consumer sentiment is very weak and that does flow through to stocks in the industrial sector. And look, again, the cuts in interest rates have occurred and further potential cuts could ultimately turn consumers - or will ultimately turn consumer sentiment around and we'll see an improvement in those stocks that are directly impacted by weak consumer sentiment.

Grove: Finally, Peter, in fiscal 2013 are mining services companies going to continue to do well, given the bullish outlook for our resources sector or is the party over?

Rae: Look, there has been a lot of talk in the press lately about the mining boom finishing, China is starting to slow, demand for commodities is going to drop, commodity prices have come off from their peaks. There is a lot of work out there still for these mining services companies. If you look at the capital expenditure plans of the major mining companies for the next couple of years, particularly also in the energy sector for LNG, there is still a lot of work that's going to be occurring over the next two, perhaps three years.

So, I think there is some good demand for the services of these mining services companies, but you have to be selective and pick those that are going to benefit from that CapEx and once that CapEx does start to slowdown, some of these players will be hurt by that slowdown. So, it's really a case of selecting those that can benefit from the current CapEx boom and just being a little bit wary of what happens once that CapEx does start to slowdown.

Grove: Peter, thanks very much for joining us.

Rae: Thank you, Nick.

Grove: To read the recent consumer and industrials report, Morningstar.com.au premium subscribers can go to the special reports tab and then click on the link below.

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Financial services earnings outlook
04/07/2012 In an environment of weak equity markets, weak credit growth and higher funding costs, where will the earnings of the banks and other financial services companies come from? Financial services earnings outlook Nicholas Grove 04/07/2012 http://video.morningstar.com/aus/video/120702_banks_fcast_audio.mp4

Nicholas Grove: The current global macroeconomic outlook is not what you would describe as rosy, and given the current environment, investors may be wondering where the earnings of the banks and other financial services companies will be coming from when they post their results in the near future. Here to give us an idea of what to expect, I'm joined by Morningstar's David Ellis.

David, thanks very much for joining us.

David Ellis: Pleasure, Nick.

Grove: First of all David, let's discuss the big four banks. Given the current environment, can we expect much from them in terms of future earnings growth? And are their dividends secure in your opinion?

Ellis: The four major banks are in a pretty good position, pretty strong position. Earnings growth will be moderate, nothing too fancy, nothing too aggressive or strong, but there will be earnings growth that's for sure. It's coming from credit growth. There is still even though system credit growth is not strong, the four major banks are taking share from the non-bank sector, and they're growing their loan books at a steady - a moderate but steady pace.

So there is credit growth. Margins have been maintained. Costs are being managed down or certainly growth in expenses is being held. And at this stage of the credit cycle, bad debts are still benign. So we're quite confident that the dividends for the four major banks are sustainable, and there is a number of reasons: we're in a weak credit growth environment so the banks are not growing their loan books aggressively, but yet still generating strong profits. So, the low loan growth means that there is less capital required to support the balance sheet growth, and there is a lot of organic capital being generated or created from the profits that the banks are earning.

Grove: Looking to the wealth managers just for a moment, the likes of AMP, BT, Perpetual and so on, what are going to be the key earnings drivers that investors should keep an eye on?

Ellis: Well, they are in a different position all together compared to the banks. Obviously, we're in an environment now where investor confidence is weak. The equity markets, both globally and in Australia are volatile to say the least and weak. So fund flows into the fund managers, the wealth managers have been lackluster at best, because the markets last year, the 12 months ending 30th of June, we had - the ASX 200 was down about 11% in Australia.

So the balance of the funds under management declines when equity markets decline. So lower funds under management means lower margin income for the wealth managers, and combined with lower margin income is pressure on fees. So the wealth managers are facing headwinds from two directions at the same time, so pressure on fees and lower funds under management, which means lower revenue or income. So what we're looking for, for the wealth managers is obviously a turnaround in equity market sentiment.

Grove: David, the Australian Property Trusts have been performing pretty well lately, outperforming the ASX 200s since last December, broadly speaking what's behind this performance and do you expect it to continue?

Ellis: Well, put simply the reason for the strong performance of the Australian REITS, Australian Property Trusts has been a sharp decline in interest rates. So the cash rate has fallen, the Commonwealth Government Bond rate has fallen dramatically. We’re in a falling interest rate environment. The Property Trusts offer a pretty solid and attractive yield, and so in a lower interest rate environment, the 6% to 7% or 8% distribution yield from the Property Trusts obviously looks very, very attractive and in these volatile markets, the earnings and hence the distributions of the Property Trusts are quite defensive.

So a lot of retail investors are seeking, of course, less risk, less volatility and the Australian Property Trust are offering that. Since the GFC, they've all been recapitalized, their gearing levels have reduced. They've got much stronger balance sheets and even in the last 12 months, there has been a number of buybacks. So some of the Property Trusts are returning capital to investors, so that they look attractive. Now whether that will continue, a lot depends on interest rates.

Grove: Finally David, what are the key things investors should keep in mind when it comes to this sector as we head into the new financial year?

Ellis: If we just look to the banks, particularly the four major banks, the banks are a very good reflection of the economy. So, if looking 12 months or looking several years ahead, if the economy does continue to grow at a similar rates or moderate rates that we're currently experiencing, particularly the banks in the financial services sector will tend to move with the economy.

So, what we are looking for the financial services sector is more economic growth. We're obviously hoping that we avoid any economic slowdown. Obviously the economy, the Australian economy is being boosted by a massive resource investment, but the non-resource parts of the economy are struggling. But if we continue to grow at trend, which is say 3% to 4%, then the financial services sector will benefit from that and particularly the four major banks.

Grove: David, thanks very much for joining us.

Ellis: Pleasure Nick.

Grove: To read Morningstar's recent financial services forecast, Morningstar.com.au premium subscribers can go to the special reports tab, and click on the link below.

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Listed infrastructure investing 101
02/07/2012 Morningstar's Adrian Atkins helps investors get a handle on a few of the basics when it comes to a sector that is often perceived as being overly complex. Listed infrastructure investing 101 Nicholas Grove 02/07/2012 http://video.morningstar.com/aus/video/120629_infrastructure_audio.mp4

Nicholas Grove: When confronted with the prospect of investing in the listed infrastructure space many people maybe scratching their heads after being struck by the sectors apparent complexity, but here to help investors navigate these waters, I'm joined by Morningstar's Senior Equities Analyst, Adrian Atkins.

Adrian, thanks very much for joining us.

Adrian Atkins: No problem, Nick.

Grove: First of all Adrian, can you give us a brief idea about and a few examples of the kinds of companies that make up this sector and what it is they do?

Atkins: Sure. There is four broad categories of infrastructure stocks listed in Australia. We've got: regulated utilities, unregulated utilities, toll roads and airports. So the regulated utilities own the poles and wires, and the gas pipelines that connect to our houses located in cities. The unregulated utilities own long-distance gas pipelines running from gas fields to cities. Then toll roads - pretty straightforward; and airports as well.

In the regulated utilities sector we've got SP AusNet and Envestra and other companies. In unregulated space we've got APA Group and Hastings Diversified Utilities Fund. In the toll roads there is Transurban and for airports there is Sydney Airport.

Grove: Adrian, all the stocks in this sector what you would describe as defensive income stocks?

Atkins: Yes, they're all defensive, some more so, I think, probably airports are the least defensive. But the other thing you need to consider is the level of gearing they have, and because they have such stable revenues they all use quite a lot of debt, which is fine at most points in time, but whenever you get a credit crisis it can put them under little bit of pressure. They've all cleaned up their balance sheets a lot since the GFC, so we're not expecting anything disastrous. But nonetheless it is something that you have to be aware of.

Grove: Adrian, in the recent report you discussed the relationship between these stocks and falling interest rates. Would you mind just elaborating briefly on this relationship?

Atkins: Sure. We were looking specifically at the regulated utilities, because for the regulated utilities the regulator decides what a fair amount of profit is and he works that out, part of it is interest rates. So, as interest rates fall, he recalculates the amount of profit and he should all else equal come up with the small profit number.

So, we are a little bit concerned for the regulated utilities. We think that the next regulatory resets - these are where the returns get set every five years. We think that regulator will reduce returns. So, there could be some downside there. Given that these stocks have performed very well over the last year, we think maybe it's a good time to start switching into other types of infrastructure stocks or even defensive AREITS.

Grove: Finally, Adrian, what are the main risks that investors should remain cognizant of when investing in this space?

Atkins: The main risk is, I think, debt. There are other things to consider, of course, some of them do have some sort of economic cyclicality. There is regulatory risk for the regulated utilities and there is demand risk for the unregulated utilities, but by and large the biggest issue to watch is debt.

They are capital-intensive assets. They need to borrow money, and if credit markets freeze up then that is a potential risk. As I said though, I think, balance sheets are much improved and should be okay bar a severe credit crisis.

Grove: Adrian, thanks for joining us.

Atkins: No problem. Thank you for having me.

Grove: To read Adrian's recent special report Morningstar.com.au. Premium subscribers can go to the 'Special Reports' tab and click on the link below.

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Avoiding the turkey stocks
29/06/2012 In the latest update to the “turkey portfolio”, Morningstar’s Gareth James gives an insight into what type of stocks investors should avoid. Avoiding the turkey stocks Christine St Anne 29/06/2012 http://video.morningstar.com/aus/video/120628_turkey_audio.mp4

Christine St Anne: Morningstar has put together a portfolio of companies that they consider are ‘turkey’ stocks. To get the idea about what are these turkey stocks, I'm joined by Morningstar's Gareth James.

Gareth, welcome.

Gareth James: Thanks, Christine.

St Anne: Gareth, how did you identify stocks that fit into a turkey portfolio?

James: Yes so, the turkey stocks were identified based on market capitalization and earnings. So, we looked for companies with a market capitalization between $500 million and $4 billion, and we also looked for companies with earnings below $50 million. That was for the forthcoming year and the year after that as well.

St Anne: Are these stocks predominantly in one sector?

James: Yeah look, we didn't set out to pick stocks from any one sector, but as it turned out these stocks that we found were from the resources sector, so the whole thinking behind the turkeys portfolio was to identify overvalued stocks and because we noticed a lot of mining companies that were getting overvalued, so we weren't altogether surprised that that was the outcome.

St Anne: Gareth, you made an update to the turkey portfolio, what have been the key changes?

James: Yes. So, we obviously started the portfolio 18 months ago and the reason was to identify overvalued stocks so we could highlight these stocks to our client base, and so they knew what stocks to avoid.

We have been tracking the performance of that portfolio and as we expected those stocks that we identified have performed particularly badly, but the interesting thing is that we've looked at the performance of the portfolio currently and we've looked at updating the portfolio, but it's actually quite difficult to find these overvalued stocks in the current market. So, what we've noticed is that there's been a real change from many overvalued stocks to virtually no stocks with these attributes.

St Anne: Now the GFC was an extreme market event, were there more turkey stocks after the GFC?

James: Yeah, well it was interesting because obviously the GFC happened, and so if you were looking at the market in say March 2009, there was lots of very cheap stocks around. But of course, particularly in the commodities space, there was an incredible rebound and what happened was that that got a bit carried away.

By the time we were looking for these overvalue stocks. There was quite a few stocks around, where their valuations had just got ahead of their potential earnings. So, it was really about that rebound coming out of the GFC that caused this problem of overvaluation amongst some companies.

St Anne: So, Gareth, what are the key lessons investors can learn from this turkey portfolio?

James: Yeah, absolutely. The whole idea behind the portfolio in the first place was to identify overvaluation in the market. I think it's really important, irrespective of what's going on in the wider world such as problems in Europe, or slowing of Chinese growth, that you should always focus on company valuation and you should look at the value of the company that you're buying shares in versus to its potential earnings, its profits.

So, although in the current environment it's very different from when we started the turkeys portfolio, there is no longer that overvaluation that we saw previously. It's still relevant for clients because they should still look at companies based on earnings versus market capitalization, and of course other areas of the business too. But yeah, so that's really the key lesson from the turkey’s portfolio.

St Anne: Gareth, thanks so much for your insights today.

James: Thanks, Christine.

St Anne: To find out the names behind these turkey stocks, premium subscribers can access the special reports tab on our website, and click on the link below.

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Big miners under the microscope
28/06/2012 With Rio Tinto and BHP Billiton due to release their earnings in the near future, Morningstar’s Mark Taylor gives investors an idea of what to expect from the two mining giants. Big miners under the microscope nicholas Grove 28/06/2012 http://video.morningstar.com/aus/video/120627_bhp_rio_audio.mp4

Nicholas Grove: In the not-too-distant future Rio Tinto and BHP Billiton will release their earnings results; Rio Tinto for the first half of calendar 2012 and BHP Billiton for the full year to the end June. Here to discuss what to expect from the big two miners, I am joined by Morningstar's Mark Taylor.

Mark, thanks very much for joining us.

Mark Taylor: Thanks, Nick.

Grove: First of all, Mark, in a recent report you said your earnings estimates for the two companies were broadly in line with those of the market, except for BHP where you said your earnings estimates had some “whiskers” and were slightly above consensus. What do you put this down to?

Taylor: Well, BHP in the recent past made major shale gas acquisitions in the U.S. including Petrohawk, and those acquisitions are of a magnitude that have increased the petroleum division's contribution to earnings to around about a quarter for the whole group. So, oil and gas is now very important to BHP.

The U.S. gas price has been very low, so the market has been discounting the contribution from those shale gas assets in the U.S. We have a more sanguine view of how that's going to pan out. So, we've probably credited BHP with solid earnings from the oil portion of those shale gas assets more so than the market probably has so. We're just a little bit more optimistic about the outlook for those shale gas assets and that is an area that we could be proven to be wrong in the fullness of time. Time will tell.

Grove: Mark, you described your earnings forecasts for Rio Tinto as aggressive. What's behind this outlook?

Taylor: Well key, I suppose, is our outlook for the aluminium industry. It's well-known that Rio made a very large acquisition a number of years ago: $40 billion for Alcan. That's been a huge weight on their earnings ever since with the aluminium market very depressed. We think a key reason for the depression in the aluminium market has been Chinese oversupply of aluminium, almost deliberately to suppress the price of a key import alumina.

Historically, the industries had this link between alumina and aluminium prices, and Chinese companies have taken advantage of that. We think that has just about played out. Alumina prices are being delinked from aluminium, so we see profits moving again upstream to players like Rio, which have bauxite and alumina assets, not just the downstream smelting assets. So that migration of profits, that’s what we're expecting to see in Rio's earnings and we may be a little bit premature on that front, but once again time will tell.

Grove: Also, Mark, in your report you discussed where the two companies earnings sensitivities to certain commodities lie; broadly speaking, which company has the more risky set of sensitivities and conversely which company has the more beneficial?

Taylor: I mean, it's a difficult question to answer, because you can say for BHP that it's a far more diversified company, so on balance, over time its earnings stream should be smoother, because when one commodity is doing well and other is perhaps not doing as well and they offset each other. But there is also that expression diversification. If you are diversified into all the worst commodities, then it doesn’t really help you.

But on balance we think BHP is more diversified asset portfolio is going to hold it in better state. Rio has very aggressively gone into iron ore to the point where in the last half of the year iron ore contributed 85% of its earnings, which is fine while the iron ore prices is going gangbusters. But when the inevitable happens and it falls, that potentially leaves Rio very exposed on the earnings front.

Grove: Finally Mark, 1st of July sees the government's mineral resources rent tax and carbon tax come into effect, will your earnings estimates for the big two remain unaffected by this?

Taylor: Yes. The carbon tax we see is only a minor issue for them in terms of costs and so on. The mineral resources rent tax, obviously, much larger impact but we have had those impacts baked into our forecasts for a long time now. So, there won’t be any change to earnings forecast when they are formally introduced.

Grove: Mark, thanks very much for joining us.

Taylor: Thanks, Nick.

Grove: To read Mark’s recent special report on BHP and Rio Tinto, Morningstar.com.au premium subscribers can go to the 'Special Reports' tab and click on the link below.

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The 5 sources of moat
21/06/2012 Morningstar US' Paul Larson breaks down the five ways firms can keep competitors at bay and which ways are more durable over time. The 5 sources of moat Jeremy Glaser 21/06/2012 http://video.morningstar.com/aus/video/120612_moat_mstar_audio.mp4

Jeremy Glaser: For Morningstar, I am Jeremy Glaser. Finding long-term competitive advantages, or economic moats, has long been a cornerstone of our equity research process. I'm here today with chief equity strategist Paul Larson to see what the sources of these moats are and to hear some new insights that he has on them.

Paul, thanks for joining me today.

Paul Larson: Glad to be here again.

Glaser: Let's start with the source of that economic moat, those competitive advantages. What are some ways that businesses can really put some distance between themselves and their would-be competitors?

Larson: We found five major sources of moats, and those sources are one, the network effect, and this is an effect where when you have customers that start using a network, that network suddenly becomes more valuable for all the other users of the network. Some examples here like eBay. It has the most buyers, and therefore it has the most sellers. And it has the most sellers because it has the most buyers. It's a virtuous circle. A more recent example would be a company like Facebook. When you or I join Facebook, Facebook suddenly becomes more valuable for all of our friends and as more of our friends join Facebook, it's more valuable for us. So, that's a network effect.

Another source of economic moat is customer switching costs, and these are the inconveniences that customers would have when they switch from one product to another. As they say time is money and money is time. It may not cost money to switch from one service provider to another, but if it costs time that's the same thing.

Another source is intangible assets. These are things like patents, basically an explicit monopoly, government licenses that explicitly block competition. Or [this can be a source] if a company has a strong brand that allows it some pricing power for that particular brand.

Another competitive advantage is something that we call efficient scale, and this is a dynamic where you have a limited market that is being efficiently served by one or a very small number of competitors, and some markets are just natural monopolies or natural oligopolies. A great example here are the airport companies like the Mexican airports. Most cities can't support just one major commercial airport, so it doesn't make economic sense to have more than one. If you have it, you benefit.

And the final source of moat is cost advantage, and this is simply when you have a company that can provide a better service at a lower cost than the competition that allows the company to either have a fatter profit margin or the same profit margin as the competitors, but in theory higher volume and higher asset turnover.

Glaser: I know you've done a lot of research into how sustainable some of these sources of advantage are. When you take a look across different types of moats, do some stand out to you as really being kind of a better moat, one that's going to last longer than some of the other reasons?

Larson: Yes. One of the things I recently did is categorize each and every company that has a wide- and narrow-moat rating by their source or sources of economic moat. And what we found is companies that benefit from the intangible assets actually have the best returns on capital by a fairly wide margin relative to the other sources of moat. And digging into why that might potentially be, you have a large exposure to the health-care sector, which basically patents [make up] the moat there. Also you have a larger exposure to the consumer sectors where you have these large relatively stable companies that benefit from brands. The health-care and the consumer companies certainly have high returns on capital, and that contributes to the intangible assets cohort having the absolute highest returns on capital.

Conversely, the source of moat that has the lowest fundamental performance [is found with] the efficient-scale companies, and this makes sense if you think about it intuitively. The efficient-scale dynamic is based on companies having an attractive niche that they have positive economic profits, that they have a moat, but not so profitable and so attractive that they are going to attract new competition into the market. So, it makes sense that the efficient-scale companies would have the lowest returns on capital.

Glaser: Now, when you looked at individual companies and were just looking if they are wide- or narrow-moat, what were some of the differences between wide and narrow? What were some the sources that would have contributed to being one or the other?

Larson: Well, we found that the wide-moat firms are more profitable than the narrow-moat firms. I think, there is zero surprise here because the factors that we're looking at, such as return on invested capital, return on equity, return of assets, so on and so forth, are the things that we look at when we're actually assigning the economic moat.

Now, it's not the absolute level of return on invested capital that we care about when we're assigning the economic moat rating, it's actually the duration of the excess profit over the company's cost of capital. I'll give you an example, if you have a random fashion retailer that happens to get lucky, hit some fashion trend and has a 50% return on capital for a year or two, we're not automatically going to say, "Well, gee, that's a wide-moat firm. They have huge returns on invested capital." They just got lucky.

But if you look at a company like a railroad or a pipeline, these are companies that don't have high returns on invested capital. They are actually quite low, around 10%. But the sustainability of that return is exceptionally long, and that's what we look at when we're assigning our economic moat rating, the sustainability and not the absolute level.

Glaser: The more of those sources that you have, it seems like it's easier to kind of extend your benefit over the decades.

Larson: Also, when you have a higher return, if you're going to have a given variability of earnings over time, if you have a higher return on invested capital to begin with, you have a little bit more of a buffer before you hit that cost of capital than if you have a lower return.

Glaser: You mentioned that some of the wide-moat companies might not have a huge return on capital, but are going to earn that over a long period of time. What about the stability of earnings? How important is that then in determining the moat rating?

Larson: It is relatively important. One of the interesting things that I found in the study looking at the sources of economic moat is that the network-effect companies actually have the least stability in terms of their earnings. What I did is I took a 10-year history of all these network-effect companies and looked at the time series and how the earnings changed over time, and network effect by far had the least stability. Meanwhile, the cost-advantage and also the intangible-asset firms did relatively well.

Glaser: Paul, once investors are kind of armed with these economic moat ratings, what's the best way to actually invest in them? What's the best way to really think about actually putting your money behind some of these names?

Larson: Well, I think one of the bottom lines here is that wide-moat firms are fundamentally are better companies than narrow moat firms. Surprise, surprise there. Also companies that have more competitive advantages had better fundamental performance returns on capital than companies that only had a single competitive advantage, all else equal. Also I'd say that for intangible-asset companies, while the moat might not be as identifiable as some of the other sources, the intangible-assets source is relatively attractive. So don't downplay brands and patents and such.

Glaser: Paul thanks for your thoughts on moats today.

Larson: Thanks for having me.

Glaser: From Morningstar, I'm Jeremy Glaser.

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A microcap play on Amcom
18/06/2012 Amcom Telecommunications chief financial officer David Hinton outlines the growth outlook for the company and how the company aims to differ from other telcos in the market. A microcap play on Amcom Christine St Anne 18/06/2012 http://video.morningstar.com/aus/video/120613_amcom_audio.mp4

Christine St. Anne: We were at the Microequities Conference in Sydney today and one of the presenters was Amcom, a microcap telecommunications company with a market cap of $260 million. I spoke with Amcom's David Hinton about his outlook for the company.

David, can we just start by asking your plans about organic growth for Amcom?

David Hinton: Yes. The business model is very much built around serving customers. That's our core value; serving customers, giving them good value and excellent service. We have experienced 20% organic growth over the previous six months. Our fiber business writes a significant amount of new business each month. And with the acquisitions that we have done recently being L7, a leading IT integration company and in the previous year IP Systems based in Melbourne. We have significant building blocks in place to drive that organic growth of the business.

St. Anne: And on that point of acquisitions, David what are your plans, how are they panning out now?

Hinton: Yes. The acquisitions that we have done previously have been built around strategic intent to make sure that we have the capabilities to grow the business and keep it relevant to meet customers' growing needs into the future. So, that's about providing them with cost-effective data communications, flexibility around telephony because communications is an essential part of running a business world - running a business. So, the demand for data is very strong, and we can build our story around that.

St. Anne: Now you're based in Perth and you've got telecommunications networks in Adelaide and how do you service the other parts of Australia?

Hinton: Yes, yes. Our network is very much Perth-centric. We do have network infrastructure in Adelaide and in Darwin. Where we do have the opportunity to sell on a national basis in terms of data connectivity, we do buy services from other telcos in the other cities. We don't intend to roll out fiber infrastructure in Melbourne or Sydney or Brisbane. So, buying and using other people's networks is okay by us.

St. Anne: Now David finally, what are your plans to differentiate yourselves from other telcos? Are there any plans for new services?

Hinton: Yes, that's a very good question. As I said before, we like to think that we have excellent customer service and our sales people and our customer service facing people, they are very much incentivized and oriented towards delivering that. I think we are small enough to be able to provide that excellent service, and we also provide services very quickly in terms of commissioning. In terms of how we differentiate, we use a vertically aligned sales structure and we have account managers who are dedicated to our customers.

St. Anne: David, thank you so much for your insights today.

Hinton: My pleasure. Thank you.

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Retailing for the future: Woolworths chief
15/06/2012 Woolworths chief executive Grant O’Brien speaks out about emerging innovations in food retailing and how the consumer is changing the retailing/manufacturing dynamic. Retailing for the future: Woolworths chief Christine St Anne 15/06/2012 http://video.morningstar.com/aus/video/120614_wow_future_audio.mp4

Christine St Anne: Woolworths Chief Executive Grant O'Brien spoke at a recent Australia-Israel Chamber of Commerce Sydney Lunch. O'Brien spoke out about how the retail giant was using innovation in food retailing.

Grant O'Brien: In food retailing we’re, if you like, addressing two parts; one is the new and the other is the, I guess, the existing and more accepted part of our business, which is the bricks and mortar. We've got customers, as I said, that are dividing and conquering, and what we happen to do as a result, is innovate. We're innovating by providing in the online space greater access, greater choice, greater ranges, all those sort of things. But the challenge for a bricks and mortar retailer like us is that we continue to ensure that our bricks and mortar remains relevant.

St Anne: He also spoke about getting the balance right between bricks and mortar and online retailing.

O'Brien: We have got a concerted effort on increasing the reasons for people to visit a bricks and mortar store. Yes, we'll do online and we're well underway with that, but I think retailers can come unstuck if they run to online and forget about the relevance of their bricks and mortar store.

Female Speaker: Given that you've got so much invested in them, so you're saying in fact the online could cannibalize your stores, if you're not careful?

O'Brien: They work together, and what you've got to do, is you've got to make sure that you're providing extra reason for people to visit the bricks and mortar.

St Anne: Those extra reasons include a new approach that involves shopping as a theatre and some very innovative technology.

O'Brien: If I look to the innovations that we are driving at the moment, we are putting back into our stores a whole lot of innovation and theatre, if you like. We're rolling out at the moment sushi counters, where we've got sushi chefs in all of our stores, so that there is freshness, there is theater, there is tasting.

We are working also to integrate that with what we're doing in the technology space. So, we're working on an application at the moment that when you drive into the car park, it will recognize you in the car park and start to, based on your previous shopping experience, load your shopping list and show you through the store.

St Anne: Big retailers like Woolworths have come under criticism for squeezing manufacturers, but O'Brien says retailing has now come under the sole control of the consumer.

O'Brien: When I started and I was cutting my teeth in the merchandise area of our business, it was unquestionable that the manufacturers had the power. They had the products, they controlled the shelves, they controlled the supply chain. If you picture in your mind the Arnott's truck, the Arnott's truck, the red truck would pull up outside of the supermarket, it controlled the shelf, it decided how much product came in and it controlled and had the data, which it would come and present back to the retailer and say here is what you need to do and the retailer would say, good thank you. Power was with the manufacturer.

That changed I would say 5, 10 years ago, where retailers started to control the supply chain. They built their own warehouses. Product went through the warehouses. We had access to data, so we were in a very different place to where we had been, and it was a different relationship with manufacturers.

We're both in second and third place now to a very important person, who is number one and unquestionably number one at the moment, and that's the customer, because the customer actually has access to all those sort of things now. They control the supply chain. They can control whether or not they come into a store or they get it delivered to their home. They can control the data. They have got transparency across the globe in terms of what prices they should be paying for goods, so it's moved from manufacturer to retailer to consumer.

St Anne: Nevertheless, there were partnerships to be had between food retailers and manufacturers, which could be developed with the focus of the consumer in mind.

O'Brien: So, last week I spoke at a forum for the AFGC, the Australian Food and Grocery Council. That's the body that - one of the overarching bodies for the manufacturers. And I went and spoke as a retailer and one of things I proposed to them, I have since done that in writing formally to the Chairman of the AFGC, is that we should form a body moving forward with both retailers and manufacturers are together, because I think that's one of the messages from me today. I think that's a way forward for us is to focus on the consumer, not each other so much and we'll both win as a result.

St Anne: Christine St Anne for Morningstar.

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Can Wesfarmers rejuvenate its Target brand?
13/06/2012 Morningstar’s Peter Warnes discusses the outcome of Wesfarmers’ recent strategy day and whether it can revitalise the Target brand. Can Wesfarmers rejuvenate its Target brand? Christine St Anne 13/06/2012 http://video.morningstar.com/aus/video/120612_wes_target_audio.mp4

Christine St Anne: Wesfarmers recently held its Investment Strategy Day for a number of institutional investors. Today, I’m joined by Morningstar’s Peter Warnes to give us his views on the business. Peter, welcome.

Peter Warnes: Good to be here, Christine.

St Anne: Peter, first of all, what was the reason behind this Investment Strategy and who were the winners?

Warnes: Christine, Strategy Day is really just a review of the portfolio. They have an operational portfolio of 10 individual businesses and Richard Goyder and his team look at it as an annual portfolio review, if you like, and set what the outlook and the strategies going forward are.

I describe Wesfarmers as a mini Berkshire Hathaway and I think that's what it is. These individual businesses are managed at the operational level and head office is the banker if you like. Now the winners in that strategy, clearly Coles has continued to dominate and take a lot of management time. It was a very, very big bite back in late 2007, $19 billion and at almost doubled the size of Wesfarmers.

Look, the turnaround there has been terrific, and Ian McLeod has done a terrific job getting a business that was badly managed and underinvested now up to speed, and now has got significant momentum.

Other positives winners there have been Bunnings. And Bunnings is really a powerhouse, if you like, in that home improvement hardware space and industrial and safety also a very, very good operation. And now that they have turned it around and restructured it, it’s strange enough, could be a real sleeper and a big winner.

St Anne: On the other side of the coin, who were the not so good performers?

Warnes: Well, Christine, there always is in a portfolio, you can't have all of them going well. Well, you could but it's very rare that happens, and so yes, there are couple of operations there that are a bit sluggish at the moment, and Target has been one of them.

The management could be, if you like, criticized for dropping the ball on Target a little bit and spending a lot of time on the other discretionary or non-discretionary operation there which is discount department store Kmart. Guy Russo has done a terrific job of rejuvenating that, margins in Kmart up from 2.7% in financial ’09 up to over 5.1% in 2011. Target on the other hand, margins down from about 10% to 7.4% in the last year and I don't want that deterioration to continue.

They’re going to say, hang on a second, step back, we've got to start looking at this. We want to - so there is a restructure going on in Target, which was probably a little bit overdue. I would suspect that what's happened is that the Target -what Target has lost strange enough a rejuvenated Kmart is probably picked up and the numbers suggest that a little bit. But look, the write-off there or the restructuring charge about $30 to $40 million, they’re going to be really start doing more work on sourcing and more effective sourcing from Asia.

Look, the distribution setup is fine, they’ll probably reformat some stores and what have you, but it's been a four-year turnaround, like Kmart was. And the new Managing Director of Target, he has got some pretty reasonable retail experience and Richard Goyder will back him.

Elsewhere on the negative side, resources, but only because delays in commissioning of the Curragh, new plant up there and some weather-related issues, but they'll hit their straps once they are cleaned up.

St Anne: Peter, so can Kmart and Target grow simultaneously or would they have to ultimately cannibalise each other?

Warnes: Yeah, Christine I mean look, we are in an environment where we have got a frugal and a very, very cautions consumer and so the headwinds are very, very strong. What Target and the management of Target are trying to do is they are going to reposition Target between a headline department store, a Myer and David Jones and above the discount department stores of Kmart and Big W. So if they can slot in there and be a mid-tier department store that's the space they are looking for. It's going to be interesting to see whether they can pull that off.

Cannibalisation, probably if they do position it where it is there’ll be less cannibalisation because they'll be competing less at the bottom end of the market, if you like, in the discounts area and there will be more Target or “home brand”, “private label” apparel and footwear and what have you. Look, interesting exercise, if anyone is going to pull it off Wesfarmers management will.

St Anne: Peter, you mentioned that Coles was a strong performer, how does that stack up against its biggest rival Woolworths?

Warnes: Christine, from a sales point of view Coles is outstripping Woolworths comfortably, I think for the last 12 consecutive quarters. Coles has reported significantly higher headline and comparable store growth than Woolworths and that's positive because that reflects volume growth and supermarkets are all about volume. All the initiatives they are trying to do - both operators are trying to do - whether its increased loyalty programs, lower prices, all they are trying to do is increase foot traffic, increase basket size and if you get those two right, than volumes go up. And then you’ve got volumes going up across your distribution chain, which is called the “productivity loop” and then you reap the benefits down the track.

So Coles, they have rejuvenated that business but strangely enough the gap between the margin in terms of the operating margin at Coles and Woolworths hasn't contracted very much. Back in 2009 the margin was about 347 basis points between Woolworths and Coles, it's only shrunk to 330 points now, and it should have shrunk more. Why hasn't it? I suspect because of Woolworths very, very powerful liquor operations based on Dan Murphy and I think that's the secret.

Woolworths is still making very, very world-leading margins in food and liquor at 7.6% and Coles are finding it hard and so their big box offer, which is first choice, is way, way behind Dan Murphy's and I suspect that's the reason for the difference. So, they are running hard but not making any ground on Woolworths, or any significant ground on Woolworths, but the business is certainly firing much, much better than it was.

St Anne: Peter, thanks for sharing your insights with us today.

Warnes: It’s a pleasure, Christine.

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Taking a punt on Tatts Bonds
08/06/2012 Gaming and wagering company Tatts is looking to raise $200 million by selling some bonds and Morningstar's Ravi Reddy helps investors decide whether or not they're worth their while. Taking a punt on Tatts Bonds Nicholas Grove 08/06/2012 http://video.morningstar.com/aus/video/120608_tatts_bonds_audio.mp4

Nicholas Grove: Tatts Group recently said it will look to raise about $200 million through the issue of some bonds. The gaming, wagering and lottery’s operator said it will put the proceeds towards the repayment of some bank debt, but many pundits believe it will put the proceeds towards a possible bid for the South Australian government’s lotteries business, which look set to be put on the block in the not too distant future. Here to help investors decide whether or not these bonds are worth a go, I am joined by Morningstar Equities Analyst Ravi Reddy. Ravi, thanks very much for joining us.

Ravi Reddy: Thanks Nick.

Grove: First of all Ravi, these Tatts bonds sound like they have a very vanilla flavour to them. Would you mind giving us an idea on how they are structured and what you think of the margin that’s been set?

Reddy: These Tatts bonds are a rare offering for retail investors and that’s because they are at senior ranking debt security. So what does that mean? It means that in a windup scenario, bondholders stand next to bankers and institutional debt holders rather than behind them. Most of the income securities on the ASX are subordinated, so that means they had lower ranking.

Other than that, the bonds have a seven-year term. They pay quarterly, unfranked interest payments based on the margin of 3.1% over the 90 day BBSW rate. The margin actually came in at the high end of the indicative range which was 2.9% to 3.1%. We were expecting to be at the low end given our experience with recent issues. So, that was a surprise.

Grove: Ravi, what sort of benefits and exposures do these bonds offer retail investors?

Reddy: The Tatts bonds provide exposure to a relatively defensive business, which has a high mix of stable revenues and this suits a debt investor. The business will change in the future with the expiry of the Victorian gaming licence in August 2012. So revenues will be more skewed towards lotteries than wagering, however the margins will be lower. Well, wagering revenues are reasonably stable, they can be affected by outside factors such as bad weather and things like the equine flu and Hendra virus, but essentially the business will become more defensive, have more modest revenue growth, but have more steady revenue stream.

Grove: Ravi, what sort of risks and other factors should investors take under consideration before buying these securities?

Reddy: We caution that while lotteries and wagering revenues are reasonably resilient to an economic downturn, prolonged softness in consumer confidence and lower household spends are going to impact Tatts revenues and earnings. There are also risk with increased competition and a potential loss of license.

There are some uncertainties facing the business, the longstanding CEO retires in October 2012. We also expect Tatts to be a front runner to acquire the South Australian government's lotteries business. This would make the business more defensive, but it would carry more debt. We are comfortable that it could manage the debt and that we view the acquisition as a net positive for the Group.

Investors should also realize that these bonds are floating rate securities, so changes in interest rates are going to impact interest payments. So, on a declining interest rate environment, interest payments will go down and the opposite in a rising environment.

Grove: Comparing them with debt issues we've seen from other ASX listed companies recently, do you feel these bonds are an attractive offering for retail investors?

Reddy: We like the Tatts bonds because they are a senior ranking debt security, which is backed by a relatively defensive business. We also like fact that the interest payments are mandatory and not deferrable. That's said, investors have got to realize it's still an unsecured security, so it's riskier than a bank deposit. We also suggest investors to seek professional advice before making an investment decision.

Grove: Ravi, thanks very much for joining us.

Ravi: Thanks, Nick.

Grove: To read more about the Tatts bonds issue, Morningstar.com.au premium subscribers can go to the hybrids tab and click on the link below.

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Banks under pressure
28/05/2012 Morningstar's David Ellis discusses how banks are positioning their business in an environment of low-growth and higher funding costs. Banks under pressure Christine St Anne 28/05/2012 http://video.morningstar.com/aus/video/120523_banks_audio.mp4

Christine St Anne: The recent announcements by Westpac, National Australia Bank and the Commonwealth Bank highlighted that banks remain under pressure. To discuss some of the challenges they face, I am joined Morningstar's David Ellis. David welcome.

David Ellis: Pleasure, Christine.

St Anne: David, were there any surprises from the announcements by Westpac, NAB and the CBA?

Ellis: Not really. Most of the three results were pretty much in line with expectations, particularly the headline profit numbers. The minor surprises were the strength of the dividends, so dividend growth was good and probably a little bit more than what I was hoping or expecting. Bad debts were stable and in line. Credit growth was pretty much known prior to the announcement - the result announcements.

So, overall as I said, the big numbers were in line. The biggest surprise was the strength of the dividend, which is a good indicator of the confidence that the banks have of the near-term outlook.

St Anne: On the point of high dividends, do you think banks are well-placed to sustain these dividends?

Ellis: Yes, it's a very interesting question. It's a very interesting point. Because on one hand you think low credit growth means low profit growth, which means low dividend growth, and over the longer term I would agree that dividend growth should be consistent with earnings per share growth. But what we are seeing at the moment, the banks are experiencing a period of low credit growth and we don't expect that to change any time soon.

But because the banks are such large and diverse businesses with a number of profit - I'll use the term levers, with a number of options that they can maximize profit growth even in a low credit growth environment. So, the profits are still growing, not dramatically, the underlying profits, so the profits before bad debts and then tax are growing roughly around 3%, 4%, 5% level.

So, profits are growing moderately, but the banks are accumulating large amounts of capital. So their return on equity, their return on capital although high is under pressure because they're continuing to increase their capital basis. Now, because of that I am expecting higher dividends or certainly the dividend reinvestment plan discounts will be - where applicable - will be cancelled and possibly even dividends the DRPs neutralize, which means that the banks will go into the market and buy an equivalent number of shares to match new shares issued under the DRP.

So that should lead to high dividends and if not high dividends then potentially share buybacks. But this is not going to happen for today or tomorrow. We're probably looking at 18 months, at least 12 months, maybe 18 months or even a little bit longer than that. The big risk - the downside risk to my scenario, my thesis of high dividends is a sharp deterioration in economic conditions here in Australia.

St. Anne: There certainly has been a deterioration in the global economy and now we're looking at higher funding costs, how are the banks positioning their businesses to address these challenges?

Ellis: Well, it's a very difficult challenge for the banks. Funding costs are increasing, there is no doubt about that and they continue to - and will continue to increase. It's a combination of lower margins on customer deposits, so domestically funded customer deposits and that's typically the term deposit sector and higher offshore wholesale funding costs.

So, whichever way you look at it, the banks' cost of funding is increasing and will continue to increase. So what did the banks do to respond to that and that is out of cycle interest rate increases or if the Reserve Bank cuts the cash rate further this year, I’d expect that the four major banks would not pass the full amount of any cash rate cut on to borrowers.

So, what's happening overseas is a worry. It's obviously impacting global wholesale funding markets. At the moment it's limited to - restricted to European wholesale debt markets. Apparently at the moment U.S. wholesale markets are open, Asian markets are still open. The banks, the four major banks are not under any pressure to access wholesale funding markets. They have got pretty much their funding requirements in order for this current financial year.

So they have the luxury of standing back and waiting for some sort of clarity or waiting for markets to stabilize. With the domestic funding, as I said to you, the term deposit market in particular is extremely competitive. We expect that competition to continue. We don't see any real - we don't see the banks experiencing less funding cost pressure from customer deposits sourced locally.

St Anne: Finally, David, are the banks well placed to meet the Basel III requirements?

Ellis: They are very well placed to meet the Basel III capital requirements that commence on January 2013. It is a staged implementation. But the banks already exceed the Basel III minimum capital requirements that in total aren't effective until 2015, 2016.

But they already meet the initial requirement that starts in 2013 and the four major banks already exceed the higher, later requirement in three to four years time.

St Anne: Thanks for your insights today, David.

Ellis: It's a pleasure, Christine.

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Report: Managing a global mining portfolio
22/05/2012 Kingsgate Consolidated chief executive Gavin Thomas gives us an update on the company’s latest mining acquisitions and issues confronting the global business. Report: Managing a global mining portfolio Christine St Anne 22/05/2012 http://video.morningstar.com/aus/video/120517_kingsgate_report_audio.mp4

Christine St Anne: Kingsgate Consolidated is a mid-tier resources company. We recently caught up the Company’s CEO, Gavin Thomas, who spoke to us about the Company’s recent acquisitions and plans ahead.

The gold producer and exploration company owns mines in Thailand and Chile. Closer to home, the Company also runs projects in New South Wales and South Australia. Kingsgate’s Thomas says it's Chatree gold project in Thailand is on track for further development.

Gavin Thomas: The concept is that we will have at least one other upgrade whether it’s a complete new expansion or an upgrade to current facilities - we are not sure yet.

St Anne: Its Chile operations are also developing according to plan.

Thomas: Nueva Esperanza, is a project we have done, that is a little beauty. As far as I am concerned, that will be seen as a very astute purchase once we have finalized all of our drilling. We took over a company called Laguna. We have purchased two blocks called Esperanza and Teterita from Kinross and we now call the whole project Nueva Esperanza or ‘new hope’ in English. It has certainly got a lot hope. We’re going to start off with sliver rich areas and for the first four or five years we’ll be producing mainly sliver and then a gold and silver complex after that.

St Anne: Kingsgate reduced single mine risk in 2011 when it brought Challenger via Dominion mining followed by the Nueva Esperanza silver project in Chile with Laguna Resources and finally the Bowdens silver project in New South Wales.

Morningstar’s Mark Taylor has identified the new projects as bringing on potentially more risk for the Company.

Mark Taylor: I suppose now that they've got the expansion of the Chatree mill bedded down, that’s a core pillar of stability for the Company. It represents about 80% of our fair value estimates. So, there is a degree of stability and they have anchored themselves to a project that’s throwing off good cash flow and will increase in profitability in the near future.

So the risks outside that are probably the Challenger mine because it is higher cost and does require considerable capital expenditure in terms of development and so on. Also their Chile projects and the Bowden silver project in New South Wales. These projects like all undeveloped projects by definition have higher risk, because they’re sort of an unknown quantity until they get into production and there come a lot of capital expenditure, which is a risk until you are making money on that investment. So those are the key risks the Challenger mine and their new development projects.

St Anne: The Challenger mine in South Australia posed particular problems for the company, which hit its production levels. Kingsgate’s Thomas says the issues surrounding the mine are issues facing the industry as a whole.

Thomas: I would say - I think it’s a problem with all mid-tier gold mining companies in Australia. It’s a challenge for all of us and we are just - our January production was terrible. There is no other word for it. We had maintenance and manning issues, the maintenance was a manning issue, the mining contractor lost his maintenance manager and we lost a jumbo operator. Those two issues combined cost us around 4,000 to 5,000 ounces of gold.

That’s an issue that we as the industry, here in Australia, have to face a huge competition on our limited skills base and we are not the only company that will be impacted by such an issue over the next two or three years.

St Anne: Taylor says the Challenger mine is unlike the Thailand project and that will always be a higher cost project.

Taylor: Well, I think it is a mine that is always going to be not as straight forward as say Chatree in Thailand. So there will continue to be ups and downs. We are just expecting a return to the status quo, which is round about 25,000 ounces a quarter.

In an ideal world things would get a bit better. There are some positive signs in terms of high grades in shoots and positive ore reconciliation to reserve. So, it’s not with that positives but having said that, it is always going to be a higher cost mine.

St Anne: Governance risk comes with the company’s offshore projects and Morningstar’s research note identifies this as another risk for the Company. Only recently, the company was involved in a legal stoush with the Thailand Government over environmental issues.

Thomas: Well, I think Thailand has accepted that there is a degree of political risk there. You go into any Fraser Institute of Study and it's down the bottom. You’ll find Australia and Chile way up the top. I think what we said about our shareholders requested us about four, five years ago to geopolitically diversify away from Thailand.

So, we have geographically and politically spread ourselves. Obviously, everyone here understands Australia. I've built two mines in Chile. We have my old team, we are putting it back together again. We are hitting the ground running, and I think people will be surprised that how quickly, we developed that mine, relative to some of the other projects in Africa say for example.

We are hitting the ground running, and it's a great place. Chile and Western Australia are the two places I think you can get mining approvals through with as little red tape as possible, and I think people will be very surprised that how quickly we can crank that whole project up.

St Anne: Compared with many resource companies, Kingsgate Consolidated is more generous when it comes to giving dividends to their shareholders.

Taylor: I think you have to say that any mining company of any description that pays a dividend at all, it's tantamount to a miraculous event really. And the fact that they've paid one fairly consistently and it's a payout ratio of around about 45%, 50%. It compares very well with peers especially companies of Kingsgate’s size. I mean of course there are no guarantees that that can continue, but as it stands that would appear very attractive.

St Anne: For Thomas, it requires fiscal discipline and long-term management in order to give investors good dividends.

Taylor: We believe in having a 50% profit payout basis to shareholders. It requires fiscal discipline. It requires long-term management. We build our dividends into our cash flow, so every six months we'll review our cash flow forecast and the dividend line gets put in and so we can report to the Board we are on track or we are not.

But basically we believe in total shareholder return. And when you have good mines, and you can drive the margins down through productivity increases, you do have the ability to pay dividends. But it does require a huge amount of discipline on the expenditure side, and I think we're pretty good at that.

St Anne: The company share price seems to reflect the heightened risk with prices halving since 2010, but Morningstar's Taylor says it's important to focus on the fundamentals of the company.

Taylor: Look, I think the market does what the market does, it goes up and down, and a lot of what happens in share prices is a sentiment rather than the underlying fundamentals of a company. And it's which pieces of information the market chooses to focus on and in a positive market, having these development projects in the company, they would be rated very highly and everyone would be excited about the anticipated increase in production and all that sort of thing. But because they're in a negative frame of mind they are worried about the dollars that are going to need to be spent to bring these mines into production, so, it will chop and change.

St Anne: Christine St Anne for Morningstar.

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Facebook a future advertising force
21/05/2012 Morningstar US' Rick Summer sees Facebook and Google dominating the Internet advertising market as Facebook finds better ways to monetize its massive user base. Facebook a future advertising force Jeremy Glaser 21/05/2012 http://video.morningstar.com/aus/video/120515_facebook_mstar_audio.mp4

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Facebook has been one the most highly anticipated IPOs in years. I'm here today with senior analyst, Rick Summer to see if now is a good time to dive in or if investors should wait for a better opportunity.

Rick, thanks for joining me.

Rick Summer: Sure thing.

Glaser: So let's get your first take on Facebook. When you dive into the company's financials, what do you see? What do you like about this company?

Summer: I think first and foremost, we can't forget how many users it has. There are north of 900 million monthly actives who are going to the site, and more than half of those are actually interacting in some way with Facebook on a daily basis. That level of engagement is absolutely tremendous.

Secondly, you have a wild level of profitability. You have almost 50% operating margins, and a meaningful $3.7 billion in revenue on trailing basis. This is a company certainly to be reckoned with and certainly a future force that already has a business model that's proven today.

Glaser: Let's take a look at the economic moat. It's the cornerstone of lot of Morningstar's equity research. What kind of competitive advantages do you think Facebook has, and will it be able to keep those up over time?

Summer: It's a great point, and this really underlies a lot of what we're doing and talking about with respect to Facebook and with respect to our valuation, as well. Facebook's moat is really built around its user base. So, it's actually 900 million users who are not only just going there, but they are interacting with it. It's part of their identity; it's part of how they communicate with their friends within their Facebook network.

That in and of itself is the most important compelling part of the moat, but it's not just a destination. We have people that are using authentication, meaning the login credentials for Facebook at other third-party websites. We have other third parties that are actually incorporating Facebook data, social plug-ins, comments, and lots of different things. You actually have Facebook spidering out into the fabric of the Web. Those are very difficult connections to be able to dislodge by a competitor.

Secondly, Facebook has actually monetized this and proven that it can generate excess returns on capital even in an environment where ad pricing is pretty weak, because we haven't really figured out yet how to advertise in social networks.

Glaser: So where does the moat come out then?

Summer: Right now, we have a wide moat. The only other wide moat company in the Internet space that we cover is Google, of course. And we're looking in the Internet advertising land of this being a two-headed monster going forward.

Glaser: It doesn't sound like Facebook is going to go the way of MySpace, Friendster, or other social networks that haven't done so well. But what kind of growth is in front of Facebook. It's seem like almost everyone already has a Facebook account. Will the company be able to grow users, or does it need to grow users in order to expand that top line?

Summer: This is an important dynamic. We've told a lot of our clients that this is not Google, and it's really unfair to compare the two. Google was at a very different place in the growth cycle [at the time of its IPO]. It had the advantage of being able to grow users and grow market share over time.

Facebook is different. [It has] nearly a billion users. So in terms of users, sure we can double the users, maybe we can triple users over time, but we're not going to quintuple. And we can't have 10 times the number of users; obviously, that's more people than what we have in the face of the earth.

What we really have are new revenue opportunities, ways to actually increase advertising. We have very small units of advertising. We have north of $7 per user that's being monetized right now. That's not extremely compelling today. So you have to be able to figure out that Facebook can actually monetize this in a much bigger advertising network sort of way.

Two, is we haven't seen an influx of local advertising dollars onto the Web yet. We, obviously talk about Groupon quite frequently. We know that Google's made inroads into the local market. We really believe that Facebook has a lot of very compelling assets to grow the local advertising space in an extremely positive way.

Lastly, we're not as bullish on this as some other research firms are, but we do look at Facebook Credits, which is a payments platform, as being an extremely lucrative way for the firm to offer payments for digital goods. We think physical goods is also an opportunity, but we're still looking at north of $1 billion that Facebook can end up generating from revenue we believe over time.

Glaser: Then what are some of the risks to growth not quite meeting those expectations?

Summer: I think that Facebook needs to make sure that it continues to innovate in ways that don't detract from its user base. The company doesn't want to be the next MySpace; it doesn't want to be the next Friendster. So if Facebook ended up pushing too much advertising, doing things that ended up alienating their users, we will have second thoughts about what the company is doing with respect to its moat.

I think secondly, in the near term there is a tremendous amount of risk. With the advertising that is being placed today, there's not measurable return on investment for a large bulk of these. So we have a lot of funny math that's going on by advertisers and agencies to understand they're getting the proper bang for the buck. Just recently we heard that General Motors is pulling out [its Facebook advertising] campaign because it didn't feel that it was getting the bang for the buck.

We think that Facebook solves his problem over time. We think that network is way too compelling; the data is too compelling for Facebook not to turn into this dominant advertising platform. But today we don't have best practices around that.

Glaser: Facebook a wide-moat business, which sounds great, but you don't want to buy it at any price. Where does your valuation come out? What should investors pay for this growth?

Summer: We're coming out [with a valuation of] $32 a share. Obviously the IPO pricing range is above that, and we expect it to trade even north of that. What we're telling investors is these near-term risks could actually be a very positive thing for investors down the line. Sit on the sidelines today. We're going to see growth slow. We're going to see profitability in terms of margins go down over time, and during this next to 12 to 18 months that could cause some massive pressure on the stock at the same time.

You may get a chance to get this wide-moat business at a substantial discount to the IPO price during the next 12 to 18 months. Right now, when you're looking in the Internet advertising sector, you've got Google, and you've got Facebook. Google is still trading at a pretty substantial discount to our fair value estimate. Why would you pay for premium for Facebook today when we think it's worth $32.

Glaser: Rick, thanks for your thoughts today.

Summer: Thank you.

Glaser: For Morningstar, I'm Jeremy Glaser.

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CFD trading tips
17/05/2012 Treated with care, contracts for difference can be a cost effective way to benefit from share market volatility. Here's what you need to know. CFD trading tips Jeffrey Hutton 17/05/2012 http://video.morningstar.com/aus/video/120515_CFDs_audio.mp4

Jeffrey Hutton: Contracts For Difference or CFDs have been in the Australian market for about 10 years now, but are they more risk than reward? Joining us to tell us what we've learned since their introduction is Ashley Jessen from Capital CFDs. Ashley, thanks for joining us.

Ashley Jessen: Thanks for having me, Jeff.

Hutton: Ashley, do CFDs stack up as an investment?

Jessen: Yeah, absolutely. It's a good question. I mean CFDs haven't necessarily got the best wrap as far as risk is concerned, I guess. During volatile markets, any trader needs to obviously protect the downside and protect their risk, that's the number one rule of any successful trader. You've always got to protect the downside.

Now with Contracts For Difference, they are a leveraged instrument, so they give you access to greater gains, but they also give you access to greater losses as well. So, when you're trading a product like a Contract For Difference, one of the things to keep in mind is that when the volatility increases, you have opportunity, obviously much more opportunity than you normally would, but when you think about it, you always control the amount of leverage on your account. It's one of the things with CFDs, is the amount of leverage that you get access to.

So, during the times when the market is quite volatile, you can always scale back your leverage, and that's one of the smarter things to do, and always keep your stop-losses nice and tight, and just make sure that you're in control of the amount of risk that you have on your trades.

Hutton: Maybe this is a good time to stop and explain how they work.

Jessen: Yeah. Well, let's start off with CFDs or Contracts For Difference. CFDs enable you to mirror - or they mirror the underlying performance of the stock holding index that you're trading. So, say for example, you wanted to trade BHP. Well, CFDs enable you to trade BHP, but let's say you wanted to buy $10,000 worth, instead of putting 100% of the funds upfront, like you do with say shares, you only need a small amount of money upfront in order to control the full amount.

So, you benefit from all the full movements of the contract for difference, or of the underlying share, but you only need, say 5% of the money upfront. Same with access to indices around the world and foreign exchange, CFDs basically give you a broad market. You can trade anywhere around the world, basically with one piece of software, and you're pretty much ready to go.

Hutton: So you don't have to come up with all the cash upfront?

Jessen: Yeah. So, say for example, BHP is running at just say $40, you wanted to buy 1,000 of those. Well normally, you would have to front up $40,000 cash. When it comes to CFDs, you may only need to put in approximately 5% of the money upfront. So, instead of putting up $40,000, with $2,000 of your own money, you can control $40,000 worth of BHP shares.

So, one of the things that investors need to be really mindful of, and traders in particular, is how much leverage you have, because obviously the more leverage you have, the greater the chance of wins - bigger wins, but the greater the chance of also the downside as well.

So with leverage, comes a bit of a double-edged sword, you need to obviously be mindful of the downside and protect that downside risk, which we were talking about just a second ago with regards to stops. So, you always want to make sure you're running stops with your trading to limit the downside. It's really the only way that you can really look after your portfolio to make sure that downside is covered.

One of the things that we were talking about a little bit earlier was that when you have a loss - and in particular, we have any sort of trading product - if you have a loss, say a 25% loss on your portfolio, it takes 33% just to get back to breakeven. A 50% drop in your portfolio. It will take a 100% just to get back to breakeven.

So, the larger your losses, the higher - that the harder it actually is to get back to just even breakeven, let alone profit. So, smart traders whether they are trading CFDs, futures, foreign exchange, or any of those products, the smart traders will always limit their downside and make sure they keep them nice and small.

Hutton: Just how much in terms of loses should an investor tolerate?

Jessen: Well, very good question, and this is one of the toughest questions, because getting in and buying a position is actually quite easy, but knowing when to get out, whether in profit, or in a loss, is one of the questions that stumps a lot of traders. Usually couple of ways you can determine that: one of them is technical. So, you look for the technical indicators on the chart and you might look for common support areas and a support level is basically where the stock may have come down. It may have hit a certain point, rallied back up, and it might be approaching that level again.

So at some level, the investor is out there and the traders say BHP, or the index or the Aussie dollar represents good value at this price. So, say even the Aussie dollar as an example, when it gets to parity, some people might say that's excellent value and it may have bounced off that level a few times.

So smart traders normally put their stop just below those support levels, just to give themselves a little bit of room just in case it hits it again and then bounces off and rallies again. So say as an example one of the most widely used risk management principles is never risking more than 1% to 2% of your capital in any one trade at any one time.

So, if you're going to take position in BHP, say you've got $20,000 of your money in cash, 1% of that is just $200. So, you take a trade on BHP and then if BHP were to move against you more than $200 or $200, then you would take a loss on that trade and you would move on to the next trade.

So, the number one rule of successful trading is always to your losses small. So, you keep those stops in your - that the overall portfolio, you're never losing too much of that. As I was saying 50% loss takes a 100% to breakeven. If you're sustaining losses of more than 1%, 2% or 5% of your portfolio it just gets so much harder to get back to breakeven.

Hutton: This might be a bit cheeky, but would you sell a CFD to your mother?

Jessen: That's a very good question. CFDs are for a more of an experienced trader. So if my mother was into trading, which she isn't then there would be - it's not a product that is difficult to understand.

Basically it mirrors the underlying and you need to control the amount of leverage that you have on that position, all the positions that you take. So, as long as you understand the leverage aspect to it, and the fact that you the trader - you always control the leverage on those positions.

So it's not the broker that controls the leverage, it's you the trader. So if you use that in a sensible fashion then CFD is an effective tool. So long as you understand the leverage, the more leverage, the bigger the wins, the bigger the losses and the lower the leverage the more you can control it.

Hutton: Ashley Jessen, good luck to you and your mum. Thanks for joining us.

Jessen: Thanks a lot Jeff.

Hutton: It's my pleasure.

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Orica - an explosive investment?
08/05/2012 Morningstar senior equities analyst Peter Rae talks investors through the most recent interim result from the country’s biggest explosives maker and chemicals supplier. Orica - an explosive investment? Nicholas Grove 08/05/2012 http://video.morningstar.com/aus/video/120508_orica_audio.mp4

Nicolas Grove: The country's biggest explosives maker and chemicals supplier, Orica, this week announced a half year profit of about $253 million, down around 4% on the same period in the prior year. Here to talk us through the result, I'm joined by Morningstar's Senior Equities Analyst, Peter Rae.

Peter, thanks very much for joining us.

Peter Rae: You're welcome, Nick.

Grove: First of all Peter, what were the main drivers of the result and did it meet your expectations?

Rae: Broadly, it met expectations, maybe it was just a little bit above my forecast. The key issues were much as we thought. Of course this result was hurt significantly by the shutdown of the ammonium nitrate plants up at Kooragang Island near Newcastle so that had a big impact on the result. Reduced EBIT by about round about $90 million, which was what they told the market, so there was nothing surprising about that. So, that's why the result overall was lower by about 4%.

In terms of the key themes, it was pretty good. Demand for mining chemicals and mining explosives was very strong, and they were the key drivers of growth that help to offset that negative impact of the Kooragang Island shutdowns. Demand for ammonium nitrate, which is the key ingredient for explosives, was very strong, particularly in Australia. We saw volumes up 15%. Now part of that was the fact that the first half last year was impacted by severe weather events, so mining activity reduced in the first half last year.

If you look at the underlying growth in demand for explosives here in Australia, it is round about 7%, and that's pretty good and that's a trend that we think will continue. Demand for explosives in the Asian region was good too for mining there, and also Latin America, strong demand for explosives there. So, they were probably the key things that drove the result. So if we didn't have that $90 million negative hit from Kooragang Island, it would have been a very strong result.

If we look at some of the other businesses, the chemicals business; mining chemicals was strong but general industrial chemicals were weak, which is not surprising given the weak environment in industry and manufacturing. The Minova business reported a slight increase in profit, so hopefully that indicates a bottoming out for that business there.

Grove: Peter, was the half-year dividend around about where you thought it would be, and is Orica on track with what you expect it to pay shareholders at the end of the year?

Rae: Despite the slightly lower result, they increased the interim dividend by $0.01 a share. Now that signals to the market, I guess, the Directors are happy that the second half is going to be a good result. I am forecasting a dividend of $0.96 per share for the full year. I don't see any reason to change that. It's a payout ratio of around 51% to 52%, which is consistent with what they have paid out previously.

Grove: Peter, you have recently expressed some concerns about Orica's Minova underground mining and tunnelling business in the way it has been performing. What do you think will become of this division?

Rae: Look it's difficult to say. The previous management seemed intent on retaining that business, and Ian Smith has not made any comments to the contrary at this stage. They have an efficiency review underway, and particularly in the U.S., which is where business is really underperforming. There is an efficiency review underway, and they are trying to extract some efficiencies to offset some of the competitive pressures that they are experiencing, particularly in the U.S. They are also looking at new products and higher technology offerings as well to try and differentiate themselves from some of their competitors.

But look, the business is returning - or its providing a return on net assets of under 8%, which is less than half the 18% target that they had, when they bought the business. So it's a significant underperformer. For them to keep it, they really need to make some significant improvements to the business, otherwise I think they should be thinking about whether there is parts of that business that they should divest, and in the U.S. in particular, there is some very strong competition and it just does not appear to be abating. So it is a big issue for them to try and get that business to perform, and if they can't, then they have to seriously think about whether they retain or sell parts of that business.

Grove: Finally Peter, what risks should investors bear in mind when it comes to investing in a company such as Orica?

Rae: There is a couple of key risks. One of course is their exposure to the mining sector. The mining sector is going gangbusters at the moment, and as long as that continues, then their volumes of explosives sold to that industry will continue to rise. They made comments yesterday at their briefing that they see volume growth being pretty strong for some time. But if there was a sudden or unexpected downturn in the sector, then that would have an impact on demand for explosives.

One thing that you should bear in mind is that, even if there is a slight downturn, it's not going to have our major impact on them. They are also benefiting from changes in strip ratios, which means that ore grades as they decline then more explosives are required to extract the same amount of ore, so that's something that will benefit them, despite what happens in the resources sector.

One of the other risks that I guess is front of mind after the Kooragang Island incidences - they are chemical company releases of chemicals or chemical spills are always going to cause damage to the company, both reputationally and to earnings. So that's something that they really have to manage carefully, and Ian Smith commented they have put procedures and processes in places, and now they will ensure that the incidence that did happen at Kooragang Island won't happen again. But it's easy to say things like that. But they really do need to have the processes to ensure that they don't have major spills.

Grove: Peter, thanks very much for joining us.

Rae: You're welcome.

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Huntley's top income stocks
11/05/2012 Morningstar’s Ian Huntley gives us his views on quality income stocks in the market and whether we will see the start of a bull run. Huntley's top income stocks Christine St Anne 11/05/2012 http://video.morningstar.com/aus/video/120510_huntley_conf_audio.mp4

Christine St Anne: Morningstar recently held its investment conference in Sydney. We caught up with Ian Huntley who shared his views on the top stocks in the Australian market.

Ian in your presentation you said that investing in Australian equities was like going into a Woolworths store with lots of choices. What stocks should investors invest in, given all these choices available to them?

Ian Huntley: Just like with Woolworths, customers are looking for different things but for a serious person trying to build assets for their retirement, which is a first class income producing assets. They should be looking at stocks relatively low in risk, which are going to give them very good income and growing income over the years.

Don’t worry too much about the price fluctuating, it will. Just like the prices of everything in Woolworths. Look at the income and look at the dividends – that’s what you want. You want that income to be stable and growing. Maybe it may comes down a notch or two in harsh times.

Morningstar have a moat rating on companies. That is really a rating on the stability of income - the closer it is to a royalty stream of income the closer it is to a government bond stream of income. But unlike a government bond, a moat company will adjust for inflation, and can over the years do quite well.

What you are looking for are companies that are paying good dividend yields that are better than bank deposits. The problem with going into bank deposits, are that people have totally forgotten that they [interest rates] can go down. They are going down around the world and they can go down in Australia too. Your income goes down. Your money’s safe, but your income’s going down.

Meantime a lot of other customers to the stock exchange supermarket are buying income stocks. There has been a bull market of income stocks for quite some time now. For instance the big daddy of them all, Telstra at $2.60 was yielding over 10 per cent fully franked, tax-free. Today it hit $3.60. That’s just in 12 months. The stock exchange is a terrible place, it’s shocking isn’t it? You can make money and get a good income there!

St Anne: Just with the banks - they are very attractive income-wise but with a low-growth environment and pressures in Europe, do you think they are still in a position to deliver that income?

Huntley: They are delivering good dividends - they are increasing their dividends. They’re not going to go to the races like they did in the 90s and give a great capital growth but they are giving stable and growing dividend growth of the fully franked kind and the yields are very good. They are pretty close to double bank deposits.

I think you’re much better to invest in the banks than in the deposits, but you don’t want to have more than 30 to 35 per cent of your portfolio of the bank stocks.

St Anne: With the resources companies Ian, do you think now is the time they should become more income-orientated and start giving dividends back to investors?

Huntley: That’s a big ask. Yes

St Anne: Yes, you do think so? Okay. Finally Ian, do you think now we are on the cusp of perhaps a stronger market. Perhaps even a bull market?

Huntley: I think that will happen. Theoretically there should be quite a sharp down turn ahead of it, which could happen mid-year. You are already seeing a bull market in income stocks. Over the next five or seven years I would expect a bull market. I would think it will be starting later this year or early next year. It will take on a number of different phases over the years - different leadership over that period of time.

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Wesfarmers' quest for bigger baskets
27/04/2012 Morningstar’s Peter Warnes gives investors an insight into how Coles' sales are stacking up against those of its arch-rival Woolies, and how other businesses under the Wesfarmers umbrella are travelling. Wesfarmers' quest for bigger baskets Nicholas Grove 27/04/2012 http://video.morningstar.com/aus/video/120427_wes_audio.mp4

Nicholas Grove: Coles supermarkets owned by Australian listed conglomerate Wesfarmers recently unveiled third quarter sales of $6.1 billion. The supermarket giant also revamped its FlyBuys loyalty program in an effort to increase the size of shopper's baskets. Here to give us his thoughts on how the supermarket giant and its parent company are travelling, I'm joined by Morningstar Head of Equities Research, Peter Warnes.

Peter, thanks very much for joining us.

Peter Warnes: Thanks Nick, good to be here.

Grove: First of all, Peter, how did Coles' third quarter sales stack up against those of its arch rival Woolworths and what were the key drivers?

Warnes: Nick, Coles have still got momentum. There is little doubt about that. This is the 15th consecutive quarter that they have achieved positive growth in comparable sales, which is a terrific performance. They have headline growth of 4.1% and comps growth of 2.7% against Woolworths' headline sales growth of 2.9% and flat comps. In addition to that, Woolworths have got the momentum on Coles in liquor and the underperformance of Coles' liquor operations dragged their food operations back by 0.8 of a percent. So their food operations are really firing compared to Woolworths and that momentum is going to be hard to piggyback.

Grove: How did the more discretionary side of things in Wesfarmers retail operations like Target, like Kmart, how did they stack up against their opposite number in Woolies’ Big W?

Warnes: Nick, in that discretionary space, it is very-very difficult. They are still deleveraging by households and very-very frugal and cautious customer. The results from Kmart and Target were if you like it, poles apart. Target is going under a restructuring if you like, with new management and their headline sales were down about 4% and their comps were down about 6%, and that was really due to kind of, trying to restructure and get promotional sales that previously were not profitable at all, so they're cutting out the promotional sales. Their inventory was in good shape, until they didn't have a lot of cheap inventory to get out of the door and so that affected the top line as well, but the margin was better.

Now, in terms of Kmart, there's been a bit of a revival there after a sluggish last quarter of 2011 and they've gone back into the positive territory, with headline up about 1.6% and comps up about 1.9%. I suspect there's a little bit of cannibalization. I think Target loose a bit and Kmart get a bit, but that positive growth there in Kmart is pleasing.

Strangely enough, Big W also pleased, they had headline sales up 1.4% and comps were down about 0.9%, but that was a turnaround; and they indicated that the retail conditions were better in January and better in February and better in March. So as we progress through the quarter, they saw conditions just easing a little bit better. So overall those discretionary performances weren't too bad.

Grove: Just as an aside Peter, in your opinion, does Woolworth's recent foray into hardware retailing pose any kind of threat to Wesfarmers’ Bunnings operation in terms of its market dominance and its earnings?

Warnes: Nick, home improvement hardware is a big market segment in retail. It's probably about $40 billion to $42 billion worth of annual sales. Bunnings is the largest in the space, but it's only got about 17% or 18% of the market. So it's very fragmented and there is a lot of space there for another big player to come in, and that's what Woolworths via the Masters joint venture is endeavouring to do. I mean they have got 10 stores up and running now, and those results for the third quarter up about 29% off a very, very low base is pleasing, but its way-way too early to suggest, one, what the trend is like and two, what the impact on Bunnings is going to be.

Having said that, they have a long-term plan to open and rollout 150 stores. But Bunnings are not letting grass go under their feet either, and they have opened their 200th warehouse in the quarter, and they have 91 more warehouse stores in the pipeline at different varying stages of development to be rolled out over the next couple of years. So it will be competitive, but there is space there for two big players to compete, and I don't think it's going to have a significant effect on Bunnings going forward.

Grove: Finally Peter, do you think the FlyBuys revamp, as a part of Coles longer-term turnaround program is a sensible strategy?

Warnes: Look, supermarket is all about foot traffic and volume, and it doesn't matter how you get them through the door. Once you've got them through the door, then you've got to make sure that they are satisfied in embracing the offer that you're making. That was one of the drivers of the Cole's supermarket performance. What happened is, they are getting increased foot traffic, and in addition to that, the basket size is increasing. So that combination of increased foot traffic and increased basket size is very, very powerful from a volume point of view and that's the goal. So, the FlyBuys program with the Vicar of Dibley running it if you like. I mean it's all about trying to get more new customers through the door, attracting new customers and increasing the loyalty of the existing customers; and if you do that, the volume follows.

Now there is a cost involved, but Coles argue that strange enough, just like Qantas frequent flyers, that Coles FlyBuys will ultimately become profit centre, not a cost centre; and it will take a couple of years to do that. But look, it's a promotional activity. It's designed to attract foot traffic and lift the basket size and that's - if they pull that off, then the momentum will continue to be at Coles and I think it's probably positive.

Grove: Peter, thanks very much for joining us.

Warnes: No trouble Nick.

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Spotlight on small caps
30/04/2012 While small-cap investing is not without its risks and not for the faint of heart, there are still plenty of opportunities to be found at this end of the market. Spotlight on small caps Nicholas Grove 30/04/2012 http://video.morningstar.com/aus/video/120430_smallcaps_audio.mp4

Nicholas Grove: While there are risks associated with small cap investing and while many of these stocks may not be suitable for all investors, there are opportunities to be found at this end of the market. Here to discuss Morningstar's latest Best Small Cap Businesses Update, I'm joined on the line by Morningstar's Peter Rae.

First of all, Peter, how has the portfolio performed since its last update in February, and what kind of factors are behind this performance?

Peter Rae: Well Nick, the portfolio had performed very well through February and March with 9 stocks in the portfolio delivering an average return of 9.2% for the period. This beat the ASX200 Accumulation Index return of 4.1%. There are a number of factors behind this outperformance.

Firstly, small caps in general performed well through the March quarter, with some reasonable earnings numbers coming through in February. Secondly, a handful of our best small cap business stocks performed exceptionally well. The New Zealand auction website Trade Me raised 25% since we included it in the portfolio in February. It delivered a first half '12 earnings result which was in line with expectations, but more importantly the long-term outlook remains very positive. We're expecting strong growth in earnings over the next five years.

There was another Internet-based business, Carsales.com, which also performed very well. It delivered a return of 20% for the period. This company delivered 20% growth in interim profit, which was on strong revenue growth and also maintenance of high margins. Similar to TradeMe, this business also has a very strong brand, dominant market position. It's outlook is for further strong growth given the continuing trend for classifieds to shift from print to online.

There were also a number of - or couple of other stocks that did very well with IT services company, SMS Management & Technology returning 17%, and the four wheel drive accessories maker ARB Corporation returned 13%.

Grove: Peter, could you briefly take us through Morningstar's selection criteria for the portfolio?

Rae: Yeah, certainly. Look, in selecting stocks we focus on a number of key attributes that set a business apart from its peers. Firstly, we look for businesses that have strong or leading market positions and businesses such as TradeMe and Carsales come to mind there, or we look for businesses with an established niche in a particular market segment, and growing businesses such as ARB Corporation has a particularly strong niche.

Some of the businesses, but not all have been rated with an economic moat, but regardless we still think that the businesses we have in the portfolio have particular business strength, such as strong maintainable brands and that's something that we look for.

We also look for companies with strong management and proven ability to deliver sustainable above average returns on equity and financial strength of course is very important, and we also try to avoid highly cyclical stocks.

Grove: What precautions should investors take and what risks should they be aware of when investing in the small cap space?

Rae: Look, small cap stocks in general are higher risk. Often they lack the product, geographic, and business diversification that a larger stock might have, and therefore they can be more exposed to downturns in the business cycle. Of course, this can also be an advantage if the stock has a particular profitable market niche. Look other risks: often it can be difficult for smaller players to access the necessary capital to finance the growth, and in an economic downturn smaller businesses with excessive debt levels can come under serve financial pressure.

Key-man risk is something to be aware of also. Many small businesses are heavily reliant on one or a handful of managers, particularly where there is a founder who is still a dominant player. Stock liquidity can also be an issue, if the shares are thinly traded, which can often be the case where there is a small free float due to founders holding a major proportion of the stock. Look, given the risks in small caps they may not suite all investors, and for most investors, we think there should be a small part of a well balanced diversified portfolio.

Grove: Peter, just on something that should be front and center in investors' minds at the moment, are any of these companies in the portfolio good dividend payers?

Rae: Yes, Nick. Look, we have a few with fairly good dividend yields. The best dividend yield is from SMS Management & Technology, which offers a forecast 2012 yield of 5.2% fully franked. This company has strong cash flows, no debt, and it maintains a payout ratio of 65% to 70%.

Also the vitamins and supplements distributor, Blackmores, is currently on a yield of 4.7% fully franked. It also has a relatively strong balance sheet and maintains a high payout ratio. Carsales, iiNet and Reckon, they also offer yields of about 4%, with Carsales and iiNet fully franked, and Reckon 90% franked. Look on average the yield for the portfolio is reasonable at 3.9%, and there is a fairly high level of franking there.

Grove: Peter, thanks very much for joining us.

Rae: Thank you, Nick.

Grove: To read Morningstar’s latest Best Small Cap Businesses Update, Morningstar.com.au, premium subscribers can go to the special reports tab and click on the link below.

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Keeping watch on Woolworths
26/04/2012 Morningstar’s Peter Warnes provides some insight into what the retail giant’s third-quarter sales results mean for both the company and its investors. Keeping watch on Woolworths Nicholas Grove 26/04/2012 http://video.morningstar.com/aus/video/120426_wow_audio.mp4

Nicholas Grove: Australian retail giant, Woolworths last week unveiled its third quarter sales results and here to discuss what they mean for the company and its investors, I'm joined by Morningstar Head of Equity Research, Peter Warnes.

Peter, thanks very much for joining us.

Peter Warnes: Thanks Nick.

Grove: First of all Peter, in your opinion how did the sales stack up overall? In the Australian food and liquor division what you called ‘the engine room’, how did that perform?

Warnes: Yeah Nick, the sales numbers for the third quarter were a little softer than we were looking for, only marginal, but 2.9% increase in Australian food and liquor, which is the engine room, was just off the pace a tad and comparable sales were dead flat. I would have thought that management would have been a little bit disappointed with those.

The top line numbers up 3.7%, when you add in Petrol and all the other operations. Again, probably a little soft than we look for. But look, the engine room is still firing. But look it's very, very difficult. The conditions out there are really very, very tough. Forget about frugalism and then everyone is shopping down. I mean, the weather has been absolutely abysmal, particularly on the east coast and that has really exacerbated the sales performance.

Grove: Were there any areas of the result that caused you any major concern?

Warnes: Again, this niggling thing that's happening in Australian food and liquor. I mean, you could argue that the food operations were a tad softer; in other words, slightly negative growth, because liquor is still driving forward very, very well. I mean, liquor is about 16% of the Australian Food and Liquor sales, and it had another very strong performance.

So, what's happening there - I mean Woolworths are on a very, very aggressive store opening campaign. They'll open 39 supermarkets this year, and there has got to be some cannibalization there. So I think that's what's trimming up, what's happening at the headline number and certainly what's trimming up the comps.

Grove: Peter, while Woolies didn't provide any full year earnings guidance last week, are they on track with your numbers and what kind of other headwinds are they facing in this final quarter?

Warnes: Nick, you're correct. No update on guidance. Guidance is still for NPAT, and this excludes $300 million provision for the consumer electronics, Dick Smith restructure and ultimate divestment. NPAT growth of between 2% and 6%, and our numbers are slightly to the top end of that. It will depend on just what's happening with margins, because margins and efficiency in the supply chain will ultimately determine where the NPAT sits.

Look, yes there are headwinds out there, there is no doubt about that. This is the most competitive environment I have ever seen, with two of the big majors really are - this is a slugfest. This is a heavyweight championship of the world if you like, and people are getting bruised, and I would think that it's going to go on for a little while. But those two retailers will still come out very-very well, they will still be very profitable. There is no signs for concern in either Coles or Woolworths.

Grove: Finally Peter, we're all aware of the shifting sands in the retail market, the migration of the consumer to online, Australians being more frugal and saving more etcetera, etcetera. How well do you think Woolies is adapting to this changing environment?

Warnes: Nick, they've adapted as well as any one, and don't forget this is the biggest retailer in the country about - on a comparable basis, close to $0.30 of every $1 spent goes through Woolworths or Woolworths' owned operation, and that's a hell of a number. The online pressures will obviously affect the discretionary area, but they are not in the big, big tickets items. They are in the more discount department stores and that's not really on where online competition really thrives.

It certainly doesn't thrive in food, and so they have been relatively adaptable. It does affect Dick Smith and consumer electronics and they have decided to belatedly and thank goodness, to pull up stumps; and so if you say are they reacting to it, yes they are and they have packed their bag and going home.

Grove: Peter, thanks very much for joining us.

Warnes: Pleasure, Nick.

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Telstra commits to dividends
23/04/2012 Morningstar’s Peter Warnes tells investors what they can look forward to down the track from the telecommunications giant, after it recently unveiled its capital management strategy. Telstra commits to dividends Nicholas Grove 23/04/2012 http://video.morningstar.com/aus/video/120423_telstra_audio.mp4

Nicholas Grove: At a recent investor presentation, Telstra unveiled its capital management strategy and reaffirmed its commitment to paying a $0.28 a share, fully franked dividend in both fiscal 2012 and fiscal 2013, while at the same time effectively ruling out a share buyback for the time being.

Here to give us his thoughts on the outlook for the telco, I’m joined by Morningstar Head of Equities Research, Peter Warnes.

Peter, thanks very much for joining us.

Peter Warnes: Thanks, Nick. Good to be back.

Grove: First of all, Peter, what do you think of Telstra’s capital management strategy, and do you think they're treating shareholders with due respect?

Warnes: Nick, in my expectations and right up my alley, I think they are treating their shareholders with respect. When you have capital allocation or free cash to distribute, they have to look at how they allocate it and there’s three buckets, if you like, and shareholders should get a good part of that.

I think, what they’ve done by saying look, nothing for the next couple of years, we’re going to hold that dividend in place, which is still very attractive, and we’re going to then increase fully franked dividends in the future, and I'll applaud them for that. I was very, very suspect of a share buyback, and I don’t think that’s the way to reward shareholders, unless you’re going to distribute excess franking credits.

Grove: Peter as the NBN is rolled out across the country, you said, Telstra will receive compensation payments that would generate franking credits that can be distributed as fully franked dividends. When do you think shareholders can expect to see an increased payment?

Warnes: Nick, firstly those compensation payments that are going to be paid by NBN Co and the government will be pre-tax in Telstra’s hands. Telstra will then pay tax on those payments, and then create the franking credits that they can then distribute. At this point in time, Telstra has no excess franking credits. They have enough to pay fully franked dividends in 2012 and 2013 at the rate of $0.28 a share, and that is what they will do.

Excess cash will start to accumulate and they’re starting to accumulate right now. In the year to June 2012, they have estimated that excess cash will be somewhere between $0.5 billion and $1 billion and by 2014, it will be somewhere between $2 billion and $3 billion. They will wait until those franking credits are generated, and then in 2014 will lift the dividend, which will be fully franked. Now there is potential to lift it quite substantially, but again I think conservatism will come into play and I am looking for something around $0.34, $0.35 to be paid fully franked in 2014.

Grove: Peter, how is the company faring against its competitors, and do you see any kind of M&A activity happening any time soon?

Warnes: Nick, against competition, look it’s very competitive out there still. We‘re not talking about PSTN, which is the copper network, let’s just ignore that for the moment. Let’s look at, in mobiles, and in network applications and services. Look competition is still very, very intense in mobiles, but Telstra is still continuing to regain market share that was lost previously, when they didn’t embrace the iPhones early enough.

They’ve spent a fair bit of money on marketing in the last 18 months, but now they’re just kind of easing back on subsidies, on handsets, and so that will be beneficial for both the margin in mobiles, and I would suspect that they are continuing, as I said, to gain market share against - Optus is still trading very, very well and a very, very strong competitor. I still suspect that Vodafone is under the whip.

In terms of M&A, look David Thodey has said that they are interested in consolidated media and why wouldn’t they be. Foxtel has been a very, very good investment for them. But it will come down to price, and it will come down to see what the regulator has to say, if they put a bid on the table, and had to move then to 75% of Foxtel, which the regulator might have some questions about, given also that Foxtel have just acquired Austar as you are aware.

So M&A is possible. I wouldn’t rule out something in Hong Kong, because as Hong Kong assets are very, very good assets, and they may well find something to bolt onto those. So, nothing in the early stages, but you could see M&A next year.

Grove: Finally, Peter, you’ve written widely of late about the importance of dividends in a post GFC world. Given your views, where do you think Telstra fits in a good solid, well diversified, conservative portfolio?

Warnes: Well Nick, you're right. I mean, post GFC, income from all investments is critical. There has been hundreds of billions of dollars of investors' money lost in the GFC and they’re obviously gun shy and you’ve seen how they are voting; they’re voting with their feet. Look at the billions of dollars that are in Australian fixed term deposits, and I think that that they are telling you that really we want a return on our assets, no matter what they are and in terms of equities, the same situation.

So, we’ve been driving and looking at companies that have sustainable earnings and sustainable dividends, and it will be the icing on the cake, if in fact you could grow those dividends. So, in terms of Telstra, they are saying, $0.28 a share for next two years and an increase in 2014. Well, on that basis, given that the yield is somewhere north of 8%, and grossed up for franking closer to 12%, look Telstra should be a cornerstone in any investor’s portfolio, particularly income investors.

Grove: Peter, thanks very much for joining us.

Warnes: Pleasure, Nick.

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Housing credit and the investor
20/04/2012 Australian mortgage lending has witnessed a structural decline, so what does this mean for shareholders in the banks? Housing credit and the investor Nicholas Grove 20/04/2012 http://video.morningstar.com/aus/video/120420_housing_audio.mp4

Nicholas Grove: Australian mortgage lending or housing credit has witnessed a structural decline, and joining me to discuss what this means for shareholders in the banks, I'm joined by Morningstar's Senior Equities Analyst, David Walker.

David, thanks very much for joining us.

David Walker: Hi, Nick.

Grove: First of all, David, how the levels of mortgage lending affect the value of bank shares, particularly shares in the big four?

Walker: Well, mortgage lending or housing credit is crucial for big bank shareholder value, but especially for Commonwealth Bank and Westpac, where home loans account for respectively 60% and 58% of total loans on the balance sheet. So, that means that home loans account for a large proportion of net interest income, which is the largest and highest monthly source of bank revenue and banking operating income, and therefore of earnings, and therefore of shareholder value and dividends.

Grove: In your recent special report, you say you don't expect to see a return to pre-GFC levels of housing credit growth over the next five years, what are the factors behind this outlook?

Walker: There has been a structural decline in home lending or housing credit growth from the double digit rates of growth that we saw before the GFC, Global Financial Crisis, to the mid-single digit rates that we're currently seeing. Now, before the crisis the double-digit growth rates were part of a very long-term trend towards higher household debt, leveraging and borrowing, which began with financial deregulation in the 1980s.

Now, financial deregulation freed households from the restrictive lending laws and bank credit practices of the 1970s and the early 1980s, and it started a long term uptrend in household borrowing and debt and leverage, which fed on - which both fed on and engendered higher housing prices. People had to buy more to buy houses, and that in turn bid up the price of houses thus requiring more borrowing. Now this continued largely unchecked with some volatility until the global financial crisis, when the scale of the crisis, the extent of the alarming headlines led to a very sudden and profound change in the attitudes of Australian households to debt, credit and saving.

In the last quarter of 2008, the household saving rate went from about 4% to over 11% in just one quarter, so there was a sudden and dramatic large shift in household attitudes to debt and saving. No doubt, caused by the scary headlines, and the thoughts of what might happen to households, so obviously they became more aware of their vulnerability with their high rates of leverage and levels of debt especially due to fears of higher unemployment, even though the Australian economy came through the crisis very well, the unemployment didn't rise very much. So, the increase - that structural increase in household leverage can't be repeated because it was a product of financial deregulation, which won't happen again.

For double digit growth rates to return, we need to see the kind of very favorable investing in household environment that we saw in the 1990s, and most of the '20s. We have to see expectations of large increases to housing prices, and that's not about to happen. Investors would have to be a lot more confident - none of these things are about to happen, we’re in for a prolonged period of flat, maybe slightly rising, slightly falling housing prices, and the risks are mainly on the downside.

The Australian economy doesn't recover soon, if growth doesn’t start to become more evenly distributed, then housing prices are likely to trend lower. We could be in for a period of flat house prices and high yields like we had before World War II for example. So, all of this is going to affect the desire and ability of households to borrow against houses, and that's why the country and the banks are in for a long period of single digit growth in housing credit, a very different outlook from what many of us lived with for 25 years.

Grove: David, given your outlook, which banks will be most adversely affected, and on the flipside, which banks will be least affected?

Walker: Okay, so the banks with the highest proportions of home loans on their balance sheet, total loans in descending order - Bank of Queensland, Suncorp, Bendigo & Adelaide, Commonwealth Bank, and Westpac. ANZ and NAB, of course, also have huge values of housing loans on their balance sheet, but the ratios are relatively smaller because the proportions of business loans are so much higher, and it's partly due to these banks' overseas exposures, which in the case of ANZ and in the case of NAB as well, remembering NAB also has many U.K. home loans on its balance sheet, and they don't account for our analysis which is about Australian home loans.

Grove: David, in your report, you talk about rate cuts late last year doing little to spark demand for loans, and expectations for high house prices, high utility prices, higher fuel prices, et cetera, also dampening borrowing, what do you believe has to happen to get borrowers back borrowing?

Walker: The February out of cycle rate rises by the banks led to an unexpected and large effect on household borrowing confidence. We heard the likes of Stockland's CEO, Matthew Quinn say that, the February out of cycle rate rises triggered such a decline, he's saying, he's never seen such a sudden decline before. So, from here probably 50 basis points of Reserve Bank official interest rate reductions fully passed on, mind you, which is not going to happen, also without the anxiety of further out of cycle increases, which is also not going away.

Realistically, it would be necessary to stimulate a recovery of confidence in the housing market. Now that's going to happen realistically, so the most likely outcome is continuing improvements in affordability. Affordability is recovering. Reserve Bank Financial Stability Report has confirmed that. Yields are improving as well, so at some point affordability will improve to the point that that should stimulate a bit of a recovery in housing credit.

We're forecasting a modest recovery from around 5% to around 7% over the next two years, not very much, but something. Now investors will probably get a bit more interest again now that yields are rising as well.

Grove: David, thanks very much for joining us.

Walker: My pleasure, Nick. Thank you.

Grove: To read David Walker's special report on housing credit Morningstar.com.au premium subscribers can go to the special reports tab and click on the link below.

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Is Australia's investment pipeline full?
13/04/2012 Recent comments in the press suggest Australia's $900-billion investment boom may have peaked, but is this necessarily the case? Is Australia's investment pipeline full? Nicholas Grove 13/04/2012 http://video.morningstar.com/aus/video/120413_pipeline_audio.mp4

Nicholas Grove: Recent comments in the media by a number of pundits suggest Australia's A$900 billion investment pipeline may in fact be full, removing a key support buttressing the high Australian dollar. But is this in fact the case, here to give us his insights on the subject, I'm joined on the line by Morningstar's Head of Equities Strategy, Ross Bird.

First of all, Ross, what do you think is behind this claim and do you agree with it?

Ross Bird: It's an interesting topic at the moment. We have seen some very strong growth over the last five or six years in capital expenditure. Firstly, coming from the public sector during the GFC to help support the economy, but then sort of quickly taken over by ongoing growth in the mining sector in particular, and that has continued up until the fourth quarter of this year. The ABS data for that period does sort of show very strong year-on-year growth, and even the forward estimates for FY '12 and FY '13 continues to suggest reasonable growth.

I think the area where some concern has emerged of late is firstly, the estimates that the ABS put out and they put out several estimates over the course of the financial year. We are currently at the fifth estimate and that actually saw a slight decline on the fourth estimate, what I think caught people's attentions in maybe wondering this could be signaling taking in activity given that in prior sort of estimates, each estimate tended to be higher than the previous estimate as new projects have come to light.

So, there is probably an element of caution there from that fifth estimate compared to the fourth estimate for the FY '12 year. Nevertheless, for FY '12, they're still - well, the ABS is still looking at growth of up to 34% on the same period in FY '11 and then for FY '13, where they've just have issued the fifth estimate, there is still additional growth of the order of 10% to 15%. So, not as great in terms of year-on-year growth, but growth nonetheless.

I think, it's just a period where we are just seeing an element of sort of caution coming into people's mind from slowing in momentum, but nevertheless the momentum is not turning negative. It's just simply a case of ebbs and flows in what is a very cyclical industry, and we've enjoyed very strong conditions over the last 5 six years. Of course, every year that it grows - to continued growing, it’s got to require an increased level of expenditure to be maintaining the momentum, so it does get harder year-on-year. I think, overall though the profile still looks reasonably strong, particularly sourced from the mining sector.

Grove: Secondly Ross, where do you see the dollar and commodity prices heading in the short to medium term, and what does this mean for our market?

Bird: I think it's partly due to some of the issues we just sort of spoke about then. Commodity prices have started to stabilize and indeed sort of pulled back a little bit over the last quarter, and that is mainly due to the comments coming out of China where we are seeing some slowing in momentum in GDP growth, not to say, these numbers are anything but still fairly impressive in absolute terms. For instance, last year, we saw GDP growth of the order of 8.9% in China. That's come in the year 2011. This year, the authorities have indicated somewhere around maybe sort of round about 8% growth. So some slowing momentum, but 8% growth is still fairly solid in absolute terms.

So some investors and maybe speculators in the commodity markets have sort of taken their profits and run to a degree on those sort of comments, recent comments by BHP and Rio, in addition saying that demand for iron ore has slowed somewhat just in recent times has taken some wind out of the sails as well.

So, look overall, we're probably seeing a little bit of a soft period in commodity prices from where they were a quarter ago. I note that copper prices are off about 10% over last month. The CRB Index, which is a composite of various commodities, is down about 7.3% since it peaked in late February. So, there is a little bit of momentum slowed there, but naturally too the commodity prices are still reasonably strong, and we would expect them to sort of remain about current levels, but of course, it all depends on the ongoing data primarily coming out of China that will ultimately drive that.

Grove: Ross, what do you think are the key things investors should keep in mind, given what we've been discussing?

Bird: I think, overall, we have to recognize that this sector, whether it be for the capital expenditure or mining or the influences on the A$, they're all sort of cyclical in nature. They will ebb and flow, but will be driven in time by fundamentals, but also during - at times there will sentiments influencing how strong or weak the packings are as well.

So, I think, overall we have come off a reasonably strong base. We are probably sort of seeing to a degree some softening in views of the A$ of late, given that we're probably expecting the RBA to cut rates in May, so that lessens the attractiveness of A$ relative to other currencies at the margin. We are seeing inflation, by and large under control.

As I just said, we are seeing commodity prices just a little bit softer than where they were a few months ago. So, all of that, sort of, points to maybe some slight softening or stabilization of the A$, certainly not going any higher in the short term. So, with that in mind, there is just some adjustments that investors probably take from that. It’s not all bad of course. A weak A$ can, to a degree, assist the sectors that have been struggling under a high A$ scenario such as manufacturing and non-resource exporters from Australia. So, there is some sort of relief there for some of those sort of industries just for the moment.

Grove: Finally, Ross, where do you see the market tracking over the next couple of months?

Bird: Yeah, it's interesting question in a sense that we've had a good March quarter. Our market is up 8.4% as measured by the ASX 200 Accumulation Index. So, we've had a good start to the calendar year. Probably normally, after a sort of a good ride, it's probably time for a little bit of a consolidation or a breather. So, I would say in the context of maybe, sort of resources just being a little bit soft for the reasons we’ve just mentioned, and they make up such a large part of our market. I would expect the overall market probably just to consolidate the gains we’ve seen in the March quarter - maybe retrace a little bit, nothing untoward. And then probably we will see by the end of June, will probably be at broadly similar levels to where we are now, I'd say.

Grove: Ross, thanks very much for joining us.

Bird: My pleasure. Thank you.

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The 'real' economy
05/04/2012 Expect volatility as countries, businesses and consumers learn to live with less debt and move toward the 'real' economy, author Satyajit Das says. The 'real' economy Jeffrey Hutton 05/04/2012 http://video.morningstar.com/aus/video/120403_das_real_audiop.mp4

Jeffrey Hutton: Has the age of debt come to a close, and are we headed toward the ‘real’ economy? Well, to tell us what that means and whether it's true or not is the author of Extreme Money and financial commentator, Satyajit Das.

Das, thanks for joining us.

Satyajit Das: Thank you for asking.

Hutton: In your book and then interviews and in presentations you talk about the ‘real’ economy. Can you expand on that and tell us what it means?

Das: Well, I think you've got to go back to the drivers of growth. You know, what drove the world? I mean you look at history, and it's driven by innovation. So you have massive jumps like the industrial revolution and then you get different phases of different types of technology coming along and propelling the global economy forward. Second thing that happens is you get new markets. So, basically - and we saw one around 1989, people forget when the Berlin wall went down, what happened was you integrated a whole bunch of people into the global trading system, where they started to buy not Larders, but Porsches because previously they didn't have a choice.

So, under those circumstances those were the first two, and then you get productivity improvements and all sorts of things along the way. That's what drives growth, but we forgot all about that, and we basically thought we could have steroid-driven growth which is debt-driven growth, and that's now being withdrawn. So we got to find ways to do that. And it's not as if there's a shortage of problems in the world to be fixed. I mean, you can look at energy sources, clean energy, non-renewable energy, you look at improving food yields, improving things like water conservation, improving environmental emissions; there's a whole bunch of problems we can talk, and we've got to go back to solving those problems.

One of my great sort of bugbears in life is the spirit of financialization meant very talented people, who were very clever people ended up shuffling paper in financial institutions for no other reason than basically they got paid a heck of a lot of money to do that, rather than, what I would call ‘productive work’.

So, we've got to have to reorient that. But that's like a generational thing, because you can't take somebody who is basically a banker and convert him into somebody who is an agronomist overnight.

Hutton: Is what you are saying even possible given our political system?

Das: Probably not, because essentially what you have is a political cycle which is three or four years, and what we're talking about is something which needs almost like an industrial policy plan which covers, say, 10, 15, 20 years. So, you're going to be faced with the problem of; A, if we want to do this adjustment, you got to have this huge diminution of living standards, and then you're saying, well, I'll promise you that we'll do all this, it will take 20 years, and most politicians will say to you, but this is not going to get me re-elected at the next election and that's why they're never going to actually do anything about it, and that's the sadness of this whole process.

Hutton: Are you at all optimistic?

Das: Look, I think, people play a lot of games around the world; optimism, pessimism, being a permabear and permanent optimism. I think I fundamentally look at the facts in front of me, and I think the way for people to improve everything is to face the facts and then address the issues. That's how I thought problem solving works. But at the moment, most people would prefer not to hear inconvenient truths, and I think one of the funniest things about that is what Mark Twain, if I remember correctly, once remarked, ‘it ain't what you don't know that gets you, it's what you know that just ain't so’. And I think people just don't want to face the realities of their circumstance, and it's very natural.

A woman called Elisabeth Kubler-Ross wrote a book about five stages of grieving. It was about death. The first stage is anger, then there is denial, then there is bargaining, then there is depression, and then there is acceptance. I think we are in denial.

Hutton: Is Japan's stagnation over the past 15, 20 years a sign of what Australia has in store?

Das: I think it's not so much that Australia will look like Japan because we are very different in economic structure, but the whole global economy will be stuck in a low growth environment. I think the analogy of ‘turning Japanese’ to me means many things, but one of them it means is low growth, because that's what Japan had, and also the digestion of the debt problems and the problems associated with the debt bubble.

So, I think that's the similarity. I think that's probably, in a realistic sense, the best scenario the world can face up to and that is basically the analogy. How that will affect Australia is interesting because Australia has a rather unbalanced economy because we've got a very strong mining sector and a very strong domestic service. We don't have a highly diversified base. So, Australia's position is going to be very different to other countries.

For instance, I can see countries like China and the United States closing their borders pretty much at being autarkic, because they're self-contained, we're not. So, we will continue to be buffeted by the external influences, particularly the lower growth. So, the effect will be that our commodity exports will slow down, our export industries won't do as well, and that will be how the economy adjusts. So, it's never going to be exactly the same for everybody, but they will be the ripples from the storm.

I always laugh when Australians - Lindsay Tanner who is the ex finance minister to task in Extreme Money, saying I had quite deliberately described Australia as a tiny economy. He in his review of the book said, it's the 14th largest economy in the world, and my response to that was, it still doesn't matter. Simply because at the end of the day we are so open and exposed to external environment.

So, I think the Japanese is a slow growth environment and Australia has to roll with it in whatever way it can. We can do certain things to make our lot a little better, but if you make the wrong decisions, it makes it more difficult for us.

Hutton: Much has been made about the rot investment banks like Goldman Sachs, and we saw that in an opinion piece recently in the New York Times. Is that opinion piece - that resignation letter a sign of a change in culture, or is that just a tip of the iceberg of the rot in the system?

Das: I think it's probably the tip of a very rotten system, and I'm a little bit surprised at the coverage it's getting, and also some of the commentary I'm reading, because anybody who thinks an investment bank is client-centric is delusional. Most businesses are adversarial. You want to give some things to somebody of value, but you're going to try to extract whatever you think is a fair return or whatever you can get for it. So, to assume this decision-making process collaborative is kind of odd.

The next thing is, okay, well, so they've effectively done certain things which we could question, but then every other investment bank probably does the same things. So, Goldman Sachs on its own is probably not unusual in that sense. But I think what is really being missed here is a fundamental issue, because what he is pointing out is something which has been in the system since the early 1990s, which is a conflict of interest. Because once you get universal banks and you get investment banks creating almost an in-built conflict of interest between the interests of the client and the interests of the house itself, which is trading its own money, you've got this in-built problem of who do I favor.

I have seen this over 20, 25 years occur in banking; it's not anything new. We've missed several historic opportunities to address this because when Sarbanes-Oxley came in when the research scandal broke, the way to deal with that would be to say, if you basically trade and sell stocks to clients, you can't trade on your own account, and your research has to be only for clients, it can't be for your own trading accounts. So, you could have done that and they didn't do it. This time around we have rules like the Volcker Rule which is trying to split of trading from other parts, but we all know it's going to be watered down and it's not going to be very powerful.

So really, to basically get agitated and anxious about how evil Goldman Sachs is or how evil a particular investment bank is, is meaningless. It's the entire system, which is flawed and at fault. But nobody wants to reform the system, they just feel better if they can find a salacious story, and basically say, how terrible somebody else is, and that to me is the real issue that needs to be addressed, and it's not going to be addressed.

Hutton: Do you think the financial media can do that?

Das: Well, that's a question perhaps Jeff you should answer because you're part of the financial media. I think it's a broader question. To cover these things entirely properly, you need obviously a couple of things; one is people with the expertise and the grasp of the issues to deal with them and the information and the knowledge. That's not easy. The second issue is independence. Media organizations for better or worse are no different to Goldman Sachs, in the sense they are expected to earn returns for their shareholders. So basically, it's a matter of how conflicted that interest can become.

I mean if you actually look at most financial papers to be brutally honest, they rely on banks and financial institutions for advertising revenue, and I know the editorial and the publishing is separated, but I'm not disingenuous enough or childish enough to believe that those two don't impinge on each other; sometimes in obvious way, sometimes not in obvious ways.

So, that's a fascinating thing as to whether we could ever really have a true free press and a true informed press. I think the communists actually understood this better. There is a very famous comment by a communist dissident in Eastern Europe in Czechoslovakia. He said he was always amazed that people in the West thought that the media was free and what they were reading was the truth. He said in communist countries we understood it was propaganda, so we disregarded anything that was in the press, but you actually believe it to be true, which is kind of odd.

Hutton: Das, thank you very much for joining us.

Das: It's my pleasure. It's nice to be with you.

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Banks, buybacks and Basel III
03/04/2012 With new global banking regulations to be phased in over the next several years, Morningstar looks at what they will mean for both the Australian banks and the Australian investor. Banks, buybacks and Basel III Nicholas Grove 03/04/2012 http://video.morningstar.com/aus/video/120403_basel3_audio.mp4

Nicholas Grove: New global banking regulations known as Basel III are set to be phased in over the next several years. Here to shed some light on what these regulations mean for the Australian banks and for the Australian investor, I am joined by Morningstar's Senior Equities analyst David Walker. David thanks very much for joining us.

David Walker: Greetings Nick. It's good to be back.

Grove: First of all David, generally speaking what do these new regulations involve and what is their purpose?

Walker: Basel III is a new global package of bank capital adequacy, liquidity and stress testing standards, developed in response to global financial crisis in which deficiencies in global bank regulation were identified. The package aims to improve the quality, consistency and transparency of the bank capital base, raise the transparency of the base, also enable banks to fund themselves more securely in the event of a prolonged closure in funding markets and generally improve the quality of bank capital reporting.

Grove: David, you mentioned in your recent special report that common equity will have a greater emphasis under Basel III. You also mentioned that common equity Tier 1 ratio or CET 1, why is this important?

Walker: Common equity is the highest quality of company and indeed bank share capital. It's defined as shareholder’s funds and less preference capital. So, it's the highest quality form of capital for absorbing bank losses. Basel III is going to pay more attention to common equity than Basel I and II, the two earlier packages, because in the global financial crisis, problems emerged where banks didn't have enough high quality capital to absorb the losses they had to.

So, Basel III is going to specify tighter definitions of equity, higher ratios of common equity to lending assets, so that banks are in a better position to absorb any future losses without having a draw on the tax payer support, which has happened in a number of countries and deeply indebted tax payers.

So, the key concept here is that common equity Tier 1 ratio, which is the ratio of common equity, so shareholders funds, less preference capital, so that the equity linked to ordinary shareholders divided by risk weighted assets. That's total lending assets, where each loan receives a weight, where the weight is higher if it's a riskier loans. So, business loans receive a higher weighting than say for home loans. So, the ratio decreases where there is a high proportion of business loans requiring bank to hold more common equity Tier 1 capital.

Now, there are global targets for common equity Tier 1, however national regulators like Australia's APRA have discretion in how they apply those targets. APRA has said it will generally adopt the global targets, but with some stricter definitions and an accelerated time table for implementation. Now the reason – it’s good news it's because Australia's banks are in such a strong position now.

Grove: David, how well prepared are the Australian banks to meet these new standards?

Walker: So, the two main capital adequacy targets by the 1st of January 2013, so now just nine months away, for banks to have a minimum of 4.5% of common equity, as a portion of risk weighted assets, and then by January 2016 for that to be up to 7.5%.

Now in the latest available figures, Australian major banks already have more than 7.5% ratio, common equity Tier 1 capital to risk weighted assets. So, nearly four years ahead of time table, banks are already ahead of target. Now the margins are not great, still they are already over the line nearly, just about, so it's a very strong position for them to be in.

Grove: With the introduction of these new standards, should investors be conducting any sort of re-weighting of their exposure to the banks?

Walker: The reasons the banks are in such a strong position with their common equity Tier 1 ratios is obviously they have accumulated so much common equity in recent years. They recapitalized at the bottom of the crisis, restored their balance sheets from the hits from companies going broke, which couldn’t fund themselves. Then they maintained their dividend reinvestment plans, which while dilutionary brings a lot of that dividend back on to the balance sheet. They've also had low credit growth, especially in business lending.

So, they haven't had to put aside much extra capital to back any potential losses on those loans. So, they're in a very strong position now, and they don't need to raise capital through major equity raisings, anytime soon we can see because they already comply with the Basel III targets, which APRA has said it is likely to introduce in Australia.

So, we don't think that Basel III has any implications for Australian retail and shareholders' exposure to the major banks. It's important to understand that these higher common equity ratios will reduce returns on equity below what they were in previous cycles.

I mean generally require more capital to be retained, which will have implications for dividends. However, the banks are not about to about to cut the dividends in our view. There would have to be very hard landing in China, and period of great distress to the Australian economy for bank dividends to be threatened. We think dividends are in the bank. To use the title of another recent special report of ours and that shareholders of the major banks can hold them with a degree of confidence, of course within the context of a diversified portfolio.

Grove: Finally David, in your report, you said that capital ratios that have buffers above the Basel III minimums set by APRA make buybacks and special dividends unlikely in 2012 and 2013. But, can investors look forward to some of these handsome capital returns further down the track?

Walker: So, having met the 2016 targets already and generating more surplus capital organically all the time, the banks could within the few years emerge with significant amounts of surplus capital. Prospects for buybacks and special dividends will depend on several things. Firstly, the stability or otherwise in financial markets, the economic situation and outlook, the rate of recovery in credit growth and the proportion within that of business lending, since business lending as discussed earlier, requires a higher weighting in calculating risk weighted assets.

If markets settle down, if Australian economy and the global economy grow smoothly and steadily, and if the recovery in bank lending, and especially in business lending isn't too strong, then we could be looking at buybacks and special dividends, subject to the approval of the regulator APRA by 2016.

I think predicting buybacks and special dividend this year is premature. The banks are all being very conservative. They want to carry more capital rather than less, at this uncertain time, and so they should. So, they are no buybacks or special dividends coming just around the corner, but the banks would not want to hold on to very large amounts of surplus capital forever. So we’re subject to those four things going right, we could be looking at buyback in special dividend in a few years time.

Grove: David, thanks very much for joining us.

Walker: It's my pleasure. Thank you, Nick.

Grove: To read this special report, Morningstar.com.au premium subscribers can go to the special reports tab and click on the link below.

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Is the equity rally here to stay?
23/03/2012 Rallies on equity markets may have more to do with a short-term debt lifeline than anything else, says author Satyajit Das. Is the equity rally here to stay? Jeffrey Hutton 23/03/2012 http://video.morningstar.com/aus/video/120322_Das_rally_audio.mp4

Jeffrey Hutton: Since the beginning of the year most markets seem to be rallying, but is it a sign of return of confidence? Well, we put that to Satyajit Das. He is the author of Extreme Money and a financial commentator and he is here with us now.

Das, welcome.

Satyajit Das: Thank you for asking.

Hutton: Das, the S&P 500 is up about 12%, the ASX is up 7%, even the Nikkei is up 20%. Is confidence back?

Das: This is the Draghi rally. I call it the Draghi rally. Because Mario Draghi the head of the ECB pulled a rabbit out of the hat, because remember the tail end of last year in the last three months we were all looking ahead to the debt maturities in Europe going how in heavens name they were going to raise 1.9 trillion to finance sovereigns and the banks. Well, Draghi solved the problem very neatly. So, he couldn’t print money, but he came up with a very elaborate structure which is; he now lends money at 1% from the European Central Bank to the European banks, European banks then take the money and go buy government bonds, so simultaneously you’ve solved the funding problem of the banks and the sovereigns, and he has pumped trillion dollars in.

The way I think about it is it’s like a dead body, if you pump enough electricity through it you’ll see signs of life. And basically that structure is what is underpinning to a substantial degree the rally. So, it’s more a relief that the debt crunch we were expecting on the sovereign European front has been delayed. But people are getting a little carried away with themselves here because they are assuming this is a magic fix. It has bought time - it’s all it’s done. Now, if you use the time, which is three years because these facilities have maturities of three years, and you could do everything you needed to do you have some chance of maybe muddling your way through this.

But if I know European politicians and if I know politicians anyway, the chance of making all the right calls and doing all the right things is not high. So, we basically just bought some time and we are on a holding pattern, but we are going to run out of fuel at some point in time and the interesting thing is the market is starting to ask, well, Draghi, do this again, and Mario Draghi is now under a lot of pressure. He is on pressure from the Bundesbank not to do this because they’ve now belatedly started to worry about printing money which is, sort of, to Germans like Hell, you know, you don’t it or go there. But at the same time he knows markets expect him to keep the support going. So, he is in a very, very difficult balancing act. So, there are still tensions there.

Hutton: Do money managers need to rethink their fees?

Das: I think money management has grown up in a very strange environment over the last 30 or 40 years, which have been very benign and good to them. And in places like Australia where you have the superannuation flows of 9% going up to now 12% flowing into your coffers, it really has been more about gathering the funds and doing that right rather than what I would call investment excellence. And as I always jokingly say during this period, you know, you just needed to be long and patient and things would work out for you and the rising tides lifts all boats to varying degrees.

Now, what you've got is a very interesting inflection point for the fund management industry. The first point about the fund management industry is it's a very expensive process. For retail funds, you're looking at management and expense ratios of couple of percent. Even for wholesale funds, you know you are getting 0.5% or upwards depending on the asset class. Now, that's okay if you're making 10%, 15% a year. People are very forgiving of your 2%.

Now, if you're going to make 2% and charge 2%, I don't think you're going to have happy investors. So, as the return basically ratchets down, I think fundamentally returns are going to ratchet down, mainly because the leverage has gone out of system and under those circumstances, the fund managers need to think very, very carefully about how they do their businesses. Also, their business models are really quite deeply flawed. At a very basic level, let's look at some very simple things like benchmark driven investing. And the fundamental thing is they say, I've beaten the benchmark by 5%, but if the benchmark is down 20%, I've still lost 15% of my money and I think investors are going to get a lot less tolerant of that, particularly if it’s sustained. I think in the past people have sustained those losses and lived with that because they have more good years than bad years. Now, with the high volatility, it's going to become more tricky.

The second issues is the way the money is managed is you give it to specialist managers, somebody who is equity-only; and basically if you look at the equity-only guy, he's got to be fully invested all the times, and under those circumstances if the markets are not going to perform and equity is not the asset class to be in, they're trapped. So, all these problems are sort of starting to come up to fund managers, and to be honest, they are a bit like rabbits in headlights. They’re startled and they're frozen because they don't want to throw out 30 years of a business model because they believe it's the correct business model and they don't want to re-engineer that and then find the market goes back to normal, which is very difficult. So it becomes very difficult for them to actually adjust in that sort of environment and that's some of the challenges they face.

Hutton: So they should have flexibility to go to cash if they need to?

Das: Firstly, there have to be absolute returns. Secondly, there have to have the flexibility to buy whatever. I always joke that vintage cars in the last couple of years were better investments than most financial investments and there’s a very funny story about that around Bill Gross who obviously run PIMCO's Total Return Fund. He actually used to collect stamps and he basically sold his collection and basically gave the money to charity which is very nice of him, but somebody worked out the compounded return on the stamp portfolio and pointed out that it was far better than the total return fund. So perhaps his advice was Bill should have invested all the money in stamps not in real assets.

So, essentially there have to have flexibility across asset classes, the portion of the assets and become absolute returns. That’s really difficult in the modern environment when we have created this cult of specialists, somebody looks at equities, somebody looks at bonds, somebody looks at this and somebody is the asset allocator. That becomes really, really difficult. And also, to some extent they have to be able to go short and from time to time it makes perfectly good sense to take leverage into your portfolio. So, all of that has to be factored in, but that is not a model that a traditional fund manager is, A, skilled for, B, mentally attuned to, and the entire system is designed for.

Hutton: So the party is over?

Das: The good times are gone and the party is over and they're going to have to adjust. People forget, in Japan I saw the destruction of the fund management industry in the 1990s. In Japan there was a lot of other things that went on, but there has been a destruction of the fund management industry because they just can't generate returns. And you see in the United States at the moment and countries with low interest rate money market funds are being destroyed, because it just doesn’t make any sense at this level, because you are losing money to basically invest money and nobody is going to tolerate that. That becomes kind of interesting. Also, one of the things that has happened in 2008 and 2009 that people perhaps would rather forget is there was an enormous destruction of confidence in financial advisors, in fund managers and so forth. And to some extend it takes time to rebuild the trust. Essentially, for them to go back and say well, it was just temporary arbitration and the model is fine and we'll do this, doesn’t really get you there.

I think people are becoming more discriminating, the investors are becoming more discriminating. I think for the first time in my life I see people becoming much more anxious to actually become financially literate. Previously it was, look I have money but I don’t have really the skills, I’ll hand it over to somebody. Now they are going; hang on, he is interested in mine and I am perfectly aligned necessarily. So I need to do this for myself. So all of that is playing into the fund management industry, but the good thing about the fund management industry is they have decided this is not a problem. So they have got their heads well and truly in the sand and they're just hoping that one day when they pull it out, the world will have returned to the way it was

Hutton: What's your view of housing prices?

Das: Look, Australian housing is one of those strange assets. Firstly, you can't have a rational discussion because it is like having a rational discussion about the existence of God, because you either believe it or you don’t. And essentially debating - there is no rational debate about it. But I think you go back to a fundamental thing about houses. Houses are not a financial investment. They are consumption good, because you need shelter. And essentially anybody who things that house is an asset is kind of diluting themselves, because they're going to always have to have shelter unless they have decided to become a street person or live al naturale in the wild somewhere. So basically, the asset class that we call housing is kind of a weird asset class anyway, because to me it is a consumption good, everybody else it's an investment.

The second issue is Australian housing is highly manipulated. It's a very manipulated market in terms of governments can control it by releasing land, changing zoning, changing the rules of what you can build - everything. Supply becomes constrained or unconstrained depending on what they do.

Secondly, the incentive structures that governments can apply through either things like the home - first homebuyer scheme, manipulating interest rates, stamp duties, capital gains tax, you name it, I mean basically it goes on, so highly manipulated market. So, to look at it in absolute terms of pure financial investment as some people want to do is kind of meaningless. However, there is some dynamics which are very evident and very difficult to deny.

If you actually look at what's happened in Australia is because of the tax benefits of capital gains and negative gearing, there is an over investment in housing and people have seen this as a long-term store of value, but the problem is an asset like housing is highly debt dependent. Because people have to be able to borrow to buy, because nobody can come out with a cheque of $500,000 and say I want to buy that. Here is my cheque. They don't do that.

So, supply of credit is fundamentally changing, though in Australia the government leans very heavily on the banks if you don't basically become a big housing lender. So, that's the first problem. So the question is whether the banks will be able to sustain the lending volumes, and we've seen the lending figures and they have slowed down quite dramatically. Part of it is them slowing down, part of it the demand isn't there.

Then the next problem is in the housing market, as you get these, what I call bubble effects, like in the mining towns and so forth where sudden influx of people, limited stock, puts that up, but then you get, what I call the cascade. So, one house goes up, then you can't buy that, so you buy the next house, so that goes up and that goes across the country to some degree, and we have benefitted from that.

So, if the commodity prices come off where we get that effect going down. If the financial market is tight, and interest rates go up, that part of it tightens and the rest of the economy where the bulk of people work has been weak all along. And you are looking at things like retail and services sectors, where the bulk of Australians work – manufacturing - they are all very weak or under real pressure.

So there is no income growth, and I keep saying to people there is no point looking at 5.2% unemployment. It's the incomes that people get, which are much, much more important. Are they earning? So, if you get that perfect storm for housing, which is the commodity boom drags itself to a conclusion, money tightening up, and income is not growing over a period of time or unemployment rising, then the combination is going to have a major effect on the - obviously the housing prices, but that coincides immediately with the problem in the banking sector because they are about 80% invested in housing directly or indirectly.

So, that loop starts to close and that's what you fear, and I think our politicians and central bankers probably every night say a prayer that that particular confluence of events doesn't take place.

Hutton: Das, thanks so much for joining us.

Das: It's my pleasure. It's nice to be with you.

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Investing in hybrids 101
19/03/2012 After a recent spate of hybrid issues by some big-name companies over the past few months, Morningstar goes back to basics and gives investors the essentials about these securities. Investing in hybrids 101 Nicholas Grove 19/03/2012 http://video.morningstar.com/aus/video/120319_hybrids_audio.mp4

Nicholas Grove: Investors may have noticed the recent surge in hybrid issues over the past several months from big names such as Woolworths, Origin Energy, Westpac, just to name a few. You may have also heard terms bandied about such as perpetual notes, subordinated notes, and convertible notes, but what are all these instruments, how do they work, and what does it all mean?

Here to teach us a bit about them, I'm joined by Morningstar Equities Analyst, Ravi Reddy.

Ravi, thanks very much for joining us.

Ravi Reddy: Thanks, Nick.

Grove: First of all Ravi, broadly speaking what is meant by the term hybrid?

Reddy: Well, these have certainly been the flavor of the month. If we go back to the Woolworths' notes issue last year, then raisings have been more than A$6 billion. There's been a lot of interest. A hybrid is a security which has both debt and equity characteristics, but it's also being commonly used to describe a pure debt securities, such as subordinated notes and retail bonds. The more correct term for this is interest rate security.

It's important to note, there's not one generic type of security on the issue. Whilst some of the securities only show similarities, each has its own unique terms and conditions. You only have to look at some of the prospectuses, which are more than 100 pages to realize that there are a lot of differences, and each has its own specific terms and conditions.

Grove: What sort of risks do these securities carry, and conversely what are their benefits, particularly when it comes to retail investors?

Reddy: There are quite a number of risks. There is credit risk, interest rate risk, spread risk, liquidity risk, conversion risk, term risk. We discuss these in more detail in the report we've recently published, but I think what investors need to understand is that these aren't bank deposits with a government guarantee. They offer a higher return, which means there is a higher risk. Also, typically these securities are unsecured, and they rank just above ordinary equity. So, what does that mean, in a wind up scenario, you could end up losing all your capital, and this has happened in the past with some previous issues by like Allco Finance, and some of the Babcock & Brown issues, so I think that's what investors need to realize.

Yes, but there are benefits, because it allows investors to invest in a security where they can get a higher rate of return than say a bank deposit, and it also allows investors to - you can trade them, so it means you can - if you do need access to capital you can sell them on market. While they rank above ordinary equity, they tend to be less - the prices tend to be less volatile than ordinary shares, and the other thing is you can get regular distributions. They typically pay distributions quarterly, or - and some pay semi-annually, so there are benefits as long as people understand the risks of what they're getting into.

Grove: Ravi, what sort of qualities do you look for, and should an investor look for, when it comes to these types of securities?

Reddy: We look for a high degree of certainty of getting your capital back, certainty that you'll get distributions, and of course, we look at the yield. The question we ask is, to what degree can the underlying business support the commitments required by the security, and what yield does that justify? So, our preferred exposures in the income securities space are those securities issued by the major banks and the high quality industrials.

Grove: What sort of factors can impact the prices of these securities?

Reddy: There are quite a lot of factors; there's changes in credit spread, changes in the financial position of the issuer or P/Es, changes in regulation or legislation, corporate activity, returns you can get on alternative investments. I'll touch on, probably credit spread is a good one. A credit spread is the interest rate differential between the benchmark rates such as a government bond and a non-government security. Now credit spreads change as there's changes in actual or perceived risks. So, if a credit spread widens, it implies there is a higher risk.

Let's say with a lot of concerns about the financial stability of banks, in such a scenario we'd expect credit spreads to widen on securities issued by banks. Another way of saying that is that we'd expect prices to fall, or the yield to increase.

Grove: Finally, Ravi, where do these sorts of investments fit within a well-diversified conservative long-term portfolio?

Reddy: There are opportunities for capital gain, but the main purpose of investing in these is to get a regular income distribution stream. We suggest that they should be part of a diversified portfolio, and we also suggest that investors should seek profession investment advice before making investment in one of these securities, because they need to be aware of the risks, as we discussed before. They are not like bank deposits, they are riskier, so with a higher return you're going to have a higher risk.

Grove: Ravi, thanks very much for joining us.

Reddy: Thanks, Nick.

Grove: To learn more about investing in hybrids, Morningstar.com.au premium subscribers, can go to our website, click on the 'Hybrids' tab, and click on the link below.

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How do you make money in a volatile market?
15/03/2012 We pick the brains of Philip Parker, managing director of Parker Asset Management, and try to unlock some of the secrets of his success. How do you make money in a volatile market? Jeffrey Hutton 15/03/2012 http://video.morningstar.com/aus/video/120314_parker_audio.mp4

Jeffrey Hutton: Parker Asset Management was named the Best Performing Fund Manager of The Year last year by Mercer. Joining us here now is Philip Parker, the founder and managing director of Parker Asset Management. We thought we'll pick his brains in these volatile times to tell us about the secrets of their success.

Phil, thanks for joining us.

Philip Parker: Thank you very much.

Hutton: So, Philip, you’re the guy to ask; what companies and sectors should people be looking at for the rest of the year and into 2013?

Parker: Okay. So, towards the end of calendar year '11 and the beginning of calendar year '12, we started to focus more - end of last year - particularly on resource support companies. We've had some stocks in the portfolio for quite a while, but then we also added to some ones that we really liked after the reporting season.

Hutton: It sounds like you're heavily leveraged to the mining services sector and infrastructure, is that fair to say?

Parker: That's very fair assessment, Jeff. It's funny, on a trip I did to Narrabri about a year ago, I was talking to one of the guys, who was a plant manager at a business that we didn't buy into, but what I learned was that win, lose or draw at the mining end, the guys supplying the parts were just making a fortune.

It got me thinking who’s supplying the valves? who’s supplying the pumps? Who’s pumping the water? Who’s building the new sites? Because, I think if you look at assessments, it is about $42 billion of spend coming in the next 18 months in the resource sector.

Now, some of the resource companies will be affected by commodity prices. That's another story, but the people supplying the infrastructure and the parts for this industry are going to make money win, lose or draw. So, it's been an ongoing theme for us, and Tim Riordan, who works with me, has been spending a lot of time looking at the companies has have I, on the road, and we found some very interesting businesses. We've found a company that just pumps water, for instance, which we are very keen on.

Hutton: How do you go about choosing the companies?

Parker: My background is a value investor. So, I am really interested in companies that have got a history of very sound earnings. If we can't see that history, we want to go and understand what the business is doing if it's a newly listed company.

Just to give you an example of that we – to answer your question, we discovered a company in December 2010, and basically they just did corporate travel. That was their business – Corporate Travel Management is the exact name. All they care about was the travel industry, and here was a business that was listing with the $70 million market cap. They had money at the bank, cash at the bank - you could buy the whole business for $50 odd million, and they are going to do $13 million in 2011 fiscal year, which they have done EBITDA. For this year '12, they are going to do $16 million. So you are buying the business on 3.5 times enterprise value to EBITDA. So, very cheap multiple when you take the value of the company, deduct the cash and then divide the earnings into it.

So, we got really interested. So, we met them at a conference in Brisbane. We then met them in the site here in Margaret Street, Sydney. We also, in those visits, those two visits we learnt that no one customer represented more than 5% of their EBITDA and that they only had 7% of the market share. They were buying cheap businesses at less than the multiple on their business, and then bringing them into their IT integrated world with motivated young sales staff and they have growth that business significantly.

So they're now about 8% to 9% of the market from 5% to 6% of the market. We think they are going to grow to probably 15% of the market. We bought them at $1 share price, but we bought – it was $50 odd million, they are now trading at $2.

Hutton: Do equities make sense anymore for retail investors?

Parker: I am positive of it, and I'll tell you why. If you - and it might be something that they would like to look up. There is a report that's done every year in February by Credit Suisse and the London School of Economics, and what it does, it's a very simple report in the sense of what it's achieving.

It looks for equities versus bonds versus bank bills, and it looks for the comparison of if you put a dollar or a euro or whatever the currency is in each of these different economies that have these things - very sophisticated markets, 100 years of data - 110 years of data, and it's shown that over 110 years, Australia - I'd give you an example Australia. A dollar invested in the All Ords, the ASX 300 or whatever they call it now, has grown to $2,800. A $1 invested in 10-year bonds just rolled over for 110 years is now worth $4.70, so you've five times your money and a dollar in bank bills about $2.70.

If you look at different economies, you look at the next best economy, funnily enough from its results across the board is South Africa. So a dollar in equities in – a rand in equities is now worth 2,100 in its own currency and then bank bills and bonds are similar to the Australian experience. Then you get countries like Canada and so on. So you get the theme.

Equities in countries that have got a natural resource where they have got a bit of an added advantage do extremely well, but the big thing is if you are in there, you get massive outperformance, 2,800 times your money on equities for maybe two generations of a family versus five times your money in a bond. That to me is the salient point.

Now, I don't believe - having said that - I don't believe in sit and forget, all right, because people fair enough get freaked out if the market falls 20%-30%. I think, Warren Buffett said if you can't hold a stock even if it falls 50%, you shouldn't be in the stock because he is taking the long view. I'd take the same view that you want to be in companies for the long run, but at the end of the day if things are cyclically expensive you've got to sell out, move to cash and wait for that to turn and then reinvest again.

Hutton: All right. Time to make a call, at the end of year, where is the ASX?

Parker: I never make predictions like that, Jeff, to be honest with you. What I would think is possibly up from here, but not by much. Volatile after June, but not too volatile into June, and that's the way we are sort of playing it. So we like volatile markets because we can take advantage of big moves in stocks. We can buy companies that are being beaten down or we can sell companies that are being rised up.

If I had to put a number on it, I probably think it might get to 4,500, but I’m not going to back the house on that. We're not about that sort of thing. We're about picking undervalued stocks and then using overvalued markets to protect the portfolio. That's all.

Hutton: Philip Parker, it's been a real pleasure. Thanks for your time.

Parker: Thanks a lot. Nice to meet you at last.

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Reporting season: QBE
28/02/2012 Morningstar analysts provide investors with their earnings season insights in these concise, timely video snapshots. Reporting season: QBE -- 28/02/2012 http://video.morningstar.com/aus/video/120228_report_QBE_audio.mp4

Q: Were QBE's earnings above, in line or below your expectations?

Peter Warnes: QBE's results for FY'11 finishing December 31 were right in line with expectations. Don't forget in early January, QBE shocked the market with a significant earnings downgrade, and at that time gave guidance of NPAT between $645 million and $760 million and U.S.$704 million profit was right at the midpoint of that range. So, no surprises there at all, and the market should be quite content.

Q: What were the key drivers of the result?

Warnes: Key drivers of the result; again, have been previously telegraphed to the market. Significantly higher catastrophe claims. They increased substantially from 6.8 billion to just over 10.4 billion. That was the biggest impact on the profit. In addition to that, we had these low risk-free rates that inflate the future outstanding claims and that feeds into the claims ratio and widening credit spreads also had an impact on the investment income, both realized and unrealized losses. So, they were the key drivers of the result, which obviously were all negative and that was telegraphed to the market as I said in early January.

Q: Was there anything about the result that surprised you?

Warnes: In the presentation that the management provided to the analyst community and the general public, there were some surprises and they were basically all positive. Firstly, attritional claims which are those claims that are less than U.S.$2.5 million per claim and there is hundreds of thousands of those, they are home contents and motor vehicle insurance claims and what have you. They filled the 49.2% of the total of net earned premium and that is a fantastic performance. That was surprise number one.

Surprise number two was that the negative impacts of FY'11 are already starting to unwind and in the first two months of this year, large risk and catastrophe claims are only at 1% of net earned premium, whereas at this time last year, they were at 4.5% of net earned premium. In addition to that, already movements in interest rates globally have seen over 50% of unrealized losses taken into the investment income numbers have already been recovered. Pleasingly, there is no impairment on any instrument within the $28 billion global portfolio. That is again another positive surprise, very few investment companies and insurance companies could suggest that's the situation in their case.

Additionally, on the surprise side, the forward guidance is positive. The company and the management is looking for the combined operating ratio to be less than 90%, down from 96.8% in 2011 and the insurance margin to be better than 13%, significantly higher than the 7.1% figure of 2011. In addition, the long-serving CEO, Frank O'Halloran is hanging up his boots in August, after 35 years stint, a fantastic innings and his successor will be John Neal who has been groomed to take over that CEO role. He has a very, very strong background in underwriting risk and that will hold the company in good stead going forward.

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What's in a corporate credit rating?
22/02/2011 Morningstar's Heather Brilliant says cash flows, solvency scores and other credit measures can tell us a lot about a company's future.

Basic principles of dividend investing
08/03/2011 Morningstar's James Cooper helps those investors new to the sharemarket understand the concept of income stocks.

Getting the good oil
03/06/2011 Morningstar's Mark Taylor helps investors get a better understanding of what makes a good oil and gas company.

Reporting season: Iluka
23/02/2012 Morningstar analysts provide investors with their earnings season insights in these concise, timely video snapshots.

Reporting season: AGL
24/02/2012 Morningstar analysts provide investors with their earnings season insights in these concise, timely video snapshots. Reporting season: AGL -- 24/02/2012 http://video.morningstar.com/aus/video/120224_report_agl_audio.mp4

Q: Were AGL's earnings above, in line or below your expectations?

Gareth James: For the first half of the 2012 financial year, AGL Energy reported a net profit after tax of $117 million. That's 51% lower than in the previous year. Now, we prefer to focus on underlying profit which removes derivatives and other financial instruments. On that basis, underlying profit was $232 million. That's 3% higher than in the previous year and that's pretty much in line with our forecasts. For the full year, AGL Energy expects to make net profits after tax of $470 million to $500 million, and that's pretty much in line with our full year expectations of $486 million.

Q: What were the key drivers of the result?

James: AGL Energy's net profit was boosted within the retail business by higher customer numbers and higher prices. Within the Merchant Energy business, which is the energy procurement business, increased generation and higher prices helped profits, as well as lower hedging costs. Development fees were lower in the first half of the financial year, but are expected to increase in the second half. Pleasingly, customer numbers grew by 100,000 in the first half of the year and AGL remains on target to meet its growth expectations in this regard.

Q: Was there anything about the result that surprised you?

James: The most notable feature of AGL's first half results was its announcement that it will increase its stake in the Loy Yang power station in Victoria from 33% to 100%. AGL intends to pay $448 million for the equity it doesn't own, and in addition, it will raise $1.5 billion, and this will fund the purchase of the equity and it will also fund the repayment of debt.

So, the $1.5 billion will be funded via a hybrid issue which will raise $650 million and an equity issue which will raise $850 million. The transaction is subject to approval by the ACCC. So, there are still a few hurdles that have to be overcome before that deal will be finalized.

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Reporting season: Suncorp & IAG
24/02/2012 Morningstar analysts provide investors with their earnings season insights in these concise, timely video snapshots. Reporting season: Suncorp & IAG -- 24/02/2012 http://video.morningstar.com/aus/video/120224_sun_iag_report_audio.mp4

Q: Were Suncorp's earnings above, in line or below your expectations?

David Walker: Suncorp's interim earnings for the first half of FY '12 was slightly below of what was consistent with our full year forecast. So, we downgraded our full year forecast slightly. What happened was, claims from the Christmas Day hailstorm in Melbourne were above what we were expecting and two items that are very difficult to predict, net interest margins in the non-core bank and loan impairment expense in the non-core bank were worse than we were expecting.

However, we have upgraded our forecast for FY '13 and subsequent years, because the underlying performance in the general insurance business is going very well and management is set to hit it's target of a 3 percentage point improvement in the underlying insurance margin by the end of FY '12, so for the second half of FY '12, which we're now in. So this, of course, makes management look good and it is a meaningful improvement in the underlying profitability of the business and we have factored it into our forecasts going forward and therefore upgraded our valuation.

Suncorp's capital position was also quite strong, again. There was no special dividend. We are expecting special dividends or capital returns in time. However, the interim dividend was higher than we expected, so we upgraded their full year forecast. Suncorp has a strong capital position, because it's non-core bank. That loan book of dodgy loans to property developers around Australia isn’t runoff and is steadily releasing regulatory capital faster than expected and we expect in time, that as market settles down, some of that surplus capital will be returned to shareholders.

Q: Were IAG's earnings above, in line or below your expectations?

Walker: So, IAG's first half result was a good result in difficult conditions again with the Christmas Day, December, hailstorm - Christmas day hailstorm in Melbourne and floods in Thailand in the earlier half of November. The main point about IAG's result was the second half insurance margin guidance and indeed the underlying insurance margin in the first half. So IAG's insurance margin guidance in an underlying sense is going quite well and better than we expected and we will be upgrading our full year forecast and forecast for subsequent years.

There has been an underlying improvement in the performance of all the divisions except Asia, so Australia Direct, that’s the retail brands, Australia Intermediated, that's the CGU business brand, and especially the U.K., whereas previously IAG guided towards a recovery in U.K. earnings towards breakeven in 2012 financial year. Now, they're more confident about reaching breakeven in the second half. This is a material upgrade and it’s important to factor that in.

Also, it seems that the two Australian divisions, that's the retail brand and the business brand, are having more success than we expected at passing on the high reinsurance costs from the disasters of last year. This businesses' pricing power is quite strong after all. There also seem to have been other underlying improvements in risk selection, risk pricing and operating cost efficiency in both of those Australian divisions. So, IAG did surprise the market. We will be upgrading our full year insurance margin forecast. This also, of course, augurs well for the business in FY '13 and subsequent years.

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Reporting season: Woodside
22/02/2012 Morningstar analysts provide investors with their earnings season insights in these concise, timely video snapshots.

Insurers in the eye of the storm
17/01/2012 Given the recent high levels of natural disasters and extreme weather, investors may be wondering if they should expect more of the same from the general insurers in 2012. Insurers in the eye of the storm Nicholas grove 17/01/2012 http://video.morningstar.com/aus/video/120116_insurers_audio.mp4

Nicholas Grove: Given the recent high levels of natural catastrophes and extreme weather events, both here and overseas, investors may be wondering if higher claims costs, lower insurance margins, and lower profits for the general insurers are here to stay. Here to help investors get an idea of what to expect from the general insurers in 2012, I am joined by Morningstar's Senior Equities Analyst, David Walker.

David, thanks very much for joining us.

David Walker: Thanks, Nick, it's good to be back.

Grove: First of all, David, roughly speaking, what sort of claims costs are the insurers expected to incur as a result of these recent events?

Walker: IAG is looking at around $400 million to $420 million in total catastrophe claims for the first half; Suncorp about $360 million to $420 million; and QBE had a run of nearly $500 million in claims towards the end of the year. Now these huge claims bills stem from the devastating hailstorm in Melbourne on Christmas day, the floods in Thailand for IAG and for QBE. Various other global catastrophes for QBE, like Hurricane Irene in the Americas, and the - another smaller New Zealand earthquake on the 23rd of December.

So the insurers had the bad luck of a run of severe simultaneous catastrophes towards the end of the first half and that's what we are seeing.

Grove: David, we all know how unpredictable the world and the weather can be, but should shareholders simply accept storms and earthquakes and bushfires et cetera, as being part and parcel of investing in these companies, and if they can't take the heat, get out of the kitchen?

Walker: Shareholders in Australia and Australasian general insurance companies need to understand that they are taking on concentrated exposure to: hailstorms, other storms, severe weather, earthquakes, natural disasters in Australia and New Zealand, which is a region prone to volatile weather, and particularly in New Zealand to earthquakes. Now with QBE, you could always say it's globally diversified, and it manages to lay-off some of that Australasian regional risk worldwide, however even QBE is not immune as we've just seen. If there's a run of catastrophes worldwide all at the same time, that's what happened towards the end of the second half. Even they are not immune, they had a huge profit downgrade on Friday. So, this kind of exposure to unpredictable weather and earthquake risk is part and parcel of being a shareholder in a general insurance company. Similarly, general insurance companies also bring exposure to investment markets, because they invest billions of dollars in premiums into the markets and that can be volatile as well.

Grove: David, in your opinion, should shareholders expect a better or worse year in 2012 for the general insurers compared to 2011?

Walker: It depends completely on the number and severity of catastrophes, and on what happens in the investment markets. All of those variables are not predicable. So, the outcome for general insurance shareholders by the end of 2012, it will depend on the number and severity of catastrophes in Australia and New Zealand for IAG and Suncorp. Co-incidents of global catastrophes for QBE, reinsurance costs and pricing, and how well the insurers can pass all those on to customers and investment market volatility, and we are - as we all know in a period of particularly high volatility in investment markets.

So it's very hard to forecast the earnings and dividends of the general insurance company, when it depends on the weather; it's hard enough to forecast investment markets, let alone the weather as well, and yet as we can all see this is a major influence on the profitability of a general insurance company. The best you can really do is evaluate how well they price and layoff and diversify their risks. But even when they do that with the best will and skill in the world, if there's a run of catastrophes all at the same time, they can't avoid heavy claims costs.

Grove: Do the Australian insurers still stand in good stead in terms of their reinsurance programs and capital positions?

Walker: IAG recently announced a 13% increase in its reinsurance bill for 2012. Now that was somewhat better than many forecasters were expecting one year ago, after the last summer's natural disasters, but it's still a double digit increase, and they'll have to pass that on to customers. However, we think they will in time. Suncorp's reinsurance year is on a financial year basis. So, we won't know the increase in their reinsurance costs for FY '13 until around about the end of June this year.

QBE's reinsurance arrangements are complicated because they are global. Stocks is a bit of a black box. They also underwrite their own inventory insurance, so it's a bit harder to tell. However, the 13% outcome for IAG is not bad under the circumstances, and suggests that IAG management was able to negotiate a fairly good outcome for shareholders under the circumstances. Because, you got to remember this company has just been through yet another year of disaster claims well above budget, well above allowances, which means that disaster claims were also, therefore above allowances for the reinsurers. It would have been more than they were expecting. So, a 13% increase for higher level of cover is not bad under the circumstances.

On capital; Suncorp has surplus capital, and intends to make a capital return to shareholders, once investment markets have settled down, not at this time. QBE's capital position is also strong. IAG's capital position is not tight, but needs monitoring. We wouldn't want to see it too much lower, and if there were a run of major hits, in terms of catastrophes or if investment markets deteriorated very severely, then we'd have to be a bit more concerned. What you might see from IAG is the underwriting of the DRP for example is to make sure they retain a bit more of their capital they would be paying out in the dividend.

Grove: David, thanks very much for joining us.

Walker: My pleasure. Thank you.

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Reporting season: JB Hi-Fi
14/02/2012 Morningstar analysts provide investors with their earnings season insights in these concise, timely video snapshots. Reporting season: JB Hi-Fi -- 14/02/2012 http://video.morningstar.com/aus/video/120214_JBHiFi_report_audio.mp4

Q: Were JB Hi-Fi's earnings above, in line or below your expectations?

Tim Montague-Jones: JB Hi-Fi's earnings were in line with our expectations. They came out with a profit downgrade back in December, and the result is in line with that downgrade, so no big surprise. Sales were up 5.5%, and this is largely due to the fact that they opened 10 stores during the period, while comparable sales actually fell, resulting in an EBIT decline of about 5%. Net profit was also down about 9.4%; this is largely because of the buyback. They actually borrowed money to buy back shares at a high interest cost means that the net profit is down, but this is in line with our expectations.

Q: What were the key drivers of the result?

Montague-Jones: The key drivers, as was reiterated to us and released back in December, is price deflation, which is occurring in electrical division in the whole industry, where flat screen TV prices continue to tumble. So, the volume of sales has increased, for flat screens in particular up 15%, but the actual prices are falling by 27%. So, your comparable sales growth is actually down 17%. So, to compare this year's result on last year's, with a lower sales while your costs continue or slightly rise, it's going to obviously contract your margin, and that's what's occurred here. The profit margin has declined. So, the reported profit is down 5% compared to last year.

Q: Was there anything about the result that surprised you?

Montague-Jones: The possible slight positive from the result is in the last 13 days comparable sales growth is up 1%, which could indicate that maybe retail conditions have stabilized. We would think it's a bit too early to tell at the moment, but it does offer some maybe glimpse of a potential that there might be a brighter future ahead.

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Earnings season winners and losers
01/02/2012 Peter Esho of City Index reminds us that when it comes to the upcoming earnings season, it's about beating expectations. Earnings season winners and losers Jeffrey Hutton 01/02/2012 http://video.morningstar.com/aus/video/120201_earnings_outlook_audio.mp4

Jeffrey Hutton: Australian corporate earnings kicks off this week. To give us an idea of what to expect, here is Peter Esho from City Index. Peter, thanks for joining us.

Peter Esho: Jeff, thanks for having me. It's a pleasure to be here.

Hutton: Well, firstly Peter, I just want to ask you about Gina Rinehart's purported investment in Fairfax. Is she seeing something in the media sector that others aren't?

Esho: Look I think so. I think what we've seen over the past few months is really the cyclical businesses in the Austrian market bounce off their lows. They have come down significantly from their highs during 2011. We saw retail stocks bounce from their lows, very, very depressed lows, of course. We saw the mining services businesses bounce off their lows. We saw resource stock companies themselves, uranium players, but we haven't seen media really bounce off its lows and it's been so depressed.

And I think this is a trigger as an investment, as an endorsement for a business like Fairfax, which has its fair share of challenges. Prior to this rate, it was trading on a price to earnings ratio of about six to seven times. This is a business that's still very profitable, a business that's very dominant in the online content space, a business that recently showed its ability to extract value from an online investment through Trade Me, a business which is shopping around it's radio assets and might find a windfall in selling, realizing value, paying off some debt.

And so, I think this will resonate well with the likes of APN, which is also been very heavily sold off. It's very dominant in the outdoor advertising space and I think also Ten Network Holdings, which has a outdoor advertising business, has got some very smart Australian media personalities on the Board and has recently stripped out costs and well-placed for eventually the cycle to pick up in media and advertising and that will all flow through to the bottom line.

So, I think this is the start of the media sector re-rating.

Hutton: P/E levels have come down quite a lot over the past 12 to 18 months. Do you think this season will be enough to encourage investors back into the market?

Esho: I think this reporting season will show that businesses out there are still earning some respectable numbers, but price to earnings ratio is a very important topic, because you obviously have the pricing, but in terms of the earnings it's not just the level of earnings, but it's the ability of those earnings to grow. If you're paying 20 times, for example, if you assume those earnings don't grow, it will take 20 years for you to make back your investment if 100% of the earnings are paid out.

So, I think price to earnings ratios will adjust on growth assumptions and unfortunately, I think over the next few years we are still in a relatively low growth environment. I don't think we'll get the large price to earnings ratio adjustments unless businesses can show their ability to grow above average levels in this current period. There won't be too many, but I think if you take the ASX 200, for example, you will have a handful of businesses that will show an ability to grow. They are the ones that could see that price to earnings ratios, perhaps expanding a little bit.

Hutton: Do you think we can expect more visibility about full year results out of this earnings season?

Esho: I don't think so. I think management has learnt the consequences of putting out assumptions out there that are the missed, and I think a lot of managers out there just don't have the visibility in their businesses. They don't have the confidence, and I actually think it's good that they are coming out and being quite honest saying they don't know what will happen. They are aware of the consequences of missing. I mean, if you exceed your targets, you get a pat on the back and you perhaps are rewarded a little bit, but the consequences of missing are far larger. So, I really don't think we are about to get that visibility in this reporting season.

Hutton: Okay. Then who are the winners and losers?

Esho: I think the good businesses are - the high quality businesses are not necessarily the businesses that will generate the largest returns in share prices going into this reporting season. Let's take Woolworths, for example. It's a fantastic business, but unfortunately the earnings assumption out there in the market are for growth of between 2% to 6% on what was a very good year last year. So, Woolworths is a very good business, but I don't think it will be a winner in terms of surprising the market or pleasing the market when it prints its earnings numbers.

I think there are a lot of businesses like media, for example, which have been heavily discarded, which will come out with bad numbers, but those numbers might actually be a trigger to see the share prices higher only because of valuations. I think there is a lot of bad news already priced into businesses. If that news comes in not as bad as expected, I think you could see a rebound in businesses like Pacific Brands, for example.

So, I think BHP, Rio Tinto will disappoint. We saw a glimpse into their production numbers over the past few weeks, and I think that disappointment will not be the absolute earnings of these businesses, it will be earnings relative to expectations. Expectations are just purely too high. Iron ore prices consolidated towards the end of 2011. They fell off their highs. They're ramping up their volumes, BHP and Rio Tinto, but the market is expecting growth. Prior periods where the earnings base has been very high, record high levels.

So, I think the expectations are for perfection and if you don't get that perfection, I think you could see a weakness or you might get gains, but I think you'll get better gains elsewhere in the businesses that expectations are so low it could actually come out and exceed really bad expectations.

Hutton: Peter Esho, thanks for your time today.

Esho: Thanks for having me.

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Reporting season: Westpac
16/02/2012 Morningstar analysts provide investors with their earnings season insights in these concise, timely video snapshots.

Reporting season: Lend Lease
20/02/2012 Morningstar analysts provide investors with their earnings season insights in these concise, timely video snapshots. Reporting season: Lend Lease -- 20/02/2012 http://video.morningstar.com/aus/video/120220_lendlease_report_audio.mp4

Q: Were Lend Lease's earnings above, in line, or below your expectations?

Tony Sherlock: Their first half earnings were probably marginally below our forecast, and that was really a function of slower sales for residential and commercial developments. These transactions are still occurring, they're just taking longer to settle. So, the company previously indicated that the average lead time between enquiry and sale was 6 weeks, and in the current environment reflecting, I suppose a slightly weaker economic outlook that period is taking close to 12 weeks, and that's impacted their level of settlements and also the earnings for that Australian development division.

Q: What were the key drivers of the result?

Sherlock: The key drivers of the result was a very strong contribution from the Valemus businesses, which comprised Abigroup, Baulderstone and Conneq, and this is the first time that they have appeared in a half-year result, and they delivered a very strong contribution to the group. Margins were up for that division to just over 5%. Revenues were very strong, and the company painted a very strong outlook for that business, and that's fairly expected, and that aligns really with the level of construction activity that happening in the resources industry and going forward that division is likely to benefit from the work that's happening in the LNG space as well.

Q: Was there anything about the result that surprised you?

Sherlock: Look the result didn't contain any major surprises. I think, what I and the market were actually looking for was an update on, or a positive news release with respect to Barangaroo development. Now their first building is - construction has actually started on that, but they haven't actually as yet secured tenants in there. The company has not as yet locked down capital partners. Whilst discussions are progressing in that space, they're not at the point where they're able to make an announcement. I think I, and again the market are also looking for the prospect of the company bringing forward development of some of the other commercial and residential towers on the Barangaroo site, and I think in the current environment that's becoming, I suppose, less likely, and the delivery timeframe is probably going to be more in line with that originally proposed rather than an accelerated delivery schedule.

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Reporting season: Wesfarmers
17/02/2012 Morningstar analysts provide investors with their earnings season insights in these concise, timely video snapshots. Reporting season: Wesfarmers -- 17/02/2012 http://video.morningstar.com/aus/video/120217_report_wes_audio.mp4

Q: Were Wesfarmers' earnings above, in line or below your expectations?

Peter Warnes: Wesfarmers' first half result for the six months to December 31 of A$1.2 billion, that's before non-trading items was just fractionally below our expectations, but really have to be a hard taskmaster to mark it down. All-in-all, the composition was a little different to what we're expecting, but the top line number just slightly below expectations.

Q: What were the key drivers of the results?

Warnes: Key drivers of the result were continued good performances by their retail operations in total. Their total retail operations had sales just above A$26 billion and EBIT up nearly 7%. In this environment that is a very, very good result, with margin just improving 10 basis points. If we drill down into those operations, Coles again the anchor was very, very good. Albeit the momentum has slowed and that was what the market was a little bit disappointed with, although we were very, very comfortable with it.

When you've got a company that's increasing their EBIT by 2.5 times their top line sales number, in this environment that is very, very good performance. The Coles margin continued to expand, up 24 basis points, to 4.33%, and that was despite a drag by the liquor operations, which probably cost them near enough to 10 basis points.

Q: Was there anything about the result that surprised you?

Warnes: So, overall, we were comfortable with Coles. The other surprise was Kmart. Kmart, despite the fact that the both headline and comparable sales were slightly negative the EBIT was up nearly 9% and the margin moved from 7.7% to 8.6%. Again, in a discretionary environment that's an excellent result. Target whilst was a little disappointing in terms of where it finished, for them to hold a 70 basis point move on the downside in margin in this environment we were quite satisfied. Elsewhere Bunnings continued to perform very, very strongly. EBIT up 6.1%, and only a two basis point move down in their margin to 12.77%. Again, in this environment, a very, very good report.

Industrial and Safety surprised us nicely on the upside. This I'm starting to reclassify now as almost Bunnings Wholesale. A nice move in sales up nearly 9%, but EBIT jumped nearly 23%, and margin is moving nicely north to 11.5%. They were the surprises on the upside. On the downside, Resources was disappointing, the EBIT number was flat at A$250 million. There were reasons for that, still some legacy costs from the Queensland floods, and they're having problems commissioning this new expanded operation at Curragh, but we would think that the sales volumes will improve in the second half, and that result will be better in the second half.

Insurance was down, and we all know the reasons why insurance was down. It's only a small part of their operations, and there was no surprises there, because this has been well telegraphed to the market.

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Reporting season: CBA
15/02/2012 Morningstar analysts provide investors with their earnings season insights in these concise, timely video snapshots. Reporting season: CBA -- 15/02/2012 http://video.morningstar.com/aus/video/120215_cba_report_audio.mp4

Q: Were CBA's earnings above, in line or below your expectations?

David Walker: CBA's interim result for the first time for the financial year of 2012 was in line with our expectations. We don't expect to have to upgrade or downgrade our full year forecast. The composition was of quality with fairly good performances across most divisions. There was a compositional surprise, in that bad debt surprised on the downside, while operating costs surprised on the upside. However, the increase in operating costs was due to some one-off factors, so the costs should normalize in the second half.

Q: What were the key drivers of the result?

Walker: This key drivers of the results were slow growth in credit, slow growth in lending environment, pressure on net interest margins on the retail bank from the higher wholesale and deposit funding costs, lower wealth management income in a weak and volatile equity market, high operating costs as I mentioned, lower bad debts expense as I mentioned, and a better insurance results due to favorable claims experience and premium growth.

Q: Was there anything about the result that surprised you?

Walker: The surprise was the further improvement in bad debts expense to very low levels, well below mid-cycle levels. This underlines just how good CBA is at risk management. So the loans it wrote last year and the years before have not gone bad on the bank. The bank has expertise at underwriting loans, choosing low-risk customers, low-risk risks, and bringing those on to its balance sheet, and pricing those and tracking those customers. So it's a model of how to grow a low risk bank.

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Reporting season: WOW & WES
03/02/2012 Morningstar analysts provide investors with their earnings season insights in these concise, timely video snapshots. Reporting season: WOW & WES -- 03/02/2012 http://video.morningstar.com/aus/video/120203_wow_wes_audio.mp4

Q: Were Woolworths' sales above, in line or below your expectations?

Peter Warnes: Woolworths' sales for the first half of their financial '12 year were basically in line with expectations. Up 5% at the headline rate and up 3.7% excluding petrol and petrol was quite elevated in this half because petrol prices over the half were up 13.5% year-on-year and that pushed that top line growth to 5%. Overall, about in line with consensus and in line with our expectations.

Q: What were the key drivers of the report?

Warnes: Key drivers of the report were still the dominant Australian food and liquor operations, albeit that they dominate the space. Their sales performance was just a tad disappointing albeit that we're in a very, very difficult retail environment and it's been very well publicized for many, many months. Elsewhere, Big W was pleasingly -- had an improvement in the second quarter over the first quarter and actually got back into positive real growth after a period of negative growth for the last couple of years. New Zealand did quite well and we're just starting to see some of the benefits trickling through from the Masters' openings. Seven Masters stores opened in the quarter and whilst it's way too early to get a trend there, those stores are tracking expectations.

Q: Was there anything that surprised you about the performance?

Warnes: In terms of positives, the liquor operations of Australian food and liquor continue to do very well. There is little doubt that Dan Murphy's in the big box space and the acquisition of Cellarmasters has enabled Woolworths to get a march on the competitor and it has made some very, very significant gains in that liquor space, so that's a positive. Other surprises were as I said, you know, Big W did surprise on the upside and I think New Zealand also did pretty well, leveraging off that euphoria from their World Rugby Cup victory. In consumer electronics, the Australian and New Zealand operations were a little better albeit still a fairly marginal performance and the decision to restructure and ultimately divest the Dick Smith consumer electronics operation didn't come as any surprise at all. I mean, we have been suggesting this should happen for at least two years or more. The space is very, very competitive. JB Hi-Fi have done a Woolworths' if you like in the space and dominate it along with Harvey Norman and Good Guys. I think the best decision has been made to withdraw from that standalone operation and they can still participate in consumer electronics by pushing it through the Big W outlets and through the multi-channels.

Q: Were Wesfarmers' sales above, in line or below your expectations?

Warnes: Wesfarmers' sales for the first half of their financial '12 year to December 31 were just a little bit below expectations I would have thought, up 5.4% in total to a bit over 25 billion and strangely enough exactly the same growth that Woolworths reported for its total sales, excluding petrol at 3.7%. Just a little bit below expectations but, gee it's very, very marginal.

Q: What were the key drivers of the report?

Warnes: Key drivers of the report continue to be the resurgence and the momentum in Coles, which is Australian food and liquor, and a very good performance continuing from the Bunnings home improvement operations. Coles continue to win the space above Woolworths' at this point in time, albeit that it's only marginal at this point in time. Deflation continues to be a problem for all retailers and that 2.1% deflation in the half is split roughly one-third due to produce and two-thirds due to the reinvestment in prices, which is attracting greater foot traffic and therefore volumes.

Bunnings was again another solid performance with 6.8% growth at the headline and 4.6% comparable for the half. That's again in an environment, particularly where their trade operations were being affected by one, weather, and two, a very subdued homebuilding activity throughout Australia. So, Bunnings still doing very well.

Further down the chain, the discretionary retailers Target and Kmart, both had slightly negative quarters and halves at both the headline and comparables, but because of deflation got back into positive territory in terms of real growth and volume growth. In the environment that's not a bad situation and I do think that there will be some improvement going forward as both of those operations have had some very, very strong inventory management, particularly seesaw inventories have been cut right back. So, they are going into January in very good shape. So, other than that it wasn't a bad performance.

Q: Was there anything that surprised you about the performance?

Warnes: Surprises were, in the liquor part of Coles disappointing where it was a positive from a Woolworths' point of view. They are certainly lagging in the big box area. First Choice is well behind the Dan Murphy offer and there are a lot of things to be answered there. We would suspect that management now is going to have a very hard look at the liquor offer. They were the recipient of a pretty ordinary IT platform in liquor and that has been remedied now and I would suspect that we will see an improvement in liquor.

Elsewhere, I suspect that Kmart might have been an little bit disappointing because, you know, it has had the wood if you like on Big W and has had continuing revival under Guy Russo and it was also slightly negative headline and comps, and I think the market was looking for a better performance there, but overall no great surprises. There is no demons out there in Wesfarmers' retail operations and a lot more customers shopping at their outlets.

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Reporting season: Telstra
10/02/2012 Morningstar analysts provide investors with their earnings season insights in these concise, timely video snapshots. Reporting season: Telstra -- 10/02/2012 http://video.morningstar.com/aus/video/120210_report_telstra_audio.mp4

Q: Were Telstra's earnings above, in line or below your expectations?

Peter Warnes: Telstra's half year earnings for the six months to December 31 were basically in line with our expectations for equity holders at $1.468 billion and a very good performance all around, albeit that the composition of the bottom line was a little bit different to what we anticipated, but overall, a solid performance, guidance met, and more importantly, full year guidance reaffirmed.

Q: What were the key drivers of the result?

Warnes: The key drivers of this result were a very, very strong performance in mobiles. This is the cornerstone now of Telstra's future growth and another 958,000 mobile customers were added in the six months, and that's off 1.6 million additions in FY11. So, this momentum is very, very strong. Importantly, 436,000 new mobile broadband customers and 338,000 new handheld mobile customers. This is the core of the mobile business and these numbers should make Stephen Conroy and Mike Quigley be very, very nervous.

This growth in mobile is accelerating. A year ago fixed mobile customers exceeded mobile broadband customers. The numbers then were 2.5 million fixed, 1.97 million mobile broadband. At December 31, the tide had turned completely and there was 2.74 million mobile broadband customers and 2.4 million fixed broadband customers. That is a very, very huge swing and I believe the momentum will continue. Fixed broadband is not what people are looking for. They are looking for connectivity and mobile connectivity and particularly in the age bracket between 20 and 39. That's what's happening in the marketplace.

Elsewhere the Network Applications and Services was a very, very strong result, up 19.4% at the revenue line and it is another very, very strong growth operation within the Telstra Group and I expect those revenues, which are running at about an annualized rate of $1.1 billion at the moment to surge through $2 billion within five years.

The PSTN revenue was down as expected by 9% as people chopped off their fixed lines and migrated to mobile, but bundling offers there did soften the reduction. This is the copper network revenue stream that Telstra will be compensated for when the NBN agreement is finally signed and they will be compensated very, very nicely.

Elsewhere, Sensis within the Digital Media operation did disappoint as it struggles to really get on top of this very, very rapid migration from print to online media, and particularly in the yellow and white pages. There are still some problems there, albeit it's a small part of the business but that was disappointing and will be a disappointing result for the full year, albeit we do expect a second half recovery.

Q: Was there anything about the result that surprised you?

Warnes: The surprises in the result were, as I said, this very, very strong move in mobile and the disappointment on Sensis. Surprises on the positive side, as I reiterate, is in mobile space and in addition to that the Network Applications and Services, they are going to be the two strong performers over the next three or four years for Telstra. We have $11 billion worth of net present value of payments coming from NBN Co and the government that will offset the fall in PSTN fixed line revenues and that is really going to underpin the free cash flow and the revenue stream for Telstra for many, many years into the future. This really does underpin the $0.28 fully franked dividend for many years and so we see that as a very, very nice situation. So, overall a very strong performance at the operational level and a sound result.

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Reporting season: Newcrest
10/02/2012 Morningstar analysts provide investors with their earnings season insights in these concise, timely video snapshots.

Reporting season: Leighton
13/02/2012 Morningstar analysts provide investors with their earnings season insights in these concise, timely video snapshots. Reporting season: Leighton -- 13/02/2012 http://video.morningstar.com/aus/video/120213_leighton_report_audio.mp4

Q: Were Leighton's earnings above, in line or below your expectations?

Ross Macmillan: Leighton's results were exactly in line. Leighton has worked very hard over the past three or four months to ensure that the market knew exactly how much it was going to report. It had been forecasting net profit after tax of A$250 million. A month ago it upgraded its operating net profit after tax to A$270 million.

Now, the company reported an underlying net profit after tax of A$272 million, so right on line there. They also reported one off capital gain on the sale of their HWE Mining business to BHP of A$167 million. Unfortunately, there were two impairments. There was an impairment on their investment in BrisConnect that was written down A$49 million, and there was also impairment on their Middle East operations and the impairment there was A$50 million. There was also, minority interest received A$5 million of the profit.

Q: What were the key drivers of the result?

Macmillan: Key drivers of the result were the good underlying performance from the 400 mining, infrastructure, construction, and service projects that the company is currently undertaking. In particular, I would single out the mining operations in Australia and also the mining operations in Indonesia as performing particularly well during the last six months.

Certainly, they have also made good progress on their two troubled infrastructure construction projects in Australia; on the Brisbane Airport Link that's now 95% complete and on the Victorian Desalination Plant, that's also 90% complete. They are both heading towards successful completion.

Q: Was there anything about the result that surprised you?

Macmillan: Two surprising things in the result. Firstly, dividend payment of A$0.60, unfranked. Now, that's a return to dividend payments after the final dividend for the FY11 year, there was no dividend payment. That was mainly due to the company reporting a large loss, so shareholders back receiving dividends.

Now, the second surprising thing in the result and somewhat troubling was the Middle East operations, the Habtoor Leighton operation, still not performing as we would expect. It's still underperforming. It's certainly been awarded a number of good contracts, but legacy receivables are the key issue there. The company is having trouble getting payment from some of the projects that it has undertaken and I think that that will consume a lot of management time over the next six months.

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Reporting season: BHP Billiton
09/02/2012 Morningstar analysts provide investors with their earnings season insights in these concise, timely video snapshots. Reporting season: BHP Billiton -- 09/02/2012 http://video.morningstar.com/aus/video/120209_report_BHP_audio.mp4

Q: Were BHP's earnings above, in line or below your expectations?

Mark Taylor: They were below our expectations, but we were at the upper end of market. They were pretty much in line with consensus, but whichever way you slice it, it was still a very, very strong result, probably their second strongest interim result on record despite some price weakness in some key commodities and some very strong headwinds on the cost front. They generated almost $US10 billion in underlying net profit, so a pretty good result really.

BHP's result is a much more balanced result than Rio's is likely to be. Their asset distribution is more balanced and diversified. Rio is heavily skewed to iron ore and I think that probably means that Rio won't suffer quite the cost impacts that BHP did. They don't have the coking coal exposure in Queensland and iron ore is just such a huge slug of Rio's earnings. So, they're going to enjoy relatively high iron ore prices and growing volumes there. So, I expect their result will be more run-of-the-mill and inline with our expectations.

Q: What were the key drivers of the result?

Taylor: The key drivers were steady-as-she-goes result from the iron ore business despite some softening in prices. Key detractors were copper, which suffered from softer prices and also some lower grades at some key mines and some industrial action, and the coking coal result was a bit softer than expected to with the remnant weather effects of weather in Queensland still impacting there. And I think you saw some of the lower volumes as a result of some one-offs, meant that unit costs rose over a fixed cost base, but nevertheless there was still some element of surprise in the amount of cost increase in some areas, that's something that we're taking onboard a bit in the future tempering some of our thought process.

Q: Was there anything about the result that surprised you?

Taylor: I guess the thing that surprised was just how strong the petroleum division result was. BHP recently purchased Petrohawk Energy, a shale gas producer in the U.S. and gas prices have been very weak in the U.S. and there was some expectation that perhaps that was going to dampen the result from the petroleum division, but to the contrary, BHP reported a very strong result there. I think they focused on the liquids-rich portion of those gas fields and that was one of the reasons that helped, but also they have favorably low operating costs as well. So, that was a positive surprise. And I guess on the downside, just quite the extent to which copper and coking coal suffered at the hands of grade and weather and other things. Those divisions were surprisingly weak. Aluminum was not unexpectedly weak. A pretty woeful result there, but well flagged.

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Reporting season: NAB
07/02/2012 Morningstar analysts provide investors with their earnings season insights in these concise, timely video snapshots. Reporting season: NAB -- 07/02/2012 http://video.morningstar.com/aus/video/120207_report_nab_audio.mp4

Q: Were NAB's earnings above, in line or below your expectations?

David Ellis: NAB's earnings for the first quarter of 2012 were below my expectations and also below the market consensus numbers. I was looking around about the 1.5 billion for cash earnings and the result came in at about 1.4 billion.

Q: What were the key drivers of the result?

Ellis: I think the key drivers of the result were the sharp fall in net interest margins from about 2.28% down to 2.19%, so that surprised me. I think it surprised the market. That fall in net interest margins was primarily due to high funding costs, both from customer deposits and wholesale funding. It's not surprising that wholesale funding costs are up so high, but I was a bit surprised that customer deposits costs were higher. The second main driver of the result was high bad debts, but not in Australia, the high bad debts were primarily from NAB's U.K. operations and also the U.K. banks accounted for a fair proportion of the decrease in net interest margins. So, the U.K. banks were -- caused the main surprises of the result.

Q: Was there anything about the result that surprised you?

Ellis: Just to reiterate, the Australian operations, which of course are the largest part of National Australia Bank performed soundly, no major surprises in Australia, bad debts were under control. NAB benefited from very strong lending growth in both home loans and business loans and also strong growth in customer deposits. However, NAB's U.K. businesses are under review. NAB announced a strategic review of its operation in the United Kingdom and the outcome is expected to be released in May this year and NAB noted today that continuing on a similar business model and structure in the U.K. is not an outcome they expect. So, the U.K. businesses were a big drag on the overall group result and that was the major surprise of today's announcement.

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Buckling up for 2012
13/12/2011 Focus on solid dividend yields and high-quality companies that offer essential services and products, says Morningstar's Ross Bird. And remember - don't get caught up in the headlines. Buckling up for 2012 Nicholas Grove 13/12/2011 http://video.morningstar.com/aus/video/111213_fcast_2012_audio.mp4

Nicholas Grove: 2011 is a year many investors would probably rather forget, but what can they expect from the equities market in 2012. Here to help us prepare, I'm joined on the line by Morningstar Head of Equity Strategy, Ross Bird. Ross, thanks very much for joining us.

Ross Bird: Good morning, Nick. How are you?

Grove: I'm well, thanks Ross. First of all, what are going to be the most important influences, both positive and negative and external and internal, on our share market in 2012?

Bird: Yes, look I think 2012 is going to be another interesting year. In many ways, just a continuation on from 2011. I think some of the major themes that we had to grapple with this year are going to continue on next year and remain as the major themes. Let's go through the list. First of all, we start with sort of China and India, which are both important trading nations for Australia.

Their GDP growth has been quite strong of late. We expect GDP growth in both countries to slow somewhat a little bit next year. Not to say that’s doom and gloom, it's more just the rate of growth, not be absolute; whether it’s going to grow or not, and we still expect them to grow strongly, but just maybe sort of slowing a bit from current levels.

So, some slowing there, but in absolute terms still very robust growth numbers that will require ongoing higher volumes of raw materials and energy from countries such as Australia. So, overall good, but just some moderate slowing from what we have seen this year and any past years.

For Europe, unfortunately, I think it's going to continue to be very much the same as this year. It is going to continue to struggle through, and we would not be surprised to see Europe go back into recession, at least for part of next year. Very difficult to sort of say for how long with what's going on there, but overall very, very weak growth if any growth at all for next year. No magic wand in Europe. It's going to take some years for them to sort their issues out, so in the meantime, relatively weak growth, if indeed possibly negative for a while there.

In the U.S., again, some of the recent economic data has been a little bit more positive than we were counting on, so that’s the good news, but nevertheless we still expect to see a bit of a muddle through recovery in the U.S. next year, similar to this year. GDP growth currently at 1.5% year-on-year for the third quarter there, somewhere around sort of 1.5%, 2%, is sort of where we're looking for the U.S.

So, again, a very slow recovery in this cycle compared to previous cycles coming out of a downturn and the key there is sort of jobs growth and housing activity, which is just taking a very long time to recover.

I think moving on domestically to Australia; look, general economic activity overall is quite solid, but we are still very much in our two-speed economy as we have discussed previously. So look overall, Nick, in many cases, similar conditions to what we've seen in 2011. I think, the broad themes currently out there are going to continue. However, Australia is likely to perform quite well in a relative sense compared to many of its other OECD peers, which is good news domestically, but I’d say challenges remain overseas.

Grove: Ross, which sectors of the share market are you most bullish about?

Bird: Yes, look, it's an interesting topic given the framework we've just discussed from a very broad macroeconomic basis. Obviously, investors, not just here, but around the world are going to remain very cautious and very nervous about challenges ahead that we've just discussed. So, I think in that environment, we need to continue to look at those sectors that are sort of effectively, non-cyclical, very essentially related to either services or products that we need in our everyday lives, things that we can't do without so to speak, and businesses that are not too dependent on growth from overseas, particularly in overseas, western economies.

So, really, we are looking at those defensive industrial sectors, such as: consumer staples, healthcare, utilities, and some infrastructure companies; telecommunications looking good, and we're also – from a medium-term perspective, while we sort of maintain a positive view on China and India in the medium term, notwithstanding a few little challenges just in the shorter-term, we continue to have a favorable view on energy and the resources component of the material sector, you know, the production of iron ore, coal, base metal, such lot. But, just noting that the short-term is going to be a little bit challenging as China and India, sort of, overcome their inflation challenges there, but from a medium term point of view still very positive on those segments.

I think the domestic banks, again are in very good shape, and fundamentally we maintain a positive view on the banks as well. Nick, however, as we have seen this year sometimes investors view global banks as global banks and banks tend to get tarnished with a very broad brush when something bad happens overseas. Not that it has anything directly to do with our banks, but it's just the way investors behave. So, probably banks are going to continue to trade on very attractive looking multiples, but in an operating sense they're going to perform – continue to perform well. So, we do love them fundamentally, but we just have to be a little bit patient in terms of, sort of I think, seeing the full results, come through from the good work that those banks are doing.

Grove: On the flip side, Ross, which sectors of our share market are you most bearish about?

Bird: We continue to be sort of fairly cautious towards the more cyclical sectors, ones that are just reliant on strong economic growth to see businesses do well. So, we continue to be cautious on the consumer discretionary sector, where I discussed the retailing situation just prior. Just to say, I don’t think the interest rate cuts we've seen from the RBA today is sufficient to really sort of kick start the consumer and getting them back into the store per se, overlaying that of course with the structural changes we're seeing in retailing with online sales and the strengths of the A$ making overseas purchases sort of cheaper and even sort of traveling overseas and people spending their money overseas rather than here.

I still think that those sort of influences are still going to be around to make life tough for the discretionary retailer. Also cyclical industrials, companies in the building materials trade, non-mining construction sort of areas, I mentioned the non-essential retailing sort of areas, manufacturing businesses with the strong A$, likely to continue to find the going tough in 2012.

Grove: Finally, Ross, what is the most important thing investors should bear in mind when heading into the New Year?

Bird: I think, we are in an environment where there are ongoing challenges ahead at very much a global level. We always sort of have to come back to the principles of sound portfolio management, and of course, that is always choosing high quality companies. At Morningstar we have what we call ‘moat ratings’, which try and reflect the qualities of companies, so we would certainly suggest that portfolios should have preponderance of moat-rated companies in their portfolios, which the moat ratings can be found on the Morningstar website of course.

Companies with strong track records through a range of economic scenarios, not just companies that could do well in good times; we need to be comforted by holding companies that can perform well in challenging times, because no doubt we are in the midst of that sort of situation at a very broad level.

Also, I just mentioned in the previous question focusing on those companies that offer essential services or products for our everyday life, so companies involved in the utilities industry, telecommunication industry, things that we can't live without basically. I think, there it's important that the companies in those sectors that are well run, I think will be well supported by investors.

We also, I think, just need to keep in mind that while we are expecting more ongoing, if you like, bad news out of Europe and from time-to-time maybe from the U.S., we just always have to keep in mind that equities as an investment class are for the medium to long-term, and we – we don’t want to get too caught up in headlines and get too nervy. Indeed these conditions often present the best of buying opportunities for the right sort of stock.

So, we always have to maintain those disciplines of sound portfolio management, maintain diversity through portfolios, maintaining a sense of where fundamental value is, and if the market gets too sort nervous or bearish on particular sectors or stocks that can represent good fundamental buying to the medium term.

I also think, again what's emerging from 2011 and will continue next year, is that the importance of dividend yield as part of the overall investment returns in the portfolio. So again, looking for companies that have strong, reliable, dependable dividends, I think with a good franking component ideally is very much the focus as well, and really just being prepared to take that medium-term approach to portfolio management.

Grove: Ross, thanks very much for joining us.

Bird: Thank you, Nick. It's a pleasure.

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The big four in 2012
21/12/2011 While criticising the banks may be a popular local pastime, there is a lot to be said for having a stable and profitable financial system as we head into the new year. The big four in 2012 Nicholas Grove 21/12/2011 http://video.morningstar.com/aus/video/111220_banks_2012_audio.mp4

Nicholas Grove: Despite Australia's banking system being ranked the third safest in the world by the major ratings agencies, it's no secret that bank bashing is a popular local pass time. But as we head into the New Year what should investors expect from the big four. Here to help us answer this question, I'm joined by Morningstar's David Ellis.

David thanks very much for joining us.

David Ellis: Thank you, Nick.

Grove: First of all, David, as an investment what are the main strengths and advantages of the big banks heading into 2012?

Ellis: Well, definitely the main strengths are the balance sheets, the earnings stability, and what I see is the key advantage for an investor, of course, is the sustainable dividends. So, the dividends are high at the moment, share prices are relatively low, and we argue that those dividends are sustainable going forward. So the banks, of course, the four major banks have got such a strong market position in Australia, dominate the retail banking and net interest margins are good - under pressure a little bit, but still should be maintainable. Another clear advantage is that we see that asset quality, loan quality is improving, and bad debt expense is falling, although at a lower or slower rate than in previous financial years.

So, the capital positions are increasing, improving, balance sheets are stronger, the asset quality is better, margins are stable, bad debts are lower, dividends are higher. It's pretty simple. A number of the banks had record dividends in the 2011 financial year. We see those dividends being at least maintained and more than likely in the next few years, maybe not next year but maybe a year after, or the year after that we would expect the payout ratios, the dividends to actually increase, which is a very positive and good sign for investors.

Grove: On the flipside, David, what are the key risks that the banks carry with them into the new year?

Ellis: Well, obviously there's a lot of uncertainty globally emanating out of Europe particularly. There are also questions over the U.S. economy and the U.S. banking system. A lot of those global issues are affecting the cost of funding, and the four major banks do rely on wholesale funding for roughly about 40% of their funding needs and roughly about half of that is sourced from offshore. So the disruption or dislocation that's occurring particularly in Europe is affecting funding costs. There’s no question about that. It is a big risk, but to counter that risk we've got strong increases in customer deposits here in Australia as investors are deleveraging, households are deleveraging, businesses are deleveraging.

There's an aversion for risk assets such as equity investments. So, bank deposits are continuing to grow and to grow strongly. So that's countering the increased risks of – in the wholesale funding markets offshore. So, the problem with the funding costs is that it's exerting pressure on margins, and even though now the Reserve Bank has cut the cash rate twice in the last two months, by 25 basis points each time, there is pressure on the banks to not pass on further cash rate cuts in full –partially or in full. So, there's pressure on the margins, but the banks have got a lot of the levers to pull and to use to limit the damage that may arise from higher wholesale funding costs.

Grove: David, we constantly hear about the big banks coming under fire from politicians, the public and various media outlets. In your opinion, is this warranted?

Ellis: Well, there's no question the four major banks in Australia are very unpopular from the public's perspective. The politicians see the banks as easy targets to criticize. The massive – the very significant profits the banks generate, the very strong market positions they hold, the pricing power they benefit from and the relatively high senior executive salaries that are a feature of the banks make them, as I said, an easy target. However, and this is a big however, there is a lot to be said for having a strong and stable, and profitable financial system. You only have to look at what's happening in Europe where in certain countries the financial – on the banks, the financial systems are under a lot of pressure, and it's leading to a credit crunch. So, the banks are just not lending. Some banks – obviously, there's a lot of – some of the economic issues, the austerity issues are leading to social unrest in certain countries, whereas we don't have that. We don't see that occurring any time soon.

Grove: Finally, David, how well positioned are the big banks to weather any kind of left field Black Swan-like events should they pop up in 2012?

Ellis: That's a hard question because depending on what type of black swan event it is, all I can say is they are well positioned, well placed to cope with unexpected events that may occur globally. But, you can't give it an ironclad categoric guarantee that they would cope with all types of events. But certainly their balance sheets are strong and are continuing to strengthen. Their earnings are strong. The Australian economy is relatively resilient even though economic growth is slow, below trend, but it's still resilient.

We've got a – our federal government has low government debt. The Reserve Bank controls the cash rate. The cash rate is at 4.25%. So if economic conditions deteriorate, Reserve Bank is in a position, has the flexibility to reduce the cash rate, which because of our large proportion of variable home loan rates in Australia, that monetary policy transmission is effective and timely.

So we have a number of levers, and it's not just the banks, it's the government, it's the Reserve Bank, it's the economy. We have a number of levers that provide support and would limit the damage caused by an unexpected black swan event. But you can't rule it out completely.

Grove: David, thanks very much for joining us.

Ellis: Thank you, Nick.

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Resources sector investing in 2012
19/12/2011 The year just witnessed could hardly said to have been kind to the local resources sector. But what can investors expect from resources in 2012? Resources sector investing in 2012 Nicholas grove 19/12/2011 http://video.morningstar.com/aus/video/111214_resources_2012_audio.mp4

Nicholas Grove: 2011 was a year that wasn't kind to the share market and the local resources sector also didn’t escape unscathed, but what can investors expect from this sector in 2012. Here to help us prepare, I'm joined by Morningstar's Mark Taylor.

Mark, thanks very much for joining us.

Mark Taylor: Thanks, Nick.

Grove: First of all, Mark, where do you see bulk commodity prices heading in 2012, generally speaking?

Taylor: Well, we are coming off of the back of a recent slump in prices that was to levels that, we think, was unsustainable in many cases like for iron ore, where it was below the cost of production for many high-cost Chinese producers. So, we see some positive momentum leading into the beginning of the New Year, but in the longer term we expect to see a gradual decline in bulk commodity prices, including iron ore just as new lower cost production comes on stream, particularly from the three majors, BHP, Rio and Vale.

Grove: Looking to the year ahead, Mark, should investors be looking at the larger or smaller end of the resources spectrum or both ends?

Taylor: Well, it would be a very, very rare event for us to be recommending investors focus on smaller end of the market, and it's definitely not a time to be doing that when you got the likes of BHP and Rio on single-digit prospective P/E multiples. Their balance sheet is very strong and they're in such an incredibly strong position, and if there is some more market weakness, they can take advantage of that because they've got the balance sheets and the firepower to ride these sorts of things through. They're masters of their own destiny because they are so strong.

Grove: Mark, you recently spoke about the importance of balance sheet strength, when it comes to resources companies. Given the global macro environment, how important will balance sheet stability be in 2012?

Taylor: Well, I think it is going to be important because even if things do start to improve, there is still going to be that heightened uncertainty in people's minds. So it is going to be more difficult to borrow money. There is going to be wider margins of safety required in terms of investments in new assets. Banks are going to want to see a much wider margin of safety.

So, companies probably are going to have to have more money set aside for project development than they may actually need. So, there's multiple fronts where to have a stronger balance sheet, it's going to be far better – or it's going to put you in much stronger position than competitors.

Grove: Finally, Mark, what is the key thing investors should bear in mind, when investing in the resources sector in the coming year?

Taylor: Well, I think you've just got to remember fundamentally that the resource sector is characteristically cyclical, so you got to take the good with the bad, have a longer term investment time horizon, understand that you might not make instant returns, but if you're buying value, low-cost quality companies in the longer term, that's going to put you in good stead. It's a same old story, but it’s a story that it lasts the test of time.

Grove: Mark, thanks very much for joining us.

Taylor: You're welcome, Nick.

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Media sector investing
16/11/2011 As companies slice advertising budgets amid softening consumer sentiment, investors may be wondering if media stocks are worth their while. Media sector investing Nicholas Grove 16/11/2011 http://video.morningstar.com/aus/video/

Nicholas Grove: Weak consumer sentiment continues to plague the Australian media sector, permeating through the retail industry and therefore into company's advertising budgets. With the ASX 200 media index down about 18% for the year to October, investors may be wondering if there is a silver lining anywhere in sight.

Here to discuss what to expect from the sector, I am joined by Morningstar's senior equities analyst, Tim Montague-Jones. Tim, thanks very much for joining us.

Tim Montague-Jones: Cheers Nick.

Grove: First of all Tim, in a recent report, you mentioned that media companies are cutting advertising budgets, and restructuring for a lower growth environment. Is this environment here to stay?

Montague-Jones: Recently, at the AGMs, we have seen quarterly performance from retail companies, showing that retail conditions continue to remain very weak at the moment, and all kind of reporting negative quarterly numbers. So, retail conditions are weak, and that flows through into the media sector, and we expect media spending to remain tight at the moment; and retail and media are effectively preparing for a weak environment into next year. That means cutting costs and scaling back in the anticipation of the weak environment, and obviously they will be hopeful for a better than expected weak environment.

The interest rates is a step in the right direction for consumer confidence, and Christmas will remain a crucial period, especially for retail, and that will flow through into early next year for advertisers. So, kind of prepare for the worst, and hopefully, get the best.

Grove: Tim, you also mentioned that the old media companies, like the old newspaper and television oligopolies are seeing their audiences fragmented by the internet and digital multi-channels etcetera. What are these companies doing to adapt, and are they still investable?

Montague-Jones: A lot of it depends on the company. If we look at television, multicasting and free-to-air TV channels is fragmenting audiences. So, a general television channel isn't pulling in the audience share, historically what it has done. So what they are doing is, becoming more niche and focusing on specific demographics, to try and build a portfolio of channels to aggregate a sizeable audience share, and some companies have been more successful at that than others. Channel 7 doing extremely well, and for Channel 10 and Channel 9 are not doing as well.

For newspapers, they are rolling out effectively a premium business model, which is effectively what they are trying to do is to maximize their audience share by offering free general news content, but also, generating subscription revenues by putting niche, more specialist type content behind a firewall. So they are all adapting to the threat of online, because online effectively have lowered the barriers to entry for media source and also to access media as well.

Grove: Tim, on several occasions, you have mentioned your preference for new media companies as opposed to the old ones. What is it that makes these new media companies more preferable?

Montague-Jones: We take a long term approach in investing. So over the next five to 10 years, we have a feeling that new media stocks will continue to do well, as there is a migration of advertising revenue, and a migration of audiences to online content. So we want to be investing in those stocks which are taking market share from the more mature industry types, such as newspapers and television. And for some time, we have been recommending a number of good strong internet stocks which have dominant market shares, and generating high cash flows, high profit margins, and have proven to have a sustainable growth going forward, and we continue to have that feeling that those companies are the ones to invest in.

Grove: Finally Tim, where do these new media investments fit within a well diversified, conservative long-term portfolio?

Montague-Jones: We believe there is a structural shift going on. It's not just a cyclical downturn, but it's a structural shift of a migration of revenue. So we believe a core portfolio holding should be in some of these stocks, especially the winners, which you would be able to find out from our report, are core holdings for any portfolio.

Grove: Tim, thanks very much for joining us.

Montague-Jones: You’re welcome. Thank you.

Grove: To read Tim Montague-Jones latest special report on the media sector, morningstar.com.au premium subscribers can go to the special reports tab, and click on the link below.

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Banking earnings preview
25/10/2011 Morningstar’s David Ellis discusses what we can expect from Macquarie and three of the big four when they report earnings over the next several days. Banking earnings preview Nicholas Grove 25/10/2011 http://video.morningstar.com/aus/video/

Banking earnings preview

Nicholas Grove: Banking earnings season is upon us. With three of the big four stated to report their full year results for the year to September over the next several days. The Macquarie Group is due to give its half yearly results. Here to discuss what we can expect from Macquarie and the three majors, I am joined by Morningstar Head of Australian Banking Research, David Ellis.

David, thanks very much for joining us.

David Ellis: Thanks Nick.

Grove: First of all David, given all the ugly macroeconomic issues we’ve seen over the past several months, what are the key risks and issues investors should be mindful off going into these results?

Ellis: Well, key risk for the Australian retail shareholders are really revenue growth and from revenue growth it obviously flows through to earnings growth which flows through obviously to dividend growth and most of our retail investors of course are very much interested in dividends. On the positive side we believe that the four major banks have got quite a strong and sustainable dividend payout ratio levels and that is one of the key attractions of the banks at the moment: Their high, fully franked dividend yields which, as I said, we believe are quite sustainable.

Grove: David, NAB is first cab off the rank, are expecting a strong, steady or week result from this bank?

Ellis: NAB will deliver the strongest result of the three majors that are reporting in the next few weeks. It’s going to benefit from strong lending growth in both consumer and business banking, benefit from strong deposit growth and those three sources of business will push out the revenue growth and earnings growth we are expecting anywhere from 15% to 20%. So NAB’s result will be strong, but what we’re concerned about mostly for NAB is net interest margins. Because they’ve been pushing for loan growth particularly in the mortgage sector, we may see some softness our weakness in net interest margins. But, overall it should be a pretty solid to strong result.

Grove: Given the continuing weakness across financial markets, what can we expect from Macquarie's result?

Ellis: That's a hard one. Macquarie is the hardest of the banks to try and get a good feel of what they are going to report. Obviously, Macquarie is very much influenced and impacted by global financial markets and obviously what we have been experiencing over the last couple of years is pretty weak, weak in trading volumes, weak M&A flow, newer IPOs are very sparse. So, a lot of the big picture items that affect Macquarie’s earnings and businesses, they’re really pushing up against it. So we expect actually a weaker result compared to first half 2011, but there is a lot of uncertainty about the way the results are actually going to come in.

Grove: Finally David, what sort of results do we expect next week from Westpac and ANZ?

Ellis: They will be good results as well, but probably won’t have the strong growth that we are expecting with National Australia Bank. But they will be good. ANZ’s earnings will be up over 10% and Westpac’s will be up probably below 10% but still a pretty robust result. So, we are looking for dividends again and with NAB and with Westpac, probably I wouldn't be surprised if the actual dividends are announced are higher than what we are forecasting. So there could be a pleasant upside surprise with dividends for NAB and for Westpac. So Westpac, we are looking for solid earnings growth and probably good dividend growth. ANZ, probably will be come in with a higher earnings growth figure but we are not expecting them to shoot the lights out with their dividends at ANZ.

Grove: David, thanks very much for joining us.

Ellis: Thank you Nick.

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Telstra, dividends and the NBN
21/10/2011 Morningstar’s Peter Warnes shares his thoughts on the road ahead for the country’s biggest telco, after shareholders approved its participation in the NBN rollout. Telstra, dividends and the NBN Nicholas Grove 21/10/2011 http://video.morningstar.com/aus/video/

Telstra, shareholders and the NBN

Nicholas Grove: Shareholders this week approved Telstra's participation in the National Broadband Network. The country's largest telco also reaffirmed its commitment to a $0.28 fully franked dividend both this year and in 2013. Here to discuss these developments, I am joined by Morningstar's head of equities research, Peter Warnes. Peter, thanks very much for joining us.

Peter Warnes: Thanks Nick. Good to be here.

Grove: Firstly Peter, to the NBN, for this deal between Telstra and the NBN to proceed, the competition watchdog has to green-light Telstra's structural separation and its migration plan. What do these conditions involve and will Telstra get the nod?

Warnes: Nick, simply the SSU is a commitment by Telstra to, if you like, disconnect its fixed line voice and broadband services from the copper network and the HFC network, and then the migration of those services to NBN. It's a commitment to do that by July 2018. The SSU also requires Telstra to provide transparency and equivalency for the services that it's going to provide to the wholesale customers during the transition. The migration plan is a binding instrument, if you like, that details the migration and the disconnect of those two networks, and importantly it also gives Telstra's wholesale customers some safety in terms of their services won't be clipped. Their customers, in other words, the customers of wholesale customers will be able to establish when they disconnect.

Will Telstra be successful? Will the ACCC give them the nod? Yes, I mean Telstra has already submitted these two plans, a 306 page document and there was no way that the ACCC was going to just brush that through. I suspect there will be a little bit of give up on the equivalency and the transparency aspects of it, but other than that any meaningful change, any meaningful movement from what Telstra has already submitted, I don't think that will come about and I think within a couple of weeks the ACCC will come to an agreement with Telstra and it will be approved.

Grove: Peter, what are the key benefits and drawbacks that you expect Telstra to come away with from its participation in the NBN project?

Warnes: Nick, benefits and drawbacks: the benefit, they really had to go down this route because the government put them in a place where they couldn't really win if they didn't submit to the requirements of the government. So they've taken the next best option and gone with this structural separation and NBN. The benefits will be the payments they're going to get from the government, which are substantial but over an extended period of time of $11 billion after-tax net present value. They don't sell any assets, which is positive, and so the company and the shareholders get comfort in the fact that $11 billion is coming their way over a period of time starting kind of from 2013 through to the backend of the decade and then a little bit into 2020.

The drawbacks, the drawbacks are, well if this didn't happen, Telstra would be the Telstra of old, and it would have its copper networks and it would have a robust mobile and broadband operation, but of course those copper networks take a hell a lot of a maintenance, and so transferring all your customers and closing down that network is going to save a lot of maintenance CapEx. So that's probably positive as well.

Grove: Peter, in your view is Telstra's dividend guidance achievable, all things being equal, and are there any risks to this guidance that you see on the horizon?

Warnes: 2013 is when the payments start to kick in from this transfer of customers and the closing down of the copper and HCF networks, and the leasing of the infrastructure associated with it. Then it just starts to move up a little bit and picking 2014 aging off a little bit in 2015. But the free cash flow that's coming to Telstra's coffers between now and 2015 probably average around about $5 billion - probably that's a little bit conservative. Now the annual dividend in the current structure, current capital structure, requires just under $3.5 billion to satisfy. That's a very, very nice margin of safety between $3.5 billion and $5 billion, and so I've got no problems with the sustainability of Telstra's dividend through to 2015 and probably beyond.

Grove: Finally, Peter, as we see the proliferation of smartphones and tablets and the whole post-Steve Jobs world, how well-positioned do you think Telstra is to capitalize on this?

Warnes: Well, they are in a very, very good position. The good position goes back to Sol Trujillo when he went down the route of building the Next G network. That has put Telstra in a very, very powerful competitive position in the mobile or wireless space. Because of that position and because of a very, very significant marketing promotion to get customers back onto the mobile platform, they now are looking at a very, very robust and growing mobile and broadband wireless operation. The company is transforming from being providing voice over phone service to data over devices, and what's happening is this mobility or connectivity that everyone talks about - everyone wants to be connected and strange enough more and more people want to be connected but have wireless connection. What's happening is that the data, the amount of data that's moving across the broadband is increasing. Their launch of 4G just again elevates them competitively into another very strong position where download speeds on the 4G, if you've got a 4G compatible device, is up to 40 mbps now and that's sensational. They are in a very strong position.

Grove: Peter, thanks very much for joining us.

Warnes: Pleasure, Nick.

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Europe and the big four
30/09/2011 As the rhetoric surrounding the European sovereign debt crisis continues to ebb and flow on a daily basis, what does it all mean for Australia's banks? Europe and the big four Nicholas Grove 30/09/2011 http://video.morningstar.com/aus/video/

Nicholas Grove: As the rhetoric surrounding the European sovereign debt crisis continues to ebb and flow on a daily basis, investors may be left wondering what this means for Australia's big four banks. Here to help shed some light on this issue, I am joined by Morningstar Head of Australian Banking Research, David Ellis.

David, thanks very much for joining us.

David Ellis: Thanks, Nick.

Grove: First of all, David, what kind of exposure do the Australian banks have to the European sovereign debt crisis?

Ellis: The four major banks have very, very limited exposure to Europe, and virtually nil exposure to Greece, and similarly low levels of exposure to other Southern European sovereigns. So, at best the exposure is nil and at worst it's immaterial. So, it’s not an issue for the four major banks.

Grove: Secondly, David, when it comes to global banks, where do our big four stand in terms of capital strength?

Ellis: Unfortunately, it's difficult to do direct comparisons because of the different interpretations of the global capital regulation as they stand now. So, in Australia the four major or the banking system in Australia is of course regulated by APRA.

APRA have traditionally interpreted the global capital rules quite conservatively and hence the published capital ratio levels for the Australian banks look low compared to some of the European and U.S. capital ratios. But the global banking system is moving towards a new standard, it's called Basel III and that will be effective from the beginning of 2013. Importantly the four major banks already meet and exceed the new minimum core capital ratios that will be part of Basel III.

So, as I said that it is difficult at the moment to compare directly the Australian capital levels with European and U.S, but it's safe to say that we are – we, the Australian banks - are in a strong capital position. As I said already, meeting and exceeding the minimum our tier capital levels, whereas quite a few European banks and possibly some U.S. banks, again require substantial recapitalization and potentially nationalization or partial nationalization in Europe which we, of course, don't have that problem here in Australia.

Grove: Just on the topic of the U.S., how likely do you think a double dip recession is in that country and what would this mean for the Australian banks?

Ellis: Well, it's looking increasingly like that's going to be the outcome. Some commentators are actually saying that U.S. is already in a recession. It's difficult to know, of course, exactly where the U.S. is but certainly not positive, that's for sure.

If the U.S. does go into a double dip recession, how will it affect Australia, well – and the Australian banks? It's more of a – I'd see it more as a confidence issue. If the U.S. economy was recovering moderately or even strongly, I would expect that to flow through to Australian businesses and corporates, as a sign to start investing and growing and increasing demand for business credit. That’s one of the big problems we've got in Australia at the moment that business credit is still – growth is negative, and it's unlikely to go positive until we see some more stronger signs, more consistent signs of economic growth in the U.S.

Grove: Finally, David. Over the coming year what is the most important thing investors should keep in mind when it comes to the banks place in their portfolios?

Ellis: At the moment one of the key attractions of the banks, of course, is dividend yield. So, that's a key measure for investors to watch and monitor any changes in the dividends. Changes in the dividends will be – broadly speaking - will be supported by increases in credit growth and on the downside if there is any sharp increase in unemployment, any sustained sharp increase in unemployment, well that will be a negative for – credit growth will be a negative for asset values specifically house plus values and that will flow through as a negative for the banks. So, credit growth is a key flag and unemployment – changes in unemployment is the second most important one.

Grove: David, thanks very much for joining us.

Ellis: It's pleasure to me. Thank you.

Grove: To read a special report on this subject, Morningstar.com.au premium subscribers can go to the Special Reports tab and click on the link below.

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Mining sector investing 101
26/09/2011 In this educational video, Morningstar helps novice investors understand some of the terms often found when you first pick up a mining company research report. Mining sector investing 101 Nicholas Grove 26/09/2011 http://video.morningstar.com/aus/video/

Nicholas Grove: Even if you're only a new comer to the share market, you're likely to have heard the names BHP Billiton and Rio Tinto. In this video, Morningstar Senior Equity Analyst, Gareth James helps novice investors understand some of the terms often found when you first pick up a mining company equities research report.

Gareth welcome.

Gareth James: Thanks, Nick.

Grove: First of all, Gareth, why should investors be interested in the mining sector?

James: Well, the mining sector is an extremely large part of the Australian market. There are around 2,300 companies listed on the Australian Stock Exchange, and around a third or 750 of those companies are mining companies. So, investors have a lot of companies to choose from. In the Australian economy, the mining sector is obviously extremely important too. Australia's two largest exports are iron ore and then coal. So, mining is very important to Australia.

Grove: What kind of investors should consider buying shares in mining companies?

James: The mining sector is typically considered a high-risk sector, particularly the small end of the mining sector. So, those companies with market capitalizations below $100 million, they are particularly high risk investments, so they tend to suit speculative investors. At the other end of the mining sector, we have the large, diversified, blue-chip mining companies. They tend to be highly profitable businesses, dividend paying stocks. So, we consider those companies to be medium risk, so suitable for long-term portfolio.

Grove: Gareth, what should investors look for in a mining company?

James: You look for different things, depending on the mining company. So, if you're look at small mining companies, those companies don't tend to be profitable, they tend to be exploration companies. So, you really need to focus on how much cash those companies have and how quickly they're getting through that cash. You also need to look at the track record of the directors and senior management, because when you're investing in those companies, you're really backing the individuals who are running the company.

At the other end of the market, for the larger mining companies, such as the blue-chip, diversified companies, you need to look at what's in that portfolio and what kind of commodities they're producing. You also need to look at what we refer to as the cash cost. Now, this is the operating costs per units of commodity produced. So, large mining companies will have very low cash cost and that's what you're really looking for in those stocks.

For the larger companies as well, you really need to have a good understanding of how much of the commodities they actually own. So, to do this, you can look at their resource and their reserve statements, and those statements tell you how much of the particular commodities they own in the ground. So, that's important, because that tells you how long that mine life is.

So the other thing that you need to be very aware of with mining companies is that capital expenditure. So, we'll use the term CapEx. For the smaller companies, this is very important because they can have a high CapEx, and they obviously don't have any earnings. So, it's important to understand how quickly they're getting through their cash pile.

For the larger mining companies, it's important too, because although they may have very high operating cash flow, if they have extremely high capital expenditure, then they may not generate very high free cash flow. Obviously, free cash flow is the important metric when we're looking at valuation of any company.

Grove: Finally, Gareth, what should investors do to get started?

James: So, I think the mining sector is a high risk sector. It can offer extremely high potential gains, but you do have to be aware of the risks. So, I think what we would recommend is that, investors take their time. Before investing they need to do a lot of research, so they can use the Morningstar website to look into companies' financial backgrounds. They can look into directors and senior management using the website too.

They can use Morningstar's equity research to understand more about the companies. Investors can also contact the research analysts here at Morningstar too. So, my advice would be to take your time, possibly set up some of your favorite stocks in the portfolio tool on the Morningstar website and keep an eye on them maybe for 6 months, 12 months time. When you're comfortable that you fully understand the risks then maybe consider making an investment.

Grove: Gareth, thanks very much for joining us.

James: Thanks Nick.

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