WINTER 2009
Prescott Securities Investor’s Digest The 2009/10 Federal Budget
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Cash or Shares Cash may have been king in 2008, but in this low interest rate environment cash now holds less appeal. For many investors, it's decision time
By Darryl Gobbett Adviser, Representative and Chief Economist
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Stocks to watch Market uncertainty and falls in commodity prices are causing negative sentiment in commodity stocks. We examine the possible implications.
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We live in interesting times Notions of fear, doom and pessimism are just beginning to be challenged by a changing tide of sentiment.
If setting the Federal Budget were easy, anyone could do it! Darryl Gobbett walks us through the key provisions of a particularly challenging budget. This year’s Federal Budget sets Australia on a course of sharply increased government spending and large Budget deficits for the next 4 to 5 years at least. As part of hauling in the costs of these future deficits there are some negative changes to superannuation and the Age Pension. The Budget is part of the government’s strategy, starting in late 2008, of maintaining low interest rates, cash hand-outs, spending on education, training courses and facilities, as well as
public and private infrastructure spending. It is all done with the aim of avoiding unacceptable levels of unemployment. For 2009/10 the Budget forecasts the economy to shrink about 0.5% after inflation and then to grow 2.25% in 2010/11. Consumer price inflation is forecast at 1.75% this year and 1.5% in 2010/11. Employment is forecast to fall 1.5% through 2009/10 with unemployment rising to 8.5% by June 2010. Against this background and with the major spending increases, the Budget is expected to be in underlying cash deficit of $58 billion in 2009/10 and remaining in deficit until at least 2012/13.
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To fix or not to fix? Interest rates in Australia have rapidly fallen to historic lows. But is fixing your interest rate the right thing to do today?
NEW REPORT MAKING SOUND DECISIONS WHEN LEAVING A JOB OR TAKING A SEPARATION PACKAGE. CALL US FOR YOUR FREE COPY OR EMAIL info@prescottsecurities.com.au
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As reasons to start reducing superannuation concessions and Age Pension access. the government has used the need to clear the future deficits and the expected costs associated with an ageing population. From 1 July 2009, tax deductible or Concessional Contributions to superannuation will be halved to $25,000 per year. For those over 50 years of age Concessional Contributions will be capped at $50,000 each year until the end of June 2012. There were no changes to the contribution limits for after-tax monies or Non-Concessional Contributions, of $150,000 per annum, or the $450,000 that can be contributed in a year to cover that year and the following two years. The current tax rates within superannuation and pensions including those on withdrawals were not changed. The government has chosen to extend until June 2010, the 50% reduction in the minimum pension draw-down rates which apply to each age group.
The super changes which limit how much can be tax-effectively contributed, whilst not altering the benefits of superannuation for those with large benefits or receiving income streams, seem designed to appease the baby boomer and older voters. It is likely that these benefits for older voters will be “grandfathered”, that is they will never be altered in any real sense, while at the same time tax benefits and Age Pension access for younger voters seem likely to be further whittled away. Consistent with this approach to minimise the impact on older voters, was the proposal to raise the Age Pension age to 65.5 from July 2017 and then continue to raise it by 6 months every 2 years thereafter. By July 2023 it will be age 67 for everyone.
This may well mean many Age Pensioners will get no or little increase in Age Pension from September 2009. The government has announced that the new rules will be implemented so that existing Age Pensioners will have their payments maintained in real terms.
The Australian Future Tax System Review Panel is looking at aligning the age at which people can access their superannuation with Age Pension eligibility. The report is due in December 2009. There is also a major government review of superannuation underway.
The health insurance rebates are to be restructured from July 2010 according to age and phased out according to income. The rebate falls to 0% for singles earning over $120,000 pa or couples earning over $240,000 pa.
The government announced the single Age Pension will be increased $32.49 per week and the couple’s combined Age Pension by $10.14 per week. On another positive note for mature workers, only 50% of the first $500 per week of work income will be counted under the Centrelink Income Test. However, offsetting this benefit for many Age Pensioners, is the increase from 40c to 50c in the withdrawal of Age Pension for each dollar of assessable income. This includes income “deemed” to be earned.
MORNING NOTE If you want to keep a close eye on the market on a daily basis, consider looking at the Prescott Securites Morning Note. This is a summary of events on financial markets here and overseas over the previous 24 hours.
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The Pension Bonus Scheme will close from 20 September 2009 for new applicants. The government also announced it is not proceeding with the May 2008 proposal to include gross tax free super payments for assessment of eligibility of Commonwealth Seniors Health Card. This should allow many self funded senior Australians to retain this card.
As with any Federal Budget, there are a lot of detailed changes not covered in this snapshot that will affect investors, people saving for retirement, retirees and families. All of us will be affected in different ways. There are also likely to be the usual changes as interest groups lobby the government when people understand how they may be affected. Already there is significant concern about the increase in the Age Pension age. We will be looking at some of these issues in future Investor’s Digests.
It covers company announcements for the previous day, significant economic or topical news from the US, a summary of Asian, European and US markets, as well as a commodities and currency report. You can view and download it from our website every weekday, or if you prefer to receive it via email, please contact your adviser at Prescott Securities.
Cash or shares? By Geoff Smith Adviser and Representative
For investors, cash may have been king in 2008, but in this low interest rate environment, cash now holds somewhat less appeal, meaning that for many investors, it's decision time. Geoff Smith explains the whys and hows.
Compare this to a new investment in shares. Share prices do fluctuate and as we have seen over the past year, this can be quite dramatic. As is often the case, an over selling or over reaction has occurred, the result being that we are now seeing excellent opportunities in owning certain shares and some share market recovery is occurring.
A person with, for example, $100,000 to invest in early 2008 could get a one year Term Deposit at 7%. At a 30% marginal rate of tax this is a return of 4.9% (or 4.2% if paying 40% tax).
Even through these times of considerable uncertainty and share price falls, there are some sectors still paying fairly stable dividends. Yields from the big four banks have been stable over the past 10 years, dropping only slightly in recent months.
If you subtract the inflation of 2.5% over the last twelve months, then the real rate of return after tax is closer to 2.4%, or 1.7% respectively.
A big plus is that banks' dividends carry franking credits that provide added tax benefits. In effect the tax has already been paid at 30%.
These are still positive gains and important for many investors.
As an example, let’s look at the Commonwealth Bank (CBA). The forecast dividend over the next few years for them is in excess of 6.5%, or equivalent to over 9% before tax if we add the franking credits.
Let's now look at a similar situation in today's investment environment. Starting another one year Term Deposit at 4% in early 2009 with the same $100,000 could produce a 0.8% real after-tax return for the 30% tax payer, or only 0.4% for the 40% tax payer with inflation at 2%. Even though the inflation rate has fallen, and this may be temporary, it means that in effect the purchasing power of the initial deposit is close to going backwards. This is not good.
above showing the return on term deposits this is a substantial amount of income to be received. At a 30% marginal rate of tax, the shares provide 6.5% income (or 5.6% if paying 40% tax). Even with inflation at the expected rate of 2%, the real return is an appealing 4.5% or 3.6% respectively. While investors in equities do not enjoy the capital certainty that cash or fixed interest offers, the important long term benefit of capital growth that shares can provide is an added bonus. In conclusion, it is important for investors to be aware of the long term impact of taxation and inflation undermining the return of cash. And don't forget the old saying, “It is better to be a long term owner of the bank than to be a faithful customer�.
When compared to the examples Source: Iress, Morningstar prescott securities winter 2009 3
Stocks to watch
By Travis Adams Direct Equity Analyst
High quality, long term, consistent earnings, low debt and product differentiation... these are always attractive considerations for investors.Travis Adams looks at two healthcare companies that seem to tick the boxes.
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In early March 2009 the share market reached the lowest point of the current downturn. Since that time it has rallied strongly, up 30% in just over three months. It is worth noting that the market was down as much as 55% from its peak back in November 2007. Many people are now feeling more comfortable about the share market. The real opportunity from any downturn is that share market volatility and general price falls provide great prospects for long-term investors. Share markets often overreact to positive news on the way up and also to negative news on the way down.
With a patient, long-term investment view, investors should use share market falls as the occasion to make good investing decisions. To help manage the risk of price fluctuations we suggest investing in high quality companies that have long term, consistent and growing earnings, with low debt and some type of pricing power or product differentiation. Most healthcare stocks fit these criteria. In the past they have provided strong and defensive revenues with consistent profit growth and many have low debt.
There is a strong correlation between the “ageing population” and the increasing demand for the products of healthcare stock. Below, we detail two excellent companies to consider as they are now trading on attractive fundamentals.
the capacity to set up a pathology collection centre. This could allow for low volume standardised testing and potentially eat into SHL’s competitive advantage. The current share price reflects these threats.
Classified as a defensive growth stock, CSL has recently seen share price pressure from the share market. Some of this stress has come from larger investors rotating their investment positions from more defensive to more risky assets after a return to favour for the share market.
Sonic Healthcare (SHL) is a radiology and pathology service provider. By consolidating its business both here and overseas it is using its expertise to drive cost efficiencies. SHL is now a main player in Australia, and with its 2 competitors Healthscope and Primary Healthcare, they cover 90% of the Australian pathology sector.
Offsetting this, the company has made large purchases of comparable operators overseas as a consolidation phase continues. As with all corporate expansion programmes, problems and risks can arise. In SHL’s case this could occur if they pay too much for a competitor. We believe some of this is already reflected in SHL’s share price and we expect SHL to positively adjust to the changes proposed by the government, enabling it to continue to be a strong performer in the years ahead.
Compounding this, CSL’s share price weakened further after the US Federal Trade Commission rejected their proposed acquisition of the US blood fractionator Talecris on concerns that market power would become too concentrated. CSL initially considered appealing to the Federal Trade Commission (FTC) decision, but withdrew, citing that it would not be in the best interest of shareholders. Funding for the Talecris acquisition was completed by CSL in September 2008. With the US FTC rejecting the offer, CSL has now announced an on-market share buyback to return the excess funds to shareholders.
Source: Actual Data: Iress and Morningstar. Forecast Data: Thomson Financial Consensus Estimates distributed under licence by Morningstar.
There was some fear this year’s Federal Budget would include large cuts to pathology services. While this did not eventuate, some subtle changes have reduced the attractiveness of SHL. Medicare rebates were cut and this will slightly reduce their Australian revenue. Nevertheless, SHL is confident that the government will see the need for adequate funding and change their policy. Even though a third of SHL’s income is derived from Australian pathology services, the Medicare changes should not be significant for the company.
CSL (CSL) is a large biotechnology company which has successfully established itself in a dominant global position in the blood plasma sector. It also develops, manufactures and markets pharmaceuticals, vaccines, antivenoms and plasma-derived therapeutic products. In addition, CSL is also working on specialist products which include the H1N1 (“swine-flu”) vaccine and the human papilloma virus vaccine. Distribution of Gardisil and Ceravix for large international pharmaceutical companies also enhances their revenues.
Money was raised by CSL at $36.60 per share and a share buyback below these prices is expected to improve earnings per share and the return on equity to the benefit of shareholders. Despite the preference for the Talecris purchase, a buyback appears to be an attractive option for investors. CSL has had several large orders from the Australian, Singapore and US governments to supply the H1N1 virus (“swine flu”) vaccine. The widespread fear surrounding the potential pandemic status of the virus could be a windfall for them. With the share price fall, CSL looks good value for those considering exposure to a well-managed, global pharmaceutical organisation.
When the Australian Government reviewed the profitability of the sector they removed the Memorandum of Understanding that enabled a 5% automatic increase in payments to these companies each year. Funding will now be allocated on an annual basis. Restrictions on pathology collection centres have also been removed by the government, which enables anyone with
In our opinion and, should there be no major changes to fundamentals, we believe that both of these businesses are at attractive long term purchase levels. Source: Actual Data: Iress and Morningstar. Forecast Data: Thomson Financial Consensus Estimates distributed under licence by Morningstar.
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Interesting times catalysts, the seizing up of the credit markets globally in late 2008, with the collapse of Lehman Brothers, led to the sell-off in share markets. This meant investors looked to the most liquid market they could find to sell assets and repay debt. In Australia, the credit market closure or tightening has prompted the government to guarantee our banks so they could continue to borrow overseas. There has also been a record volume of capital raisings and bond issues by banks and other businesses with proceeds being used predominantly to strengthen balance sheets and repay debt.
By Matthew Kerrish Adviser and Representative
Notions of fear, doom and pessimism are just beginning to be challenged by a changing tide of sentiment. Matthew Kerrish explains the mechanism behind the markets' gradual climb back. The ancient Chinese curse said, "May you live in interesting times" and times have most certainly been interesting over the last 9 months or so. In the early part; fear, doom and pessimism reigned supreme with the daily media saturating us with words like ‘depression’ and ‘severe recession’. Global share markets were sold off sharply as investors fled to less risky investments such as Government bonds and the number of share issues rapidly increased as companies struggled to repay debt and recapitalise their balance sheets. Assets everywhere were being revalued and it seemed nothing could be done to avoid financial Armageddon. Since late March though, the sentiment tide has changed, albeit slightly. Governments and central banks of the major countries have acted in unison to lower interest rates, prime the economies with cash and get banks lending again, as well as supporting or nationalising any major financial institution that looked like falling over.
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A prime example of the extreme measures taken by central banks has to be the decision by the US Federal Reserve to buy corporate debt (bonds) directly from the market as a means of maintaining financial stability as well as stimulating economic recovery and growth. This effectively meant that the government, through the Federal Reserve, became the banker to companies as traditional banks would not, or could not lend. When banks become unable or unwilling to lend, it makes life difficult for those companies that need to borrow, such as by overdraft or issuing securities, for working capital to fund their ongoing operations. Companies cannot issue Letters of Credit or their banks are unwilling to accept them for the purchase of either raw materials or finished goods. Demand drops and when it does, there is an impact on a company’s earnings which eventually flows to the bottom line, affecting profitability. This has a knock-on effect to other companies and industries that either support or depend on the importers and exporters. Take the mining industry for example. Here we have seen many operations either scale back new projects, delay or lower output or defer shipments because of falling demand from the countries who often depend on our raw materials. So, whilst the ‘sub-prime’ mortgage and related issues in 2007 may have been the
So far in 2009, Australian corporate balance sheets were, and continue to be, generally in sound shape and most companies are still reporting profits. Our banking and financial system is robust and well regulated. Even with the large Federal Government deficits that are now forecast for the next few years, government debt will remain low in comparison to our global counterparts. Our Reserve Bank has the capacity to lower interest rates further if need be. In a sign of shifting sentiment, ‘bad’ news is not being met with a wave of selling on the share market. Most importantly though, our natural resources are still seen to add value to the emerging economies in Asia and in other parts of the world where it is often being used to build their transport, communications and public infrastructure. Those economies, whilst not immune from the economic downturn, are well placed to recover strongly as their economic fundamentals of growing populations, low public and private debt and reasonably priced property, are often much stronger than many major economies. Debt levels in emerging economies are modest and they are not suffering from the de-leveraging that continues to impact the rest of the world. We believe the strength of the global economic recovery, when it eventually gets underway, will be of significant advantage to Australian companies. Investors still need to be patient throughout the remainder of 2009 whilst all these internal pressures remain in the market.
To Fix or Not to Fix?
By Adam Barker Lending Adviser and Representative
‌that is the question! In recent months interest rates in Australia have rapidly fallen to historic lows showing us how quickly things can turn in financial markets. But is fixing your interest rate the right thing to do today? In the lead up to the 2008 Federal Budget, everyone was worried about the ‘Inflation Genie’ being let out of the bottle and interest rates were heading towards 10%. One year later, they have crashed back to earth and the government is now spending madly to stimulate the economy. These economic times present some great opportunities, but beware. While it may seem like a smart move to lock in a mortgage interest rate at the moment, the reality is that lenders are still going to make sure that they make a profit. Five year fixed rates are around a full percentage point higher than current variable rates, and many are even higher. They are essentially saying you can lock in your repayments if you
would like some certainty in these times, but you will pay for the privilege. There is no correct answer with regard to fixed versus variable rates. What is right for you will depend entirely on your own situation. If you are on a limited income, or anticipating a reduction in income in the near future due to your own personal circumstances, then fixing may be the best option. While you will pay more for this peace of mind initially, you will be able to plan a budget around this and identify your required outlays. Loans for long term investment would benefit from fixing at this time, as the required repayments will remain stable. At the same time the income received from the underlying investments purchased will likely increase over time, resulting in the investment gradually moving towards neutral and even positive gearing. However, there is a downside as fixed rate loans tend to be less flexible than variable. Depending on your lender you may not be able to make additional repayments, and, if you can, the extra amounts are likely to be limited and you may not be able to redraw these from the loan in the future. If you find you have sufficient income and have more to put into your mortgage, it may be best to leave the
loan as variable. Variable loans frequently have no limit on extra payments, meaning that if you continue to maintain your higher loan payments from the time the interest rates were at their peak, you can save yourself a lot of money. Every additional dollar over the current minimum payment you can pay will reduce the principal and pay the loan down faster. If the loan is large enough, your variable rate could be made lower still by refinancing and seeking a discounted rate. Some lenders are offering variable rates of around 5% depending on the loan amount and purpose. To win from a fixed loan, the Reserve Bank would need to increase the variable rate by over a full percentage point to be in the same range as fixed rates. In addition to this, there is also the risk that the economic conditions will deteriorate and the Reserve Bank of Australia will cut rates. Of course, that assumes lenders pass these cuts on to us! Our Lending Advisers can offer advice on the best loan structures to help you meet your long term goals. We encourage you or your family members to explore the options in the current economic environment. Whether you are seeking your first home loan, or refinancing an existing loan, we can provide the best ongoing advice. Please contact us on (08) 8372 1300 to discuss your options. prescott securities winter 2009 7
FREE RETIREMENT SEMINARS
Pencinl. this i
Major Retirement Seminar Hilton Adelaide 233 Victoria Square Adelaide Wednesday 28 October 2009 2.00pm - 3.30pm or 7.30pm - 9.00pm If you would like to learn more about any of our seminars or reserve your seat, please call 8372 1300 or email seminar@prescottsecurities.com.au
Psst! Thinking of retiring? Against the predictions of many, the Australian economy is showing encouraging signs of robustness.
FREE SEMINAR
Wednesday 28 October 2009 2.00pm - 3.30pm or 7.30pm - 9.00pm For retirees or those wishing to retire soon, it is Hilton Adelaide, 233 Victoria Square, Adelaide vital to keep a close eye on the lie of the land.
Prescott Securities October Major Retirement seminar is a not-to-be-missed opportunity to obtain the best, most up to date insights into your retirement prospects in a recovering market.
HURRY! SEATING LIMITED Call 8372 1300 or email seminar@prescottsecurities.com.au
Essenti ntia a l readi readi n g Buying a home and establishing a mortgage is a big deal for anyone... literally! It is a complex and time consuming process. Prescott Securities Lending Division is available to assist you in navigating these waters safely and provide ongoing advice on avoiding tricks and traps. We have access to many lenders and can advise on the best loan structure to not only help you, but provide for your long term goals in the future.
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Call us now for a copy of our free home buyers guide. Its full of valuable information to help you make the right choices. One more tip... the First Home Owners Grant BOOST expires on the 31st December 2009 and will begin to reduce in September, so now is the time to speak to one of our Lending Advisers in our Adelaide office on (08) 8372 1300.
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Prescott Securities Limited | ABN 12 096 919 603 | ASX Market Participant | Australian Financial Services Licence No. 228894 | www.prescottsecurities.com.au | info@prescottsecurities.com.au Disclaimer: The information contained within this document was compiled by Prescott Securities Limited (PSL) based on materials from other sources and PSL provide no warranty regarding the accuracy or completeness of the information. All opinions, conclusions, forecasts or recommendations are reasonably held at the time of compilation but are subject to change without notice by PSL. PSL assume no obligation to update this document after it has been issued.ËšExcept for any liability which by law cannot be excluded, PSL, its Directors, employees and agents disclaim all liability (whether in negligence or otherwise) for any error, inaccuracy in, or omission from the information contained in this document or any loss or damage suffered by the recipient or any other person directly or indirectly through relying upon the information. This publication is intended to provide background information only and does not purport to make any recommendation upon which you may reasonably rely without taking further advice.ËšThis publication does not take into account any persons investment objectives, financial situation and particular needs. Should you consider the acquisition of a particular financial product as a result of the material contained, you should obtain a copy of and consider the Product Disclosure Statement (where applicable) for that product before making any decision. PSL may receive a fee for advice and/or the implementation of an investment decision. PSL and their representatives may have financial interests in some/any of the product(s) included within this report. Prescott Securities Limited (PSL) is the holder of an Australian Financial Services License No: 228894. PSL is a WHK Group firm. ' Prescott Securities Limited July 2009. All rights reserved.
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