Retirees, investors should consider rising interest rates, more


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May 17, 2017

DNR Capital is positioning for rising interest rates and an inflationary environment and is currently underweight the four major banks, property and Telstra.
Recent support for bonds suggests the reflation trade might have run its course.
However this is likely to be a short term bounce and bond yields have probably bottomed according to DNR Capital Portfolio Manager, Scott Kelly. “Global growth appears to be accelerating, inflation in the US is picking up and the political environment is changing away from supply side policies and towards fiscal stimulus,” said Kelly.
Kelly said: “We believe bond proxy and defensive exposures will find it difficult to continue their strong outperformance and in some instances are at risk of capital losses, due to stretched valuations.
“Whilst the banks should benefit from higher interest rates, the run in share prices has the sector trading on full valuations. There remain several risks and headwinds, including the new levy the government has introduced, elevated housing prices, credit growth, bad debt normalisation and further capital requirements.
“Despite the recent pull-back and attractive headline dividend yields, we believe there is still some risk of dividend cuts, particularly NAB and WBC and the growth outlook is low-single digit at best,” added Kelly.
“REIT valuations are expensive, with cap rates and bond spreads now at all times lows. The growth outlook is also challenging, in particular for retail, with the recent slowing of moving annual turnover (MAT) growth. In addition, the prospective arrival of Amazon is likely to represent a challenge for retailers, which will have a flow on affect to their landlords.”
Telstra faces a number of long-term structural challenges, including increased competition for its mobile business – which will generate ~50% of cash flows post the NBN roll-out.
“We believe Telstra’s dividend will be closer to 25cps than 30cps, on a five-year view.
“The potential securitisation of NBN cash flows might alleviate short-term pressure on the stock price if the dividend is cut, however we believe the market is also underestimating the long-term need for capex and debt reduction.”
“The DNR Capital Australian Equities Income Portfolio has an objective to provide a reliable, growing and tax-advantaged income stream with potential for capital growth.
This is particularly important for retirees, who are looking to replace salary and wages and match the rising cost of living,” noted Kelly.
“Therefore, we prefer companies with a sustainable, growing and tax-advantaged dividend profile. We want to have a high degree of confidence on what a company’s dividend will be in
3-5 years.”
Alternative quality companies for investors seeking income and in the DNR Capital Australian
Equities Income Portfolio include Aurizon, Caltex and Henderson Group.
“The market reaction to Cyclone Debbie created an opportunity in Aurizon, given the pullback.
There is a negligible valuation impact on the stock as the majority of the earnings are
recovered through the regulated network,” noted Kelly.
“New management has hit the ground running with potential for further positive surprises in
terms of Intermodal divestment, further cost-out and capital management.” Kelly added.
Caltex is also a stock that is underappreciated by the market according to Kelly.
“Whilst the downside from the loss of the Woolworths contract appears to have been fully
priced, upside from recent acquisitions and likely cost-out has largely been ignored. In
addition, there is latent value in the company’s physical assets and the potential for further
capital management,” Kelly said.
An alternative to the major banks is Henderson Group, which has been added to the DNR
Capital Australian Equities Income Portfolio. “The group’s merger with Janus will provide
enhanced diversification, scale and distribution capabilities,” said Kelly.
“In addition, there are a number of potential positive near term catalysts for Henderson,
including additional synergies, a rebound in European inflows and a recovery in performance
fees off historical lows. The stock has an attractive dividend profile and is cheap, trading on a
post-merger and-synergy PE of around 13 times”, Kelly noted.

SOURCE: DNR Capital


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