Lincoln’s Health of the Market report reveals healthier outlook but challenges remain
The Financial Health of Australian listed companies has recorded the first significant improvement since 2004, as companies decreased leverage on balance sheets and increased liquidity in response to the financial crisis.
Independent research house Lincoln Indicators today released its semi-annual Health of the Market (HOTM) report, analysing the Financial Health of all 1,800 plus Australian listed companies. The report revealed the number of financially healthy ‘Strong’ and ‘Satisfactory’ companies increased to 29 per cent (from 25 per cent 6 months earlier) and the number of financially ‘distressed’ companies falling from 16 per cent to 12 per cent.
“The findings of the latest Health of the Market report should interest all sharemarket investors who seek to understand the quality of the companies they invest in to assist with informed portfolio decision-making,” said Lincoln Indicators CEO, Elio D’Amato.
Key findings of Lincoln’s Health of the Market report:
- The overall Financial Health of Australian listed companies has improved for the first time since 2004, but 60 per cent of ASX listed companies still have a Financial Health rating of either ‘Marginal’ or ‘Distressed’.
- Financials, Consumer Discretionary and Industrials are the healthiest sectors. Materials, Energy and Health Care are the least healthy sectors. The Financial, Utilities and Industrial sectors are the most improved.
“The number of companies exhibiting unacceptable results remains at high levels,” Mr D’Amato cautioned. “Many companies still continue to be exposed to high levels of financial risk and Lincoln reiterates the importance of remaining vigilant when investing in the sharemarket.”
“Opportunities nevertheless still exist. Quality companies have indeed benefitted from the financial crisis and our Health of the Market report provides a warning to investors of the importance in conducting thorough and careful review prior to making any investment decision.”
Lincoln forecast 2010 to be a “net positive” for local share investors but identified a number of macro issues that challenge the recent positive market performance:
House prices: The residential property market continues at unsustainable levels when measured on debt to equity, debt to income, debt to disposable income or total mortgages to gross domestic product (GDP) ratios. How long can it last?
Globalisation: Australia’s banks are now more exposed than ever to the whims of foreign money markets. Australia’s relatively high interest rates make Australia ‘hot’ but any exit of the accumulated foreign capital will affect sharemarket performance.
China: Australia’s reliance on the continued boom in China is a cause of concern with the growth rate potentially difficult to sustain in the long term, particularly if global demand doesn’t pick up any time soon.
“Investing in stocks that meet the criteria of Financial Health has never been more important,” Mr D’Amato said. “While we remain optimistic on the broader market’s performance for 2010, the sharemarket’s path will not be a direct one and we are likely to face some volatility going forward.”
“It is easy for your investing decisions to be controlled by the broader market sentiment and the most important time to be vigilant is when everything looks bright. There is no substitute for researching and monitoring the continued Financial Health, economic environment and fundamental performance of the companies behind the stocks.”
Health check: performers, watchers and earners
Lincoln’s Health of the Market report looks back at the ‘star’ performers over the past six months, identifies stocks to watch as market conditions continue to improve, and picks potential winners for income investors:
- Lihir Gold Limited (LGL): Record annual production and profits coupled with historically high and rising gold prices. Newcrest Mining Limited (NCM) takeover offer of $3.87 was rejected by LGL. It has given rise to speculation of a sweetened offer.
- TPG Telecom Limited (TPM): Solid interim results driven by strong broadband subscriber growth. Strong growth prospects with Pipe Networks Limited (PWK) acquisition which took effect on 17 March 2010 strengthening its infrastructure and client base.
- Forge Group Limited (FGE): Strong performance across all divisions and upgraded its earnings guidance due to strong order book. Strategic alliance with Clough Limited (CLO) looks to go ahead and bodes well for the company’s future.
Stocks to watch
- Woolworths Limited (WOW): Financial Health and earnings growth have been consistently strong through the GFC. WOW continues to dominate its sector and growth prospects continue to be attractive particularly its expansion into hardware.
- JB Hi-Fi Limited (JBH): Earnings growth continues to be attractive and JBH continues to lead its sector. Recent CEO resignation may have created a value opportunity.
- Decmil Group Limited (DCG): Has a solid order book following key contract wins and extensions. DCG will benefit from a positive outlook on the resources and energy sectors in Western Australia.
For the income investor:
- Envestra Limited (ENV): Whilst ENV stapled securities do not pay fully franked distributions, they do return a yield of approximately 10.28%. Given the defensive nature of the company’s gas distribution business, it may be particularly attractive to overseas investors who are unable to derive benefit from franking credits.
- David Jones Limited (DJS): Australia’s leading upmarket retailer surprisingly defied weak market expectations during the financial crisis. Besides commanding a solid fully franked dividend yield of 6.36%, the company also has a history of growing both its earnings and dividends.
- Super Cheap Auto Group Limited (SUL): Whilst on face value SUL does not appear to be the most attractive share, distributing a fully franked dividend of just 4.02%, this dividend payout has been increasing at a rapid pace, paying 20 cents in the last 12 months compared to 14 cents in the previous corresponding period. A growing business operating within the discount end of the market provides the earnings underlying these dividends.
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For a full copy of the report visit: www.lincolnindicators.com.au
Appendix - Definition of ratings
The Lincoln methodology is based on accounting ratios and characterises the financial standing of a company using a single figure on a scale of risk from 0.01 to 1, with the company’s level of risk increasing as the measure moves up the scale towards 1.
Strong (0.01 – 0.10) and Satisfactory (0.11 – 0.30)
• These companies have a financial standing that is interpreted as having sufficient cashflow and balance sheets robust enough to finance growth, or withstand significant business shocks or prolonged economic downturns.
Early Warning (0.31 – 0.50)
• These companies need to address key issues in regard to their business operations in order to achieve a healthy financial position and if not addressed may pose financial difficulty in the future.
Marginal (0.51 – 0.80)
• These companies have unsatisfactory risk above desired levels and it is preferable that management focus on getting the company in better shape. May have difficulties funding future growth or withstanding significant shocks or prolonged economic downturns.
Distress (0.81 – 1.00)
• These companies exhibit similar financial characteristics of failing companies. It would be difficult to recover should there be any negative developments. Recovery will generally be slow.
Lincoln Indicators Pty Ltd ACN 006 715 573 (Lincoln) AFSL 237740.
This information is current as at 4 May 2010.
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Indices data source: ASX-listed company data is copyright and provided by Morningstar Australasia Pty Ltd (‘Morningstar’) © 2009 ABN: 95 090 665 544, AFSL: 240892 (a subsidiary of Morningstar, Inc). All rights reserved. The data and content contained herein are not guaranteed to be accurate, complete or timely. Neither Morningstar, nor its affiliates nor their content providers will have any liability for use or distribution of any of this information. To the extent that any of this information constitutes advice, it is general advice that has been prepared by Morningstar without reference to your objectives, financial situation or needs. Before acting, you should consider the appropriateness of the advice and obtain financial, legal and taxation advice before making any financial investment decision. Investors should obtain the relevant product disclosure statement and consider it before making any decision to invest. Please refer to our Financial Services Guide (FSG) for more information www.morningstar.com.au/fsg.asp. Some of the material provided is published under licence from ASX Operations Pty Limited ACN 004 523 782 (‘ASXO’). Consensus forecast data is copyright Thomson Financial.
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Lincoln is Australia’s leading fundamental analysis research house and fund manager offering intelligent sharemarket solutions for the conscientious investor. Founded in 1984 by Melbourne University academic and Australian Olympian Dr Merv Lincoln, the company’s specialist knowledge is based on Dr Lincoln’s PhD thesis which analysed and derived models to assess the financial health of businesses. The resulting Lincoln methodology combines company health assessment, key accounting ratios and other quantitative and qualitative measures to identify well-managed companies with strong growth prospects. Stock Doctor, the software-based incarnation of Dr Lincoln’s approach, was introduced to Australian investors in 1996 and has proven itself over more than decade of sharemarket conditions.
In 2003 Lincoln established its Managed Investments business to allow investors to experience the company’s distinct investment methodology through a professionally managed portfolio. In 2007 the Lincoln Australian Share Fund was opened to retail investors, with the Fund offering two classes of units: wholesale and retail. The launch of the Lincoln Retail Australian Share Fund has since broadened the reach of Lincoln’s methodology even further. Today, the Fund has grown organically to around A$119 million in funds under management as at 31 March 2010.
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