Why tech, telco and mining are attractive
T. Rowe Price's Australian equities team has bought into telecommunications for the first time in five years, and is more bullish than many on commodities.
Glenn Freeman: In this edition of "How We Invest Your Money" I'm speaking to Randal Jenneke from T. Rowe Price who is covering off some of the winners and losers from the earnings season for financial year 2018 and what this means for their portfolio outlook going forward.
Randal, thanks very much for your time today.
Randal Jenneke: My pleasure, Glenn.
Freeman: Now, we've come to the end of the reporting season for the full year 2018. What were some of the sectors that really stand out as being either having outperformed or being slightly disappointing?
Jenneke: I think if you look at the reporting season, we saw a lot of dispersion in results. And really, that was driven, I think, by the earnings environment and also, some confidence that investors had around where they expected future returns and earnings growth to come from. So, if you looked at the month of August, we saw very strong performance from the IT sector, from the telecommunications sector and the healthcare sector. And conversely, we saw pretty subdued performance from the mining sector, from the energy sector and from the banks.
If you think about the total returns of the fiscal 2018 year, the market delivered very solid returns of 15.4%. I think in anyone's language, that's a very good year. And that's really been driven by the fact that earnings in 2018 grew by 8%, better than people had thought probably at the start of the year. And a key driver for that was a combination of commodities being very strong and then also the industrial part of the market also doing better.
One side of the ledger that I think was a little bit disappointing during August was that when you look at into 2019, earnings for 2019 were revised downward slightly. If you, kind of, think about our expectation for 2019, again, I'd focus on the underlying earnings picture and there I do think that given the dispersion we've seen in returns that we'd probably see some of the sectors that lagged a little bit during August, such as the mining sector, do better. And I think, some of the P/E expansion we've seen at the more expensive part of the market also is going to prove a bit of a headwind for those stocks.
In telecommunications, just to call out one sector, the main issue for the month of August was the proposed merger of TPG and Vodafone. And really, the market liked that because we have industry structure improving from four players going to three, Vodafone being very strong in mobile, TPG being very strong in their broadband business.
Freeman: From the perspective of your portfolio at T. Rowe Price, do you have much exposure to that telco sector or to some of those – to the commodity space, for instance?
Jenneke: So, we've been following the telco space very, very closely for the last few years. We haven't owned any stocks within the sector and it's been a very poorly-performing sector. And we were looking for evidence that we were likely to get a combination between TPG and Vodafone. It's very logical. It's a good fit and also does change the dynamics for the overall industry as I mentioned before. We expect that the return environment should be better. So, we actually bought into TPG ahead of the announcement on the view that it was likely to happen and obviously, this will be a much more powerful combination and also, represent higher returns and stronger growth prospects for the combined business going forward. So, that's the first exposure we've held in telecommunications now for five years.
On the commodity front, we've been increasing our position in the mining stocks over the last few months and we took the opportunity in August to do that again. Because what we think the market is missing here is that whilst we've had strong commodity price improvement and earnings growth on the back of that, we think that that's going to continue longer than people think. We've got a very supportive global backdrop for commodities and therefore, for the mining sector. Cost structures are very good. Balance sheets are very healthy. And we tend to like the names that not only have got very good positions on the cost curve, but also very strong balance sheets. So, names like South 32, names like Rio Tinto, for instance.
Freeman: Now, when we spoke at the start of the year, back in January, you were talking then about the banks and how you anticipated that banks would have a better 2018 and 207. But even in terms of financials more broadly, what sort of exposures do you have there, so in the banks, but also in other parts of the Australian financial sector?
Jenneke: So, we do have exposure to the banks, but we are actually still underweight the banks. We have quite a large underweight. We are overweight in the financial sector using the general insurance part of the marketplace. So, two key positions for us are IAG and Suncorp. I guess, when I was thinking about this being a better year for the banks, it was really on the view that lot of, I guess, the concerns that we saw in 2017, some of those would abate in 2018. I guess what's transpired so far is that the Royal Commission has been bigger headwind for the sector than certainly we had envisaged. So, I think, a lot of people in the markets was. And also, the property market has now also started to become a bit of a headwind for the sector as well.
So, while we think that we've probably seen the worst for the banks, we do prefer the general insurers where we see that the pricing outlook continues to be very solid. If you think about what's happening in general insurance globally, Australia is seeing the biggest pricing premiums and pricing increases out of any market. So, we think, that's terrific in terms of what it means for higher returns and earnings growth going forward. And then, you've got the dominance of IAG and Sun as the scaled players. And we think that in that environment they will expand their margins as well.