April 2014

Investment review

Market Review

2

Focus for this month:

Fixed Interest

Valuations in particular high PE segment;

Defensives;

Banks; and

Opportunities.

Fixed Interest

3

• Term deposits have come off as the yield curve has moved down. 6 and 9 month TD’s with the big 4 are down to 2.50%.

• We have been buying shorter maturities with similar yields compared to the new issues which have longer maturities.

• We like WCTPA, CBAPC. • NABHA has does done well because Suncorp has started buying back off market their

perpetual securities

M2012

J A S O N D J2013

F M A M J J A S O N D J2014

F M A M

:NABHA.ASX@AUX

79.36

66

69

72

75

78

Market Review

4

Valuations

Significant contraction in the valuation dispersions between high and low PE stocks.

Recent pullback is healthy but we are still concerned.

However still a growth-constrained world and expect companies that can deliver sustainable double-digit growth will continue to deserve a premium.

Market Review

5

Defensives

Defensive stocks were the first to attract interest post the GFC when investors remained risk averse.

Consequently PE’s on these companies have increased.

While earnings for these companies remain defensive we note a deteriorating returns profile.

Market Review

6

Defensives

One measure to assess if a stock is over or undervalued is to look at the Price-Earnings to Growth (PEG) ratio.

The top left quadrant implies overvaluation with and the bottom right indicating value.

Given these ratios and the fact we prefer to own companies with improving returns profile, we are underweight this segment of the market.

Market Review

7

Banks

Australian banking sector has experienced solid share price growth over a numbers of years.

Despite the impact of the GFC, bank profits have risen steadily driven by improving net interest margins, cost efficiencies and low bad debt charges.

Market Review

8

Banks – will this profit growth continue?

During GFC major banks solidified positions as foreign banks retreated and regional banks were taken over or too undercapitalised.

Banks were also quick to aggressively provision for problem loans.

As a result a significant level of improvement in profitability has come from a decline in bad debt expenses with losses more subdued than expected.

Future profit growth will be more reliant on underlying improvements in revenue and costs.

Likely driven by a small pick-up in credit growth, offset by a slight pick-up in competitive behaviour and a continued focus on extracting efficiencies from IT.

Bad debt environment to remain subdued, level of write backs will slow and the bad debt charge will slowly normalise.

We expect steady mid digit profit growth.

Market Review

9

Banks – Risks?

A potential increase in competitive activity.

Regulatory risk remains a threat – “too big to fail.”

The largest risk to the sector is as always economic conditions in Australia, in particular its exposure to housing/employment.

Market Review

10

Banks – Outlook

Dominant market positions;

Steady profit growth;

Strong capital levels;

Benign asset quality;

Provides a reasonable basis for steady dividend growth, and ultimately steady share price appreciation.

Cautious in the short term regarding the multiples given the bad debts are at a low point in the cycle.

Market Review

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Opportunities

Reluctant to chase high PE stocks despite the recent pullback and we view some defensive stocks as expensive.

We are positioned in stocks we feel have strong earnings growth not fully recognised by the market and will likely re-rate. Key opportunities include:

Recall;

Macquarie Atlas Roads; and

Lend Lease.

Opportunities - Recall

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Thesis

Sustainable growth not priced by the market;

Spin off not well covered;

Under-investment by Brambles;

Recent news-flow – HSBC win, first major acquisition; and

Valuation: PE < 14x with double digit growth, 30% discount to US peer, market under-estimating opportunity.

Opportunities – Macquarie Atlas

13

Thesis

Improving quality not yet recognised by the market;

High quality toll roads in France – only 2 years in 51 with negative growth;

De-gearing and restructuring to release significant cash flow;

Recent news-flow – Pick up in traffic, refinancing debt at cheap rates; and

Valuation: EV/EBITDA 10.5 versus 28.5x for Brisbane motorways.

Opportunities – Lend Lease

14

Thesis

Quality under-rated by the market;

Infrastructure spend and housing spend picking up;

Transparency of earnings improving;

Recent news-flow – Third tower, >$3b road contract wins, Bluewater for sale; and

Valuation: PE 12x versus 15x for market, 1x PEG.

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Disclaimer

SOURCESGoldmanSachsMacquarieMorgan StanleyIRESSBloomberg

DISCLAIMERThis document has been prepared by Dalton Nicol Reid Pty Ltd, AFS Representative - 294844 of DNR AFSL Pty Ltd ABN 39 118 946 400, AFSL 301658. It is general information only and is not intended to be a recommendation to invest in any product or financial service mentioned above. Whilst Dalton Nicol Reid has used its best endeavours to ensure the information within this document is accurate it cannot be relied upon in any way and recipients must make their own enquiries concerning the accuracy of the information within. The general information in this document has been prepared without reference to any recipients objectives, financial situation or needs. Before making any financial investment decisions we recommend recipients obtain legal and taxation advice appropriate to their particular needs. Investment in a Dalton Nicol Reid individually managed account can only be made on completion of all the required documentation.