Resources Market Cap Weight S&P/ASX300 Australian Equity … · 2016-01-11 · PE Dispersion - 75th...

Please refer to page 25 for important disclosures and analyst certification, or on our website

www.macquarie.com/research/disclosures.

AUSTRALIA

Valuation dispersion continues...

Resources... becoming less relevant

Resources...back to the beginning

Source: Datastream, MSCI, Macquarie Research, January 2016

11 January 2016 Macquarie Securities (Australia) Limited

Australian Equity Strategy Courage Under Fire Outlook 2016

Australia is hostage to a fragile global backdrop. Sentiment is grim and

momentum driven markets make it hard to fight a bearish consensus.

However, we don’t think the world is collapsing and we believe Australian

fundamentals will get better and not worse over the coming 12 months.

Despite an abundance of risks (Chinese growth and currency, US

interest rates and credit markets), we think the market can finish 2016

meaningfully higher. We think consensus is too pessimistic on Australia’s 12

month return prospects and expect a total return of ~17% through year end as

economic growth troughs and business confidence improves; as corporates

continue to support weak organic revenue growth with aggressive cost

reductions and selected financial re-engineering; as the A$ enters its final leg

lower; as banks manage the decline in collateral values (est. 7.5%) and a

deteriorating bad debt some cycle; and as the valuation skew broadens

performance into the recent growth sensitive and operational laggards.

The time to have turned negative was when the ASX200 was 5900 not

5000 (see “Reality Bites” – August 2015). This was when transparency

around growth was lower; when the terms of trade were starting rather than

substantially through their downward adjustment; when the AUD was

significantly higher; when commodity price expectations were stubbornly high

and the trajectory for recovery optimistically steep; when resources were 20%

of the market not 10%; and when the first Fed rate hike was something we

feared rather than looked at in the rear view mirror. This is not where we are.

The market would have a greater cushion for risk if valuations were “cheap”

rather than just “fair”. But, earnings fundamentals should improve ex

resources, investible cash flow is growing, ROE’s are rising, leverage remains

below the average and structural forces will keep bond yields low. The outlook

is about incremental improvement rather than incremental deterioration.

Credit market dislocations will bring balance sheets more into focus

through 2016. However, the Income Statement will remain “king” outside of

the obvious stress areas (commodities and commodity related) if recovery

eventuates. Earnings hold the key for stock & sector rotation.

Key thematics are: 1) the anti global growth (correlated) trades – inbound

tourism, food security, packaging & fleet management and outdoor media; 2)

sustainable dividend yield; and 3) Growth, but margin expanders over

revenue growers. We avoid stocks with high leverage, weak/deteriorating

cash flow and shorter dated debt maturity profiles but we are not seeking

companies that, strictly speaking, have the strongest balance sheets given

our belief that credit/funding market dislocations will remain isolated and

earnings recover further.

We stay overweight banks versus resources, raise our domestic cyclical

exposure vis-a-vis global A$ beneficiaries, trim our high multiple growth

exposure back even further while remaining in selective high quality

defendable dividend yielders. Growth stocks will not de-rate without an

earnings driven disappointment but relative outperformance will moderate

further given stretched valuations. Our top picks for 2016 are: LLC, ORA,

ECX, IPL, BBN & QAN.

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Jan-88 Jan-91 Jan-94 Jan-97 Jan-00 Jan-03 Jan-06 Jan-09 Jan-12 Jan-15

PE Dispersion - 75th less 25th Percentile

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1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015

Resources Market Cap Weight S&P/ASX300

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Earnings Interger - ASX300 Industrials vs. Resources

Resources

Industrials

Base = 100 as at Jan-88

http://www.macquarie.com/research/disclosures

Macquarie Wealth Management Australian Equity Strategy

11 January 2016 2

Global over Domestic factors for now....

Growth remains scarce and sentiment around a global recovery fragile. This will keep volatility

elevated and the domestic market highly correlated with oscillations in global sentiment. Further

out, we think domestic equity market conditions are set to improve and we think the market will

end 2016 appreciably above the current level in the absence of a global growth scare.

Fig 1 Australia has been trading like an Emerging Market

Source: Datastream, Macquarie Research, January 2016

At this stage, we are not confident domestic drivers are strong enough to outweigh a combination

of exogenously driven concerns – growth, currencies depreciations, commodity prices and

deteriorating credit conditions. Patience will be a virtue through 1H16 as we are forced to endure a

continuation of trends which are already quite stale and stretched - momentum over value, small

caps over large, defensive over cyclical and offshore over onshore earners.

However, assuming the global backdrop stabilizes, the key to taking on more risk within Australia

is greater transparency and confidence on the turning point in the domestic growth cycle – the

labour market, the A$, fiscal policy, the domestic credit cycle and China are the five key

macroeconomic indicators we are monitoring for conviction in this. We think an inflection point will

come before the end of 1H.

A positive view on Australian equities (in A$ terms) does not require a better than expected global

growth outcome and a worse than expected global growth outcome will bring the market’s

defensive characteristics back into play (in US$ terms). We assume global growth remains sub-

par (disappointing), interest rates remain low, credit market dislocations remain relatively isolated

(no systemic financial implications), the US$ continues its uptrend and that further competitive

devaluations are coming. This is not great but in light of the adjustment already underway across

the domestic economy and the changing composition of the equity market (commodities stocks

are less than 10% of the market cap), this is not bad.

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MSCI Australia relative to MSCI World and MSCI EM

Australia vs World

Australia vs EM


11 January 2016 3

Consensus is overly bearish on the Australian outlook

Near term the path of least resistance remains down (although we have not altered our view that

the market will near term remain range bound between 4950 and 5300 – see “The Pursuit of

Happyness” – October 2015, we think consensus is overly pessimistic on 12 month return

prospects). We expect a total return of ~18% through year end 2016 as economic growth troughs

and business confidence improves, as corporates continue to support weak organic revenue

growth with aggressive cost reductions and some financial re-engineering, as the A$ enters its

final leg lower underpinning double digit EPS growth, as banks manage the decline in collateral

values and a deteriorating bad debt cycle with moderate pricing offsets and as the valuation skew

broadens performance into the recent growth sensitive and operational laggards.

Fig 2 Resources are a shrinking part of the overall market capitalization


From a macro perspective, trends and structural shifts within the Australian economy mean that

measures like GDP growth are likely to misrepresent underlying demand conditions within the

economy through 2016. The surge in resource export volumes, and decline in capital equipment

imports, will support GDP growth. But domestic demand is set to remain much weaker. This

reflects a divergence between investment (contracting as the mining capex curtailment continues),

residential construction activity (peaking, and declining in 2H), and consumer demand (moderate

growth). The contribution from public demand should remain muted, but remains a wild card in an

election year. Whilst we expect house prices will contract modestly through 2016, elevated

household wealth (supported in part by equity market gains) and solid employment growth should

see consumer demand remain elevated. The rotation of activity back onshore (tourism, education,

services), thanks to the economy’s continued response to a lower A$, will also support spending.

This is not a view that the expensive stocks get more expensive (at 6 PE points the differential

between the average PE of the 25th and 75th percentile across the ASX200 is already at extreme

levels). It is a view that we begin to see the conditions develop that drive a more normalized return

and valuation distribution as concerns that hindered the market through 2015 begin to moderate. It

is not solely reliant on a Materials/Energy sector rebound but other laggards (such as Financials,

Telco’s and Staples) begin to contribute more positively to market returns.

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1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015

S&P/ASX300 sector weights

Resources Industrials ex Banks Banks


11 January 2016 4

Our view does require a change in the “status quo” and this is hard to envisage at the current time

given market direction. It is hard to get bullish by assuming the same things that have worked for

the past few years continue to work in the absence of a sharp spike in risk aversion and/or a broad

based revenue shock. The alternative - a moderate return year for Australian equities - is an

assumption that nothing changes. In other words, the global macro backdrop remains constant

(low growth, low inflation), style and size leadership continues (momentum over value and small

caps over large caps) and that portfolio thematics repeat for yet another year (offshore earners,

growth certainty and yield dominate stock selection). We cannot dismiss this but the conditions

that will keep consensus trades as consensus trades are become harder to justify if our belief that

earnings fundamentals are solid, ROE’s will show further improvement (margin over asset turn

driven) and low bond yields will continue to keep the yield trade bubbling along (see “Stand by me:

Dividend Yield – December 2015).

Fig 3 Growth stocks continue to get more expensive


Australian market fundamentals will get better

In our view, the time to have been negative was when the ASX200 was closer to 6000 than 4900

(see “Reality Bites” – August 2015); when transparency around the domestic growth backdrop

was at its lowest; when the terms of trade were starting rather than substantially through their

downward adjustment; when the AUD was significantly higher and calls for sub US$0.70 were

outliers rather than consensus; when commodity price expectations remained stubbornly high and

the trajectory for recovery optimistically steep; when the first pages of every weekend newspapers

was an advertisement on why house prices would keep rising; when resources were 20% of the

market rather than just 10%; and when the first Fed rate hike was something we feared rather

than looked at in the rear view mirror. This is not where we are now.

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Jan-88 Jan-90 Jan-92 Jan-94 Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12 Jan-14

12 Month Fwd PEs for Industrials (25th percentile & 75th percentile vs median)

25pct 75pct

75 percentile relCurrent rel = 3.52x

Rel Low = 1.00x (Dec-89)Rel High = 7.7x (Aug-00)

Average = 2.89x

25 percentile relCurrent = -2.09x

Rel Low = -3.5x (Dec-00)Rel High = -0.85x (Jul-90)

Average = -2.02x


11 January 2016 5

Fig 4 2016 EPS expectations sharply lower Fig 5 Another negative EPS year for resources

Source: Macquarie Research, January 2016 Source: Macquarie Research, January 2016

Outside of global risks, we are most concerned that the market is not cheap. At 15x forward

earnings it remains “fairly” valued rather than “good” value. On the positive side, key risks are no

longer being ignored and being bearish is now a strongly held consensus view. This does not

imply that risks are priced correctly or that the market is capable of absorbing each successfully.

However it does alter the medium term risk-reward skew such that any sign growth and/or

business sentiment is improving in combination with no significant deterioration in earnings

expectations and a stable to rising RoE should be enough to drive better performance from the

domestic value/cyclical stocks and squeeze multiples higher regardless of whether the starting

point is not particularly appealing.

Fig 6 2016 ASX200 Return Expectations

Source: IRESS, Macquarie Research, January 2016

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Earnings revisions FY1 (x)

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Current forw ard PE (x) 15.5

12 Month Forw ard PE (x) 16.3

12 Month Forw ard Earnings Interger 361

Dividend Yield (%) 4.5%

31 Dec 2015 year end level (ASX200) 5249

8 Jan 2016 current level (ASX200) 4959

Implied Index Level (AX200) 5900

2016 Capital Return 12%

2016 Total Return 17%


11 January 2016 6

Fig 7 MSCI Regional Valuation Metrics

Source: MSCI, Macquarie Research, January 2016

MSCI Indices PER P/B EPS gr ROE DY PER P/B ROE DY PER P/B PER P/B

MSCI AC Asia ex JP 11.8 1.3 6.2 11.0% 2.9% 12.0 1.6 13.2% 2.9% 11.5 1.5 3% -13%

ASXJ Consumer Discretionary 12.2 1.5 12.6 12.4% 2.2% 11.1 1.8 15.9% 2.4% 11.0 1.8 11% -16%

ASXJ Consumer Staples 21.2 2.7 11.7 12.9% 2.0% 16.0 2.6 15.5% 2.4% 18.7 2.7 13% 1%

ASXJ Energy 10.7 0.8 11.0 7.6% 3.4% 9.8 1.7 15.4% 3.2% 10.1 1.4 6% -41%

ASXJ Financials 9.0 0.9 4.1 10.5% 3.8% 12.0 1.4 11.5% 3.2% 10.4 1.2 -14% -23%

ASXJ Health Care 23.4 3.8 23.7 16.2% 0.9% 18.5 3.2 15.8% 1.1% 21.3 3.2 9% 18%

ASXJ Industrials 12.5 1.1 6.2 9.0% 2.5% 13.1 1.4 10.8% 2.5% 12.6 1.3 -1% -13%

ASXJ Information Technology 14.3 2.0 8.2 14.1% 2.1% 13.1 2.0 15.9% 2.2% 11.9 1.9 20% 6%

ASXJ Materials 13.2 1.0 21.2 7.4% 3.0% 10.2 1.4 13.3% 3.2% 11.6 1.3 14% -25%

ASXJ Utilities 10.8 1.2 -15.8 11.2% 3.6% 12.6 1.4 10.8% 3.3% 13.4 1.4 -19% -15%

ASXJ Telecommunication Services 14.4 1.7 4.9 12.1% 4.0% 13.0 2.0 15.3% 4.1% 13.6 1.9 6% -8%

MSCI China 10.7 1.3 8.1 12.5% 2.7% 11.5 1.8 15.1% 3.0% 9.9 1.5 8% -10%

MSCI Hong Kong 14.1 1.1 8.0 7.6% 3.3% 15.4 1.4 8.9% 3.2% 14.8 1.3 -5% -17%

MSCI India 16.8 2.7 16.7 15.8% 1.8% 14.4 2.6 16.7% 1.5% 15.0 2.4 12% 12%

MSCI Indonesia 14.4 2.4 10.0 16.8% 2.7% 11.2 2.9 22.5% 3.2% 13.6 3.0 6% -19%

MSCI Korea 10.3 0.9 0.6 9.1% 1.9% 9.3 1.3 12.7% 1.7% 9.2 1.1 12% -17%

MSCI Malaysia 15.0 1.6 7.3 10.6% 3.3% 14.3 1.9 13.2% 3.6% 14.7 1.9 2% -17%

MSCI Philippines 17.5 2.4 11.5 13.7% 2.0% 14.9 2.2 14.7% 2.7% 16.7 2.6 4% -7%

MSCI Singapore 11.7 1.1 5.5 9.1% 4.4% 14.1 1.5 11.1% 3.7% 13.3 1.4 -12% -25%

MSCI Taiwan 11.7 1.4 2.3 12.4% 4.4% 14.0 1.7 13.2% 3.9% 13.3 1.7 -12% -15%

MSCI Thailand 11.7 1.5 11.1 12.9% 3.9% 10.8 1.8 16.5% 3.9% 11.7 1.9 0% -19%

MSCI World (Dev) 15.8 2.0 7.5 12.7% 2.7% 14.5 1.9 13.6% 2.7% 13.4 1.7 18% 14%

MSCI AC World (All) 15.0 1.8 10.3 12.1% 2.8% 14.1 1.9 13.7% 2.9% 13.0 1.7 15% 6%

MSCI Japan 14.0 1.2 10.5 8.8% 2.1% 16.9 1.3 8.5% 1.7% 13.7 1.1 2% 11%

MSCI USA 16.8 2.6 7.8 15.3% 2.2% 15.1 2.2 15.5% 2.1% 14.1 2.2 19% 20%

MSCI Australia 15.0 1.7 1.3 11.0% 5.3% 13.9 2.0 14.6% 4.7% 13.2 1.8 14% -7%

AU Consumer Discretionary 19.2 2.5 9.1 13.3% 3.7% 17.9 1.8 11.5% 4.0% 14.8 1.6 30% 58%

AU Consumer Staples 17.3 2.1 -1.9 11.9% 4.9% 16.7 2.6 15.2% 4.5% 15.9 2.3 9% -10%

AU Energy 17.0 0.9 -6.7 5.5% 3.6% 16.6 2.1 11.2% 3.2% 17.1 1.5 0% -38%

AU Financials 12.9 1.6 4.8 12.0% 5.8% 12.8 1.7 13.3% 5.8% 12.3 1.6 5% -1%

AU Health Care 23.2 6.1 9.8 26.4% 2.2% 21.1 4.0 21.0% 2.5% 19.0 4.7 22% 31%

AU Industrials 24.2 3.5 9.5 14.6% 4.1% 18.6 2.1 11.6% 4.4% 18.6 2.1 30% 71%

AU Information Technology 14.5 3.5 -1.0 23.9% 3.2% 17.8 4.1 17.9% 2.6% 15.5 3.9 -6% -12%

AU Materials 16.7 1.1 -19.0 6.8% 6.7% 12.6 2.4 19.6% 2.9% 12.1 1.9 38% -41%

AU Utilities 21.4 1.7 9.0 7.7% 5.3% 15.7 1.4 8.2% 4.7% 15.7 1.3 37% 30%

AU Telecommunication Services 15.4 4.5 5.9 29.5% 5.4% 13.8 4.1 30.1% 6.8% 13.6 4.1 13% 11%

12 Month forward estimates LT Average (12M forward ests) Current vs post-2010 avgAvg since 2010


11 January 2016 7

1. At any price?...Valuations not a constraint in 2016

We have softened our stance on multiples being a constraint to upside. Our view was that the

market needed to trade cheaply (at least 1 standard deviation below the long term average of 14x

for the Industrial universe) in order to reset for a sustainable cyclical upswing. We are now more

comfortable with an above average multiple for a number of reasons.

Earnings are set to improve and we have past the maximum point of pessimism for

discounting domestic cyclical weakness. We think mark to market risk for the commodity

related sectors remains meaningful but this is more isolated sectoral risk unless driven by a

broader global growth slowdown which is not our central assumption.

Fig 8 Margins becoming more important for earnings growth


Fig 9 Not cheap but not expensive any longer


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Industrials Sector

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Actual Forecast

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Australian Market PER - All Companies


11 January 2016 8

While the cost of capital is set to rise further (we estimate 50 basis points over the coming 12

months to 6.3% - still 350 basis points lower than post GFC), we think its impact will be

relatively subdued across the cyclical and value end of the market which is trading on

earnings rather than valuation risk. Those most susceptible to a rising cost of capital – the

yield sensitives – are more likely to hold multiples into an improving earnings backdrop rather

than see significant contraction. Similarly, the majority of high multiple stocks are growth

rather than rate sensitive (excluding the yield + growth component of the market like

infrastructure). We think these stocks are more vulnerable to stock specific disappointment

than a rising cost of capital.

We think the yield argument for the market remains supportive. At a 4% yield, we would need

to see the ASX200 rise ~12% in order to bring the dividend yield back in line with the long

term average. We have previously written about the risk to dividend sustainability (see “Stand

by me: Dividend Yield” – December 2015) and the need to raise return on capital over return

of capital (see “Face Off” – August 2015). Our concerns around unsustainable payout ratios

and multiple expansion potential for yield stocks have not changed.

However, with bond yields likely to remain low (~3.0% for the 10 year), the yield spread

extremely skewed in favour of equities and volatility higher than in recent years, the hunt for

sustainable and high quality yield supports a significant share of the capitalization of the

market (approximately 53%).

Stronger growth and not higher yields pose the biggest threat to relative performance and re-

rating potential of Australian yield stocks. A rotation away from yield needs confirmation of

stronger growth and not simply an exogenously driven rise in the discount rate. We are

concerned that the payout ratio has reached levels that are unsustainable if they continue to

rise in line with the prior 4 years. However, provided 2015 marks the growth trough, we are

confident that 4-5% distribution growth is defendable despite valuation multiples sitting at

around average levels.

Fig 10 Dividends are taking an ever rising proportion of profits

Fig 11 ...with capex the largest causality as its ratio to profits falls

Source: Factset, Macquarie Research, January 2016 Source: Factset, Macquarie Research, January 2016

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A$m Aggregate Profit vs. Capex(ASX100)

Aggregate profits

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11 January 2016 9

Fig 12 Payout ratio for the ASX100 reaches all time high...

Fig 13 A flat payout ratio equates into a 10% decline in dividends paid...


2. Income Statement is King but Balance Sheet is becoming a pretty Queen...

A rise in the cost of credit, tightening lending standards and a collapse in commodity prices that

has driven a significant decline in cash flows will increasingly bring balance sheet risk back into

focus for the entire market through 2016. However, we do not expect the balance sheet to

become more important than the income statement except on an isolated basis through

2016.

We think the impact of tightening credit markets will be a function of four factors:

1) The persistence of rising credit costs;

2) How it relates to the funding profile (maturity schedule) of existing liabilities;

3) Where commodity prices go; and

4) How corporate fundamentals (particularly cash flows and earnings) are tracking.

Outside of the commodity related areas, corporate fundamentals remain strong (leverage is

moderate, interest cover is exceptionally high, cash flows are growing and the maturity profile for

non financials is not aggressive). A rising cost / tightening availability of credit has the potential to

further impact capital spending for the broader economy but we think the direction of commodity

prices rather than developments in funding markets will be more important in determining how this

risk unfolds.

If commodity prices fall further than the need to access capital increases. If the cost of credit rises

but commodity prices don’t fall, than this becomes an issue of whether firms currently have

sufficient funding or can alter capital management plans. There is a potential for a “vicious” circle

to develop which will ultimately have significant flow-on implications for capital spending across

the economy but this remains a risk rather than a central case scenario and the trend of lower

commodity related CAPEX is already well progressed.

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2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Forecast Payout Ratio at Year End(Market Weighted)

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ASX100 Industrials

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2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

A$mAggregate profit vs. dividends

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Dividends (flat payout)


11 January 2016 10

Our strategy is to stay away from stocks with high leverage, weak/deteriorating cash flow

and shorter dated debt maturity profiles but we are NOT seeking companies that, strictly

speaking, have the strongest balance sheets. In other words, we avoid weak balance sheets

rather than seek out strong balance sheets as an investment criteria – all things equal for a

number of reasons:

Stress points should remain sectorally contained with relatively minor spill over impacts to non

resource sectors. We agree with our Asian strategist Viktor Shvets (see “Rights, Wrongs &

Returns” – November 2015) that unless the velocity of money recovers and/or the Fed

embarks on additional QE, global liquidity will continue to erode and that the US$ is likely to

appreciate further. However, while we are factoring in a rise in aggregate cost of credit, we are

less worried about spill over impacts from a deterioration in global credit markets at this stage.

Australia is unlikely to have an endogenously driven credit event. It will likely require an

endogenous shock that has contagion impacts. We are worried about US corporate

releveraging (primarily via buy-backs), stress points in commodity sectors (as evidenced by

the spike in HY spreads) and the potential for earnings deterioration to erode broad credit

conditions. However, historically spreads have contracted as the Fed has raised rates on

stronger growth. Similarly, a stronger growth backdrop in combination with a moderate

inflationary backdrop is not usually associated with a broad based increase in defaults

(rather the reverse).

Fig 14 Cash flows growing strongly supported by further margin expansion

Source: IRESS, Macquarie Research, January 2016

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Industrials - Growth in operating cash flows

EBITDA Interest Paid Tax Paid Chg in Inventories Chg in Trade Debtors Chg in Trade Creditors Maintenance Capex Dilution Growth in OpCFPS

Actual Expected

Sector Analysis


11 January 2016 11

Fig 15 Swap spreads have been rising for 2 years Fig 16 10 yr spreads back to pre GFC highs

Source: Bloomberg, Macquarie Research, January 2016 Source: Bloomberg, Macquarie Research, January 2016

Corporate Australia is not heavily geared, maintains strong cash flows and elevated

interest cover. We think corporate Australia is well placed to weather a moderate rise in

borrowing costs. Leverage has remained well behaved post GFC with 2016 forecast to rise

marginally year on year to 47% but still remain below the long term average. The coverage

ratio has benefited significantly from a decline in borrowing costs and a relatively flat debt

burden to now sit at a record high 7x. Encouragingly free cash to invest is also expected to

remain strong through 2016 despite another year of strong dividend growth and despite an

exceptionally low cost of debt. To date, firms have not used debt funding to finance growth

and/or capital management unlike their US counterparts. Given the spread between the

cost of debt (4.1%) and the cost of equity (7.5%), we think the potential for EPS

accretive buy backs remains an attractive opportunity for the market and for

outperformance by stocks undertaking buybacks particularly given the recent mauling in share

prices.

Fig 17 Low cost of debt gives latitude for accretive capital management


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1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

Buybacks Dividends Equity Raisings

Capital Management ('000)


11 January 2016 12

As expected, stress points remain within the resources space with interest cover declining to

4x (the lowest level in 12 years) despite relatively flat leverage. Of the majors, we think BHP

and RIO will sacrifice the dividend and/or implement DRP’s to sustain them before requiring

additional capital raisings in the absence of a more dramatic and sustained decline in

commodity prices (although perversely we think cutting the dividend might be a strong

capitulation sign for the stocks). However, both BHP and RIO will require additional debt

facilities over the next few years, while S32’s debt free balance sheet is likely to become more

of an asset if commodity prices remain weak.

Stocks with elevated levels of gearing, FMG, WHC and NCM, are likely to see increased focus

on cash flow break even points. Higher cost mid cap producers are also under pressure and

we note that PAN, MCR and AWC are all expected to run short of cash if loss making

operations are not put on hold quickly enough.

Across oil & gas, ORG and STO have recently raised capital (heavily discounted) which we

expect will see them through 2016; however if oil prices remain lower for longer there will be

more pressing need for fresh equity or asset sales in 2017 for STO. WPL and OSH are

unlikely to raise money unless it relates to sanctioning of growth projects or acquisitions (both

are possible).

Fig 18 Large cap energy stocks are not breakeven in 2016 ...

Source: Macquarie Research, Kirit Hira – Australian Energy: Prolonged Pain, January 2016

Fig 19 Leverage ratio steady, Interest cover rising Fig 20 Resources ratios deteriorating quickly


$0

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$20

$30

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OpCF breakeven FCF break-even FCF (post dividend/debt) break-even

WPL STO OSH

2016 Forward Curve

Break-even oil price (U$/bbl)

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FY00A FY01A FY02A FY03A FY04A FY05A FY06A FY07A FY08A FY09A FY10A FY11A FY12A FY13A FY14A FY15A FY16E

Net Debt/Equity vs Interest cover - Market ex resources

Net Debt/Equity (LHS)

Interest Cover (RHS)

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11 January 2016 13

Fig 21 Industrials steady as they go Fig 22 Rising interest cover protection for LPT’s


Manageable debt maturity profile? In aggregate, the bond maturity profile of Australia

corporates (onshore and offshore) is not particularly large over the coming 12 and 24 months

at A$107bn and A$97bn respectively. With the financial sector comprising nearly 90% of

bonds up for redemption and the cost of debt at abnormally low levels, we don’t see

meaningful risk of dislocation in the bond market. We are more concerned around syndicated

loans where there is less transparency but where exposure for the financial sector is

significantly bigger. We will be publishing a more in-depth piece on this topic in coming weeks.

Fig 23 Bond Maturity Schedule for Australian Companies

AUD equivalent (billions)

Financial Corporate Total

2016 92 15 107

2017 83 14 97

175 29 204

Source: Bloomberg, Macquarie Research, December 2015

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%


11 January 2016 14

Fig 24 Biggest increase in leverage

Source: Bloomberg, Macquarie Research, December 2015

Stock Company

2014 2015 2016 Δ 2011-16 2014 2015 2016 Δ 2011-16

SYD Sydney Airport 6.0 8.1 10.2 557.2 667.2 788.0

growth % 5% 36% 26% 256% 0% 20% 18% 86%

PDZ Prairie Mining 1.0 1.1 3.6 -1.0 -1.9 -1.1

growth % -1% 6% 224% 224% 48% 97% -45% n.m

RKN Reckon 1.9 3.3 3.3 30.8 34.2 39.0

growth % -3% 69% 1% 126% 19% 11% 14% 48%

JHX James Hardie -8.5 -8.6 -10.9 205.4 183.8 267.1

growth % -114% 0% 27% 123% 49% -10% 45% 157%

SBM St Barbara 4.7 4.2 2.7 -32.9 67.3 218.3

growth % 157% -9% -37% 112% -1362% -305% 224% 221%

CSL CSL 2.0 2.3 2.8 1358.2 1521.7 1929.6

growth % 0% 17% 19% 99% 17% 12% 27% 123%

ACX Aconex -1.8 -3.4 -3.6 1.2

growth % 93% 93% -133% n.m

BSE Base Resources 2.3 2.5 2.0 -12.7 -32.6 48.7

growth % 19% 9% -20% 92% 173% 157% -250% -2247%

DLS Drillsearch 2.0 1.8 2.0 215.2 58.2 78.1

growth % 21% -11% 9% 86% 1937% -73% 34% 4123%

TGS Tiger Resources 2.0 2.5 2.3 27.2 6.1 30.8

growth % 34% 29% -7% 84% -37% -78% 409% n.m

PRG Prog. Mainten. 1.8 1.8 3.5 48.3 46.8 91.7

growth % -5% 0% 94% 71% -27% -3% 96% 519%

AMC Amcor 4.3 5.4 4.8 1003.3 1063.8 1186.8

growth % 27% 26% -12% 63% 22% 6% 12% 128%

DRM Doray Minerals 1.5 1.4 1.7 22.1 20.5 28.7

growth % -29% -9% 21% 60% 620% -7% 40% -1299%

COH Cochlear 2.4 2.4 2.3 103.2 179.6 212.8

growth % 12% 2% -4% 59% 82% 74% 18% 16%

BDR Beadell Res. 1.6 1.8 1.9 79.3 7.4 54.4

growth % -33% 15% 8% 59% 517% -91% 637% 342%

CAR Carsales 2.2 2.1 1.9 98.0 97.1 117.5

growth % 35% -1% -9% 53% 13% -1% 21% 108%

DMP Domino's 2.2 2.1 2.3 70.8 80.2 101.3

growth % 17% -4% 11% 50% 259% 13% 26% 279%

QAN Qantas 6.0 5.1 5.1 -104.2 1342.3 2025.1

growth % 78% -16% 0% 50% -151% -1388% 51% 214%

MTU M2 Group 2.6 3.6 3.2 92.3 120.9 139.7

growth % -14% 37% -10% 50% 43% 31% 16% 248%

BRS Broadspectrum 3.1 3.1 3.0 -9.7 182.2 136.8

growth % -3% 1% -3% 50% -106% -1978% -25% 132%

Leverage Free Cash Flow


11 January 2016 15

3. Portfolio Thematics

We have 3 major themes that we expect will provide alpha for investors through 2016 within the

context of our global and domestic assumptions. These are discussed below:

Anti global growth (correlated) trades – we continue to look for structural thematics that will

perform well despite the direction of global growth. These include:

I. Inbound tourism;

II. Food security;

III. Outdoor media.

I. Tourism:

a) Inbound Services China

Australian tourism, a sector critical to supporting economic growth as mining activity diminishes, is

benefitting from a surging number of Chinese visitors, who are staying longer and spending more

per head than other international visitors. China is the leading source of Australia’s inbound

tourism, contributing 22% of total visitors for the year ending Sep-15, and representing 21% of

Australia’s total value of inbound expenditure (up 43% on pcp) with a record ~$7.7bn spend for the

year (up 32% on pc). Improved living standards, rising incomes, increased accessibility to

Australia via more accommodative visas, and development in aviation connections, have allowed

China become Australia’s primary importer of tourism services

A high influx of tourists is also seen from other Asian countries including Malaysia (+16.9%), India

(+17.1%) and Singapore (+9.4%). Growing demand from Asia Pacific (exc. Japan) has reweighted

total inbound expenditure by countries over the past decade. For 2014, Asia Pacific (exc. Japan)

accounted for ~38.9% of total inbounded expenditure (compared to 27.5% a year ago).

Frequently classed as one of the most desired tourist destinations in the world, and currently

ranked 8th on the Country Brand index 2015-15, we expect to see Asian demand for travel to

Australia increase over the medium term, particularly as the affordability of visiting Australia

becomes more attractive and spending power of tourists increases once in Australia.

Fig 25 Surging number of Chinese visitors... Fig 26 ...spending more than other international visitors

Source: Tourism Research Australia, 2015

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11 January 2016 16

b) Australian “staycations” – here to stay

Macroeconomic conditions for domestic travel are now more favourable than they have been in

recent years, with a weaker AUD encouraging more Australians to holiday at home. Domestic

visitor nights were up 6% YoY in FY15, reaching 313.4m nights, and domestic travel expenditure,

which contributes ~70% of total expenditure attributed to Australia’s tourism industry, was up 3.2%

on pcp, at $73.7bn.

Since Jan-14 outbound growth has averaged 3.8%, well below the long term average of ~7.4%.

(Over the same period, total international passengers at major airports have seen an average

5.7% growth).

Should the weaker AUD be sustained, we expect that the lower exchange rate will continue to

support growth in Australia’s overnight market, (i) increasing the relative cost of overseas travel for

Australians, and (ii) making Australia an attractive travel destination for offshore visitors.

Domestic companies well positioned to benefit from the tourism thematic include: Mantra

Holdings (hotels), Flight Centre (travel agency), Amalgamated Holdings (hotels & cinema),

Village Roadshow (cinema & theme parks), Qantas (aviation), Sealink (tourism tours & travel)

and Sydney Airport (aviation).

II. Food Security

The rising purchasing power of Chinese consumers coupled with increasing concerns about food

safety, following the 2008 melamine scandal (which involved SanLu, one of China’s largest dairy

providers) prompted well-off and highly brand conscious Chinese consumers to turn to imported

alternatives. Recognised by foreign consumers as having a ‘clean and green’ environment,

offering quality products, Australia is well positioned to take advantage of trends driving its

agrifood sector- these include, (i) increasing ageing population, (ii) growing awareness of

preventative health & well being, (iii) new product development, and (iv) offshore demand.

Australian companies producing clean and green products, and leveraged to high growth

international markets (particularly China) include: Bega Cheese, Bellamy’s Australia,

Blackmores, Treasury Wine Estates and Vitaco.

III. Outdoor Media

Out of Home advertising growth has outpaced the broader advertising market over the last 10-

years (CEASA), gaining market share from other traditional forms of media. We attribute this to its

growing audiences (particularly as audiences in key demographics have fragmented from other

media), improved audience measurement, general enhancements to the presentation of its

product and investment in Digital platforms. While Out of Home advertising has almost doubled

over the last decade (accounting for $697m in revenue), it still only represents 5.7% of Australia’s

total advertising spend (up from 3.1% in 2003).

We believe the two primary drivers of Out of Home’s outperformance (vs. the total advertising

market) are (i) implementation of MOVE audience measurement systems and (ii) increasing

contribution from the roll out of new digital billboards, and the digitisation of existing static assets.


11 January 2016 17

Fig 27 Out of Home gaining market share

Source: CEASA, January 2016

We add oOh Media! (OML) to the portfolio, which is our preferred outdoor media player given its

high quality and diverse customer base across Australia (clients include Mirvac, Lend Lease,

Stockland and Qantas terminals) and long-term site portfolio. We expect OML to benefit from the

thematic and maintain double digit EBIT growth over the next five years as digitisation presents

new revenue opportunities (roughly a 3-5x revenue uplift) and advertising yields are optimised

through improvement inventory management.

2. Sustainable dividend yield

While the “pure” multiple expansion phase of the yield trade is over, a modest cyclical recovery

together with a favourable yield spread over bonds suggests the thirst for high quality yield is

unlikely to diminish. From here, defensive growth and yield stocks are more likely to see upside

commensurate with EPS growth (provided we are not on the verge of a revenue shock) but they

are still likely to provide appealing risk-reward especially during 1H when growth sentiment and

transparency is low.

Fig 28 Yield compression has been significant in high dividend sectors...

Fig 29 ...at the same time these stocks now represent a large portion of index weight


297327

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1H12 2H12 1H13 2H13 1H14 2H14 1H15 2H15 Today

Forecast Earnings and Dividend Yield of 'Dividend Yield' stocks

Earnings Yield Dividend Yield

Yield compression has been substantial in recent years

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11 January 2016 18

We believe the market is overly concerned on dividend sustainability for both banks and Telstra.

Provided our assumption of a muted growth and rates backdrop is correct, bank dividends are not

at risk and Telstra has the potential to raise its dividend distribution in coming years (buy banks for

yield + PE expansion but TLS for yield). On the other hand, while we are comfortable that the

Infrastructure and Utilities sector can broadly maintain recent dividend distribution trends,

valuations are largely tapped out (buy for yield not PE expansion). REIT’s provide the greatest

scope for long/short dividend yield trades (see accompanying notes: Australian Banks – Striking

the perfect balance; Telstra Corp – Stock take on the yield thesis; Stand by me: Dividend Yield –

December 2015).

Fig 30 Sustainable versus unsustainable dividend growers

Sustainable div payers with

PE re-rating potential

Sustainable div payers with

“bond-like” upside

Unsustainable div payers with

PE de-rating potential

Commonwealth Bank

GPT Group

Goodman

Lend Lease

Westpac

Macquarie Atlas

Sydney Airport

Telstra

Aurizon

Cromwell Property

Primary Healthcare

Scentre Group

Spark NZ

Source: Datastream, Macquarie Research, December 2015


11 January 2016 19

3. Go for (stay with) Growth – Margin expanders over revenue generators...

Australia is in the midst of a muted earnings cycle. While the trajectory will be upwards, it will be

relatively shallow characterized by weak demand driving poor pricing power and reliant on cost

cutting as a key driver of incremental earnings growth. Our benign view of the world is not one

which will catapult the current earnings backdrop into a meaningfully higher plateau. On this basis,

we think earnings will post mid-high single digit growth (~6-7% versus current expectations of 9%)

which will primarily be a function of cost driven margin expansion on top of an outsized

contribution from offshore translation benefits. Recent earnings momentum trends are unlikely to

be arrested which suggests the market may need to absorb another round of downgrades before

mid years. Stocks which fit this category are shown in the table below.

Fig 31 Strongest margin expanders Fig 32 Strongest revenue expanders

Source: Macquarie Research, January 2016

Stock Company Revg FY15A-17F Margin Exp. FY15A-17F

NXT NextDC 393% -168%

VCX Vicinity Centres 303% 8%

SDF Steadfast Group 266% 0%

CTD Corp. Travel 261% 18%

GEM G8 Education 250% -3%

TPM TPG Telecom 250% -3%

SRX Sirtex Medical 235% 22%

SCG Scentre Group 229% 8%

REC Recall Holdings 217% 5%

PRG Program. Maint. 215% 10%

MFG Magellan Fin. 213% -3%

HGG Henderson 203% -1%

ALL Aristocrat 202% 25%

RHC Ramsay 199% 4%

CVW ClearView 192% 12%

CSL CSL 186% -9%

TWE Treasury Wine 179% 9%

OFX OzForex Group 179% -7%

Stock Company Margin Exp. FY15A-17F Revg FY15A-17F

DUE DUET Group 191% 144%

UGL UGL 112% 55%

AYS amaysim 91% n.m

ORG Origin Energy 84% 85%

FSF Fonterra 77% 97%

NWS News Corp 60% 136%

QAN Qantas Airways 60% 112%

CTX Caltex Australia 58% 74%

GNC GrainCorp 48% 97%

NEC Nine Entert. 42% 88%

OML oOh!media 41% n.m

SCP Shopping Cent. 37% 94%

NUF Nufarm 37% 111%

VRL Village Road. 35% 110%

CIM CIMIC Group 29% 72%

SIQ Smartgroup 29% n.m

KMD Kathmandu 28% 120%

ALL Aristocrat 25% 202%


11 January 2016 20

4. Sector & Portfolio preferences

Financials: We are overweight financials (banks) primarily on valuation and yield support

grounds. Like other value sectors we are reliant on the sector delivering on earnings expectations

although at low single digit levels (~3-4% for 2016) we think expectations are already relatively

modest. While we expect a deterioration in the bad and doubtful debt cycle, we doubt 2016 will be

the year for negative surprise if our view that the economy will begin to trough out from 2Q

eventuates. While fundamental issues around the bank sector’s growth outlook and credit quality

cycle are impacting the investor sentiment, healthy bank dividend yields are increasingly difficult

to ignore. Our analysis indicates that currently elevated pay-out ratios could be sustained in an

environment of low credit growth and benign credit quality. ANZ offers the highest yield in the

sector (13% above the 5yr average), albeit with an associated level of near-term earnings risk.

Banks’ near term investment thesis is underpinned by the diminished risk of further capital

raisings in FY16 and supportive revenue trends on the back of the repricing actions that banks

undertook in the last six months. We hold positions in CBA, SUN and WBC.

Resources/Energy: Commodities remain in a structural bear market that is not complete. We

have low conviction in timing a tactical turning point despite a savage decline through 2015.

Recent data out of China is raising the potential for a more aggressive monetary policy stance but

it could well need further weakness to drive this. At this stage the sector has considerable

earnings downside if marked to spot commodity levels suggesting that valuation provides little

protection for the sector particularly if stresses emerge through the credit markets as is likely if

commodity prices continue to decline.

Both BHP and RIO have scope to either cut dividends or to keep them and start using DRPs to

pay for them before going to the capital markets. Ultimately both BHP and RIO will require

additional debt facilities over the next few years given the trajectory for commodity prices.

Among Energy large-caps we continue to prefer OSH. Despite robust LNG expansion options

low on the cost curve (which supports NAV roll-forward) and an active exploration program

ahead, OSH’s premium valuation has de-rated following WPL’s withdrawal of its offer. STO

remains the cheapest stock in the large-cap energy sector by some margin, however a high cash

break-even, the possibility of sizeable impairments and likely uncertainty surrounding the CEO’s

vision could weigh on the near-term investment case. WPL still appears expensive, with Browse

looking even more marginal and the balance flexibility it has traditional enjoyed not as obvious in

a lower oil price environment. We remove WPL from the portfolio.

Growth: We have been trimming our offshore A$ beneficiaries but remain overweight

growth. We expect a modest cyclical rebound that will bypass for the time being areas which are

heading in the opposite direction (i.e. housing). We are focused on stocks which are expected to

support earnings via margin expansion over straight revenue gains. We are also looking for

stocks uncorrelated with the global economic cycle & stocks accessing some level of demand

either through pockets of the economy where demand is still relatively strong (business &

consumer confidence). We make the following changes to our portfolio:

We have added Eclipx Group (ECX) as we believe the stock remains well placed to deliver

long term growth with the new management team (previously with Flexigroup) looking to drive

growth in new business and improving returns and margins, by renewing and improving the

vehicle offering, leveraging current capability and expanding into commercial equipment

finance. ECX is also targeting to lower cost to income ratios and pursue bolt-on acquisitions.

We add Baby Bunting (BBN). A baby food retailer, operating in a relatively defensive sector

which is relatively shielded from competitive threats by strict Australian mandatory baby

product safety regulations. We expect BBN to gain significant share of the speciality baby

goods market following its store rollout (the company offers compelling store return metrics,

with the existing portfolio of stores generating an average of >70% return on capital after four

years of operation). We see opportunity to leverage cost base over time, noting BBN’s gross

margins of ~34% and EBITDA margins of ~6.9% sit well below may other domestic detail

peers.


11 January 2016 21

We add Ooh! Media (OML), on the “Out of Home” advertising thematic continuing to gain

market share from other traditional forms of media. Digitisation also presents new revenue

opportunities and optimised advertising yields, which, we noted above, we like.

After running with a significant overweight in Healthcare through the past 6 months, we are

further trimming this position given valuation and earnings concerns. We maintain our

holdings in CSL and Sonic Healthcare (SHL) but on a relative basis have exited our positions

in both hospitals Ramsay Healthcare (RHC) and Healthscope (HSO).

Income/Yield: The multiple expansion phase of the yield trade is over. However, with bond yields

likely to remain low (~3.0% for the 10 year), earnings growth muted (~6-7% ex resources),

valuations at the LTA and volatility higher than in recent years, the hunt for sustainable and high

quality yield remains a key investment criteria. Stronger growth and not higher yields pose the

biggest threat to relative performance and re-rating potential of Australian yield stocks. A rotation

away from yield needs confirmation of stronger growth and not simply an exogenously driven rise

in the discount rate From here, defensive growth and yield stocks are more likely to see upside

commensurate with EPS growth (provided we are not on the verge of a revenue shock). We make

no changes to our income/yield portfolio. We maintain positions in WES, WFD, TLS and GMG.

Telstra in a unique position: Telstra is in a unique position with regard to its earnings and

dividend outlook due to the impact of the NBN rollout on its core earnings. The NBN rollout will

provide an earnings headwind to Telstra, however the company will be compensated by a raft

of NBN migration payments that are expected to total over $10bn (pre-tax) over the life of the

project. Against that backdrop, Telstra’s earnings and dividend outlook will ultimately be

determined by:

I. Its ability to sustain or grow underlying earnings despite the NBN

headwinds;

II. Returns it can generate from surplus NBN cashflow via buybacks and

M&A;

III. Any other capital management decisions such as paying out special

dividends or direct capital returns.

As our base case, we see ordinary dividends increasing from 30.5cps today to 32.0cps

medium term (fully-franked): All up, we see Telstra growing its underlying dividend from

30.5cps in FY15 to 31.5cps in FY16 and 32.0cps by FY17. At FY17 we would see this as

representing ~100% payout of underlying EPS, although there would be some buffer out of

core cashflow given capex demands. We expect ordinary dividends to plateau from that point.

Domestic Cyclicals: While sentiment around global recovery remains fragile, we are confident

that market conditions at home will gradually begin to improve with a trough likely in mid year. We

are raising our domestic exposure vis-a-via global cyclical on the back of a relative growth

momentum call.

We exit our position in SEK given earnings uncertainty surrounding the company’s increased

investment in new and existing businesses and further deterioration in the Learning division.

We add Domestic Cyclicals SUN to the portfolio. The stock is attractive on valuation terms

(trading at a FY16 PE of ~12.5 vs IAG of ~14.5x) and recent sell-off (on the back of

downgraded guidance) provides a buying opportunity. We expect margins will increase as

premium rates increase and claims issues are resolved. SUN has an attractive total return

outlook, paying a 7.4% fully franked dividend yield. Recent sell off (following downgraded

guidance) provides a buying opportunity,

We maintain our positions in MTR (given strong inbound and domestic travel demand), DLX

(expecting double digit EPS growth) and TTS (with potential margin increases).


11 January 2016 22

Global Cyclicals: We have been running an overweight on global growth and an underweight on

global cyclical (materials and energy). We are reducing further our position in the latter given a

lack of upside catalysts despite the sizeable price declines. On a relative basis we raise our

domestic exposure vis-a-via global cyclicals. While we have seen significant outperformance by

the global growth stocks, we are less worried about the valuation stretch. We think these stocks

are growth not rate sensitive and low multiple stocks are earnings not valuation sensitive. It will

take growth disappointment to unwind growth multiples and growth conviction to re-rate value

multiples. We think the latter is possible even if earnings grow only 6-7%.

We maintain active (but reduced) positions in AMC & HGG with no change to our holdings in

LLC, IP & OSH.

We have added ORA given fundamentals remain intact re solid earnings growth, leverage to

weaker A$ (which should prompt underlying acceleration by improving the competitiveness of

ORA’s local customer base), and optionality re medium to longer term growth (organic and

acquisitions).

We exit our position in BXB (expensive on valuation terms given low earnings growth and

weak cash generation), CPU (organic headwinds and lack of cyclical upside limit

attractiveness of the business in the near term) and WPL, where we see limited upside

catalysts without a broad based sector rally.


11 January 2016 23

Fig 33 Macquarie Strategy- Recommended Australian portfolio- updated


Share price Portfolio Index Active

Company Code 8 Jan 15 Weight (%) Weight (%) Weight (%)

Domestic Cyclicals

IndustrialsQantas QAN $4.04 3.5 0.6 2.9

Tatts Group TTS $4.14 3.4 0.5 2.9

Mantra Group MTR $4.61 2.3 0.1 2.2

Breville Group BRG $6.94 2.2 0.0 2.2

Dulux Group DLX $6.36 2.0 0.2 1.8

Total 13.4 12.2 1.2

Financials Commonwealth Bank CBA $79.29 14.5 10.5 4.0

Westpac Banking Corporation WBC $31.02 12.5 8.0 4.5

Suncorp SUN $11.52 4.5 1.4 3.1

Total 31.5 30.6 0.9

Domestic cyclicals - total 44.9 42.8 2.1

Global Cyclicals

IndustrialsLend Lease Group LLC $13.42 2.5 0.6 1.9

Amcor AMC $13.01 2.5 1.1 1.4

Orora ORA $2.19 1.5 0.1 1.4

Incitec Pivot IPL $3.58 1.5 0.5 1.0

Henderson Group HGG $5.89 1.3 0.3 1.0

James Hardie Industries JHX $16.20 1.5 0.5 1.0

Total 10.8 11.1 -0.3

Resources

Metals & MiningRio Tinto RIO $42.01 1.5 1.4 0.1

BHP Billiton BHP $16.45 3.0 4.2 -1.2

Total 4.5 10.9 -6.4

EnergyOil Search OSH $6.53 2.5 0.6 1.9

Total 2.5 4.0 -1.5

Global Cyclicals - total 17.8 26.0 -8.2

GrowthCSL CSL $103.12 4.6 3.6 1.0

Carsales.com CAR $11.30 2.2 0.2 2.0

Eclipx ECX $3.09 2.0 0.0 2.0

Sonic Healthcare SHL $17.29 2.0 0.5 1.5

Cover-More Group CVO $2.08 1.5 0.0 1.5

Baby Bunting BBN $2.50 1.8 0.0 1.8

oOh Media! OML $4.32 1.5 0.0 1.5

Growth - total 15.6 8.3 7.3

Income / DefensivesTelstra Corporation TLS $5.28 7.5 5.0 2.5

Wesfarmers WES $39.73 3.8 3.4 0.4

Westfield Corporation WFD $9.24 3.8 1.3 2.5

Transurban Group TCL $10.15 3.6 1.5 2.1

Goodman Group GMG $6.16 3.0 0.7 2.3

Income / Defensives - total 21.7 22.9 9.8

TOTAL 100.0 100.0 11.0

Key portfolio ChangesStocks Added Stocks Removed

QAN 3.5 SEK 2.2

SUN 4.5 CSR 1.7

ORA 1.5 NAB 8.0

ECX 2.0 BXB 3.0

BBN 1.8 CPU 2.0

OML 1.5 WPL 2.4

TLS 7.5 HSO 1.5


11 January 2016 24

Companies mentioned

Ticker Current price (lcy) Rating Target price (lcy)

LLC 13.42 Outperform 17.66 ORA 2.18 Outperform 2.59 ECX 3.09 Outperform 3.33 IPL 3.57 Outperform 4.55 BBN 2.50 Outperform 2.77 QAN 4.06 Outperform 4.70 OML 4.32 Neutral 3.80 CBA 79.42 Outperform 93.76 GPT 4.58 Outperform 4.76 GMG 6.17 Outperform 6.85 WBC 31.00 Outperform 36.47 MQA 3.87 Outperform 4.56 SYD 6.10 Outperform 6.53 TLS 5.30 Neutral 5.60 AZJ 4.15 Neutral 4.78 CMW 1.01 Underperform 1.01 PRY 2.46 Underperform 2.50 SCG 4.13 Underperform 3.70 SPK 3.26 Neutral 3.15 SUN 11.49 Outperform 12.82 OSH 6.55 Outperform 8.00 WPL 28.19 Neutral 30.00 CSL 103.12 Outperform 110.00 SHL 17.21 Outperform 23.00 RHC 64.02 Outperform 77.00 HSO 2.55 Outperform 3.15 WES 39.65 Outperform 45.08 WFD 9.24 Outperform 12.13 SEK 13.91 Outperform 14.70 MTR 4.61 Outperform 3.99 DLX 6.35 Neutral 6.20 TTS 4.14 Outperform 4.20 AMC 13.02 Outperform 15.82 HGG 5.89 Outperform 7.30 BXB 10.94 Neutral 10.79 CPU 10.85 Neutral 11.40

Source: Macquarie Research, January 2016, Prices as of market close of 7 January 2016


11 January 2016 25

Important disclosures:

Recommendation definitions

Macquarie - Australia/New Zealand Outperform – return >3% in excess of benchmark return Neutral – return within 3% of benchmark return Underperform – return >3% below benchmark return Benchmark return is determined by long term nominal GDP growth plus 12 month forward market dividend yield

Macquarie – Asia/Europe Outperform – expected return >+10% Neutral – expected return from -10% to +10% Underperform – expected return <-10%

Macquarie – South Africa Outperform – expected return >+10% Neutral – expected return from -10% to +10% Underperform – expected return <-10%

Macquarie - Canada

Outperform – return >5% in excess of benchmark return Neutral – return within 5% of benchmark return Underperform – return >5% below benchmark return

Macquarie - USA Outperform (Buy) – return >5% in excess of Russell 3000 index return Neutral (Hold) – return within 5% of Russell 3000 index return Underperform (Sell)– return >5% below Russell 3000 index return

Volatility index definition*

This is calculated from the volatility of historical price movements. Very high–highest risk – Stock should be

expected to move up or down 60–100% in a year – investors should be aware this stock is highly speculative. High – stock should be expected to move up or down at least 40–60% in a year – investors should be aware this stock could be speculative. Medium – stock should be expected to move up or down at least 30–40% in a year. Low–medium – stock should be expected to move up or down at least 25–30% in a year. Low – stock should be expected to move up or down at least 15–25% in a year. * Applicable to Asia/Australian/NZ/Canada stocks only

Recommendations – 12 months Note: Quant recommendations may differ from Fundamental Analyst recommendations

Financial definitions

All "Adjusted" data items have had the following adjustments made: Added back: goodwill amortisation, provision for catastrophe reserves, IFRS derivatives & hedging, IFRS impairments & IFRS interest expense Excluded: non recurring items, asset revals, property revals, appraisal value uplift, preference dividends & minority interests EPS = adjusted net profit / efpowa* ROA = adjusted ebit / average total assets ROA Banks/Insurance = adjusted net profit /average total assets ROE = adjusted net profit / average shareholders funds Gross cashflow = adjusted net profit + depreciation *equivalent fully paid ordinary weighted average number of shares All Reported numbers for Australian/NZ listed stocks are modelled under IFRS (International Financial Reporting Standards).

Recommendation proportions – For quarter ending 30 September 2015

AU/NZ Asia RSA USA CA EUR Outperform 48.87% 59.96% 35.63% 42.13% 59.44% 42.11% (for US coverage by MCUSA, 3.54% of stocks followed are investment banking clients)

Neutral 33.44% 25.00% 39.08% 52.55% 37.06% 38.42% (for US coverage by MCUSA, 5.05% of stocks followed are investment banking clients)

Underperform 17.68% 15.04% 25.29% 5.32% 3.50% 19.47% (for US coverage by MCUSA, 0.51% of stocks followed are investment banking clients)

Company-specific disclosures: Important disclosure information regarding the subject companies covered in this report is available at www.macquarie.com/research/disclosures.

Analyst certification: We hereby certify that all of the views expressed in this report accurately reflect our personal views about the subject company or companies and its or their securities. We also certify that no part of our compensation was, is or will be, directly or indirectly, related to the specific recommendations or views expressed in this report. The Analysts responsible for preparing this report receive compensation from Macquarie that is based upon various factors including Macquarie Group Ltd total revenues, a portion of which are generated by Macquarie Group’s Investment Banking activities. General disclosure: This research has been issued by Macquarie Securities (Australia) Limited (ABN 58 002 832 126, AFSL No. 238947) a Participant of the Australian Securities Exchange (ASX) and Chi-X Australia Pty Limited. This research is distributed in Australia by Macquarie Equities Limited (ABN 41 002 574 923, AFSL No. 237504) ("MEL"), a Participant of the ASX, and in New Zealand by Macquarie Equities New Zealand Limited (“MENZ”) an NZX Firm. Macquarie Private Wealth’s services in New Zealand are provided by MENZ. Macquarie Bank Limited (ABN 46 008 583 542, AFSL No. 237502) (“MBL”) is a company incorporated in Australia and authorised under the Banking Act 1959 (Australia) to conduct banking business in Australia. None of MBL, MGL or MENZ is registered as a bank in New Zealand by the Reserve Bank of New Zealand under the Reserve Bank of New Zealand Act 1989. Any MGL subsidiary noted in this research, apart from MBL, is not an authorised deposit-taking institution for the purposes of the Banking Act 1959 (Australia) and that subsidiary’s obligations do not represent deposits or other liabilities of MBL. MBL does not guarantee or otherwise provide assurance in respect of the obligations of that subsidiary, unless noted otherwise. This research is general advice and does not take account of your objectives, financial situation or needs. Before acting on this general advice, you should consider the appropriateness of the advice having regard to your situation. We recommend you obtain financial, legal and taxation advice before making any financial investment decision. This research has been prepared for the use of the clients of the Macquarie Group and must not be copied, either in whole or in part, or distributed to any other person. If you are not the intended recipient, you must not use or disclose this research in any way. If you received it in error, please tell us immediately by return e-mail and delete the document. We do not guarantee the integrity of any e-mails or attached files and are not responsible for any changes made to them by any other person. Nothing in this research shall be construed as a solicitation to buy or sell any security or product, or to engage in or refrain from engaging in any transaction. This research is based on information obtained from sources believed to be reliable, but the Macquarie Group does not make any representation or warranty that it is accurate, complete or up to date. We accept no obligation to correct or update the information or opinions in it. Opinions expressed are subject to change without notice. The Macquarie Group accepts no liability whatsoever for any direct, indirect, consequential or other loss arising from any use of this research and/or further communication in relation to this research. The Macquarie Group produces a variety of research products, recommendations contained in one type of research product may differ from recommendations contained in other types of research. The Macquarie Group has established and implemented a conflicts policy at group level, which may be revised and updated from time to time, pursuant to regulatory requirements; which sets out how we must seek to identify and manage all material conflicts of interest. The Macquarie Group, its officers and employees may have conflicting roles in the financial products referred to in this research and, as such, may effect transactions which are not consistent with the recommendations (if any) in this research. The Macquarie Group may receive fees, brokerage or commissions for acting in those capacities and the reader should assume that this is the case. The Macquarie Group‘s employees or officers may provide oral or written opinions to its clients which are contrary to the opinions expressed in this research. Important disclosure information regarding the subject companies covered in this report is available at www.macquarie.com/disclosures.

Analyst certification: We hereby certify that all of the views expressed in this report accurately reflect our personal views about the subject company or companies and its or their securities. We also certify that no part of our compensation was, is or will be, directly or indirectly, related to the specific recommendations or views expressed in this report. The Analysts responsible for preparing this report receive compensation from Macquarie that is based upon various factors including Macquarie Group Ltd total revenues, a portion of which are generated by Macquarie Group’s Investment Banking activities. General disclaimers:


11 January 2016 26

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