Market Update

1
(No Transcript)
2
Market Update
Peter Greentree Head of Equities March 2007
3
Focus of Today

• Market Outlook
• Valuation and Liquidity
• Resources
• Private Equity
• Portfolio Strategy

4
Market OutlookFour Years of Double Digit Returns
Driven by Earnings
Source IRESS, Macquarie Research
5
Market Outlook and Equities are now above trend
10-15 Above
Long term Trend
Index
Jan 07
Date
All Ordinaries Index (log scale)
Linear (All Ordinaries Index (log scale)
Source IRESS, Challenger
6
Market OutlookIts all about earnings mean
reversion or new paradigm?
7
Market OutlookDrivers of earnings growth

• Supernormal earnings growth has been driven by
• Long term underinvestment eg commodities
• Synchronised global growth cycle
• Industry consolidation and restructuring
• Labour market reform
• Capital management

8
Market OutlookEquity market environment

• Market EPS growth still healthy, but slowing with
  changing leadership
• Overall valuation still looks ok, but two tiered
  market. Resource are trading below 10x, but many
  industrials gt20x earnings
• Commodity prices appear to be in a broad top with
  weakness in oil and copper
• Cost pressures may be abating, but unlisted
  sector still suffering
• Corporate balance sheets undergeared
• Regearing through dividends and capital
  management
• Liquidity remains abundant MA/Private Equity
  ongoing

9
Market OutlookEarnings new paradigm or mean
reversion?

• Where to
• New paradigm
• Difficult to justify long term return on equity
  at c20
• But the fat tail can continue
• Mean reversion
• Difficult to invest above current returns vs cost
  of capital c10
• Re-regulation risk
• Recession!!!

10
Market OutlookPrice earnings ratios have been
stable
Valuations have converged with Global
11
Market OutlookReturn on equity exceeds US
Source GSJBW Research estimates
12
Market OutlookIndustrial valuations have
expanded due to MA
13
Market OutlookEquity market supply/demand
balance is favourable
Source Credit Suisse
14
Market OutlookIndustrial companies earnings are
improving

• EPS Growth has been pedestrian (circa 5)
• Some acceleration expected due to declining input
  costs and stronger domestic economy
• MA activity to remain at high levels
• Some sectors at elevated valuations vs history
  specifically property, utilities and
  telecommunications
• Growth/valuation trade-off very skewed

15
Market OutlookMost sector valuations are high vs
history
Current PER
Five Year Avg PER
16
Market OutlookCommodities supercycle or super
hype?

• Is this cycle different?
• Demand and supply led
• Irrational supply less an issue
• Investment controlled by fewer companies
• Cost structure rising
• Fewer economies driving demand
• Supply response slower
• But, demand supply will adjust

17
Market OutlookMomentum of most commodities is
slowing
Source IRESS, Challenger
18
Market Outlook Low resource valuations reflect
cyclical risks
Source IRESS, Challenger
19
Market OutlookWhere to from here?

• Price
• Major gains may be behind us
• Many metals heading toward small surplus
• Caution against extrapolating current pricing
• Volume
• Lasting driver of earnings
• Bulks offer better security (Iron Ore, Coal)
• Currency
• 83c AUD not reflecting current terms of trade
• Unlikely to see significant weakness whilst ToT
  so positive
• The cycle is not dead yet

20
Market OutlookWhy now and why Australia?

• Not just private equity
• Corporates are also under geared (eg
  Cemex/Rinker)
• Role of Investment Banks
• Returns and cashflows are strong
• Deregulation (Media)
• But, Australia is not a cheap private equity
  market
• Although, it is under leveraged

21
Market OutlookWhy now and why Australia?
22
Market OutlookWhat does private equity look for?

• Low operating volatility (gearable cashflows)
• Media, Telco, Consumer, Aged Care, Healthcare,
  Industrial Services, Retail, Packaging
• Share registers where PE can gain control
• Cost upside (operating costs, working capital)
• Asset restructuring (property sales, spin-offs,
  consolidation)

23
Market OutlookTakeover stocks appear expensive
Source Macquarie Research, January 2007
24
Market OutlookWhere to from here?

• MA cycle could last at least another 12 months
• Competition for assets increasing (Coles, Qantas)
• Shareholder revolt (Flight Centre, Qantas,
  Rinker)
• Directors fiduciary responsibility (Orica)
• Opportunity set for active managers
• Diminished over short term
• but MA, relisting, breakup natural part of
  cycle

25
Portfolio StrategyKey sector positions
Underweight
Overweight
7.4
3.3
2.6
-2.6
-3.8
-7.0
Source Challenger
26
Portfolio StrategyPreferred companies
27
Disclaimer

• The information contained in this publication has
  been prepared solely for investors on the basis
  that they are a wholesale investor within the
  meaning of the Corporations Act 2001 (Cth). It is
  general in nature and is not intended to
  constitute advice or a securities recommendation.
  Any information provided or conclusions made,
  whether express or implied, do not take into
  account the investment objectives, financial
  situation and particular needs of an investor.
  Issuer Challenger Managed Investments Ltd ABN 94
  002 835 592 AFSL 234 668 (CMIL). Past performance
  is not a guide to future performance. Neither
  CMIL nor any member of the Challenger Financial
  Services Group guarantees the repayment of
  capital or any particular rate of return.

28
(No Transcript)