THE WEEKEND AUSTRALIAN,MAY 16-17, 2015

theaustralian.com.au/wealth 33V0 - AUSE01Z01MA

Markets getting warm ... but not boiling over

With the government and the Reserve Bank talking of “green shoots” in the economy, you’d be forgiven for thinking we have just emerged from a prolonged recession. Over in the US, the situation is somewhat different. The US economy has been expanding for almost seven years and green shoots have turned into celebratory fireworks in some sectors.

Of course, after a full description of some of those fireworks you might be left thinking the only green shoots emerging are those of a bubble.

Take a look at a business called Noodle & Co. Noodle & Co is a takeaway chain with its head office based in Broomfield, Colorado. Broomfield has a population of 59,000 people.

Given this business is listed on the US Nasdaq exchange you might reasonably ask what earth-shattering wares are proffered by this chain. The answer to that is nothing really. The company sells noodles. You get to choose from an eclectic line of macaroni and cheese, noodles with butter, pad thai, spaghetti and meatballs, and steak stroganoff with cream sauce and egg noodles.

A regular-sized portion of padthai from the Tempe Arizona store will set you back $US5.69. An extra $US2.99 will get you some oven-roasted meatballs on that or some marinated steak, and for US75c you can add extra Italian parmesan cheese. Yes that’s right, cheese and meatballs on your pad thai!

You wonder how many of these meals they can dish up. According to one source, food critics began identifying it, in the late 1990s, as the best fast-food restaurant in their respective cities and it won awards for fast growth, healthy food and being family friendly. Revenues in 1996 were $300,000 but by the time the company listed in 2013, revenues had reached $US300 million from 410 stores.

For the first three months of2015 ending March 31, revenue increased 18.1 per cent to $US105.8m, up from $US89.5m for the same quarter last year.

Like-for-like comparable

restaurant sales grew 0.8 per centfor company-owned restaurants, 1.4 per cent for franchise restaurants and 0.9 per cent system-wide. Over the quarter 16 new restaurants opened, of which 13 were company-owned and three franchises.

But net profit fell to a loss of$US2.8m from a profit of $US1.4m in the previous corresponding period. The company recorded a $US5.9m pre-tax impairment charge related to eight restaurants this year. Yet shares in Noodle & Co are trading at a staggering 44 times earnings!

Another company that caught our attention in the US is Potbelly. Potbelly started out as an antique shop called Hindsight that also served toasted sandwiches to its bric-a-brac-fossicking customers. Entrepreneur Bryant Keil bought the original store in Chicago and has since expanded it to more than 280 Potbelly Sandwich shops across the US that still maintain a local store vibe (think 1980s TV show Cheers) offering live jazz and blues as well as, perhaps unremarkably, soup, shakes, malts, smoothies, and cookies.

For the first three months of2015 ending March 29, total revenues grew 16.1 per cent to $US85.8m from $US73.9m and company-operated comparable store sales rose 5.4 per cent. Net profit attributable to Potbelly Corporation was $US0.5m, compared with net loss of $US0.3m during the same fiscal period last year. According to estimates, Potbelly trades between 81 and 101 times earnings.

None of this is normal. And asmathematician Herbert Stein once wryly observed, “If something cannot go on forever, it will stop.”

But before you pull the sell trigger, it is imperative to know that these pockets of irrational exuberance are not having a dramatic impact on our local market and while there are some businesses whose shares are trading at all-time highs, more than two-thirds of the 70 per cent invested in equities in the Montgomery Fund is allocated to companies that still trade at a discount to our estimate of their intrinsic value. This suggests to us that, while dangers are indeed increasing, there may be more growth in those green shoots.

Roger Montgomery is founder and chief information officer of the Montgomery Fund.

ROGER MONTGOMERY

Bad new days of big government

During our preparatory school-ing, here in Australia, we weretaught democracy was a system ofpolity that by its very nature walk-ed in lock-step with the principlesof free market capitalism.

In contrast, we were alsotaught that socialist and commu-nist systems, by their very differ-ent existence, put the state orgovernment, not the individual, atthe centre of all economic, socialand geopolitical decisions madeon behalf of a populace.

Living within a supposedliberalised democracy, it hasbecome alarming to see Austra-lia’s obsession with the role of itsstate, level of expected govern-ment intervention and alsogeneral mindset.

The colossal attention to thisweek’s budget attests to thisobsession.

Some global investors, right-fully so, are starting to becomeever more concerned with Austra-lia’s mentality towards democ-racy, free and liberal markets andour balance between free enter-prise and the role of our state.

To be clear, governmentshould be and is a very importantstakeholder in any system, includ-ing democracies. But by definitionwithin our polity, governmentsshould be there to facilitate freeenterprise, entrepreneurialismand business, not crowd it out norreplicate it.

The fact that Australia has notrecently experienced a technicallydefined recession — an importantpart of any healthy economy’sbusiness cycle — nor has it anyeconomic plan for the future, hasset off alarm bells in some globalinvestment quarters.

As discussed within this col-umn previously, Australia partookin the international GlobalisationAccord three decades ago, whichsaw us undertake the first half ofthis agreement very effectively.

We got rid of parts of our econ-omy in which we were not mostcompetitive, for example, textiles,clothing and footwear (TCF).

We then, however, miserably

failed to undertake the second halfof this process, which ironicallywas the easier of the two halves tohonour.

This second half would see oureconomy and nation-state thendecide where best to allocate ourhuman capital, resources, ingen-uity and, ultimately, our mainfocus.

Failure to do so has seen Aus-tralia drift without any concreteplans.

Such plans, in a liberal democ-racy, should not be decided by ourgovernment but by us, the people.

In this context, “the people” re-fers to big and small businesses,entrepreneurs, investors, academ-ics and even unions.

The graph illustrates that Aus-tralia’s budget, by internationalstandards, still remains appropri-ate, but what has concerned theglobal investment communities,and continues to do so, is our owndomestic mindset, which heavilyleans towards socialist not demo-cratic ideals.

There should be daylight be-tween systems and currently, inAustralia, one could well argue,there is not.

It was understandable why thegovernment stepped in during theGFC crisis years but it is now timefor them to “exit stage left”.

As US president Ronald Rea-gan once aptly said, “no govern-ment ever voluntarily reducesitself in size. Government pro-grams, once launched, never(voluntarily) disappear.”

On this, Reagan also astutelyasserted: “To sit back hoping thatsome day, some way, someone willmake things right, is to go on feed-ing the crocodile, hoping he willeat you last — but eat you he will.”

Starting to sound like a brokenrecord, an outlier and increasinglya lone voice on this subject, Aus-tralia lacks both a vision and a planand both these should be decidedby us, the community.

Australia’s fiscal arm of gov-ernment, represented by the Lib-eral Party of Australia, and itsmonetary arm, represented by theReserve Bank of Australia, arestakeholders in our economy butthey do not constitute our core noreven our periphery. They are bothservants of our economy andshould not be confused as beingour economic stewards.

The disproportionate focus onthis week’s budget and the contin-ued frenzies surrounding RBA in-terest rate policies should concernall Australian investment andbusiness communities, as much asit is increasingly concerning glo-bal investors.

However justified, the size ofgovernment in this country has

ballooned past balanced levelsand this week’s budget could notbe considered anything less thanoutmoded Keynesian over-spending.

With our Australian ASX 200listed stockmarket valuations cur-rently supported by unjustifiableand unsustainable pillars, a seri-

ous, circumspect appraisal needsto be made.

Domestic Ultra High NetWorth (UHNW) investors, likeany other investment community,will continue to allocate their in-vestment capital to its most effec-tive likely use and theseallocations increasingly see them

invest more and more abroad. Theknock-on effect of over-relianceon government is that in a com-paratively small economy such asours, oligopolies have been al-lowed to prosper — bestevidenced by the continued stateendorsement of the “Four Pillars”banking policy.

This has, in turn, seen ASX 200companies, which have had cap-acity to invest, choose, thus far onthe whole, not to do so.

Ironically, this exemplar ofstate-sanctioned big oligopoly en-terprise is akin to that currentlychallenging Chinese CommunistState Owned Enterprises (SOEs).

The daylight between our twopredicaments, in this respect, iscurrently hard to see.

It is time to redirect our nation-al conversation back to askingwhat is our economic plan andhow can we provide opportunitiesfor Australian investment mar-

kets to prosper, grow and in sodoing, rise through prosperity notsynthetic inflation measures orfeigned expansion.

Government can assist withbroader economic productivitygrowth and efficiencies — whichare very important — but theyshould not continue to crowd theprivate sector in either investmentor spending.

Nor should they even dictate tous our national economic direc-tion, which is for us, the people todecide.

I, for one, am willing to fight forour democracy, free-market en-trepreneurial ideals and liberties.

In so doing, we all advanceAustralia’s fair.

Larkin Group is a Wholesale Wealth Adviser focusing on high yielding global investments.

www.larkingroup.com.au

Canberra should get out of the way of private enterprise

STIRLING LARKINGLOBAL INVESTOR

Source: The Economist-8 -6 -4 -2 0 2

Global budget comparisonsThe Economist poll of economists for 2015, percent of GDP selected countries

Other surpluses: Norway, South Korea, Iceland

GERMANYSWITZERLANDNZCANADAEURO AREAAUSTRALIAUSCHINAGREECEUKJAPAN

GETTY IMAGES

Economist John Kaynes: his outmoded over-spending is still with us

After tackling turbulence, Qantas turnaround shines a light on its retail bondsLess than a year ago, when Qantasreported a $2.8 billion statutoryloss, some commentators werecalling the curtain on our domesticcarrier.

But to their credit, CEO AlanJoyce and his management teamhave turned the airline around,with some help from a surprise de-cline in oil prices, and Qantas’s for-tunes look a world away fromwhere they were a short time ago.

The airline industry is toughand there have been some spec-tacular failures. It’s cyclical and

characterised by its utility-like ser-vice transporting passengers, sub-jecting it to fierce pricediscounting. Other risks rangefrom fuel prices and currency fluc-tuations to regulatory risk, not tomention plane crashes.

Qantas has proved more resili-ent than many investors thought.It looks like management’s focuson its cost base is paying off, clos-ing in on rates achieved by com-petitors. The company is on trackto reduce debt by $1 billon, as pre-viously forecast, this financial

year. The recent announcement ofthe possibility it will reinstate divi-dends after a six-year hiatus sentshares up over 7 per cent this week.

Even when the company was atits lowest, I always believed thatQantas was a survivor, making iteasy to recommend its bonds. Thefact that companies must paybond-holders interest and returncapital at maturity, combined withthe fact that shares are higher riskthan bonds as they must be wipedout before bondholders take onany loss, provided the additional

comfort to invest in an otherwisehigh-risk sector.

Qantas’s high-yielding bondswere attractive from the start,when the first of the three dom-estic bonds was launched back inApril 2013, maturing seven yearslater, paying a fixed rate of 6.5 percent per annum.

Since first issue, the April 2020bond price has moved around, de-pending on company news, mar-ket sentiment and interest rates.An improved outlook as well as theexpectation of low interest rates

saw the bond price recover from$98 in August 2014 to reach a highof $108 last month, only to declineto its current price of $106.

The good news over the pastweek was dwarfed by the expec-tation of higher interest rates overthe next few years, resulting in thepullback — remember higher in-terest rates lead to lower fixed-ratebond prices.

If you bought the Qantas 2020bond, available to all investors, atthe current price of $106, it wouldhave a yield to maturity of 4.74 per

cent per annum. That’s a goodfixed return in a low interest rateenvironment.

Qantas has two other longerdated bonds, maturing in June2021 and May 2022 with yields tomaturity of 5.32 per cent perannum and 5.43 per cent perannum, respectively. These bondsbenefit from an additional clausewhere interest is increased if thecredit rating agencies downgradethe bonds. While the current con-ditions make this unlikely, it’s animportant benefit for a company

in a cyclical, high-risk industry.Unlike the retail-focused 2020bond, these bonds are only avail-able to sophisticated or wholesaleinvestors.

My pick of the three is the 2021bond. It has a pick-up of 0.58 percent over the 2020 bond and ma-tures before the 2022 issue, so it isless risky. The higher yield of 0.11per cent on the 2022 doesn’t com-pensate enough for the extra year.

Retirees need a replacementincome and fixed-rate bonds pro-vide certainty.

LIZ MORANSMART INCOME

DONSTAMMER

Is it the end for low rates ? Don Stammerreports on bond market signals for the general investor on Tuesday in Wealth.

Shell-shocked Orica is regaining favour with investors. Dividend Detective Darren Katz reveals the numbers on Tuesday in Wealth.