Devon Funds Morning Note - 8 December 2023

Friday 8th December 2023

Global

The US indices pushed higher on Friday, as data showed that the jobs market in the world’s largest economy is continuing to cool. Job openings fell nearly 7% in November to the lowest since March 2021. This increases the prospect that the Fed will keep rates on hold next week. AI was a big theme overnight. Advanced Micro Devices soared 10% after the semiconductor company unveiled its new AI chips that are poised to challenge Nvidia’s dominance. Shares in Google-parent Alphabet surged 5% as it announced the rollout of its generative AI model. The ‘Golden Arches’ were also enjoying sentiment tailwinds related to Google and AI - at its Investors Day McDonald’s announced a big new rollout initiative and plans to connect its stores with Google Cloud technology beginning in 2024.

The Dow Jones jumped 0.2%, the S&P500 rallied 0.8% and the Nasdaq surged 1.4%. Alphabet was particularly “magnificent” as the company launched what it views as its largest and “most capable” AI model. Genesis is set to come in three different sizes (ultra, pro and nano), and will power Google AI apps such as its Bard chatbot. Executives said that Gemini Pro outperformed OpenAI’s GPT-3.5 but were vague about how it stacked up against ChatGPT-4.

Alphabet said that companies would be able to use the tool for advanced customer service engagement via chatbots and product recommendations, as well as identifying trends for advertisers. Gemini could also be used for marketing content creation as well as summarising meetings. The company gave a few examples of Gemini’s application, including showing it being able to take a screenshot of a chart and analysing hundreds of pages from research and then updating the chart. Google will no doubt be using its distribution channels to full effect and plans to license Gemini to customers through Google Cloud for them to use in their own applications.

AI has easily been the most dominant tech theme, and arguably the biggest topic globally, this year. Nvidia has been a poster-child for the excitement gripping investors – the shares have more than tripled in 2023. No surprise that competitors are now trying to disrupt the company’s dominance. Advanced Micro Devices has unveiled MI300, its range of “accelerator chips” that it said will be able to run AI software faster than rival products. The size of the market also appears to be growing with every new forecast. AMD said that the AI chip industry could exceed US$400 billion in the next four years, double its projection given in August.

A slightly more old fashioned company is targeting big growth in the years ahead as well. McDonald’s has announced plans to open 50,000 restaurants by 2027. Fast by name and nature – the plan continues the “accelerating the Arches” initiative and would be the fastest period of growth in the brand’s history. Easily the biggest food brand globally (and in the top five most valuable brands full stop, while 17 menu items are billion-dollar brands in their own right), McDonald’s is looking to build further on its following, expanding one of the world's largest loyalty programs from 150 million to 250 million 90-day active users “delivering” US$45b in annual sales over the same period.

McDonalds is “Doubling Down” on the “3Ds” (Delivery, Digital, and Drive Thru), with the addition of a fourth D (Development) earlier in this year. As part of this, a strategic partnership with Google will connect the latest cloud technology and apply generative AI solutions across its restaurants worldwide. The company said that this will help accelerate automation innovation from equipment manufacturers and improve customer and staff experiences. Customer personalization will likely compound the restaurant chain’s tech advantage.

In addition to all the tech news, markets also received a lift on Thursday on further evidence that the jobs market in the world’s largest economy is cooling down. US job openings totalled 8.73 million last month. That represents a decline of 617,000 jobs or around 6.6%, and is the lowest total since March 2021. The print was about 700,000 jobs below estimates.

Declines in job openings were widespread by industry. The biggest sector decline was education and health services followed by financials, along with leisure and hospitality and retail. The extent to which the jobs market is loosening was also evident in that it brought the ratio of openings to available workers down to 1.3 to 1. This is quite a drop as this ratio has been over 2 to 1 at the peak just a few months ago. It is also “good news” in that that Fed has been trying to cool down the jobs market (and associated inflationary pressures) which ran hot during the pandemic.

The ratio of openings to workers is now back near pre-pandemic levels of 1.2 to 1. “The Great Resignation” that was feature out of Covid is also fading. The “quits” rate had peaked around 3% of total employment in late 2021 and is now back at 2.3%. This also comes follow softer than expected private payrolls data earlier this week. Investors will not be waiting to see if this is all reflected in November’s jobs report due tonight – expectations are that the economy added 190,000 jobs in November up from October’s 150,000. Barring any major surprises here, the Fed looks likely to leave interest rates on hold when it meets next week.

The ECB also meets next week. European markets were softer, with the STOXX50 down 0.2%. The FTSE100 was flat. UK Prime Minister Rishi Sunak faces a big test next week, with a forthcoming vote on whether illegal migrants can be deported from the UK to Rwanda. Sunak’s Illegal Immigration Minister has already quit saying the legislation “does not go far enough” and that “stronger protections” were needed.

Asian markets were soft. The CSI300 in China was down 0.2%. There was some good news on China’s trade balance which widened to a surplus of US$68.39 billion in November, higher than the US$56.53 billion in October and exceeding estimates of US$58 billion. Exports climbed 0.5% year on year, after a 6.4% fall in October and exceeding expectations of a 1.1% decline. However, imports to the world’s second-largest economy dropped 0.6% compared to the same period a year ago, in contrast to forecasts of a 3.3% rise.

February.

New Zealand

Kiwi dairy farmers have also had an early Christmas present, partly courtesy of China. Fonterra has lifted its forecast farmgate milk price for the 2023/24 season.

The midpoint has gone up by 25c to $7.50 per kilograms of milk solids (KGMS). The forecast range has been narrowed from $6.50-$8.00 to $7.00-$8.00, and is consistent with rising dairy prices which we saw at the auction earlier this week. Fonterra’s net profit for the first quarter rose 85% to $392m compared to last year's period, and operating earnings increased 63% to $575m. The co-op has now upgraded full-year forecast earnings to 50-65c a share, up from 45-60c.

Fonterra cited increasing demand for commodity products, including in the Chinese market in the first quarter which is good news for the economy as well given China is our largest customer. Fonterra said it’s still early in the year, with potential for further volatility in commodity prices, but this is all very encouraging. Management said that higher margins across the Co-op's Ingredients, Foodservice and Consumer channels have driven the lift in earnings, with gross margin up from 15.5% this time last year to 21.4%.

Fonterra expects these higher margins to continue throughout the first half of the year, before tightening across all three sales channels in the second half of the year.

The good news as well is that the increased forecast earnings guidance means Fonterra is on track for a “strong first half dividend.” The overall message was upbeat, with Fonterra having a number of growth initiatives on the go. This includes partnering with a customer in Japan to launch an adult milk powder designed to target muscle loss, and partnering with a customer in China to develop a cake containing the co-op’s probiotics. Shares in the co-op lifted 2.3%. Farmers will receive a payment on the 15th of December.

The NZX50 itself was 0.3% higher at 11,496. Fisher & Paykel Healthcare jumped 1.2%, while Auckland Airport gained 0.7%. Contact added 0.6% while Meridian declined 1.9%.

Sky City has made an announcement this morning. The casino group advises that, following the completion of the first five months of trading, it now expects FY24 earnings (normalised EBITDA) of between $290 million and $310 million. This compares to $310 million in FY23 and previous guidance on 27 October 2023 of a modest year-on-year increase in earnings for FY24. SkyCity sees normalised net profit after tax for FY24 of $125 million to $135 million.

Changes to the guidance reflect a reduction in electronic gaming machine revenue across NZ reflecting “continued cost-of-living pressures and economic uncertainty, which is impacting discretionary consumer spending”, a weaker than expected performance in Adelaide which is also seeing continued legal and compliance cost pressure, and a delay in the settlement of the termination of the Auckland Car Park Concession Agreement with MPF Parking NZ Limited.

The company added that notwithstanding the recent High Court judgment in Sky’s favour, there remains uncertainty regarding the timing for the reacquisition of the car park assets. Sky noted that there has also been an acceleration of investment in online gaming operations ahead of the potential regulation of the online gaming market here. Whilst potential regulation remains at an early stage, the company is optimistic about the medium-term earnings opportunity this offers.

Australia

The Australian market was fairly flat on Thursday, with the ASX200 closing at 7,173. Sector performances were mixed, but none were particularly weak. The mining sector was firmer, but the big story of the day was the news that Woodside and Santos, Australia’s two biggest energy companies, are considering a merger.

Both companies confirmed that discussions were underway, but there was no certainty that they would lead to a transaction. A merger would create an A$80 billion company, and comes amid a wave of consolidation in the sector in Australia and also globally.

It was only 18 months ago that Woodside merged with BHP’s petroleum assets, while Santos merged with Oil Search in late 2021. Companies have been increasing leverage to oil and gas assets, on the view that that energy transition will take longer than anticipated, with fossil fuels set to remain prevalent for several decades.

A merger would create a major global player in Liquified Natural Gas (LNG). The company has assets in Papua New Guinea, while Woodside is the operator of the North West Shelf venture, Australia’s biggest LNG export project, and has a big growth project in the A$16.5 billion Scarborough venture in WA.

Both companies have recently expressed caution over the challenges of softer near-term production, higher capital expenditure and regulatory approvals. It would be interesting to see how regulators view the transaction should the companies look to progress it. After initially dipping on lower oil prices, Woodside gained 0.4% and Santos rose 0.7%.

There were also M&A developments elsewhere. Shares in Perpetual jumped 6.7% after the fund manager formally rejected a A$3 billion buyout proposal from investment conglomerate Washington H. Soul Pattinson.

Australia’s trade balance also widened in October to A$7.13 billion from A$6.79 billion the month previous. Exports rose 0.4% month-on-month, the surplus was however below forecasts for A$7.5 billion.

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