ASX Market Update 6th April 2022

ASX200 (XJO)

· The XJO closed +1.18% for the week with a high of 7,556.60 on Wednesday and a low of 7,406.20 on Monday.

· This week marked the third week in a row of gains for the XJO

· In March the XJO rose +6.4%

· For Q1 the XJO was +0.75% vs S&P500 -4.9%. It was the worst quarter for the S&P500 since Q1 2020. It was also the first time the XJO had outperformed the S&P500 for a quarter since 2018.

*Best/Worst performers on the XJO for March

Global Market Commentary

*Chart: S&P500 as at 04/04/22

Much like the S&P/ASX 200 global equity markets have seen strong recoveries over the last couple of weeks. In fact, up until Thursday evening, the S&P500 had a 10-day period where it was +11% in that time. A very rare occurrence that has only happened a handful of times throughout history. Regardless US indices seem to have broken their downtrends and look set to consolidate at these levels. It must be noted fourteen of the last fifteen April’s have been positive for the S&P500.

The Ukraine & Russia situation continues to create headlines, as expected, but seems to have little impact on equity markets outside of the EU. Increased sanctions are likely as the west pushes for Putin to be charged with war crimes for the atrocities in the Ukraine. The EU has started turning away from Russian gas with the Baltic states are halting imports. Whilst this is only a small portion of gas supplied to the EU by Russia it sends a message. Germany wants to wean itself off quickly by halving the amount it imports from Russia by the end of 2023. It has major plans to build LNG terminals so it can replace it and start importing LNG into the country. The amount needed to reduce reliance it is staggering. Just to reduce the EU’s reliance by half would require 50bill cubic meters of LNG, which is not so easily come by. Australian & the US producers will set to benefit as prices should remain elevated for some time.

The other main area of focus remains yields, cash rates & inflation. We had a major macro-occurrence to end the week, whereby the 2 year & 10 year US treasury bonds inverted and remain so today. This is where the 2-year treasury yield is higher than the 10 years. It has almost a 100% accuracy of predicting a recession in the US as it is telling us there is trouble ahead for the economy. This may alarm you, but it shouldn’t be of an immediate concern. The last four times the 2 & 10 years have inverted the S&P 500 has gone on to rally a further 29% on average, peaking roughly 17 months from inversion. A recession has then started 21 months thereafter the inversion as well. Now given how we have manipulated monetary and fiscal policy I’m not sure how reliable these past indicators can be. However, a better and more immediate indicator is when the 3-month & 10-year treasury yields invert. On average a recession has started 11 months thereafter. The spread between the two remains very wide at 181bps, so its of no concern at this point.

Australia

*Chart: S&P/ASX 200 as of 05/04/22

The landscape in Australia hasn’t changed much despite the troubles we have seen around the world. Our economy is now in a ‘Goldilocks’ stage where most sectors are starting to hum again. The tourism and services sector still has work to do but it will get there. Our jobs market is strong with unemployment to be 3.6% by year’s end, household spending is seeing solid growth as is construction. Business investment is the big one which is lifting substantially, and, in a way, we haven’t seen in a decade. This obviously bodes well for the future of the economy as business invest in themselves, they increase capacity and demand more jobs. I notice the federal government in their budget last week signaled net immigration would return to 180k pa in 22/23 and 213k in 23/24. It looks like ‘Big Australia’ is back on the agenda again. This will also help ease the labor shortages we are seeing across many industries.

The RBA kept the cash rate on hold again at 0.10%, but its stance has become more hawkish as it signaled rate hikes to come in the second half of 2022. We have Q1 CPI figures out on 27th April just before the next RBA meeting. My bet is they are going to come in hot and we see a 15bps lift by the RBA in May followed by 25bps again in June to take us to 0.50% to end the financial year. This will help ease us into the next rate lifting cycle, although I’ll doubt it will do much to trim inflation.

Technically the XJO has broken out of that downtrend we saw to start the year and had strong move to the upside. I wouldn’t be surprised to see some softness here as we head into an election soon, or at least some consolidation. Overall thought the XJO remains at attractive levels with earnings growth of around 13% expected for 21/22 and a forward PE of approx. 16x. I did mention our large outperformance vs the S&P 500 earlier and this can be simply put down to our heavy commodities-based index which benefitted from skyrocketing commodity prices. Our financial also outperformed with the prospects of higher rates being factored and limited exposure to the conflict over in the EU.

I wrote about being overweight Resources, Financials & Energy in my last newsletter to you all and that stance remains the same. You can find that article here.

Lithium

*Chart: Allkem Ltd as at 05/04/22

I have been getting a few enquiries regarding the lithium sector in the last week. I suspect this in part of extra media coverage and the fact the space is so hot. There has been a focus due to some important news release by Allkem (AKE) last week.

In a market update they announced that not only had Q1 22 prices exceeded forecasts by some margin but that Q2 forecast pricing were going to be lifted substantially as well. In their Q2 update they stated they expected to receive $US35kt for their lithium carbonate product, up from a previous forecast of $US25kt, and $US5kt for their spodumene product, up from $US2,500. Obviously, these are significant upgrades for them and have huge ramifications for the sector. If AKE can obtain these prices, then most producers will be in the same boat such is the huge demand and supply constraints impacting the sector.

They also announced in a quick update today that they will be lifting production on their lithium brine mine in development Sal De Vida. The first stage will produce around 15kt of lithium carbonate pa in H2 CY23 with stage 2 & 3 rolled into one now which will eventually output 45ktpa of product. Production will commence two years after the completion of stage 1 construction, therefore approx. H2 CY24 or early 2025.

To compound the above Mineral Resources (MIN) announced today that the planned restart of its Wodgina mine would now entail two trains instead of the previously planned one. Each train has a 250kt pa capacity of 6% spodumene product. They expect the second train to be up and running in May with the first train up and going in April. They are also investigating a possible third & fourth train of production later this year. Finally, their Mt Marion mine, which is already been in production, will increase its output from 450kt pa to 600kt pa by the end of April. Comments regarding pricing suggested they expect lithium prices to be strong into the end of the decade.

It's obvious that demand for lithium products is rising much faster than anyone anticipated. To start 2022, it was expected that prices would moderate in the second half of the year. Demand has been so fierce that it now anticipated that lithium carbonate will top out at $US40kt sometime in 2023. The hard rock spodumene product is already fetching $US5,750t in spot markets within China. This is the same product that was being sold for $US400t at the end of 2020. Overall, it’s expected that lithium demand will rise 11% CAGR between 2022 & 2032.

Extraction technology within the industry is also moving fast with South Korea’s POSCO declaring they would be setting up a $US4bill Direct Lithium Extraction (DLE) plant in Argentina to process 25ktpa in lithium product initially with 100ktpa at full capacity. Lake Resources (LKE) is an ASX listed company looking to do similar, but well behind POSCO. DLE is important as it’s an extraction method that doesn’t use evaporation ponds and extracts the lithium directly from the brines. This is important as it uses basically no water, doesn’t need much of a footprint in terms of land use and has a better recovery rate. Whilst DLE has been successful in small trial plants it’s never been done on a commercial scale before. Obviously if it works it changes the lithium supply game very quickly and allows for the addition of production capacity at a hastened rate. It has stated it will start production in H1 CY24.

Finally, lithium-ion battery composition is changing quickly. It is now predicted that Lithium iron phosphate (LFP) batteries will dominate the industry over the current Lithium NCM (nickel, manganese, cobalt) make up as soon as 2028. The benefits being much larger storage capacity, output, lower temperatures, and cheaper batteries. Now the cost of nickel & cobalt is increasingly making lithium batteries more expensive. Phosphate is relatively cheap in comparison and much easier to find. Thus, this also means the price of lithium will impact battery prices less moving forward and presents less of a problem. It now makes sense why BHP are so heavily invested in those Phosphate projects due to come online later in the decade.

As I spoke about last time around, I prefer the current producers over explorers/developers in the lithium space at this stage. Thus, this means a preference for Allkem (AKE), Pilbara Minerals & Mineral Resources (MIN). In my last update they were all about 20% lower in price, but I believe have plenty of upside over the next 12 to 18 months and should be accumulated on any dips. The reason I prefer these producers now is because they can take immediate advantage of current prices plus and ramping up immediate production.

*Chart: Core Lithium (CXO) as at 05/04/22

I have had a lot of enquires about Core Lithium (CXO)as well, I think as they are an SA company and have received some media lately. My thoughts are even though they are Australia’s next producer they have a lot of good news priced into the stock already. They are close to a $2.5bill company who won’t start commercial production until H2 2023. A lot can happen to the lithium price in that time and as I was once told by an extremely experienced analyst. The worst thing a mining company can do for its share price is go into production. This is because instead of being valued on ‘blue sky’ potential and ‘what ifs’ you can suddenly be valued on real world data such as production, costs, revenue, profit etc. Mines are extremely hard projects to get off the ground and even harder to get done on budget and on schedule. If you start to miss some targets or there are cost overruns this will be reflected in your share price quickly. Its very rare not to have some hiccups along the way. Thus, for me now CXO is as an avoid. Technically speaking I would be interested if it pulls back to the $1 - $1.20 range and can hold there. I would then be happy to pick it up as a trade with tight stop losses.

In the end the lithium sector remains hot and should be treated cautiously as it is a high-risk sector. Moves can be quick and volatile. If Chinese government intervene in pricing, or we head into a recession then this could impact demand. A lot of these lithium ‘hot’ stocks are at extremely lofty valuations, and most will never get close to a mine. I am not expecting a crash in the sector any time soon, but 20%+ pullbacks could still be experienced.

Industrial Small Cap City

To round the newsletter out I thought I would cover a few of my favourite small cap stocks that seem to be value at current prices. Again, being a small cap comes with heightened risk and thus should be treated accordingly.

Acrow Formwork & Construction Services (ACF) $0.505- A construction services company specializing in the supply of formwork and scaffolding in the industry. Have seen very solid increase in earnings over the last few years. With the construction industry in a boom phase and infrastructure spend expected to grow at above trend for the next few years ACF are in an enviable position. NPAT is forecast to grow at 84% this year with Morgan’s expecting a 7cps EPS in FY22 & FY23. That means ACF is currently trading at just 7.2x forward earnings. It also boasts an almost 20% ROE and 6% forecast yield.

Laserbond (LBL) $0.905- LBL is a specialist surface engineering company that focuses on the development and application of materials using advanced additive manufacturing technologies to increase operating performance and life of wearing components. For example, they will apply their special coating to older mining equipment to extend its life. This is important now when there are long and expensive lead times to replace and receive specialized mining equipment. They can also produce these products using their specialist material and client specifications which are proven to be much more durable. Covid has hindered their business and seen growth slow from previous expectations, however coming out the other side should also see an acceleration. The company plan to hit $60mill in revenue by 2025, mainly via organic growth. Canaccord have a $1.35 price target on them with forecast PE at 18x & 14x FY22 & 23. I can see them exceeding expectations in a time when mining and construction equipment is hard to come by and thus extending the life of existing equipment will be imperative.

SRG Global (SRG) $0.69- SRG is a global specialist engineering company working mainly in the construction and mining industries. The offer bespoke solutions to complex problems and projects and carved out a real niche in the industry. They recently acquired WBHO Infrastructure in WA for $15mill and the business has a history of generating more than $150mill in revenue. Shaw’s have a price target of $1.00 on them with forecast PE of 15x FY22 & 11.5x FY23. It is also forecast to boast a 4-5% yield during that time. Again, in an era where specialist engineering services are highly sought after and with $1bill work in hand ($6bill in tendered opportunities) I feel SRG represents great opportunity.

Mitchell Services (MSV) $0.40- MSV are simple and provide drilling services globally to the mining and energy industries. Whilst they have had a couple of tougher years, they have been smart during that time acquiring as many drilling rigs as possible and are not finished yet. Therefore, debt has grown over that time but is expected to be paid off rapidly. A family run business who still own almost 20% of the stock they are celebrating their 50th anniversary. Washington Soul Pattison see them as an opportunity as well owning 6% of the stock. Mining drilling is expected to ramp up over the next few years as we try and increase production in key materials such as copper, nickel, lithium, and fossil fuels. In 2014 they had just 8 operating rigs and $15mill in revenue. In FY22 they are expecting an average operating fleet of 74, with 85 to end the year, and operating revenue of $200-$220mill. Gold makes up 55% of their rig demand with coking coal coming in at 32%. Only 5.6% of their revenue comes from WA, thus providing an excellent avenue for further growth. Almost half of their revenue comes from QLD. Morgan’s have put a price target of $0.66 on them trading at just 8x & 5.5x forecast EPS for FY22 & FY23. EBITDA is expected to come in at $40-$44mill with an expectation of that rising to $50-$60mill in FY23. Overall, it looks like a solid turn around story.

Another market update in the books and in quick succession from our last. Hoping to keep these more regular for you as we move along. Would love to move to video or podcast form eventually but that requires me learning some form of editing software. Also, how are we already in April of 2022? Coming out the other side of this pandemic seems to have moved very quickly and 2020 is a distant memory.

Term 1 is almost over for school kids here in SA as they embark on holidays during the Easter long weekend. I can’t wait to have them both home for two full weeks and getting to spend some solid time with my boys. Also how great was that win by the Crows on Friday night. Still buzzing with that after the siren goal. Who would have thought Port would be 0-3 at this stage and likely to be 0-5 with the Demons and Carlton in the next two. Its glorious….. sorry Port fans ha ha #sorrynotsorry. Hope you all have a wonderful and safe week. I can’t wait to speak with you all soon. Until next time. Go Crows!

heath@hlminvestments.com.au

0413 799 315

Important Notice

Any advice in this article should be considered General Advice only and does not consider your personal needs and objectives or your financial circumstances. You should therefore consider these matters yourself before deciding whether the advice is appropriate to you and whether you should act upon it. I am happy to assist you in this process. To do so, I will need to collect personal and financial details from you before providing my recommendations. Please note the author may own shares in the companies mentioned in the above blog.