Aussie markets risk moving into overpriced territory

Equity investors in Australia will have limited places to park their cash in 2006, says CSFB''s David Trude.

CSFB has had a good year in the Australian markets, among other things advising Foster's Group on its acquisition of Southcorp, and currently acting as global co-ordinator on the A$2.1 billion float of Goodman Fielder. Here the investment bank's country manager and head of Australian equities, David Trude, talks about the challenges facing the Australian market in 2006.

What are some of the biggest issues facing corporates and their need for capital in 2006?

Trude: Profitability has been so strong that in the last couple of years a lot of the top 100 companies have been buying back shares and increasing their dividend payouts. So outside of M&A activity we really haven't seen much in terms of capital raisings from the big corporates. In terms of mid-caps, the IPO market competes with private equity investors, who have been taking out quite a lot of the offerings. So, all in all, corporate supply has been stunted. There have been some financially structured deals including in the private equity sector, which raised about A$3 billion at the end of last year.

Australian equity investors have become very focused on yield, how has this influenced the development of the market?

The retail market is particularly attracted to high yields. This has led to a boom in property trusts and other trust structures which can return yields of between 8% and 12%. The trusts have become another place for investors to park their cash.

So is there enough supply to soak up the demand?

No. There is a lot of cash floating around looking for a home. This cash is coming from people re-investing their dividends or from ex News Corp shareholders re-investing in other stocks after the company moved to New York. Then every time a large acquisition occurs, such as with Foster's purchase of Southcorp, even more money is returned to the market. And then you have the regular flow of cash coming for superannuation (or retirement) funds. The sale of Telstra's third tranche will help to absorb some of this liquidity, but even if you take this into account, money is growing faster than supply.

What is this doing to valuations?

The market is well priced, but is getting into overpriced territory. There is definitely too much money chasing too few deals. At the moment our superannuation pool is about 80% the size of Japan's, but within 10 years this pool will be one-and-a-half times the size of Japan's. This money has to go somewhere.

What's the solution for equity buyers?

Eventually Australian investors must get comfortable with putting more money offshore. Mandates will need to change so that funds are able to invest more offshore. Investors are already getting global exposure through the property and infrastructure trusts which own foreign assets, but more and more they will need to go direct. And they will need to overcome concerns about currency risk before this happens. The other asset investors can consider are international private equity and structured products.

Does this suggest there is a case for local listing of foreign companies?

I don't think so. A few foreign companies are about to list here, like Singapore Power, but these companies have local assets in Australia, so it's not a pure foreign listing. A number of big companies like Kraft and Placer Dome have had listings here in the past but there hasn't been any liquidity in these stocks. Retail investors just aren't close enough to these companies to support them.

Will local companies be able to maintain their dividend ratios if profitability drops off?

We're confident that corporate profits will continue to rise so investors can expect to get their 8% to 10% gross yields for a little while yet. But if profits do slip then yields may come down. There has already been a bit of a shift in appetite, which is taking the focus away from yields. We have seen growing interest in capital guaranteed products, for example, including CSFB's listed Orb warrant. Now investors are a bit more risk averse and are concerned about capital security. The guarantee comes at a cost but investors are willing to pay the premium in return for protection.

Where will M&A activity come from in the next 12 months?

There will be three sources: large takeovers such as the Foster's/Southcorp and Toll Holdings/Patrick Corp deals; small/mid-cap bolt-on acquisitions; and offshore acquisitions by Australian companies.

Tell us about CSFB's prospects for the coming year?

We underwent some consolidation a few years back but now we are on a growth path. Australia is the second biggest market in Asia for us, next to Japan. Our two biggest businesses are equities broking and asset management, but we are focused on building businesses where the margins are acceptable, such as in leveraged finance, ECM and M&A. This month we have been number three in volumes traded on the ASX. One relatively new business for us is alternative capital products, such as private equity products and hedge fund of funds. This has been big offshore but we are building this business in Australia.

Next year the bank will be rebranded to Credit Suisse, dropping the First Boston part of the name. What impact is this likely to have in the Australian market?

The rebranding to Credit Suisse early next year will have very little impact on our day-to-day business here. Globally, it will unify all our businesses and present one face to the market. The Credit Suisse name is very strong in Australia, having had a presence in the market since the 1960s.

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