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Wolseley: US rate hike pulls plug on growth


A glance at the above chart of the FTSE 100 shows it has been a strong week for equities, as the initial shock from Friday’s terror attacks in Paris continues to fade. Recent history indicates that the general public are adapting to terror related events or took it as another factor that might prompt more monetary stimulus.

Broad support for the dollar remained as core consumer prices rose 0.2% in October, marking a year-on-year increase of 1.9%, within easy reach of the Federal Reserve’s 2.0% target. The strong jobs market and rising inflation leave the Fed with little excuse when it comes to the first hike in interest rates since June 2006.

The futures market is pricing in a 66% probability of a hike at the December meeting, which combined with the policy divergence between the US and most other countries, pushed the dollar back up towards a 12-year high against a basket of other currencies.

The Paris attacks heightened expectations among many that the European Central Bank would intensify its efforts to support growth and inflation in the Eurozone, while additional stimulus is expected from Japan after recent poor data. The country’s economy shrank faster than expected at an annualised rate of 0.8% in the third quarter, putting it back into technical recession.

The latest wave of dollar strength has unsettled many market participants, given its potential to impact corporate earnings, emerging markets and commodity prices. Brent Crude Oil slipped to $44 a barrel, its lowest since August 2015, as concerns about oversupply continues to weigh on the market. Industrial metals were also affected, with gold and copper remaining near six-year lows, while zinc and lead hit multiyear troughs.

On the domestic front, Britain's economy, which has grown faster than those of most other rich countries over the last two years, slowed in the third quarter, hurt in part by weakness in manufacturing against the backdrop of a slowing world economy.

The Confederation of British Industry said expectations for manufacturing output over the next three months worsened to -6 from +5 in October 2015, the first prediction of a fall since November 2012. Official data showed on Thursday that British retail sales fell more than expected last month after surging in September, hurt by the biggest drop in food store sales since May 2014. Despite a boost from the Rugby World Cup 2015 in September, the Office for National Statistics said retail sales volumes fell 0.6 percent in the month of October after a 1.7 percent upturn in September.

Technical analysis of the FTSE 100 shows the index bouncing sharply off the physiologically important 6,000 level, moving back above the 50-day moving average at 6,280. The rising oscillators indicate the improved momentum, although they are likely to become overbought before the blue-chips retest major resistance at 6,460, making a breakout appear unlikely at this stage.

In conclusion, December’s central bank meetings will set the tone for the outlook for monetary policy deep into 2016 and is likely to spark some volatility ahead of the turn of the year. As equities move back toward recent highs, I fear the onset of monetary tightening in the US could trigger another correction back towards 6,000, as investors turn their focus as to how fast the FOMC’s tightening cycle will run next year.

Despite a strong performance in US equity indices, with the S&P rallying almost 10% since August 2015 back to within 4% of its record close, I am decreasing my exposure to US stocks. The onset of monetary tightening already appears to be taking its toll on the US housing sector, with apartment construction plunging sharply in October and the pace of homebuilding slipping amid a broader cooling of the real estate market, while builders are less optimistic about sales going forward.

Given their heavy exposure to the US, shares in Wolseley (Epic: WOS), the world’s leading supplier of plumbing and heating equipment, appear vulnerable given its premium rating. Quarterly results on 9th November confirmed that a slowdown in both sales and trading profit growth has continued in all three of its major markets.

Wolseley said its trading profit for the three months to the end of October had risen six percent to £250 million, although like-for-like revenue growth fell in the US, its largest market, for a fourth consecutive quarter. North America generated £683 million, or 76% of the group total trading profits of £857 million for the year.

The plumbing specialist warned that the weak oil and gas sector and the strength of the dollar impacted its industrial markets division, which contributes about 15% of the US’s revenues. Profits in Canada, which represents just 4% of overall trading profit, slumped 21% as market conditions deteriorated sharply in the second half of its financial year.

The group, whose brands include the Plumb Center and Ferguson, took a heavy hit from the ‘challenging’ construction conditions in the UK market, where its trading profit dropped 21% to £19 million. Like-for-like UK revenue fell 1.1% during August to October as the market for the company's core repairs and maintenance business remained weak.

Wolseley reduced its outlook for revenue growth for the group as a whole to 4% from 6% previously, for the year ending July 2016, leaving its valuation looking stretched at these levels. The shares currently trade on 16.2x earnings, which given analysts are forecasting a vulnerable 9% earnings growth next year, puts the company on an unattractive PEG of 1.8%.

The company generated strong free cash flow of £684 million, although this was swallowed by acquisitions, share buy-backs and dividend payments, resulting in a 31% increase in net debt to £805 million. The dividend was hiked 10% to a 2.1% annual yield, although the payment is well covered by earnings, leaving further room for growth.



The chart of Wolseley illustrates the sharp fall earlier this month, which saw the shares lose 8% in five trading sessions. Improvement in the wider market has helped Wolseley recover, although the medium-term trend is lower, the 50-day moving average has intersected the 200-day to the downside and there is strong resistance at 3900p.

Wolseley’s cyclical business is vulnerable to US monetary tightening and poor recent global construction data, leaving the valuation stretched. At the time of writing the share price is 3717p, although if the shares reach 3795p, I would consider a selling-short with a tight stop-loss above resistance at 3918p, offering an attractive risk / reward bias. Near term targets are seen at 3643p, 3510p and 3335p.

This report was written by Mark Allen, equity and derivative specialist. The writer does not hold a position in Wolseley, but client accounts may. The material in this report has come from web-based data sources and Wolseley’s corporate website.





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