Devon Funds Morning Note - 18 February 2025

Tuesday 18th February 2025

The cold shoulder

Global

The US markets were closed for Presidents’ Day but the European indices hit a record high on Monday. The STOXX50 jumped 0.4% and the German DAX surged 1.3%. The defence sector boomed as European leaders gathered at an emergency summit to discuss the talks between the US and Russia over ending the war in the Ukraine. These discussions have to date excluded officials from Ukraine and Europe. The FTSE100 rose 0.4% with defence giant BAE Systems jumping 8%. British PM Kerr Starmer said he was willing to put UK troops on the ground to help “guarantee future stability” and ensure any peace deal is a lasting one.

European leaders appear to be concerned that they are being left out in the cold with respect to discussions over ending the war. EU leaders are at the Elysee Palace in Paris for the talks. Rather than standing shoulder to shoulder with European allies, Washington appears to more focussed on bringing about a peace deal through direct engagement with the Kremlin.

Donald Trump has also in the past made no secret of his feelings around NATO, and his view that the US has been paying more than its fair share. Recent developments are therefore striking an even bigger chord, and what it might mean for the alliance and European security generally. Ukraine’s President Zelensky (who recently called for Europe to build its own army) has said that Vladimir Putin may be waiting to “wage war” on a weakened NATO which could be triggered by “the US taking its military from Europe."

This has served as a wake-up call to EU leaders who are now contemplating strengthening their own defences and being less reliant on US military firepower. European defence stocks charged higher as a result. Germany’s Renk Group (which makes military vehicles) and arms manufacturer Rheinmetall soared 16.5% and 14% respectively. Swedish defence manufacturer Saab soared more than 16%. In the UK, aerospace and defence company BAE Systems soared higher. Another big mover in the UK was health-care property firm Assura which rallied 9% on news it had rejected a £1.56 billion takeover bid from U.S. private equity giant KKR.

Defence spending in Europe looks set to rocket higher. At the Munich Security Conference over the weekend, the head of the European Commission proposed exempting defence from EU limits on government spending. It has been estimated that every 50 basis point increase in European defence spending is worth about US$115 billion annually, of which 40% is likely to be spent on weapon systems. Somewhat ironically, around a third of this could head to U.S. defence contractors, including the likes of GE Aerospace.

Donald Trump wants European members of NATO to more than double military expenditure to prepare for a potential Russian attack, rather than relying on the US, which is becoming increasingly focussed on security threats from China.

The implementation of protectionist measures in the form of tariffs meanwhile will have done little to cool US/Sino tensions.

In Asia, the CSI300 was 0.2% higher while the Hang Seng was flat. Tech titan Tencent jumped 4% to the highest level since July 2021 as the company's Weixin messaging app began beta testing Deepseek integration. The company’s co-founded Pony Ma has become China’s richest person on paper.

Chinese President Xi Jinping meanwhile attended a symposium on private enterprises in Beijing, with big tech execs also in attendance. The President looks to be bringing big tech in from the cold, promising a more supportive stance, and relief from excessive fines. Better late than never. President Xi voiced support for Alibaba’s Jack Ma. Rather than looking to trim down tall poppies, officials may now see the sector as a key way to revive the Chinese economy.

In Japan, the Nikkei was flat. The Japanese economy grew 0.7% quarter on quarter in December, more than the 0.3% rise expected. On an annualized basis, GDP grew 2.8%, exceeding estimates of 1%. A jump in exports helped boost GDP, while domestic demand was a drag on growth, contracting marginally. Full-year GDP growth slowed to 0.1%, a sharp fall from the 1.5% growth seen in 2023. The data reinforces the case for the Bank of Japan, which has raised rates to 0.5% (the highest level since October 2008) to continue with tightening plans.

New Zealand

The Kiwi market was on the up on Monday, dominated by A2 Milk which soared 19.5% on its result (see yesterday’s note). Investors were enamoured by the results beat, first ever dividend, and upgrading of forecasts.

A2 achieved 10% sales growth despite a declining Chinese infant milk formula market (as China births continue to decline). The company is executing well on brand awareness and marketing, and is taking market share. A2 is the fifth largest infant milk formula brand in China, but still only has ~5% of the market, so plenty of scope for further growth. The launch of its new product “Genesis” soon could spur more sales. A2 is meanwhile sitting on a cash pile of $1 billion, some of which will eventually be returned to shareholders.

Freightways also came in with a good result, and the shares closed up 5%. Contact declined 2.6% following its numbers, while Infratil was weaker following its Manawa Energy-driven profit downgrade.

This morning Infratil has announced that it is lifting its stake in the CDC data centres business to 49.75% (acquiring a further 1.58% of the company). Infratil is, along with the Australian Future Fund, exercising rights to acquire a 12% stake in CDC from Commonwealth Superannuation Corporation. Infratil’s move reflects its “strong conviction” around CDC and is looking to ride the “powerful tailwinds driving digital infrastructure”.

Also this morning, Turners Automotive has upgraded its FY25 guidance to a net profit before tax of at least $53m (previous guidance to exceed $50m net profit before tax), 8% ahead of the $49.1m achieved in FY24. This will be the fifth consecutive record profit for the company, despite challenging economic conditions.

People are continuing to buy cars, but not all might be able to afford them it seems. Heartland Bank has announced an impairment expense of $49.6 million in its New Zealand bank “in response to the impact of ongoing deterioration in economic conditions in New Zealand.” This impairment expense relates predominantly to arrears within Heartland Bank’s Motor Finance and business lending portfolios.

After the good news on the manufacturing sector, we have also had some on the NZ services sector. After 10 consecutive months of contraction, New Zealand’s services sector exhibited slight expansion during January to 50.4, an increase of 2.3 points from December. Activity/sales are at the highest level since March 2023. New Orders/Business are still static though.

It is encouraging to see the survey stabilise, although the results arestill a little weaker than global comparatives (52.2). It is a positive signal for growth. When combined with PMI, Composite Index suggests recovery which is consistent with other data. Are we at a turning point? That might be too early to call.

Falling migration levels have also been a handbrake on the economy, but there may also be some evidence of this headwind plateauing. New Zealand had a net migration gain of 27,100 in 2024. This was down from a net gain of 128,300 in 2023. The “brain drain” continued. Migrants aged 18 to 30 years made up 38% of the departures of NZ citizens in 2024.

People though are though happy to come for a good as opposed to a long time when considering tourism number. These are looking more positive. Seasonally adjusted terms visitor numbers rose 3.5% in December and are up over 12% year on year. There were 3.314 million visitors in 2024. Australia led the increase in visitor arrivals, up 127,000 (10%) from 2023. China followed with an increase of 97,000 (64%), and the United States with an increase of 32,000 (10%). Overall though, we are still 15% lower than the pre Covid peak, so further to go here.

Australia

The Aussie market was lower on Monday, with the ASX200 down 0.2% at 8,537. Sector performances were mixed. Healthcare was in positive territory, but energy, gold and financials were lower.

Westpac fell 4.1% on its update (see yesterday’s note) while Bendigo and Adelaide Bank tumbled 15%. The regional lender reported that half-year profit fell 10% on the prior six months (and -1.1% on a year ago) to A$265.2 million. The bank has been writing business but pricing has been lower it seems. Net interest margins weakened six basis points to 1.88%.

Lendlease rose 0.1% on its result. Rail haulage group Aurizon saw its share price fall then recover as half year earnings fell 4% and it warned that full-year earnings would be at the lower end of its forecast range (coal and bulk haulage has been weak). The company increased its share buyback again.

Woodside Energy fell 2.9% as guidance from the oil and gas producer disappointed, with implications that the final dividend will come in under estimates. The energy giant’s reserves and proved-plus-probable reserves fell in 2024.

BHP has released results this morning, with first half year profits down 23% to US$5.08 billon. Falling demand from China for iron ore and copper have been a big factor. Prices for these commodities also dipped during the period. The world’s largest miner has cut its dividend to US 50 cents a share from US 72 cents a year ago – this is the lowest payout since 2017.

We have the RBA meeting today. Markets are pricing in a very strong probability of a rate cut, but a resilient economy and persistent global inflation could provide cause for officials to spring a surprise.

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