Weekly Strategy Note 22/11/2021

Sectors of the Australian share market

Did you know just two sectors account for almost half of the benchmark ASX 200 Index? Understanding the 11 sectors that make up the local share market is important when it comes to building a diversified portfolio of Australian shares and reiterates the importance of having exposure to overseas markets for broader sector diversification benefits.

FINANCIALS

This is by far the largest sector, accounting for approximately 30% of the Australian share market. The four big banks – Commonwealth Bank, National Australia Bank, Westpac and ANZ - make up the lion’s share of the space, but this is also where you will find fund managers (Magellan Financial Group, Challenger, IOOF and Janus Henderson), insurers (IAG, Suncorp or QBE) and investment banks (like Macquarie Group).

MATERIALS

This sector is dominated by mining companies producing a long list of commodities, with customers across Asia driving demand (particularly China, Japan, South Korea and India). Iron ore – the key ingredient in steel production - is Australia’s biggest export, with Rio Tinto (RIO), BHP Group (BHP) and Fortescue Metals (FMG) the three largest players. Close to 80% of Australia’s iron ore shipments have made their way to China in recent years, highlighting our reliance on our largest trading partner’s growth.

Australia’s largest gold miners include Newcrest Mining (NCM), Northern Star Resources (NST) and Evolution Mining (EVN). South32 (S32) is another major miner, which was spun-off from BHP into a separate stock in 2015, so its parent company could better focus on its highest earnings commodities.

With the rapid rise in the popularity of electric vehicles, lithium producers have also received more attention. Two of the larger producers include Pilbara Minerals (PLS) and Orocobre (ORE). Lithium is one of many ingredients used in the production of batteries. In recent years, Tesla (NASDAQ: TSLA) has been one of the most traded stocks by CommSec customers trading US markets via our international desk.

Broadly speaking, miners are most sensitive to the underlying prices of the commodities they sell, together with costs associated with their production. In recent decades, the modernisation and rapid expansion of China’s economy has resulted in consistent demand for commodities like iron ore and coal. The larger miners tend to have greater capacity to keep costs lower than their junior (smaller) counterparts, thanks to economies of scale. However, China’s insatiable appetite for commodities can also pose a risk. Government restrictions on Chinese companies can have significant ramifications, reducing demand for a commodity and in turn leading to lower profits for our miners. China accounts for over half the world’s steel production.

This sector also includes building products suppliers, including Boral (BLD), James Hardie (JHX), Adbri (ABC) or Brickworks (BKW), packaging companies like Amcor (AMC), explosives manufacturers including Orica (ORI), metals recyclers like Sims (SGM) and companies that sell herbicides and insecticides to farmers, like Nufarm (NUF).

INDUSTRIALS

Quite a diverse range of companies are found in the Industrials sector. Some of the more obvious inclusions include heavy machinery manufacturers, shipbuilders, construction and engineering firms and pallet suppliers. However, some not-so-obvious companies can also reside in this sector, including stocks with links to transportation, from airports to toll road operators, airlines and public transport providers. Salary packaging, logistics firms, waste management companies and vehicle leasing businesses also belong in this sector.

CONSUMER DISCRETIONARY

This sector consists of companies that broadly sell goods or services that are characterised as ‘non-essential’. While some might argue that owning an 86 inch TV or the latest Yeezys is necessary, most would consider these to be ‘nice-to-haves’ rather than indispensable to one’s survival. That’s why fashion or consumer electronics retailers, casino operators, travel agents, footwear chains and car dealerships fall in this group. As a general rule, their performance is more likely to be impacted by how well the economy is faring. The more confident and prosperous consumers feel, the more likely they are to spend on discretionary items. The COVID-19 pandemic has accelerated the shift to online trading for many companies within this sector.

CONSUMER STAPLES

Consumer staples are companies that sell goods considered to fulfil basic needs. This includes food, drink, toiletries and vitamins. The largest companies in this sector are the major supermarket chains Woolworths (WOW) and Coles (COL), but also includes alcohol retailers such as Endeavour Group (EDV), infant formula makers like The a2 Milk Company (A2M) or Bubs Australia (BUB), fish farmers such as Tassal Group (TGR), wine makers like Treasury Wine Estates (TWE) and poultry producers such as Inghams (ING).

This sector is often referred to as a defensive part of the market, attracting some investors during tougher economic times. Most people will still buy food, shampoo, toothpaste and nappies even when the economy falls into recession.

HEALTHCARE

Healthcare is another sector considered broadly defensive in nature. While people might delay a holiday, they are much less likely to put off a hearing implant or trip to a hospital. The Aussie healthcare sector is dominated by one company, CSL Limited (CSL) which makes up almost half the sector in market capitalisation (its size on the market). While it is one of the world’s largest flu vaccine makers, it makes most of its profits from plasma products, treating people with immunodeficiency disorders, haemophilia and other rare diseases.

Some of the other large companies in the sector include Cochlear (COH), which makes inner ear hearing implants, Fisher & Paykel Healthcare (FPH), which sells medical devices like hospital humidifiers, ResMed (RMD), which treats respiratory disorders like sleep apnea, pathology and imaging group Sonic (SHL) and Ramsay Healthcare (RHC), which operates hundreds of private hospitals around the world.

INFORMATION TECHNOLOGY

Stocks in this sector are often referred to as growth stocks, meaning they are often expected to grow at a faster pace than the broader market. However, some might not yet be profitable, spending big on global expansion instead, which often means that many do not pay dividends.

Australia’s technology sector is tiny in comparison to international peers. To put this in perspective, the five largest technology companies on the Australian market are worth approximately $70bn. The five largest tech stocks in the United States (Apple, Microsoft, Amazon.com, Alphabet and Facebook) are worth around $12 trillion, which is approximately four times the size of the entire Australian share market. Nevertheless, this is where you will find cloud-based accounting software company Xero (XRO), logistics software group Wisetech Global (WTC), share registry operator Computershare (CPU), data centre business NEXTDC (NXT) and design software provider Altium (ALU).

COMMUNICATION SERVICES

This sector has been dominated by Australia’s largest telecommunications company, Telstra (TLS) for decades. Since making its ASX debut in the late 1990s, it has been one of most heavily held stocks by mum and dad investors, paying out most of its profits in dividends to shareholders. In 2017, Telstra flagged plans to reduce the percentage of profits it distributed as dividends, favouring plans to reinvest a larger portion of profits into growth as it faced greater competition. While it remains the largest company in the sector, it has failed to grow at the same pace as other stocks that sit within Communication Services, including property classifieds company REA Group (REA), job search site SEEK (SEK) or Carsales.com (CAR).

UTILITIES

Utilities are companies that provide essential services like water, electricity and natural gas. This is the smallest sector of the Australian share market. Two of the larger stocks in the sector is natural gas pipeline company APA Group (APA), which distributes gas to every state and territory, together with AusNet Services (ATS), which owns and operates the Victorian electricity transmission network. Energy producer and retailer Origin (ORG) and AGL Energy (AGL) are also in this sector.

This sector may be attractive to some investors seeking generally stable and consistent dividend payments. While sensitive to changes in regulation and prices (of electricity for example), some stocks in the sector can deliver relatively predictable revenues.

PROPERTY TRUSTS

Simply put this sector is filled with businesses that buy or develop property and lease/rent them out for income. These are often referred to as Real Estate Investment Trusts or REITS. The type of properties they own vary and can give investors access to properties that would be challenging for most to purchase directly, like shopping centres, office buildings, retirement villages, warehouses and distribution centres.

Property trusts that operate shopping centres include Scentre (SCG), Vicinity Centres (VCX) and SCA Property Group (SCP), Goodman Group (GMG) is the largest industrial property group on the Australian market, owning sites used as warehouses, distribution centres and factories. Dexus (DXS) owns and manages over 180 office buildings. Some property trusts own a range of properties, like Stockland (SGP) or Lendlease (LLC), which manage portfolios of retail, office, logistics, shopping centres, residential and retirement villages. Others have developed relationships with one or two significant tenants, like BWP Trust (BWP). It is the largest owner of Bunning Warehouses in Australia, with a portfolio of 65 stores.

Property trusts are attractive to some investors when interest rates are low, as some offer consistent dividend payments (referred to as distributions in this sector). Note that during the COVID-19 pandemic and due to lockdowns, many property trusts reduced or put their distributions on pause.

ENERGY

The sector consists of oil and gas producers, coal miners including Whitehaven Coal (WHC), fuel refiners such as Ampol (ALD), uranium mine operators like Paladin Resources (PDN) and companies that provide services to these companies like Worley Limited (WOR).

The engine room of this sector, however, remain the oil, gas and LNG producers. Woodside Petroleum (WPL) is the largest, followed by Santos (STO), Oil Search (OSH) and then Beach Energy (BPT). Their profits are driven by production levels, costs and importantly commodity prices. While they at least have some control over production and costs, they are vulnerable and sensitive to movements in energy prices. Profits receive a healthy boost in times when global supply is low and demand is high and come under pressure when the opposite is true.

Perhaps no other global organisation has a greater impact on prices than the Organization of Petroleum Exporting Countries or OPEC. Many of the world’s largest oil producing nations are members of the cartel. This can put prices at the mercy of its 14 member states, which account for over 40% of global production. However, it is often in the cartel’s interest to keep prices at reasonably profitable levels to benefit their members, which in turn can provide a little more stability for energy producing companies. OPEC holds a monthly meeting, which is often a platform for setting production targets for the month ahead. Agreements reached can impact energy prices.

Please do not hesitate to contact us if you have any questions.

WEEKLY STRATEGY NOTE