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Investing in stocks on the basis of Budget winners and losers is usually a mistake. The market prices in significant policy changes before the Budget is released, thanks to the Government’s media leaks in the lead-up to the main event. 

And the 2016 Federal Budget was reasonably tame, unless you are smoker or a higher-income earner wondering why the savings blowtorch has been directed towards your superannuation. The Government should leave super alone – or make modest changes with plenty of industry consultation first – a story for another time.

The bigger news this week was the Reserve Bank of Australia’s (RBA) interest-rate cut and growing expectations of another rate cut this year. I have written for The Bull about my expectation for one, possibly two rate cuts this year, and so far the RBA is delivering. 

So what does the combination of the Budget and interest-rate cut mean for share investors?

On balance, the two are slightly bad for Australian shares. The rate cut will maintain interest in higher-yield stocks as investors buy or hold shares for income. Lower borrowing costs and the confidence boost from lower rates (and possibly higher or at least stable property prices) will also help the sharemarket.

However, the Government’s decision to tighten superannuation tax concessions from next year, reducing the income threshold to $250,000 from $300,000, and capping contributions at $25,000, are significant imposts for wealthier superannuants.

Medium term, it means less money flowing into superannuation and less for Self-Managed Super Funds (trustees) to plough into the sharemarket. Wealth-management stocks will be affected, but the change is not enough to alter my positive view on the sector.

Infrastructure-related stocks could be another Budget beneficiary. The Budget includes more than $33 million for infrastructure projects over the forward estimates. The Federal and State governments are showing renewed interest in big-ticket rail and road projects, which is good for building-material providers and infrastructure contractors and construction firms.

But many infrastructure owners, service firms and commodity suppliers have rallied in the past 12 months and are hard to buy at current prices. 

Discretionary retail stocks look the biggest beneficiaries from the Budget and rate cut.  The 25 basis points cut equates to a monthly $43 saving on a $300,000 mortgage over 25 years – not huge, although enough to make a small difference in retail land.

As important is the prospect of another rate cut in the second half and the effect of lower interest rates on the residential property market.  Lower rates should stimulate house prices or at least moderate falls in some capital cities, causing home owners to feel wealthier and more inclined to spend rather than save. Again, it’s not huge, but the savings add up.

The Federal Budget’s tax cuts for middle-income earners, with the tax bracket raised from $80,000 to $87,000, adds about $6 of tax relief each week and stops half a million taxpayers moving into the second-highest tax bracket over the next four years. 

That won’t get cash registers ringing, but the Government has signalled its intention to deliver further tax cuts in coming Budgets, assuming it is re-elected.   

The withdrawal of the 2 per cent deficit levy for those earning more than $180,000 is a more significant income boost, albeit for a much smaller group. 

The extension of concessions to companies earning less than $10 million, from $2 million now – a policy change attacked by Labour – should help Harvey Norman and JB Hi-Fi as more companies use the immediate write-off threshold to buy goods. Harvey and JB probably have most to gain in the retail sector from Budget changes. 

I emphasise these changes are not huge tailwinds for retail earnings. And the sector has many challenges given the fragile economy, record-low wages growth, and a stubbornly high Australian dollar. The likely Federal election in July will be another spending distraction. 

Some retailers performing better than expected

But there is enough to suggest the gloom surrounding the retail outlook at the start of the year was overdone. Some retail stocks have delivered surprisingly strong performance and reinforced that retail, as much as any sector, is about backing management and picking winners.

I have covered a handful of retail stocks several times for The Bull in the past 12 months: Premier Investments, RCG Corporation, Nick Scali, Super Retail Group, and Lovisa Holdings.

Premier Investments has a total return (including dividends) of 15 per cent over one year. RCG Corp has delivered 19 per cent, Nick Scali has returned 19 per cent, Super Retail Group has a minus 20 per cent return and Lovisa has been a shocker, down 31 per cent.

Lovisa still has good international growth prospects but plenty of work ahead to restore market confidence after a nasty earnings downgrade. Although it has lagged its sector, Super Retail has some terrific businesses and seems a touch undervalued.

Wesfarmers looks interesting. I normally focus on smaller retailers, but the conglomerate has improving prospects as arch-rival Woolworths stumbles. Woolies was hammered this week after key ratings agencies cut its credit rating and as analysts lowered their profit forecasts after weaker-than-expected March-quarter sales. Woolworths, getting closer to buy territory, has too much downward momentum and too many challenges to be bullish on it just yet.

Chart 1: Woolworths

Source: The Bull

Wesfarmers should benefit from Woolworths’ underperformance, market-share losses and balance-sheet strains. Wesfarmers, too, needs to lift performance, having delivered a 5 per cent total return over 12 months and only 8.5 per cent over three.

Wesfarmers’ supermarket and discretionary businesses should get a small lift from the rate cut and its office supplies business will benefit from more companies accessing immediate write-offs for equipment. Improving sentiment in the resource sector might be a modest help to Wesfarmers’ coal operations, which have weighed on the stock. 

The market has mixed views on Wesfarmers. Four analysts rate it a buy, six a hold, and three a sell. A median price target of $41.50 suggests it is fully valued at the current $42.46. 

Chart 2: Wesfarmers

Source: The Bull

Wesfarmers can do better than the market expects in the next 12 months as retail spending growth slowly improves and as Woolworths continues to struggles. Wesfarmers would appeal more below $40 and deserves a spot on portfolio watchlists. An expected 5 per cent fully franked yield, based on consensus analyst forecasts, is another attraction.

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Tony Featherstone is a former managing editor of BRW and Shares magazines. The column provides general information rather than specific advice or stock recommendations and takes no account of an investor’s individual needs. Readers should do further research of their own or talk to their adviser before acting on themes in this article. All prices and analysis at May 5, 2016.