Weekly Broker Wrap: Strategies, Exports, Retail, and Health Care

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-Are pay-out ratios sustainable?
-Risks to exports from AUD strength?
-UBS expects modest retail sales growth
-Subdued federal budget for healthcare likely
-Yet further reforms unlikely to be announced
-Medical Developments' key product in trauma

By Eva Brocklehurst

Portfolio Strategy

On face value Goldman Sachs finds pay-out ratios in Australia appear unsustainable. Over the past 12 months the ASX200 has paid out 83% of reported earnings in the form of dividends. This is the highest pay-out ratio in 30 years, the broker notes, and well above other developed markets. The fact that a number of resource stocks have made substantial cuts to dividends over the past few months highlights the focus on sustainability.

Goldman expects growth in shareholder returns will be more muted going forward, and believes there has been too much focus on Australia's high dividend yield relative to other global markets.

The broker agrees with the underlying basis for suggestions that Australia's imputation system and record low bond yields put pressure on firms to maintain a high level of dividend payment as opposed to making future investment opportunities. Nevertheless, this does not account for two important points.

Firstly, the pay-out ratio, while still high, looks better compared with free cash flow than it does when compared with earnings. Secondly, when the cash returned via buy-backs is included, Australia drops to the middle of the range globally.

Ordinarily the broker would argue that firms are better off implementing buy-backs than making dividend payments that are potentially unsustainable, because of the negative price signal a cut to dividend sends. That said, given equity market valuations have been quite high relative to history in many developed markets, Goldman Sachs suspects capital management actions in Australia might prove to be more conservative than many international peers.

Top Picks

Credit Suisse includes Amcor ((AMC)) in its top picks for Australia. The broker considers the stock defensive and well managed, providing exposure to the global packaging market. Bolt-on M&A opportunities are also on the rise. The broker notes 32% of the company's revenue is derived in higher growth emerging markets.

Amcor is expected to generate 6.0% earnings growth in FY17 from the US$200m in acquisitions made over the past 12 months, a sequential improvement in flexibles trading in China and no further drag on reported earnings from US dollar strength. Credit Suisse retains an Outperform rating and $15.30 target.

Services Exports

Net services exports contributed one sixth of Australia's 3.0% GDP growth in 2015 and ANZ analysts expect this segment will slow in 2016, amid a waning stimulus from the Australian dollar.

A stronger-than-expected currency then raises the risk of an earlier and sharper slowdown. There is already some evidence that Australians are holidaying more overseas while education exports have already slowed.

On the optimistic front, the analysts argue that growth in inbound Chinese tourism has been less sensitive to the currency and this is a key driver of services exports. Additionally, given the extent to which a more resilient currency reflects better fundamentals, a weaker outlook for net services exports is less of an issue, the analysts acknowledge.

Retail

Retail sales for February were up 3.3%, below the 12-month run rate of 4.2%, UBS observes. Supermarkets were weak, household goods continued to moderate, driven by a weaker result in electronics, reflecting a tougher comparable as well as the unwinding of Dick Smith. Department stores provided a strong result, recording 7.0% growth.

UBS expects mid single digit growth to continue in 2016, driven by support from the housing market. The broker contends Harvey Norman ((HVN)), JB Hi-Fi ((JBH)) and Adairs ((ADH)) offer the best listed exposure, with Harvey Norman having further upside via successful execution of its efficiency strategy.

The broker also expects the department store sector, namely Myer ((MYR)), should also perform well. Sell ratings for Woolworths ((WOW)) and Metcash ((MTS)) are unchanged. The broker retains its relative preference for Coles ((WES)) within supermarkets.

Healthcare

The upcoming federal budget is expected to update projections on recent shifts in policy regarding bulk billing incentives, the Pharmaceutical Benefits Scheme (PBS) and the freeze on Medicare benefits.

UBS suspects it is too early to book material savings from the key reviews but, equally, the growing budget deficit remains a constraint on largesse. Given major reform processes are under way the broker generally expects a more subdued approach to further healthcare reform in this budget.

Monthly aged care data recently released recently showed 200 basis points in over-spending versus forecasts. While UBS believes this was dealt with in the government's Mid Year Economic and Fiscal Outlook (MYEFO), when a top up was applied and the scoring matrix changed, a modest correction may be considered at this budget.

Still, the broker suspects it is more likely that with scoring matrix changes yet to take effect, and given the political climate, the government may wish to reassess the situation later in the year at the 2016 MYEFO.

Aged care funding growth of 7.1% in the four months to October was in line with Deutsche Bank's expectations and the broker does not expect material reforms to be announced at the May budget, given the cuts already announced at the MYEFO are yet to be implemented.

The broker believes the funding reforms proposed in the MYEFO were largely intended to rein in growth in the complex health care category of funding. The risk of further reform, therefore, will depend on the success of these cuts, the broker maintains, and growth should decelerate in 2016 as providers react to the changes. Further cuts in July may be required to slow growth to the budgeted level, Deutsche Bank suggests.

Medical Developments International

Bell Potter initiates coverage on the specialist health care company, Medical Developments International ((MVP)), with a Buy rating and $7.50 target. The company offers industry-leading products in the areas of pain and respiratory devices.

The company’s Penthrox product is a self-inhaled, fast acting, non-narcotic analgesic for trauma pain. Approval for marketing in the UK, Belgium and Ireland was received in the first half.

The broker notes emergency trauma pain is under-served and a growing market. Increasing use of emergency departments has put them under pressure and Penthrox can facilitate a 3-hour turnaround performance standard and provides an attractive alternative to opioids.

The company's respiratory product is Space Chamber, designed to be used with metered dose inhalers to improve the delivery of asthma and COPD medications. Bell Potter forecasts double digit revenue and earnings from FY16 and considers the valuation reasonable relative to the stock's aggressive growth potential and risk profile. The broker expects 3-year compound growth in earnings of 66.4%.
 

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