Weekly Broker Wrap: Strategies, House Supply and Classifieds

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-Tough season ahead for banks amid margin pressure
-Morgan Stanley moves to overweight on resources
-Credit Suisse suggests lower rates should spur more investment
-Record pipeline of work suggests building completions remain elevated
-Likelihood REA and FXJ refer to volume weakness in results
 

By Eva Brocklehurst

Strategy

Defensive growth and income stocks are trading well above historical valuation, while the cyclical/risky segments seem cheap, UBS maintains. The broker envisages a risk that the relative valuation argument will carry equities to new highs. Demanding absolute valuations and low levels of risk aversion suggest a degree of caution is warranted.

UBS also notes that while the economy appears benign, specific headwinds in terms of capital and funding for the banks are likely to weigh on sentiment. The broker expects a tough reporting season for the banks amid evidence of margin pressure.

The broker pushes up its weight for mining from slightly underweight to neutral on a risk/return basis by adding Rio Tinto ((RIO)) into the model portfolio. The stock’s valuation is considered reasonable, particularly versus many other areas where the margin for error is low. However, the house view that iron ore will drop back below US$50/t in the second half continues to dampen enthusiasm.

Morgan Stanley expects earnings upgrades rather than downgrades at the August results with positive drivers in play for Australian materials after a five-year bear trade for the miners. There has also been the benefit of the first half stimulus in China, with some trailing effect that provides near-term stability for resource stocks.

The broker changes its industry view for materials to Attractive from In-Line, believing appetite for the sector is returning. There are still risks for seasonal de-stocking in iron ore and moderating growth in the second half for China but the broker expects any weakness to be shallow.

Morgan Stanley envisages an equity rotation opportunity in resources and moves to overweight on the sector in its model portfolio. The broker believes this view is supported by commodities being past their spot lows and a supply outlook that appears more constrained than it was six months ago.

The broker still favours quality rather than leveraged companies, given potential volatility. Both South32 ((S32)) and Fortescue Metals ((FMG)) traded ahead of expectations this year. South32 is upgraded to Overweight from Equal-weight based on continued productivity gains. Fortescue Metals is upgraded to Equal-weight from Underweight as it fully captures the spot price while the broker will watch for a pull back to re-visit its thesis.

The broker increases the weight in its model portfolio for BHP Billiton ((BHP)) and adds in Woodside Petroleum ((WPL)), South32 ((S32)) and Western Areas ((WSA)). Weights in Aconex ((ACX)), Vocus Communications ((VOC)) and Sydney Airport ((SYD)) are reduced.

Emerging markets ex China are now at the stage where growth is weak but stability is improving and the broker expects some of these economies should move to the gradual recovery phase in 2017, driving an acceleration in growth for the first time in four years.

Morgan Stanley is also cautious about the banks, maintaining an underweight view on the sector given the risk relating to capital, credit and margins. Linked to this is a view that housing activity has peaked.

The search for yield has been given a boost by the last reduction in official interest rates from the Reserve Bank of Australia to a record low of 1.5%, Credit Suisse asserts. The dividend yield for Australian equities has compressed to 4.3% from 5% at the start of the year but the spread between cash and dividend yields remains close to record levels at 280 basis points.

The broker believes lower rates are a reason to spur more investment not less, and with the lowest cost of debt in a generation, also believes a buy-back of shares has never been as accretive as it is now.

With the market trading at elevated valuations the test, Morgans maintains, will be whether earnings have held up in a subdued economic climate. The broker is worried that conservatism will ultimately prevail and this will mean further cuts to expectations.

In aggregate, the broker errs on the side of caution but envisages some opportunities across its coverage that may surprise the market. Resources and energy have rebounded strongly and carry positive earnings momentum into reporting season. The broker envisages some potential for upside surprise in August.

Morgans lists Telstra ((TLS)), Coca-Cola Amatil ((CCL)), AusNet Services ((AST)) and Sydney Airport as attractive, with dividend yields over 4%, low volatility and a capacity to maintain distributions over coming years.

House Supply

UBS finds that although dwelling completions have lifted to a record 190,000, the cycle is only two thirds the way through and will likely peak at 210,000 in 2018, which would be up around 50% on 2012. This suggests upside risk to the broker’s GDP-based dwelling investment forecasts. The lift is entirely driven by a super cycle in multi-unit dwellings.

UBS calculates that even if new building approvals slumped from now on, a record pipeline of work to be done implies completions will remain elevated over the next few years.

Real Estate Classifieds

New listings in the national property market fell 11% in July. While Deutsche Bank believes the decline can, to some extent, be attributed to the federal election, it is also being affected by tough comparable periods.

The broker suspects significant growth previously will put pressure on volumes in the remainder of the September quarter and there is a likelihood that both REA Group ((REA)) and Fairfax Media ((FXJ)) refer to volume weakness at their upcoming results.
 

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