Weekly Broker Wrap: Asset Managers, Media, A-REITs

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Political shocks; asset manager performance; Oz online media; Morgan Stanley urges caution on A-REITs; China and oil prices; and Aurora Cannabis.

-Material changes in economic policies in UK, US and Japan likely to impact financial markets in 2017
-Tough job seen ahead for Reserve Bank in getting inflation back to target
-Citi initiates with Buy ratings on Carsales.com and REA Group
-A-REITs sector considered likely to underperform as bond rates rise
 

By Eva Brocklehurst

Global Outlook

The global economy has endured political shocks in 2016 and Commonwealth Bank analysts expect material changes to economic policies, with ramifications for financial markets. For example, the UK government, in response to grievances highlighted during the Brexit campaign, has announced a fiscal stimulus package equivalent to more than 6% of GDP over five years. US President-elect Donald Trump is expected to unleash a large fiscal stimulus and add demand to an economy that is already close to full employment.

The analysts expect the Japanese government will follow suit and unveil a fiscal stimulus package early next year. Meanwhile, the Eurozone is expected to be the centre of political risk in 2017 with the French presidential elections to be held in April and May.

While the National Front's Marine Le Pen is underperforming in the polls, the analysts cite the lesson of 2016: expect the unexpected. At the end of next year the five-yearly reshuffle of China's leadership will occur. Senior officials are expected to be highly risk averse with little appetite for economic weakness.

In the context of political risks, Citi notes investors have become focused on Italy's upcoming referendum. The broker maintains a view that a “No” vote is the most likely outcome as the populace rejects the reform proposals. Yet the broker concedes the probability of a “Yes” vote may be underestimated. The analysts stress that how/if the electoral law is modified is more important than the referendum in determining the chances of an anti-establishment, anti-euro party coming to power at the next election.

Italians will vote on constitutional reform of the parliamentary system which mainly envisages a reduction in the number of senators, a curbing of the legislative powers of the Senate, and centralisation of a number of functions with the central government. The analysts believe the future of the centre-left government is in question, raising the prospect of early elections in 2017.

The magnitude of moves to the downside are unlikely to be large or lasting as a “No” vote is priced into the EUR/USD. A “Yes” outcome could unwind some of the recent weakness in the euro, initially. The broker believes Italy's banking sector is the most vulnerable to a “No” vote because of potential delays in ongoing capital raising operations and high exposure to sovereign debt.

Over the next few years, if Commonwealth Bank analysts are correct in their forecasts, the balance of risks may start to shift to tighter monetary policy after a long period of very easy policy. The analysts expect Australia's inflation rate to be 2.0% in 2017 and 2.4% in 2018 versus the Reserve Bank's forecast for underlying inflation to remain below the bottom of its 2-3% target band. There is still plenty of spare capacity in Australia's labour market which signals wages growth is likely to remain subdued.

The current 1.5% cash rate is expected to be the bottom of the cycle but the analysts suspect the Reserve Bank will have a tough job getting inflation back to target. The link between monetary policy and financial stability has also become more direct, and RBA governor Phillip Lowe has stated he is not keen to lower rates further if it means households take on more debt.

Australian Asset Managers

Credit Suisse's analysis of asset managers indicates that Henderson Group ((HGG)) is under earning on performance fees and has medium-term upside from its compensation ratio. There is scope for the company to lower its compensation ratio as it shifts towards its aspirational target. In contrast, Magellan Financial ((MFG)) over earned on performance fees in FY16.

While Magellan Financial utilises performance fee structures more than most, its exposure is more moderate at 10% of normalised net profit. Henderson is more exposed to performance fees at 19% of normalised net profit. BT Asset Management ((BTT)) has a higher exposure too, at 17%.

Meanwhile, Perpetual ((PPT)) and Platinum Asset Management ((PTM)) offer downside risk because of cyclically low compensation ratios. Their exposure to perfomance fees is low at 2% and 1% respectively. The broker believes the return to fund performance could mean a rise in the compensation ratios of these two stocks and the low utilisation of performance fees will limit the ability of revenues to cushion the impact.

Credit Suisse believes there are qualities in both Magellan Financial and Platinum Asset Management which justify below-peer compensation ratios, such as large scalable strategies with over $30bn in capacity and simple operating models which imply lower back office costs.

Online Media

Citi initiates coverage of Australasian online media and publishing companies with Buy ratings on Carsales.com ((CAR)) and REA Group ((REA)), Neutral ratings on Seek ((SEK)), Trade Me ((TME)) & News Corp ((NWS)) and a Sell rating on Fairfax Media ((FXJ)).

The broker's preference for Carsales.com is based on solid core earnings growth with scope for upside and new products. REA presents good value now and a $68 valuation once a property market normalises. As much as the broker likes Domain, valuing it at $0.80 a share, newspaper closure costs are most likely going to exceed future earnings and the Fairfax group is valued as a whole at $0.70 a share.

A-REITs

Morgan Stanley observes that A-REITs (Australian real estate investment trusts) are caught between rising bond yields globally and low inflation domestically, historically a scenario that drives underperformance. The broker downgrades its industry view to Cautious and looks for a stabilisation of yields as the catalyst to turn more positive.

The broker expects this sector is unlikely to outperform, even if much of the expected yield expansion is now in the price. Morgan Stanley believes bond yields will remain relatively low and the risk of a significant correction in asset prices or earnings downgrades also looks low. The broker maintains a preference for active over passive stocks and quality over value add. Office and industrial segments are also preferred over retail.

The broker suggests weakness may provide better entry points for Goodman Group ((GMG)), Westfield ((WFD)), Dexus Property Trust ((DXS)), Lend Lease ((LLC)) and Scentre Group ((SCG)). The broker's view is contingent on the impact of the anticipated backdrop of rising bond rates and lower overall growth. The biggest risk is that Australian 10-year bond rates moderate against this backdrop and the benefits of earnings certainty outweigh fears of capital value downside.

Oil Prices

Longview Economics suggests a turn higher in oil prices in coming months, if forthcoming, should result in considerably weaker demand growth from China, as authorities scale back aggressive policies regarding stockpiling. Weak underlying Chinese oil consumption, as well as higher inventories, suggests the reduction in stockpiling activity could be reasonably sharp. This could undermine the key source of the world's marginal demand for crude and add to global inventory levels, the analysts suggest.

Aurora Cannabis

Aurora Cannabis' first-quarter results were in line with Canaccord Genuity estimates. The broker's own risk analysis of Aurora Cannabis suggests a valuation in excess of CAD5.00 a share if marijuana is legalised in Canada, supporting a Speculative Buy rating, as a pathway to the recreational market unfolds over the coming months.

Based on the current month's trends, the company is on track to sell more than 200g of cannabis for gross revenue of CAD1.6m in November alone. While still early in the production and patient acquisition story, the broker views these trends as a positive support for the company's medical cannabis strategy.
 

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