Oz Result Season And 2012 – Some Thoughts

This story features NATIONAL AUSTRALIA BANK LIMITED, and other companies. For more info SHARE ANALYSIS: NAB

By Greg Peel

I'm sitting here watching the live price for the ASX 200 tick over, and today's activity so far probably sums up late 2011-early 2012: the index is struggling to move by one point in either direction. All around town stockbrokers are pouring yet another cup of coffee in a desperate attempt not to nod off, or have their feet on the desk and are scouring the employment section in the AFR in anticipation. If a phone rings, they all jump from the shock.

It doesn't help that broking houses are putting out reports such as JP Morgan's from a couple of weeks ago entitled “Short-term gain, long-term same”. The report might now be a bit dated, but never mind – nothing has changed in the meantime. Except perhaps the analysts' expectation of “a likely truce in the European debt crisis,” which is looking less likely by the day.

JPM recalls that there were four major themes impacting on the Aussie stock market in 2011. Call them Europe, China, the US and local. We worried all year that Europe could fall over, that China's economy might come in for a hard landing, sparked by a property market crash, that US economic growth might turn negative, and that weakness in the non-mining Australian economy would more than override any strength in the mining economy, which itself is tied to the fortunes of China.

The mood lightened a bit heading into 2012. The ECB began pumping serious money into the European banking system, Beijing began easing monetary policy after having tightened it for two years, US economic data began to improve, and commodity prices began to recover to boost local confidence.

JP Morgan believes ECB support will lower the immediate liquidity risk in Europe, but the solvency risk will not go away and likely resurface as a fear later in the year. A down-cycle in Chinese property poses a meaningful risk, say the analysts, but the story will likely play out gradually as Beijing orchestrates monetary control and thus sentiment should not thus turn too dark. US growth is proving a positive for the markets, but the US remains in the “long shadow cast by fiscal imbalance”. What budget cut battles might 2012 bring, wreaking havoc on market confidence? And it's an election year. 

For Australia, JPM believes the economy won't stall but will remain in two-speed mode. On a PE basis, local stocks are looking cheap but structural earnings headwinds mean they are not as cheap as they look. In summary, JPM sees the ASX 200 rising to 4500 by mid-year or earlier but falling back to 4250 – basically where it is now – by year-end.

Deutsche Bank is a bit more glass-half-full to JPM's glass-half-empty.

Eighteen months' worth of earnings downgrades for Australian companies have drawn everyone's attention, but DB notes that over that period, earnings have actually grown. The implication thus is that the analysts are the culprits here, not the corporations. Yet while earnings have grown, PE ratios have fallen. That's the sentiment part – lack of confidence (and lack of interest) has taken the “P” down just as surely as the “E” has risen.

The global environment indeed remains uncertain, but DB suggests a lot of that fear is priced in. Getting technical, the analysts note that over 2011 the trailing (historical as opposed to forward estimate) market PE de-rated by 20% in Australia, and the stock earnings yield to government bond yield gap blew out by three percentage points towards record highs. Similar episodes over the past 40 years have resulted in 15-20% stock market gains in the following year. DB also notes investors are all in defensive mode, which offers added upside potential on the first sign of unwind.

Deutsche Bank believes the Chinese growth cycle is close to bottoming. On that basis, the DB strategists are remaining Overweight the resources sector for now. They are targetting 4700 for the ASX 200 by year-end assuming further earnings downgrades of 10% but a market PE re-rating to 12x.

JP Morgan and Deutsche are some distance (4250-4700) split on their year-end targets, but they do agree on one thing. This is not a market to simply play “beta” in, that is to make sweeping market and sector portfolio allocation decisions. It will be a year in which careful stock picking within sectors will be necessary.

To that end, Macquarie last week updated its “Marquee Ideas” or conviction list selections from amongst the analysts' coverage universe of some 300 stocks.

Macquarie is recommending a “pairs trade” (long/short) to play off the Asian thematic for ANZ Bank ((ANZ)) which the analysts see as a point of difference and a tailwind, particularly when the European banks start pulling out of Asia and circling the wagons back home. To fund the long ANZ play, Macquarie is shorting National Australia Bank ((NAB)).

In the straight long plays, Macquarie is adding GPT Group ((GPT)) given the stable earnings stream offered by the REIT's high quality office/retail portfolio. This is a defensive play, looking for earnings growth and possibly a buyback and/or increased dividend.

Macquarie has also added Fortescue Metals ((FMG)) based on the advancement of the Solomon project. The analysts are not as ambitious as management in their expansion timing expectations, yet still they value FMG at a much better level than its current trading price. Sticking with the resource sector and those who service it, Macquarie has added Mermaid Marine ((MRM)) given the high level of activity expected in offshore WA oil and gas.

Coming out of the Marquee Ideas portfolio are previous components Mirvac ((MGR)), Challenger Financial ((CGF)) and Perseus Mining ((PRU)).

The straight long portfolio thus now includes Amcor ((AMC)), Fortescue, Lynas ((LYC)), Oil Search ((OSH)), Rio Tinto ((RIO)), GPT, Mermaid, SAI Global ((SAI)), Seven Group ((SVW)) and Telecom NZ ((TEL)). Macquarie has a conviction Sell on Mesoblast ((MSB)).

Each year at this time (and again in August) I point out the seeming contradiction of the concept of “expected surprise” when it comes to earnings reports. However analysts, particularly quant analysts, get all excited about such concepts and love to try to “predict” surprises. Having conducted a poll of its fundamental analyst colleagues, the JP Morgan quant analysts have decided up to 40% of stocks in their coverage universe could surprise (to at least medium level) next month – 27% up and 38% down. (No, I don't know how the numbers add up either.)

The stocks with the largest potential for upside surprise, using lots of boffin stuff, are AGL ((AGK)), Sonic Healthcare ((SHL)) and Blackham Resources ((BLK)). To the downside we have Gunns ((GNS)), while Qube Logistics ((QUB)) and Silex Systems ((SLX)) both have a large potential to surprise, say the analysts, but as to which way they can't say.

Back on this planet, the JPM fundamentalists were also polled for their views on capital management potential. 

The analysts believe the companies most likely to announce a share buyback are Ansell ((ANN)), Bendigo & Adelaide Bank ((BEN)), Dexus ((DXS)), Macquarie Group ((MQG)), CFS Retail ((CFX)), OZ Minerals ((OZL)), Sims Group ((SGM)), Telstra ((TLS)), Brambles ((BXB)), Mirvac, ING Office ((IOF)) and Rio Tinto.

Those companies most likely to announce capital raisings, according to JPM, are Downer EDI ((DOW)), Primary Healthcare ((PRY)), Paladin Energy ((PDN)), Woodside Petroleum ((WPL)) and AGL.

For more on the upcoming February reporting season in Australia: see this week's Weekly Insights "Where Is The Growth In Australia? (And At What Risk?)".
 

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