Weekly Broker Wrap: Double Digit Returns, Plus Dividend Opportunities

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By Chris Shaw

With the first quarter of 2012 drawing to a close, Macquarie has updated its expectations for the Australian equity market for the coming year. A total shareholder return for the S&P/ASX200 of 12.7% for the coming 12 month period is forecast, which implies fair value for the index of 4,593.

This return forecast comprises a capital return of 7.4% and a dividend yield of 5.3%. Within this, Macquarie expects the resources sector to deliver a total return of 12.5%, against a 12.8% return for the industrials sector.

At the Small Ords end of the market a total shareholder return of 12.5% is forecast, the split being a capital return of 7.7% and a dividend yield of 4.8%. Small industrials are forecast to deliver a return of 12.1%, while small resources are forecast to deliver a 13.2% return.

Macquarie's total shareholder return forecast for the broader market has fallen from the 14% forecast of last October, the broker attributing this to the lack of any sustained earnings per share (EPS) growth. As Macquarie notes, delivery of EPS growth remains the main factor for any reasonable capital return as valuation-driven market returns remain limited without any prospect of sustained EPS growth.

According to Macquarie, the recent reporting season in Australia reinforced the ongoing downside risk to EPS growth. This reflects both ongoing headwinds to earnings such as relatively high interest rates and negative productivity that continue to impact on margins.

Without some actual earnings growth across the next year Macquarie sees limited prospects for any expansion in earnings multiples. The market's benchmark multiple is likely to be reset to a lower level of around 12.5 times as a result.

While UBS is forecasting a prospective dividend yield for the market lower than Macquarie at 5.1% and 5.9% ex resources, the broker suggests the Australian market appears cheap on a dividend yield basis. This is because the yield is well above the 20-year average yield of 4.5%.

In terms of stock specifics when looking at attractive yield plays, UBS has identified two types. The first are defensive, low-beta and high yield plays such as telcos, utilities, toll roads, airports and REITs, as well as the banks. The second group are the value plays where the market has sold down the stock on concerns earnings and dividends are not sustainable. At present this category includes discretionary retail, media and insurance.

Assessing these categories, UBS suggests stocks such as Seven West Media ((SWM)), David Jones ((DJS)), AMP ((AMP)), QBE Insurance ((QBE)) and Myer ((MYR)) appear relatively risky on the broker's model.

Stocks appearing to offer both a high yield and some growth with reasonable risk include Telstra ((TLS)), Mirvac ((MGR)), Stockland ((SGP)), Westpac ((WBC)), National Australia Bank ((NAB)) and Spark Infrastructure ((SKI)).

With respect to the Australian residential sector, BA Merrill Lynch is now less confident in the consensus view housing starts will bottom out around 135,000 in annualised terms before recovering to around 160,000 starts by 2014.

With the consumer and credit environments remaining tough for longer than has been expected, this leads BA-ML to suggest lower than trend housing starts could be the new norm. This is due to still weak consumer confidence, some caution on lending on the part of the banks, recent negative commentary from building industry participants and the fact house prices continue to fall.

To reflect this and lower than expected guidance from Stockland, BA-ML has lowered its forecasts for Australian residential developers. The changes have led to an average cut in price targets of 3.7%.

Both Peet ((PPC)) and Stockland have been downgraded to Neutral ratings from Buy previously. Stockland's downgrade reflects the fact the company is the most leveraged to macro trends in residential markets, while contributing to the downgrade for Peet was the existence of some near-term funding uncertainty.

Among other stocks under coverage, BA-ML retains Buy ratings on FKP Property ((FKP)) and Mirvac, while Neutral ratings are retained on Lend Lease ((LLC)) and Australand ((ALZ)). 

Citi has considered the impact on Australian building materials stocks from not only the weak housing starts data but also activity levels in the non-residential sector and materials pricing. The conclusion is a mixed 2012 can be expected as there are no near-term triggers to drive improved performance.

There are some positives in Citi's view, including the potential for a rate cut in May to boost confidence levels in the short-term, which could also deliver some positive growth in first home buyer numbers. As well, Citi expects engineering construction should remain solid given resilience and leverage to the mining and resource sectors.

Among the building products plays Adelaide Brighton ((ABC)) is Citi's top call as more than 50% of profits come from the mining and engineering sectors. Most preferred among the building materials stocks is Fletcher Building ((FBU)), this given earnings growth appears underpinned by rebuilding following the Christchurch earthquake and committed infrastructure spending in both Australia and New Zealand.

Both James Hardie ((JHX)) and CSR ((CSR)) are rated as Neutral on valuation grounds, while Citi rates Boral ((BLD)) as a Sell given the likelihood earnings are weighed down by wet weather and the soft outlook for the domestic residential market.

Among engineering and construction plays Citi prefers Downer EDI ((DOW)) as the Waratah project should continue to de-risk and core operations should deliver strong growth in coming years. Elsewhere, Citi rates Alesco ((ALS)), Boart Longyear ((BLY)), Lend Lease, Peet, Stockland and UGL ((UGL)) as Buy, while DuluxGroup ((DLX)), GUD Holdings ((GUD)), Hills Holdings ((HIL)), Leighton ((LEI)) and WorleyParsons ((WOR)) are rated as Neutral. A Sell rating is also ascribed to GWA Group ((GWA)). 

Following a series of visits with US clients, Citi notes the view of these investors is the Australian economic outlook is now more subdued than on the broker's previous trip. Risk to the outlook is regarded as being to the downside at present, especially given a more modest growth outlook in China.

While most clients don't expect a hard landing for the Chinese economy there are still enough issues for some caution on the outlook for Australia, especially given the view the Australian economy was fairly hollow between the two ends of mining and trade-exposed manufacturing and tourism.

House prices remain an issue for US investors as the concern is the impact on the broader economy of any further declines in prices. Despite this, clients had no consensus view on the outlook for Australian interest rates. Some took the view rates may be cut further to better align the currency with fundamentals.

In other general comments, Citi notes a majority of clients believe the recent improvement in US economic data was solely weather related and a retracement in the second quarter would likely surprise the market.

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