Weekly Broker Wrap: Banks, Retail and Earnings Forecasts

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By Andrew Nelson

While it’s fairly easy to say that recent FY results beat market expectations by a little this reporting season, the statement can nonetheless be a little misleading. As while top line numbers may have come in a little better than forecasts, things weren’t as clear cut for forward estimates.

Last week, Goldman Sachs totalled up the number and found that while results from the August 2012 reporting season were 2.3% ahead of the analysts' forecasts, downgrades going forward were an overriding feature. In fact, the broker has downgraded FY13 earnings for almost half of the companies under coverage, while upgrading forecasts for only 21% of companies.  

And there weren’t just more downgrades than upgrades either, as the average size of downgrades also outpaced the average size of upgrades as well. The median upgrade to FY13 EPS forecasts was 4.3%, while the median downgrade size was 5.9%.

The sectors that experienced the largest downgrades to FY13 forecasts, on a market cap adjusted bias were Steel, Gold, Diversified resources, Gaming and Building materials. Upgrades were recorded across the Energy, Info tech and Transport sectors.  

The good news is the broker continues to see significant earnings leverage across the market given current earnings forecasts are based on margins that are close to their 10-15 year lows.  It’s all about the cycle turning, but Goldman Sachs still sees a number of structural issues such as slower credit growth, high household savings levels, tight financial conditions and the strong AUD that it feels will continue to keep margins under pressure and thus forestall any earnings recovery. This is especially so in for Industrial sector earnings, notes the broker.

Overall, the broker points out the best looking stocks were the ones best able to confirm an ability to grow given industry positioning and continuing investment, and the ones that demonstrated the ability to maintain secure income streams and attractive yields. On the broker’s numbers, such stocks included, but are not limited to ANZ Bank ((ANZ)), Brambles ((BXB)), CSL ((CSL)), Santos ((STO)), Telstra ((TLS)) and Wesfarmers ((WES)). Among the smaller capped companies, the broker liked Bradken ((BKN)), Domino’s ((DMP)) and REA Group ((REA)).

Goldman Sachs' overall post-reporting season bottom-up FY13 ASX300 EPS forecast is for growth of 9.1% for the Industrials sector, 8.5% for Resources Sector and 6.6% for the Major Banks.

Now let’s talk about a few issues facing the banks. Analysts at Macquarie note that gearing levels may well come under increasing pressure, as impaired assets don’t really have to increase to have BDDs (bad & doubtful debt) increase or stay flat, given BDD top-ups. Thus, a protracted run of declining asset values and extension risk could lead to the need for provisions to be increased.

What’s worse is the size of the downgrades could even be more than 10%, were declining asset values and extension risk working in unison.

The silver lining in the broker’s tale is that it seems the Big-4 have taken a fairly intelligent approach to impaired loans, with workouts undertaken to recover debt rather than the fire sale approach of days gone by. The broker notes this lesson was learnt back in the early 1990s, although there is risk if others don’t play ball and move to exit positions early at substantial discounts. There could also be disadvantage if the market for second tier assets remains closed, although, Macquarie thinks a “weaker for longer” scenario will lend itself to the provisioning of top-ups.

And here’s another bit of news for the banks, this time from Credit Suisse. The broker notes that the most recent survey of Australian bankrupts, from 2011, shows the actual incidences of bankruptcy were at their lowest level since 2002. The broker notes there is support coming from the fact that home ownership among bankrupts is increasing, thus providing collateral, while there has also been an increase in the overall ability to realise assets.

On the other hand, the broker notes there is a growing proportion of bankrupts with more than $50,000 of unsecured debt, while the instance of  bankrupts re-offending has lifted to 16%. The broker notes that fewer bankrupts are unemployed and the income of bankrupts continues to increase. All up, this makes for a concerning picture, thinks Credit Suisse, as the trends imply that bankrupts are increasingly found among the employed.

South East Queensland is home to the highest incidences of bankruptcy, with  7.7%  of  total  personal  insolvencies  and  8.2%  of  all  bankruptcies.  This number puts South East Queensland well ahead on the leader board, as number two and three, while the NSW South Coast and the Qld Central Coast were at 6.2% and 6.4% respectively.

In 41% of the cases, economic conditions were to blame. Next is unemployment, which contributes 34% to overall numbers for both business related and non-business related bankruptcies.

Analysts at Deutsche Bank gave us a bit more seemingly bad news for the Australian retail sector. After sorting through recent results and outlook statements from a number of retailers, the broker just can’t see a consumer recovery in 2013.

With that said, Deutsche does see a few bright spots such as a improving gross margins, especially in clothing, while rents and online sales also look to be on the up. The broker continues to like exposure to companies that possess drivers outside the general macro environment. Number one on this list is Premier Investments ((PMV)) given a nice cost cutting buffer and an undemanding valuation. Super Retail ((SUL)) and Domino’s also fit the broker’s criteria, but current valuations do not present attractive entry points, it feels.

Citi also sees an emerging problem for retailers in Australia, at least those involved in the gadgets and gizmos business, and it’s called Apple. In total, the company’s sales in Australia and NZ are over $4.8bn and they are shifting profit away from consumer electronics retailers.

Apple’s sales have tripled in the past three years on the back of iPhone and iPad sales, while the sales in the broader sector were fairly flat. Yet Apple's sales account for 20% of JB Hi-Fi’s Australian sales and 2% of Harvey Norman’s sales and at much lower margins than most other products. Thus while the broker expects consumer electronics spend will likely remain strong in tablets and smartphones, the shift is negative for retailers given lower margins on Apple products.

And with Apple and JB Hi-Fi continuing to build more stores, as well as Masters ((WOW)) and Bunnings (WES) expanding whitegoods offerings, there is actually $468m in new sales expected for the industry in FY13, which offsets the estimated $414m to be saved via store closures. Thus the broker sees only limited sector benefit via sector rationalisation and store closures, with Citi believing more store closures are needed to restore consumer electronics industry profits.

This general trend will also see no help on the macro front in the short-term. UBS noted last week that the August employment figures came in weaker than expected, with the trend continuing its downward trajectory. Most of the downturn came from the part-time segment of the workforce, with full-time numbers remaining fairly flat.

Jobs growth is now clearly softening, with the broker citing the net fall over the last three months, which it notes has now fully reversed the more optimistic tone that was generated earlier in the year. Hours worked are also weakening and UBS sees this as a good leading indicator of a further slowing in household income growth.

Yet despite the apparent slowing in jobs growth, the broker notes that a drop in the participation rate at least saw the unemployment rate at 5.1%, which remains within the range of the last few years. All in all, the broker thinks the “big picture” fundamentals have certainly worsened over the past month and this in turn increases the likelihood of the RBA making a further easing move.

 
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