Weekly Broker Wrap: Farewell Toyota, Building Ramp-Up And Dividend Prospects

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-Carmaker demise part of manufacturing decline
-Department stores still losing share
-Focus on Sydney, SE Qld construction in FY15
-Dividends from resources, energy?
-Oil price expected to strengthen
 

By Eva Brocklehurst

The Australian dollar is not to blame for the country being in a position in which local manufacturing of motor vehicles will cease in 2017. That's Deutsche Bank's take on the news that Toyota will follow Ford and Holden and shut up shop by 2017. In fact, Deutsche Bank analysts note history reveals the exchange rate is often a scapegoat for such closures but employment in the manufacturing sector, as a percentage of total employment, has been declining for 30 years. Manufacturing as a share of GDP has been falling since the 1970s.

In the case of vehicle manufacturing Deutsche Bank thinks short-run impacts are overstated while the long-run benefits are ignored. The analysts suspect the initial public policy response will involve additional government spending to ease the impact of the closures, probably regionally and sectorally focused, concentrating on the "high profile losers". That is, the employees of the car makers themselves. Deutsche Bank would prefer to see the high cost of cars in Australia addressed. As there is no longer a local industry to protect the analyst thinks the tariffs on motor vehicles should be abolished and widespread importing of second hand vehicles should be allowed. The argument is, if cars are cheaper, Australian households will have more money to spend on other goods. Additionally, Deutsche Bank thinks policy makers have not made enough effort to lower costs and prices than they could have done.

Christmas sales were OK but department stores continued to lose share, according to Citi. The broker notes David Jones ((DJS)) and Myer ((MYR)) engaged in less promotion during the last silly season and discounts were more targeted. As a result, the broker expects rising gross profit margins but doesn't think this will overcome the fact that department stores are losing share to specialty retailers and online. Sales trends may have stabilised but the broker observes department stores still need to deal with rising costs.

Citi also considers the building cycle activity will accelerate over the next two years and capacity constraints will loom. The broker welcomes the return of pricing power for the sector. The bright spot is Sydney, where road construction should pick up the slack when housing cools. The broker factors in a healthy housing market through to the end of FY15 and also thinks that year will see a 30% increase in the value of road and highway work, mitigating some of the housing decline. This leaves Citi favouring those plays which cover the whole domestic building cycle, expecting the reward will come through the combination of pricing power, robust demand and a synchronised improvement in markets. The view regarding the leverage to Sydney is focused on the early and late cycle construction materials but the broker concedes building products is where margin could surprise the most.

The broker also thinks many forecasts about the demise of the Australian engineering capex cycle are overdone. While spending could diminish over coming years, as the peak in energy and resources wanes, a material portion of engineering capex has no relation to construction or building materials volume. Instead, a broad based up-cycle increases customer numbers and enhances pricing power. That's not to say the broker doesn't favour exposure to construction materials. Product intensity tied to a wave of essential infrastructure projects should ramp up in FY15 and underpin construction materials. Citi is particularly drawn to businesses with leverage to Sydney and South-East Queensland construction activity. The broker observes cement, aggregates and concrete get earlier leverage than building materials and benefit as building gives way to infrastructure growth.

 This all leads Citi to favour Boral ((BLD)), which has been upgraded to Buy from Sell. Next down the ranks comes Brickworks ((BKW)), James Hardie ((JHX)) and CSR ((CSR)) with Neutral ratings.

UBS thinks the mood among resource companies during this earnings season will be more positive, with stronger commodity prices, a falling AUD/USD rate and a reduction in cost bases. That said, the gold sector is likely to be in line for further impairments with the gold price having declined markedly last year. The broker thinks companies will take a long look at the carrying value of assets in the light of changes to operating assumptions, asset closures and weak prices. Companies have been switching from growth to capital preservation. Hence, UBS expects to see the free cash flow improve and this is expected to be applied to debt reduction in the first instance. Still, the broker is holding out for a tidbit for shareholders from this reporting season. Iron ore miners, in particular, may look to return some capital. Then again, the broker warns, there's a lot to do to make balance sheets ship shape.

Peak years for capex in the Australian energy sector look like being 2012 and 2013, according to Morgan Stanley. The broker's forward estimates show a decline in capex for sanctioned projects. Capex for shale gas expansion of floating LNG projects is still in the planning phase and not included. The broker observes the debate has centred on LNG construction timelines and costs. Now, as delivery is more certain, attention is on what will be done with the cash flow. Will it be dividends, share buy-backs, debt repayment or re-investment? Morgan Stanley expects a modest increase in dividends across the LNG-exposed companies but also cautions investors not to expect large cash returns. Increased operating costs and "capex creep" are two factors present for over a decade which should keep investors' feet firmly planted on the ground. The broker prefers those companies with obvious growth options.

Morgans is overweight oil and gas and thinks the oil price will strengthen in coming months. Growth in developed countries is likely to stimulate demand and the strong season for the oil price is coming, as the US throws off its winter woollies. Most oil and gas companies are expected to benefit from the rising oil price. Still, Morgans thinks those with increasing production and/or reserves are typical outperformers. Morgans does not think oil is going up for just seasonal reasons. Developed economies are expected to grow at the fastest pace since before 2007. The analysts expect Brent to rise to US$124 per barrel this year. The broker's preferences include Oil Search ((OSH)), Santos ((STO)), Sundance Energy ((SEA)) and Senex Energy ((SXY)).
 

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