Weekly Broker Wrap: Online, Consumers, Retail And High Conviction

This story features SEEK LIMITED, and other companies. For more info SHARE ANALYSIS: SEK

-Costs a concern for SEEK
-Trade Me margins unsustainable
-Consumer electronics vulnerable
-Housing exposed retailers outperform
-Dick Smith wins share
-Genuine growth in some small caps
 

By Eva Brocklehurst

Market dominance is a key factor in the ability of online classifieds sites to exercise pricing power. BA-Merrill Lynch has compared Australasian sites with their global peers, finding that Seek ((SEK)) is one that appears unable to absorb recent growth in costs and maintain margins. Domestic margins have effectively been flat for the past four years. Merrills suspects underlying costs may impinge even when the employment cycle does turn positive.

REA Group ((REA)) and other property sites are more profitable but REA has the smallest premium compared with leading sites globally, when it comes to earnings margins. Merrills expects margin growth to accelerate as the significant investment in future products the company is making moderates, or revenue starts to offset spending. Carsales.com ((CRZ)) has the strongest market position of all sites and Merrills envisages scope to further leverage pricing power. Trade Me ((TME)) enjoys earnings margins well above peers, and 10% above levels that Merrills considers are sustainable, based on its market share. Rising costs are expected to pull these margins back into line.

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Citi queries whether headwinds are finally abating for Australian consumers, and whether the acceleration in spending priced into retail stocks will really eventuate. Higher house prices are encouraging, but to become more bullish the broker would like to see income and credit growth improve. At present, income growth is just 4%, while credit card spending growth is 5% and well below the long-run average of 15%. Australian savings fell to an annual rate of 8.7% in June 2014, down from 9.3% in June 2013. This reduction is good news for retail spending and may have boosted retail growth by 1.9% over the past year. Citi expects further reductions in savings of less than one percentage point, given persistent unemployment and low wages growth.

The broker expects retail spending to grow 5.0% in FY15. Cafes and restaurants are expected to outperform but apparel may slow, given weaker fashion trends. Consumer electronics remains the most vulnerable with uninspiring product releases. Citi retains a Buy rating on Super Retail ((SUL)) which has scope to turn around its leisure segment. Specialty Fashion ((SFH)) is also rated Buy, as the broker believes the company can lift gross margins via direct sourcing. JB Hi-Fi ((JBH)) is rated Sell, given the risk comparable store sales may decline in FY15.

Morgans notes those retailers of products predominantly exposed to the housing sector provided the most resilient results in FY14. The notable exceptions were Breville Group ((BRG)), largely because of North American weakness, and JB Hi-Fi, which experienced weakness in its July trading update largely because of soft tablet sales. Domino's Pizza ((DMP)), Ardent Leisure ((AAD)), Beacon Lighting ((BLX)) and Burson Group ((BAP)) provided the most impressive guidance and Morgans notes these are also preferred "structural growth" stocks, taking market share in their respective sectors. All trade at healthy multiple premiums as well. Kathmandu ((KMD)) continues to stand out from a valuation versus growth perspective. OrotonGroup ((ORL)) also interests the broker, with strong earnings growth expected in coming years against the background of a reasonable valuation.

The technical consumer goods market declined 3% in the June quarter, which UBS notes is the second largest quarterly decline in more than three years. Recent data for the industry indicates housing categories are improving as consumers trade up, while market share is shifting in the IT category. Major appliances are heading in the growth direction and this is positive for Harvey Norman ((HVN)). Dick Smith Holdings ((DSH)) appears to be winning market share at the expense of JB Hi-Fi. UBS remarks that consumers appear to be reacting positively to Dick Smith's "trading mentality" such as weekly deals. Further embedding the trend is the greater reliance at JB Hi-Fi on post-paid telecommunications. UBS continues to believe there needs to be a reaction from JB Hi-Fi to lift like-for-like sales.

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Reporting season has crystallised several changes to Morgans' High Conviction list. One of the biggest surprises was the small cap stocks which recovered lost ground, driven by genuine growth stories, such as that of Domino's, M2 Telecommunications ((MTU)) and Slater & Gordon ((SGH)). The broker has several new small ideas such as Shine Corporate ((SHJ)), GBST Holdings ((GBT)) and Mantra Group ((MTR)), which tap similar characteristics but on more attractive valuations. Overall, dividends remain the over-riding motivator for investors. Hence, the broker's high conviction ideas blend high quality dividend growth stocks such as Telstra ((TLS)), Transurban ((TCL)) and Origin Energy ((ORG)) with growth stories like Challenger ((CGF)), SEEK and Shine.
 

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