Weekly Broker Wrap: Equity Strategy, Financials And Steel Stocks

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-Industrials the market mainstay
-New lenders threaten major banks
-Regional banks to struggle
-Pressure may mount on insurers
-What if Suncorp bought nib?
-Sims Metal a top pick in steel
 

By Eva Brocklehurst

Equity Strategy

Steady growth in industrials earnings has featured in recent years but it has been overshadowed by the swings and roundabouts of the resources sector. Citi suspects that the industrial sector will be the mainstay of the market again in FY16. The broker notes dramatic shifts in relative performance of  ASX200 stocks, despite the market ending 2014 on a flat note. The most compelling consideration for Citi is the current pricing of the market, as bond yields move back to prior lows and commodity prices remain well below prior peaks.

Hence, the broker persists with low exposures to the "fixed income proxies", such real estate investment trusts (A-REITs), infrastructure and telecoms, because of their extended outperformance and favours the more modestly valued cyclicals such as energy, managing risk with modest positions in neutral sectors such as banks and mining.

Goldman Sachs, heading into the results season, looks for stocks where there are greater opportunities for outsized moves and potential for surprises regarding earnings or outlook, or capital management. Included in this focus list are Dick Smith ((DSH)), Harvey Norman ((HVN)), Genworth Australia ((GMA)), Medibank Private ((MPL)), Sydney Airport ((SYD)), Leighton Holdings ((LEI)), SAI Global ((SAI)), Dexus ((DXS)), Caltex ((CTX)), Fortescue Metals ((FMG)), Seek ((SEK)) and Crown Resorts ((CWN)). Those stocks the broker suspects have the greatest potential to disappoint include Sonic Healthcare ((SHL)), Macquarie Atlas Roads ((MQA)), Beach Energy ((BPT)), UGL ((UGL)), GWA ((GWA)) and BWP Trust ((BWP)).

Top Picks

Credit Suisse has added WorleyParsons ((WOR)) to its top picks for Australia. The stock is now trading at an all-time low relative to the market. Earnings risks remain considerable but the broker believes the price/earnings ratio and free cash flow yield have become too compelling to ignore. The broker also believes the company has capacity to implement a buyback and this would be materially earnings-per-share accretive.

Banks

The margins the major banks have enjoyed on credit card and personal loan products are under threat in Macquarie's opinion, as yet another lender in the form of MoneyPlace establishes itself. MoneyPlace joins the ranks of SocietyOne and RateSetter. While not certain of the rate of growth these lenders will enjoy, the broker observes momentum continues to build. Based on the current retail revenue pool, Macquarie estimates around $12bn in revenue is at risk. The broker continues to prefer those banks that can best respond to these "new world" threats such as Commonwealth Bank ((CBA)), given a proven track record in project execution and National Australia Bank ((NAB)) as it embarks on the final steps of its NextGen upgrade.

The strong operating environment that exists for regional banks is fading, in Morgans' view. This positive environment includes deposit pricing, asset quality and strong housing markets. The broker believes, despite some improvement in profitability, that the regionals will still struggle to generate meaningful organic capital. Earnings growth is expected to weaken into FY15/16, although the regionals are still expected to be stronger relative to the majors.

These banks obtained some benefit from the Financial System Inquiry although they did not secure a lot of what they wished for. Their request for a less onerous path to advanced accreditation was rejected by the regulators' (APRA and RBA) submissions. Much now depends on how APRA (Australian Prudential Regulation Authority) will interpret the findings. Morgans experts the mortgage capital intensity gap between the majors and regionals will ultimately become tighter but, until the regionals move to advanced accreditation, their low returns will likely be a ceiling on growth, sustainable pay-outs and valuation. Still, the broker continues to prefer the regionals over the majors given the relentless regulatory backdrop.

Insurance and Diversified Financials

Morgan Stanley explores potential surprises for this sector in 2015. The broker does not expect these developments to occur, just that there is probably a greater chance than is widely appreciated. The market remains optimistic regarding QBE Insurance's ((QBE)) top line recovery but the stock may surprise on the downside if premiums fall. A stronger US dollar is adding to top line pressure.Morgan Stanley believes the market is dismissing AMP's ((AMP)) efforts to drive growth in wealth and the stock could surprise in this regard, with net flows contributing to a price/earnings re-rating.

The broker notes that capital return prospects for Suncorp ((SUN)) mask the growth challenges in the portfolio. Perhaps it may exit banking, buy nib Holdings ((NHF)) and create a pure insurance play. Suncorp could also surprise the market by hitting its 10% returns target in FY15. Underlying margins could disappoint while reported margins still beat expectations for Medibank Private ((MPL)) as the broker flags two risks – a rise in claims and acquisition costs. The market may be discounting the probability of IOOF ((IFL)) rationalising its platform but buying a new platform is viable in Morgan Stanley's opinion, insulating profit margins and setting up the company for a new wave of growth.

Computershare ((CPU)) would be a surprise if it delivered negative growth but Morgan Stanley suspects the fundamental risks are building and corporate activity is not as supportive as the market believes. ASX ((ASX)) has also attracted 75 managed funds products for its new ASX mFunds service since May 2014. This may surprise if it wins a greater share of new monies, particularly self-managed super funds, and adds a new direct-to-consumer earnings stream. The market expects Perpetual's ((PPT)) global share fund to be a slow fire but it could surprise and reach its target of $1bn funds under management much earlier, given the strength of the company's retail brand and distribution.

Steel

Deutsche Bank considers Sims Metal Management  ((SGM)) well positioned to benefit from the uptick in US economic activity, a weaker Australian dollar and continued strength in the Asia Pacific business. Hence, the stock is the broker's top pick for the sector. There is considerable upside for BlueScope ((BSL)) as well and the broker retains a Buy rating based on strength in the Australian housing market, the weaker Australian dollar and firm spreads domestically and in the US. The broker has a Hold rating on Arrium ((ARI)), suspecting the balance sheet is at risk given the significant exposure to iron ore prices. Arrium will need to convince Deutsche Bank that the recovery in steel manufacturing earnings is real and cost reductions in iron ore are happening.
 

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