Weekly Broker Wrap: Supermarkets, Aviation And Small Caps

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-Aldi profile to broaden & grow
-New supermarket operator probable
-Coles/Woolies share loss likely
-Pacific Smiles expands
-Tomizone in the right place
-Greencross "rare value"?
-GDI Property concerns overplayed?
 

By Eva Brocklehurst

Supermarkets

Aldi has revealed some financial details owing to an Australian government inquiry into company tax avoidance. The company's pre-tax profit margin in FY13 was 5.2%, which Citi notes is above Coles ((WES)) and below Woolworths ((WOW)). The broker envisages Aldi has scope to grow and move on price in Australia. Adjusting for store size, given Aldi stores are half the size of local rivals, sales per store total $28m versus Coles at $33m and Woolworths at $37m. The lower sales productivity is attributable to lower prices.

JP Morgan agrees that the German-owned retailer's financial performance in Australia suggests growth is ahead of its peers. The broker suspects sales growth was around 13% in 2014. Aldi's customer profile is expected to broaden as product quality improves and more branded products are offered. JP Morgan now suspects a new entrant in food retail is likely to gain confidence now Aldi's financial performance is known. Any weakness that was thrown up in the financial revelations would have acted as a deterrent. The broker  maintains there is the prospect of another specialised format operator entering Australia and this will be a negative for incumbents, including independents supplied by Metcash ((MTS)).

Morgan Stanley observes Aldi and Costco are now reaching mainstream Australia and both are now over index with younger people and large households. The broker's survey of Australian consumers took note of future indicators of market share such as queue length, convenience and fresh offerings. Morgan Stanley believes FY20 market share forecasts may prove too conservative at 11.1% for Aldi and 1.8% for Costco, given an expanded addressable market. It appears near impossible for Coles and Woolworths to retain market share while the independents (IGA) at 11.4% do not have enough share to give up.

Deutsche Bank's supermarket pricing study for the June quarter was flat, easing back from the 2.2% inflation observed in the prior quarter and the weakest outcome since September 2013. Woolworths is investing heavily in branded product pricing and this is probably the segment where prices became too high. Woolworths increased price investment in the quarter but Coles does not appear to have responded aggressively. Both supermarkets experienced around 6.0% deflation in private label in the quarter but Woolworths branded product fell 2.6% while Coles grew 5.1%. The broker believes Coles has continued to control its own pricing dynamic and maintained solid trading momentum.

Deutsche Bank makes a case that, if Woolworths' earnings in food and liquor were re-based sufficiently for it to be in a position to grow in line with the food retail industry, it could deserve to trade at a 10% premium to the market. The broker calculates the current share price implies margins that are 100 basis points worse than consensus, or a fall of 200 basis points from their peak. That said, it is likely the market is pricing in enough downside but Deutsche Bank considers it too early to invest. Stocks rarely outperform while estimates are being cut and there are risks ahead of the arrival of a new CEO. The broker advises a Hold rating is appropriate at this juncture.

Aviation

Analysis of forward fares in the domestic market points to steady price increases and Deutsche Bank suggests this supports a recovery in domestic aviation profitability. The broker looks at trends in fares for both economy and business class and notes economy fares are up 10% versus the prior June quarter with business only slightly lower. International fares are more volatile and subdued in terms of growth. Economy fares were flat to lower heading into the first quarter of FY16 and only slightly better in business. This confirms suspicions that Australian carriers' international growth will remain negative into FY16. Some international capacity growth is coming from other carriers but this is averaging around half the growth at the end of 2014.

Small Caps

Pacific Smiles ((PSQ)) has opened two new centres, one in Canberra and one in Brisbane. This increases the company's presence in dental care in Queensland and the ACT and Bell Potter believes there are further expansion opportunities in those regions. The company now operates 49 dental clinics in Australia and has a firm growth path, aided by increasing demand for dental services. Bell Potter has a Hold rating and $2.49 target and valuation represents a total expected return of 12.4%.

Tomizone ((TOM)) provides managed WiFi services and its core product, Lightswitch, is a cloud-based platform that provides key exposure to a rapidly growing market. Bell Potter notes the higher cost of mobile to WiFi data is driving consumers to seek public WiFi (hotspots) while businesses are increasingly offering WiFi to attract customers, learn about their behaviour and connect through targeted marketing and mobile advertising. Tomizone has a track record and large customer base and the broker initiates coverage with a Buy rating and 30c target.

Having recently revised down forecasts Canaccord Genuity now incorporates higher debt levels for Greencross ((GXL)). Nevertheless, the broker believes the company has a strong medium-term growth profile and, at current levels, is in "rare value" territory. Target is $9.00 and a Buy rating is maintained. FY15 earnings growth is still expected at around 42% while FY16 and FY17 earnings are expected to grow 16%. The company has an established portfolio of around 200 retail locations and 130 veterinary practices in Australasia and is well positioned to leverage its significant first-mover advantage.

GDI Property ((GDI)) could potentially deliver more than 10% earnings growth in FY16 should it accretively re-invest some of the proceeds from the sale of Castlereagh St, Sydney, and/or increase its buy-back to 10% from 5.0%, Moelis observes. Despite a strong growth outlook the broker notes the stock continues to trade at around 10% discount to net tangible assets relative to the sector average premium of 26%. This is largely to do with the $334m balance sheet exposure to a soft Perth office market, Moelis suspects. The broker believes concerns are overplayed as 88% of this exposure relates to securely leased properties, with no value being attributed to the strong funds management business. A Buy rating and $1.08 target are maintained.
 

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