The Wrap: Supermarkets, Oz Economy & Media

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Weekly Broker Wrap: supermarkets; tourism; Oz economy; health insurance; media; and infant formula.

-Supermarket industry growth needs to lift to 3.5% or more
-Unfavourable trends in tourism likely to continue
-Strong population growth seen supporting GDP, education & tourism sectors
-Major health insurers seen well placed to deal with any cap on premiums
-Cyclical strength in advertising supporting traditional media sector
 

By Eva Brocklehurst

Supermarkets

UBS believes Coles ((WES)) needs to lift capital expenditure materially across both its stores and supply chain. Meanwhile, Metcash (MTS)) could spend more to lift wholesale sales. The broker also believes industry growth will need to lift a 3.5% or more to avoid reduced rates of return.

UBS estimates refurbishments will contribute around 1% to growth in the next three years and investments should be supportive of margins. The broker believes Woolworths ((WOW)) is investing for the long-term and should benefit from the recent investment in its stores and distribution centre.

Woolworths is expected to maintain its growth lead over Coles until FY20 and UBS retains a preference for Woolworths and Metcash. The broker does not factor in accelerated refurbishment activity for Coles or Metcash into forecasts and assumes Woolworths continues its current run rate.

Tourism

Outbound departures grew 5% in May 2018 while growth in short-term visitor arrivals during the month was below trend for the second consecutive month. Citi considers the continuation of these trends unfavourable for companies exposed to Australian tourism.

The broker expects theme parks to be loss-making in FY18, ie both Village Roadshow ((VRL)) and Ardent Leisure ((AAD)), and retains a Neutral and Buy rating, respectively.

Preliminary data suggests Melbourne's revenue per average room rate declined for the second consecutive month in June. This supports a negative outlook, in Citi's opinion, because of rising supply and meaningful Airbnb supply located near the CBD. The broker retains a Neutral rating for Event Hospitality ((EVT)). Melbourne represents around 19% of Event Hospitality's owned rooms.

Oz Economy

Strong population growth is the driver of Australia's record 26-plus years of GDP growth without recession. However, UBS analyses recent data on immigration and finds standard population growth under-estimates the reality.

Temporary visa numbers doubled since 2007 to a record level in 2016 and 2.7% share of population. The ABS data also indicates there were a record number of permanent visas issued in 2016, although these do not add to population growth in their entirety, as some people flow from temporary visa to permanent visa or citizenship.

Still, strong population growth and large number of temporary student visas in coming years are expected to support headline GDP via exports, particularly in education and tourism. This will underpin the need for infrastructure investment and support housing demand.

The population growth data also helps explain the low rental vacancy rate despite record housing supply. Given migrants are relatively young and skilled or educated, the broker suggests the positive labour supply shock will put a dampener on wages and keep the CPI low. This could be key to the Reserve Bank maintaining official rates on hold until 2020.

Health Insurance

The Labor Party is now signalling it will modify its policy of a 2% lid on premium rate increases for two years to protect smaller, largely not-for-profit insurers. Citi suggests, without such a carve out, many smaller insurers would be tipped into underwriting losses.

The broker estimates the cap would also be a major earnings headwind for the larger private health insurers, potentially causing earnings downgrades of over 25%. While Labor may not be elected, the broker suspects premium increases under the current government are unlikely to be much greater.

Nevertheless, given years of expanding margins and with claims inflation at a nine-year low, the industry appears well-placed to deal with any lid on premiums.

Media

Morgan Stanley remains a structural bear on traditional media but acknowledges that cyclical strength in advertising can help paper over the cracks. The advertising market has surprised on the upside and for businesses with high fixed costs this matters.

The broker has an Equal-weight rating for Nine Entertainment ((NEC)), and Underweights for Seven West Media ((SWM)), Prime Media ((PRT)) and Southern Cross Media ((SXL)).

In addition, a relatively strong domestic economy has delivered robust job advertising. Morgan Stanley expects Seek ((SEK)) to benefit in FY18 from a lift in SE Asian business and China/Zhaopin should benefit from the strong growth trends highlighted by listed peers.

The broker remains bullish on REA Group ((REA)) and Domain Group ((DHG)) but points out listings growth in May-July has decelerated and, if annualised for a full 12 months, could hit EPS by -10-15%.

The broker also believes recent M&A in the outdoor advertising sector could continue and scale become more important. Industry data suggests some upside risk to earnings for APN Outdoor ((APO)) and HT&E ((HT1)).

Infant Formula

UBS analyses trends in the Chinese infant formula market, which totals one third of the global market. Imported brands retain their popularity but the price premium is now down to just 11% from 50% in January 2016.

The broker suspects the easy ride for multinationals may be coming to an end as both Nestle and Danone are losing momentum on the bestseller lists and a2 Milk's ((A2M)) pricing is down for the first time in two years.

The broker suspects the market is not pricing in any downside risk to the long-term profitability of the multinationals in the Chinese market. Regulatory changes in 2018 are expected to reduce the number of Chinese-labelled infant formula brands sold in China to 500 from 2000 and could free up 10% of the market. Still, UBS suspects the market is underestimating the likely rebound in domestic brands in 2018 and these brands are showing price discipline.

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