Brokers Argue Stock Market Value While ANZ Is Upgraded

This story features TABCORP HOLDINGS LIMITED, and other companies. For more info SHARE ANALYSIS: TAH

The company is included in ASX200, ASX300 and ALL-ORDS

By Greg Peel

The word accompanying the title to Tim Rocks' September Quarter Outlook for the Australian stock market is “Deluded”. The Merrill Lynch equity strategist believes investors are failing to take account of a decelerating economic recovery.

With China deliberately reducing investment, the US economic recovery slowing, and sovereign issues pervading (ie Europe), stock market risks, suggests Rocks, remain elevated. Yet the recent pullback in stock prices did not feature a capitulation in cyclical stocks. Cyclicals – those stocks whose fortunes are linked to economic cycles – are still trading at a premium while defensives – those stocks little affected by economic cycles – are trading a a discount.

Rocks notes that if we take out the top six largest stocks in the ASX200 the remainder is trading at a 15% premium to historic valuation. The market, in general, is not as cheap as many believe. The strategist suggests negative news flow is likely to continue, finally leading to a rotation out of cyclicals and into defensives, with accompanying earnings downgrades. He is recommending investors set themselves for defensive yields in the meantime, favouring DUET ((DUE)), Tabcorp ((TAH)), Foster's ((FGL)), Origin Energy ((ORG)), MAp Group ((MAP)) and Telstra ((TLS)).

In real estate investment trusts, Rocks prefers Stockland ((SGP)), Westfield ((WDC)) and CFS Retail ((CFX)), while in healthcare he likes ResMed ((RMD)) and Ansell ((ANN)).

Merrills' target level for the ASX200 by end-2010 is 4,500.

Macquarie's equity strategists have set a target of 5068 for end-FY11. If both strategist teams are right, we will finish 2010 exactly where we are now and then rally 12.6% in the first half of FY11. But Macquarie has actually downgraded its target from an earlier 5564 to account for weakened market sentiment, as reflected in lower price/earnings ratios.

Macquarie, too, believes there is downside risk to earnings, specifically in the All Industrials (meaning the market minus the resource sector). Industrials suffer from a large domestic cyclical exposure in a time when, as Rocks has noted, the global recovery is decelerating.

Macquarie's FY11 target of 5068 represents a total shareholder return over the next 12 months of 16.6%, split into an 11.9% capital return and a dividend yield of 4.7%. Macquarie has been spending a good deal of time recently rejigging its valuation models to reflect shorter, sharper cycles ahead as opposed to the longer flowing cycles of more recent decades.

Macquarie is thus not alone in suggesting, by implication, that the world may well be entering a period very similar to the 1970s as a result of the GFC and its trailing overhang. The 1970s was a decade in which markets rose and fell sharply but stock indices ultimately entered 1980 at about the same level they left 1969.

Investors should take note that if these assumptions are correct, yield plays stand out against capital return plays for the longer term investor, while shorter term traders will need to be quick on their feet.

One feature of FY11 now assumed by all analysts is that Australian banks will find earnings opportunities constrained by a lower availability of wholesale funding. The world is attempting to pare back debt, not expand it. But of the Big Four, one bank can boast a likely offset to such funding constraints, suggests Deutsche Bank.

By following a strategy of expanding into Asia, ANZ Bank ((ANZ)) has opened access to large pools of cheap deposits – deposits which can then be repatriated and invested locally in the more mature Australian market. In the meantime, National Bank ((NAB)) is struggling with its UK assets while looking to expand local wealth management through an AXA ((AXA)) takeover, Westpac ((WBC)) is incorporating an underfunded St George and similarly Commonwealth Bank ((CBA)) is dealing with its BankWest loan book. All are competing locally for deposits but relying on offshore funding.

ANZ has an offset to funding constraints via Asia, and by leveraging those deposits is looking at a potentially “material” profit opportunity in latter years. Deutsche suggests possibly 7-12% additional profit in FY14.

To that end Deutsche has today upgraded ANZ from Hold to Buy and increased its target from $25 to $26.

The FNArena database now shows a Buy/Hold/Sell ratio for ANZ of 8/2/0, against five Buys for CBA, four for NAB and only one for Westpac. The average target price in the database for ANZ stands at $26.37.

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