A Wave Of Broker Upgrades

This story features QANTAS AIRWAYS LIMITED, and other companies. For more info SHARE ANALYSIS: QAN

– 40 broker ratings upgrades since Friday
– Resources and energy feature but upgrades are widespread
– Analysts are looking through to the other side of the disaster 

By Greg Peel

On Monday, FNArena produced 20 Broker Call entries (total stock reports worthy of note from the daily reports of the eight major brokers in the FNArena database) and there was one recommendation upgrade.

On Tuesday there were 49 entries, featuring six upgrades and three downgrades. On Wednesday there were only 28 entries but eight of them were upgrades and there were no downgrades.

This morning there are 69 entries. Of those, 25 feature recommendation upgrades. There are no downgrades. This is very unusual.

But we are suddenly in unusual times. In terms of the Japanese earthquake and tsunami we have the experience of the 1995 Kobe earthquake to draw from. In terms of nuclear disaster, we have to go back to Chernobyl in 1986. In 1986, Chernobyl was in what was then still the Soviet Union, which was not a part of the free financial markets. Japan, on the other hand, is the world's third largest economy and fully mature. If Japan is impacted, the world is impacted – right down to whether or not the new i-Pad will have to be delayed due to lack of Japanese manufactured parts.

The Japanese nuclear threat is the last in a line of problems which have beset stock markets since the February peak. MENA unrest has sent the oil price soaring, thus threatening the global economic recovery from the GFC. Debt issues have again arisen in the eurozone following more credit spread blow-outs and ratings agency downgrades. The Japanese earthquake/tsunami has threatened a short-term disruption to earnings outlooks and commodity prices but Kobe and common sense tells us that will ultimately turn around once the rebuilding phase commences. But nuclear meltdown? Get me out!

The information has been flowing from Japan hour by hour, and from other probably unreliable sources. The information is often conflicting as a fluid situation ebbs and flows. The reality is no one really knows the answer to the question “what if?” Everyone knows, however, that if the nuclear threat is contained then the stock market correction will reverse very rapidly.

Clearly stock analysts are looking towards that scenario, rather than entertaining any apocalyptic notions. As can be seen by weak opens followed by rally-backs over the past week in stock markets around the globe, there are plenty of investors out there looking for bargains as well, basing their theses on a “buy when everybody else is panicking” theme. While obviously there are some stocks in the Australian market which will suffer from lost Japanese trade (yesterday Billabong ((BBG)) announced a profit downgrade for example), elsewhere analysts have seen little reason to readdress their FY11-12 earnings forecasts which have only just been updated in the wake of the February results season.

So if stock prices fall a long way from target prices that analysts don't feel driven to reduce, then clearly recommendation upgrades must follow. And that's exactly what's happened.

Yesterday the equity strategists at BA-Merrill Lynch issued a short but sweet note simply entitled “Stocks that have fallen too far”. The report selected for attention groups of stocks that (1) were stand-outs in unjustified price falls, (2) that had fallen the most, (3) that now looked cheap on a PE basis and (4) that were safe havens. The strategists are clearly suggesting that weakness created on the back of everything that's happened since February does not have anything other than emotional basis. That emotion, of course, is blind panic.

Utility DUET ((DUE)) appears in all four categories. Qantas ((QAN)) appears in 1-3. National Bank ((NAB)) appears in 1-3. Tatts ((TTS)) appears in 1, 2 and 4. Amongst all other stocks there's everything from engineering to publishing, transport to beer.

JP Morgan has not changed its view on Macquarie Group ((MQG)). It still believes the investment bank's earnings prospects are limited in the near term. But on sheer price drop, the analysts this morning upgraded MQG to Neutral.

We can go right back to the Queensland floods to acknowledge that markets always panic unnecessarily and sell insurance companies whenever natural disaster strikes, simply assuming a jump in claims. This panic ignores both insurers' catastrophe provisions and levels of reinsurance. But having experienced floods, then Yasi, then Christchurch and now Japan, Australian insurance stocks have been hammered.

This morning Credit Suisse noted that Insurance Australia Group ((IAG)) and Suncorp-Metway ((SUN)) actually have so much excess capital they are thinking of giving some back to shareholders. Their catastrophe provisions might now be dangerously low, and reinsurance costs set to rise, but share price weakness has this well factored in. And higher prices can be passed on. QBE Insurance ((QBE)) is struggling with margin pressures and may yet not make FY11 guidance, but QBE had fortuitously locked in three years of reinsurance before the wave hit.

Credit Suisse has upgraded IAG and Suncorp to Buy this morning and QBE to Neutral.

Given the level of commodity price volatility at present, one might consider now not the best time to be making a wholesale reassessment of commodity price forecasts. But that's exactly what the RBS global commodity analysts have done this week having last updated, and upgraded, in October. Despite some sell-offs, commodity prices are now higher than the RBS forecasts set in October.

So up we go again. And this has prompted the RBA Australia analysts to plug the new forecasts into their models and thus increase earnings forecasts and target prices across the resources and energy sectors. The end result is no less than twelve recommendation upgrades in the space from RBS this morning, from junior miners through to major producers and even indirect beneficiaries such as West Australian Newspapers ((WAN)).

And UBS is also in on the act. UBS, too, raised its oil price forecasts this morning, resulting in energy company upgrades. The analysts also noted that resources stocks that were only a month ago high-flying have suddenly been beaten down to less than net present value in some cases. “A remarkable turnaround,” says UBS, and one the analysts see as offering some pretty sweet entry points for investors. UBS made four recommendation upgrades this morning.

And I haven't even covered the whole list. In short, analysts do not see an ongoing impact from the Japanese disaster, and indeed are looking ahead to where Australian companies can benefit, no matter how uncomfortable that concept might make us all feel.

One need only note this morning's local stock market action to see a repeat of the “fall first then rally back” pattern – a pattern that has so far caught out early value seekers but may yet prove very profitable. As we stand, the nuclear situation seems to be improving in Japan. A power line will soon be hooked up to restart emergency systems and water is being poured onto the reactors from land and air.

We must, of course, acknowledge that the news has swung back and forward from bad to promising several times since Friday.

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