Weekly Broker Wrap: Index Targets Moving Higher

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By Chris Shaw

As global macro news flow has surprised to the upside in the first weeks of 2012, Goldman Sachs has responded by lifting its global growth forecasts. At the same time, the broker notes investor sentiment is improving and additional risk is being added to portfolios.

This has forced a review of prospective market multiples for the current year. As a result, Goldman Sachs has lifted its forecasts for the ASX200 index. Previous forecasts had assumed investors remains relatively risk averse for at least the first half of this year, this due to ongoing downside risks stemming from the European sovereign debt situation.

But given the better data coming out and the pick up in investor sentiment, Goldman Sachs has lifted its prospective multiple for the ASX200 for 1H12 to 11.5 times from 10.5 times. Further expansion to a multiple of 11.8 times is expected by the end of the year. This forecast compares to a long-run average of 13.7 times for the Australian industrials market since 1989 (on Goldman Sachs' calculations).

Revised forecasts for the ASX200 now stand at 4,340 for the end of June and 4,600 for the end of December, up 5.9% and 2.2% respectively from previous estimates. Looking at 2013, Goldman Sachs has also lifted its forecasts but only modestly, end June and end December estimates increasing by 0.5% each to 4,780 and 5,025 respectively.

Top-down earnings per share (EPS) forecasts have also been revised. For FY11 Goldman Sachs now expects industrial EPS growth of 2.0%, down from 4.5% previously, while in FY12 there should now be 2.0% growth against a previous forecast of flat results. Forecasts for the resource sector for FY12 have also improved, to minus 8.0% from minus 10% previously.

Looking at the Australian economy, from the middle of last year UBS had expected unemployment would drift up to around 5.5% from 5.2%, the move consistent with some further, but modest, monetary policy easing by the Reserve Bank of Australia (RBA).

In terms of how things have actually played out, UBS notes Australia's unemployment rate has stayed around 5.25%. This suggests a relatively stable job market that is near full employment. But at the same time actual jobs growth has slowed to zero from around 3.0%, which UBS suggests implies a weaker jobs market.

This raises the question of whether, going forward, hiring intentions will collapse to the weaker jobs growth outcome or will there be a pick-up in jobs growth in-line with an improvement in job ads and hiring intentions?

UBS's view is hiring intentions may better capture tightness in the labour market than does the jobs growth figure. This leads to the expectation of a modest increase in unemployment from current levels, with the rate unlikely to reach the level of 6.0% being forecast elsewhere in the market. 

Given Australian economic data remain mixed and offshore risks are yet to be resolved, UBS sees the RBA as having room to trim the cash rate again if it decides to do so. But with labour hiring intentions still firm, UBS's view is the RBA may soon be back to a more clear “on hold” position with respect to the cash rate.

The RBS decision to leave the cash rate unchanged this week surprised many, but in BA Merrill Lynch's view the decision should have little impact on the Australian REIT sector. One reason for this is the lack of likely earnings surprises, especially given rent collecting now accounts for around 90% of sector revenues.

Underlying growth across all property classes should receive some support from 5-15 year leases with fixed or CPI+ rent increases. This, in BA-ML's view, should be enough for the REIT sector to continue outperforming the broader market.

The lack of the expected rate cut should have no great bearing beyond the very short-term in BA-ML's view, as the decision doesn't impact on expected total returns for the sector of 12-15%. These returns should be supported by ongoing asset sales and capital returns, so helping close what is currently a 15-25% gap to net tangible assets (NTA).

BA-ML suggests earnings growth will also be helped by lower debt costs and declining base rates, this as the REITs lower leverage via asset sales. Forecasts assume the housing market does nothing more than stabilise over the next 12 months, while median house prices are expected to fall a further 5% and housing starts a further 6%.

Under such assumptions, BA-ML's top picks in the Australian REIT sector are Mirvac ((MGR)), Dexus ((DXS)) and Westfield Group ((WDC)). Among the mid-caps Centro Retail ((CRF)) and Charter Hall Group ((CHC)) are preferred.

Further on Australian property plays, Citi has looked at the exposure of the residential developers to any supply and demand imbalances in the market at present. The first finding was over the past year, affordability has been more important in driving property demand than has undersupply in the Australian market.

As Citi points out, projects with good affordability tend to have materially higher sales on average per year than do projects with lower levels of affordability. Further, those projects with good affordability in areas of under supply tend to sell on average 26% better per annum. In other words, undersupply doesn't automatically translate to high demand if the product is not affordable.

Among the Australian developers, Citi notes Stockland ((SGP)) and Australand ((ALZ)) offer the highest levels of portfolio affordability at 82 and 79% respectively. In contrast, affordability for FKP Property ((FKP)) and Mirvac stands at around 58% and 46% respectively.

If affordability is such an important driver, Citi sees risk for some lower performing projects to cut prices, which would likely impact on project margins and profitability. Even allowing for this, Citi suggests implied valuations continue to price in a more bearish scenario than is warranted by overall performance. 

This is especially the case in recovering businesses such as Australand and Mirvac. In both cases, Citi sees upside potential for share prices if the upcoming profit reporting season can deliver some positive light on the outlook for both companies. 

Mirvac is Citi's picks of the developers over the shorter-term. This reflects a recovering development business, valuation upside, scope for near-term positive newsflow and more than 90% of net profit in both FY12 and Fy13 secured by Trust net operating income and pre-development sales.

Longer-term, Citi suggests Stockland's combination of a strong balance sheet, higher residential profitability and a superior landbank with geographical diversification should provide a greater buffer than that of its peers. This is especially the case if the market was to enter another period of constrained capital and weaker buyer behaviour.

Turning to the banking sector, Deutsche Bank takes the view the first quarter of 2012 won't be a great one given the combination of funding pressures, no asset re-pricing benefits, redundancy costs and a negative marking-to-market for wealth management earnings. This combination has seen Deutsche trim earnings estimates for the major Australian banks, the cuts in the order of 2.0-2.7%. 

Deutsche expects many of these issues will start to normalise in in the second half of 2012, as the banks should achieve a re-pricing of their mortgage books and start to show signs of some cost benefits. As a consequence, Deutsche cautions against reading too much into the results for the first quarter.

In terms of sector preference, Deutsche Bank's top picks among the big four banks remain ANZ Banking Group ((ANZ)) and National Australia Bank ((NAB)), both of which are rated as Buy. Hold ratings are ascribed to both Commonwealth Bank of Australia ((CBA)) and Westpac ((WBC)). 

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