Weekly Broker Wrap: Panning For Gold In The Tailings

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            [0] => ((PRY))
            [1] => ((WOW))
            [2] => ((CPU))
            [3] => ((ALL))
            [4] => ((SUN))
            [5] => ((CPU))
            [6] => ((LEI))
        )

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            [0] => PRY
            [1] => WOW
            [2] => CPU
            [3] => ALL
            [4] => SUN
            [5] => CPU
            [6] => LEI
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)

This story features WOOLWORTHS GROUP LIMITED, and other companies.
For more info SHARE ANALYSIS: WOW
The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Andrew Nelson

It’s not likely to be business as usual post this latest reporting season. Earnings momentum was sluggish, there are consensus downgrades on the horizon and large caps, especially our favoured big miners and banks, are no longer a destination we can heedlessly run to.

There were low expectations leading into this reporting season, but there have at least been a good number of positive reactions to results. The problem is, which positive result reactions can we trust?

Last week, as the flow of reports began to slow, analysts at UBS put forward a theory to answer this question: only trust a positive post release performance when it was preceded by outperformance leading into the result. The broker notes that these stocks have historically tended to outperform by a further 5% over the following 3 months.

Unsurprisingly, at least based on the logic of UBS, a negative reaction to a result usually preceded further underperformance. The broker notes that stocks that were underperforming heading into the result and then had a negative reaction would tend to continue to underperform by about another 5%.

On the broker’s cards, the stocks that outperformed leading into and then post a positive result so far this reporting season are: Toll Holdings ((TOL)), Boart Longyear ((BLY)), NRW Holdings ((NWH)), Acrux ((ACR)) and Perpetual ((PPT)).

The broker notes that when a stock was underperforming leading into a result this season, a positive result reaction was rarely enough to turn the general trend of the stock around. While not necessarily losing ground, UBS points out that these sorts of stocks tended to trade sideways. Examples: OneSteel ((OST)), Goodman Fielder ((GFF)), BlueScope Steel ((BSL)), Primary Healthcare ((PRY)) and Navitas ((NVT)).

BA-Merrill Lynch has its own view on where to go as the dust settles. The broker notes that small caps, especially ones in the mining services and consumer discretionary sectors, did better than much of the market.

The broker points out there were more positive surprises on the sales line, rather than the earnings this season, which the broker believes shows that margin pressure will be a major issue going forward. Given the general macro backdrop, the broker thinks forecasts are still too optimistic, especially given the weight many have placed on a stronger 2H.

OneSteel ((OST)), Brambles ((BXB)), Mermaid Marine ((MRM)) and Seek ((SEK)) are all factoring in a better than usual improvement in 2H sales, while the broker thinks consensus margin forecasts for Cochlear ((COH)), Myer ((MYR)), Woolworths ((WOW)) and Metcash ((MTS)) are simply too high.

Even more dangerous than a too optimistic 2H outlook, notes BA-Merrill, is the 14% growth now expected for FY13. The broker thinks current global reads on PMI and the consumer sentiment are pointing to a more subdued outlook. On the broker’s numbers, the underlying market PE right now is about 12.5 times, or at “fair value”.

However, an analyst team from JP Morgan warns that too much could be made of the downgrades that are still to come. Admittedly, cyclical and structural issues will still combine to limit earnings growth going forward, thus the broker thinks stock selection will need to be biased towards value and “special situations”, or the companies that possess big levers to pull to make significant underlying change.

The broker likes the energy sector, noting the strong crude price has been helpful recently. However, the broker sees the sector as more bottom-up case. With progress coming as LNG projects start to demonstrate a tangible higher value than the market currently has on them, either over time or via corporate activity.

The broker notes the death of growth drivers out there means that shares prices, at least in some part, will be driven by value, which allows a stock to re-rate without any big changes in the macro environment. As long as nothing more goes wrong. Citing valuation support relative to mid-cycle returns, the broker thinks Boral ((BLD)), Computershare ((CPU)), Aristrocrat ((ALL)) and Sims ((SGM)).

JP Morgan also likes companies that have some specific levers. Boral ((BLD)) has scope to improve via portfolio management, costs reduction and pricing; Qantas ((QAN)) can also manage costs, while restructuring could also offer benefits; Insurance Australia Group ((IAG)) has the ability to improve returns via insurance pricing and could have a UK turnaround scenario up its sleeve; Suncorp ((SUN)) also has scope to improve returns via insurance pricing; Computershare ((CPU)) has synergies to extract; Transfield ((TSE)) and Leighton ((LEI)) have problem businesses that can be addressed.

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