Weekly Broker Wrap: TV, Mining Capex And Insurance Caution

This story features SEVEN WEST MEDIA LIMITED, and other companies. For more info SHARE ANALYSIS: SWM

By Andrew Nelson

It’s been a tough year for Australia’s free-to-air (FTA) TV broadcasters and Citi is starting to wonder whether Australia is big enough to maintain three FTA networks. After taking a look at international TV markets the broker notes Australia is a bit of an anomaly, as the majority of the markets the broker looked at were supporting two commercial broadcasters, not three.

Citi has undertaken a detailed review of twelve TV markets in advanced economies and Australia, believe it or not, comes away a global leader among FTA markets, underpinned by some very supportive structural market dynamics. The main supportive factor is the health and breadth of Australia's ad market, which sits is the global top quartile on both spend per capita and for percentage of GDP.

Because of this, TV in general is able to remain a very high value product, with broadcasters and publishers able to charge some fairly hefty cost per minute rates and cost per capita. Although, the broker notes relative to total advertising, TV holds a 31% share of ad spend in Australia, making it mid-range in terms of the bigger picture.

While FTA broadcasters have admittedly been impacted both locally and globally, struggling with weaker revenues and cost inflation, Australian FTA networks have outperformed international peers. All three players, Seven ((SWM)), Nine and Ten ((TEN)) are still profitable, just running on much thinner margins for the time being. It isn’t time to be predicting clear weather just yet, however, with Citi expecting to see further content cost inflation in order for the FTAs to keep up with pay TV operators.

Given the near term risks from both structural and cyclical pressures are still firmly in place, the broker maintains its preference for Seven, given its demonstrated ability, even over the past few years, in turning viewership into money.

New media also came into focus last week, with Goldman Sachs hosting its 2012 Online Conference. The first cab off the rank was the rise and rise of mobile computing, from phones to tablets to what else have you. The industry sees plenty of opportunity here, especially given the potential of increasing transaction levels via the integration of increasing user-based data and the evolution of search, especially given geo-location capabilities.

There was a consensus that companies must have a good strategy before taking on social media, as a half-hearted presence can do more harm to a brand than not being there at all. It is also quite difficult to measure return on investment (ROI) in social media investment, although it is agreed it’s better to be there than not.

The panel also agreed upon the importance of accepting the fact that companies will, at various stages and at various levels, have to formalise an on-line strategy at some point and then be committed to that migration. Although, the broker points out it is important to keep in mind that online capex has a shorter life cycle and short-term ROI can be hard to measure, thus flexibility remains the key. A prime example is the high correlation between online sales and AUD/USD exchange rate, which is already driving a noticeable change in on line sales momentum. 

Citi also took a look at the mining capex picture last week and its findings were definitely worth taking note of. In short, the broker believes the peak in mining and energy investment will probably occur in FY13, one year earlier than it had previously expected.

Much of the brought-forward downside is due to the deferral or cancellation of coal projects and to a lesser extent iron ore. The good news is the outlook for LNG investment has not really changed and this support has Citi believing that Australia probably isn’t looking at a steep investment cliff, but likely a more manageable decline. Although, the broker notes overall business investment growth could be close to flat over the next 12 months.

On the positive side, this drop in investment could see the imports of capital goods drop off by around 1% of GDP, unwinding the rise in imports that reduced the economic stimulus from the capex phase of the boom in the first place, which would help to soften the blow to overall economic growth.

The coal, iron ore and LNG export share of GDP would then start to rise again in FY14, although Citi believes the bulk of this ramp-up won’t be seen until FY16. Up until FY16, however, the broker notes there will be a gap between the pick-up in exports and the drop-off in capex of around 1.5% of GDP. Something will need to fill this gap and the broker believes a combination of lower imports and higher spending in the non-mining sectors may well do the trick.

The broker is also of the opinion that filling this gap won’t take as much luck as seems to be implied, with there already being a significant amount of pent-up demand across numerous sectors that have been squeezed out by the mining boom over the past few years. These sectors could well fill the growth gap. An example would be the fact that the share of housing investment has fallen by about 2% of GDP from its peak last decade. Demand here, as we all know, would be economically beneficial.

However, timing remains the key, notes the broker. Mining capex could actually come off faster than thought, or the AUD may remain stubbornly high for an even more prolonged period. This makes the task of rebalancing the economy even more problematic. Still, there are some early rays of sunshine, with Citi pointing to the recent signs of stabilisation in China’s growth and stabilizing commodity prices, both of which are positives for the rebalancing. Further rate cuts will also likely be needed, even if recent data belie the need for near-term action.

Analysts at Macquarie agree, noting the combination of lower commodity prices and a still high AUD continues to undermine resource company cash flow, and the ability to keep on growing investments from current levels. The broker believes resources investment will still keep rising until mid 2013 and then plateau, which has Maccas asking a similar question to Citi; what will drive growth over the second half of 2013 and beyond?

As already noted, a much weaker currency would help, but isn’t all that likely in the short term.  So, cross your fingers for increasing housing construction activity, as the broker sees this as being almost the only candidate.  Interest cuts will be key, says the broker, and hopefully quickly given the lags of monetary policy.

Bank of America-Merrill Lynch notes that as always, the outlook for insurers always depends, to some extent, on the weather. Natural peril claims are an important component of an insurer’s claim costs and ultimately, profitability. The broker notes both  Insurance Australia Group ((IAG)) and Suncorp ((SUN)) currently budget about 7% against net premium revenue for natural peril costs, with QBE’s ((QBE)) similarly high.

While the provisioning seems about right, the broker is a little troubled by the belief investors are pricing the Australian general insurers for a benign period of natural peril losses over the next two years. This is especially so for IAG,  with BA-ML noting some analysts are even running with natural peril budgets for IAG that are well below even the insurer’s own budgets for such costs. And while costs may actually prove to be low, the broker notes it’s a roll of the dice, more guesswork than fundamental analysis.

A word of caution from JP Morgan, who notes that despite persisting headwinds, the US housing market has so far staged a stronger recovery than expected. This has in turn started to lift most stocks with material US housing exposure. The benefits have already stated to flow through to James Hardie ((JHX)) and Boral ((BLD)), but the broker thinks the current improvement and much more is already priced into the two companies.
 

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