Weekly Broker Wrap: Slithering Towards The Year Of The Snake

This story features HILLS LIMITED, and other companies. For more info SHARE ANALYSIS: HIL

-2013 heralding low growth, low rates
-Risks for domestic cyclical sectors
-Favouring of yield stocks continues
-Improvement seen for US building sector
-Infrastructure unprepared for climate change

By Eva Brocklehurst

For JP Morgan we are slithering towards 2013 – the Year of the Snake. The themes are now very familiar – a world of low growth and ultra-low interest rates. The broker contends that investors are already downbeat on any upside, while falling economic volatility reduces the downside risk. Hence, there's a narrowing in the outlook to one that's quite ordinary.

Locally, JP Morgan sees the economy moving to a riskier phase, as the public and corporate sectors hunker down and export earnings take a jolt. Those bewailing the fact that Australians are not greeting lower interest rates with spending are forgetting constraints of a soft labour market and low appetite for leverage and credit, according to this broker. If rates fall further, as JP Morgan expects, this spells risk for the domestic cyclical sectors, including banks, where the broker has a Sell signal. Mining stocks are given a modest Buy rating, however, more as a relative call rather than outright bullishness. Sentiment on near-term Chinese demand should continue to improve, but longer-term concerns will remain. JP Morgan believes the market has shown a willingness to buy earnings risk, but in cyclical industries with well-defined returns. There is a shortage of candidates and, since this is unlikely to change, the broker has a reasonable weighting to defensives but argues against giving special prominence to yield.

JP Morgan describes the current scenario as 'peace without victory', where world economies and market options have narrowed. A gradual improvement in the US private sector economy – where a large and avoidable fiscal policy error is the main risk of recession, China's soft landing, and a strong stance by the ECB – making it less likely fiscal solvency in the eurozone periphery will fall into critical territory – that's the peace bit. However, upside from the world economy is a long time coming and expectations remain modest. A narrowing distribution of outcomes robs equity markets of strong thematic patterns and, in this broker's summation, turnover. The stocks that do best in this landscape are ones which benefit from a lower cost of equity. That's all the 'victory' bit, folks.

CIMB has formed a grid concept to define stocks where its analyst views diverge from consensus, and the perceived risk is in the same direction. Stocks where the analysts' estimates are above consensus and where they perceive positive risk include Hills Industries ((HIL)), Monadelphous ((MND)), Aristocrat Leisure ((ALL)), Downer EDI ((DOW)), National Australia Bank ((NAB)) and Seven Group ((SVW)). Stocks where the analyst is below consensus and sees further negative risk to earnings are Leighton Holdings ((LEI)), Bendigo and Adelaide Bank ((BEN)), Toll Holdings ((TOL)) and Seek ((SEK)).

Citi notes, in the face of the continuing rally in the Australian equity market — outperforming global developed markets since they began recovering around mid year — there seems considerable doubt about the justification. At least for the extent of the market's rise. Some doubters point to earnings downgrades through the AGM season, others to the outperformance of defensive and high yield stocks as raising questions about the sustainability of the rally. Interest rates have mattered, Citi says. Much of the rise in the Australian market has been in tandem with global equities, after the earlier actions by the major central banks played a large part in reducing risks. However, the cuts in interest rates in Australia also look to have contributed to the re-pricing of equities, as they became more attractive for their yield, and Citi points to continued strong performance of the perceived reliable yield stocks as consistent with this view.

Earnings can still improve, Citi maintains. Bidding up equities for yield requires a degree of confidence about market earnings but the continued underperformance of cyclical stocks implies little expectation of any significant earnings upturn. Citi understands this may be some sign that earnings downgrades could be starting to moderate, because of lower interest rates. Indeed, the broker believes that is what commonly happens. The potential for improved earnings growth on the back of lower interest rates seems another justification for the rally, and one that could extend it further.

Burrowing into the market sectors, Credit Suisse conducted a small sample survey of consumer electronics shopping preferences and found some interesting statistics. JB Hi-Fi ((JBH)) was the preferred retailer by a significant margin. Across three of four product categories, more participants indicated they would visit JBH than any other retailer. Shopping preferences contrast with actual price comparisons which show JBH to be relatively expensive. Harvey Norman ((HVN)) and Dick Smith performed poorly on shopping preferences and appeared to require significant improvements to their brand perception. A disparity between shopping preference and price position highlights downside risk to JBH revenue over the medium term, according to the broker.

Another survey from Credit Suisse — this time the building materials sector in the US was under the microscope. US home prices have climbed for the eighth consecutive month according to the broker's survey of US real estate agents. Pricing was strong across James Hardie's ((JHX)) and Boral's ((BLD)) end market. Widespread home price momentum exhibited over the past nine months points to higher sustained new home construction and renovation activity. A lack of inventory was recently cited as one of the key reasons for pricing pressure, however the shortening of time needed to sell a home also hints at positive pricing, Credit Suisse said. For the two Australian listed companies mentioned, it invokes a re-acceleration in activity in the fist half of 2013. For Hardie, about 65% of volume is exposed to renovation end-markets. The survey also points to continued declines in housing inventory, which can only lead to demand for new homes, a positive aspect for Hardie and Boral. For Hardie, the broker sees upside risk to US fibre cement volumes. However, profitability (margins) could be tempered by a more flexible pricing strategy to gain market share (near-term). Boral may be closer to break-even in the US, according to Credit Suisse, and, whilst not implicit in forecasts,  it could break even by FY14.

Meanwhile, Citi has looked at infrastructure's preparedness, or otherwise, for climate change. The Climate Institute, in conjunction with Westpac, Mirvac and Manidis Roberts, recently published the report "Coming Ready or Not: Managing climate risks to Australia’s infrastructure". Citi notes from the findings that some utilities are better prepared than others. Impacts on property; electricity; road & rail and finance were looked at. For many industries, the  findings show key impacts can be via services and infrastructure that they rely on (eg transport, electricity), rather than necessarily within their own operations. Citi said property was one of the more advanced sectors, with several ASX-listed real estate investment trusts having conducted climate risk assessments. However, the broad conclusion was that most were under-prepared and many, even in high risk industries or with high risk assets, have not conducted climate risk assessments. While businesses may recognise the risk, there is a low level of knowledge about how to respond, Citi said. Risk assessment seemed particularly important for coastal/estuarine assets, geographically dispersed businesses heavily reliant on transport infrastructure, assets at risk from electricity supply disruptions, and long term fixed assets.
 

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