Transport Needs More Economic Fuel

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-Transport needs more economic fuel
-Port and rail has most favoured outlook
-Logistics is stretched
-Waiting for Qantas to deliver

By Eva Brocklehurst

The transport sector is at a crossroads. It's driven as far as it can on current fundamentals but is awaiting a further rebound in the economy to fuel up. The recent rally in the share market has lifted most players in the sector, according to brokers, except perhaps Virgin Australia ((VAH)). CIMB believes this strengthening of the sector is not because of improved fundamentals, and there is a likelihood that earnings and guidance will fail to meet expectations. Macquarie also suspects that much of the recent rally stems form multiple (PE) expansion rather than an improved earnings outlook. UBS expects earnings growth will eventuate for the sector, except the airlines and Toll Holdings ((TOL)).

CIMB sees sub-sectors port and rail having the most favourable outlook. Asciano ((AIO)) and Aurizon ((AZJ)) have coal exports to thank for this. CIMB believes this justifies their share price movements and has the broker become more comfortable with forecasts. UBS expects AIO and AZJ will post earnings growth of around 25% in FY13, based on volume growth, leverage and business improvement. Macquarie is more concerned that, for AIO – rated Hold – soft trading in intermodal and container ports will be a constraint on share price. Still, the broker finds the stock looks cheap relative to the sector. Moreover, it is attractive on a price/earnings basis given strong earnings growth prospects for the next two year. AZJ has similar constraints in intermodal but Macquarie rates it a Buy. The company still enjoys earnings certainty associated with the regulated business, an under-geared balance sheet, cost reductions and improving free cash flow.

CIMB has downgraded the logistics sub sector, and Brambles ((BXB)) and Toll ((TOL)) to Underperform because of valuation concerns. The broker believes valuations have become too stretched relative to the underlying fundamentals of the economy. A cyclical recovery would justify re-rating these but at this stage the broker finds no catalyst. UBS expects Brambles should continue to recover, but faces earnings dilution from a recent equity raising. Toll is expected to reveal sluggish general freight and problems with offshore investments which will dilute performance. Macquarie has stated its preference for earnings certainty and a track record of delivery. Here, it has upgraded Brambles to Buy, given its steady and improving growth profile, efficiencies and earnings predictability. However, Toll gets a downgrade to Hold because it's nearing valuation and there are challenges in global forwarding and maintaining margins. In respect of nearing valuation, Macquarie also places K&S ((KSC)) in the downgrade to Hold basket.

Airlines sit in CIMB's Hold bay, although the broker expects Qantas ((QAN)) has more upside and it remains one of the broker's key picks in the transport sector. UBS expects Qantas and Virgin to sustain compression in earnings because of yield pressures in the domestic market. For Macquarie, Qantas should start delivering on its international transformation this year but the broker would still like to see more regional alliances and improved flight timings to better the Asian offering. And, Macquarie reminds us, Qantas has failed to deliver on consensus earnings over the past four years. Nevertheless, Qantas has the potential to close the gap between book value and share price as its earnings improve off a low base. Macquarie thinks Virgin will disappoint, given the first half result. However, the broker has given it the benefit of the doubt, upgrading the rating to Neutral, based on an improving FY14 outlook.

CIMB expects transport infrastructure stocks should continue to be well supported, given an attractive mix of yield and growth. The broker retains a Buy rating on Transurban ((TCL)) given strong dividend growth expectations and has this stock as its top pick in the sub-sector. A Hold rating is given to Sydney Airport ((SYD)) – it has tax audit problems – and Macquarie Atlas ((MQA)) – subdued traffic growth likely . A Sell rating is given to Australian Infrastructure ((AIX)). The broker notes, with the Future Fund offering $3.22 a share, a competing bid is unlikely and, as the deal will take time to consummate, the stock is range-bound. 
 

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