Weekly Broker Wrap: It’s All About Costs

Array
(
    [0] => Array
        (
            [0] => ((CPU))
            [1] => ((AMP))
            [2] => ((BHP))
            [3] => ((RIO))
            [4] => ((FMG))
            [5] => ((ILU))
            [6] => ((PDN))
            [7] => ((AGO))
            [8] => ((MCR))
            [9] => ((AWC))
            [10] => ((IAG))
            [11] => ((SUN))
        )

    [1] => Array
        (
            [0] => CPU
            [1] => AMP
            [2] => BHP
            [3] => RIO
            [4] => FMG
            [5] => ILU
            [6] => PDN
            [7] => AGO
            [8] => MCR
            [9] => AWC
            [10] => IAG
            [11] => SUN
        )

)

This story features COMPUTERSHARE LIMITED, and other companies.
For more info SHARE ANALYSIS: CPU
The company is included in ASX50, ASX100, ASX200, ASX300, ALL-ORDS and ALL-TECH

-Intense focus on costs this year
-Diversified financials challenged
-Resources profits likely to fall
-Case for holding general insurers

By Eva Brocklehurst

As this reporting season gets up and running one thing stands out above all — cost cutting. Brokers expect the resources sector, in particular, to focus heavily on efficiencies in operating and capital expenditure in order to improve profitability and free cash flow. The market will also be putting the ruler across cost cutting in the financial sector.

Computershare ((CPU)) has been through a soft patch but Morgan Stanley expects investors will take this in stride and focus on the medium term. The broker thinks investors should be aware the company would still like to make another acquisition, although it would be surprised to hear one was imminent. Morgan Stanley expects subdued corporate activity will be a handicap in the short term and sees risk of a guidance downgrade.

For Challenger Group ((CGF)), the broker will be looking for guidance on a surplus capital target and this could be accompanied by an expansion of the buyback program. Such an outcome should please investors but what the broker would also like to see is indications of a sustainable margin. Perpetual (PPT)) is expected to show a better dividend but needs to lift its market share of inflows to justify its relatively high trading multiples, according to Morgan Stanley.

Goldman Sachs seems to agree, finding Perpetual offers the least value upside and Henderson Group ((HGG)) the most in the wealth management space, while in the middle sits AMP ((AMP)) and BT Investment ((BTT)). This broker finds that diversified financials have, over the last five months, experienced an average price/earnings re-rating of around 33%, double the broader market. Assuming a bull market scenario, this implies around 20% upside to the stocks. On this basis, Henderson has the most room for expansion and Perpetual and ASX ((ASX)) the least.

Taking a bear market assumption, the average fundamental downside is about 35%. So where are we exactly on the bull-bear see-saw? The broker is not sure, but either way has the same stock preferences. There are four Buy and two Hold recommendations on the FNArena database for Henderson. Citi expects fund flows to turn positive for Henderson in FY13 and recently upgraded the stock to Buy. AMP is a bit more mixed, with three Buy, four Hold and one Sell. UBS has the Sell rating here, believing the stock's price/earnings and valuation premium are too high.

Goldman Sachs warns about basing too many decisions on historical multiples. History tells us there is high chance the market will overshoot in either bull or bear markets but now, particularly in the case of the diversified financials, the waters have been muddied. For ASX this time there are the incursions into what the broker describes as the company's " previously perfect monopoly". For AMP there is the shift from superannuation accumulation to pressure for fees/distributions as well as a maturing membership base.

Goldman Sachs makes the point that, for the fund managers, there is a progressive running off of a large, mature, high-fee book and growing pressure as the Australian population ages and shifts into fixed income assets. In the case of Computershare there is also growing awareness that, in mature markets, core registry business may turn out to have a lower growth trajectory than previously perceived.

UBS expects headline profits will take a battering in the resource sector. The majors BHP Billiton ((BHP)), Rio Tinto ((RIO)) and Fortescue ((FMG)) are expected to post reductions of up to 40%. This decline would reflect the iron ore price correction last year. Rio Tinto has already issued guidance for write-downs of US$14 billion and the market is now expecting BHP to write down its aluminium and nickel businesses by US$3bn, reflecting tough operating conditions. Miners will be looking for where they can cut costs this year to improve profitability. JP Morgan expects the investment community will want to know the full extent to which capital is being deployed on growth projects. Key to the future is also the view on end markets, given the rebound in some prices that has occurred in the sector since December 2012.

Pricing is a significant point for Iluka ((ILU)), which stands out as the stock in the resources sector, according to brokers, with the greatest risk of upside or downside surprise. With zircon prices stabilising after the significant falls that occurred through 2012, JP Morgan expects Iluka to be re-rated after its results. Any commentary on zircon and titanium feedstock markets will be closely watched. UBS expects Iluka's report will be key to revealing the extent of weak mineral sands prices and volumes.

As for Paladin Energy ((PDN)), JP Morgan notes low uranium prices persisted throughout the period in question and it is unlikely that Paladin will report positive cash flow. Both brokers note there's likely be little for the market to be positive about with Paladin. Even with the stock trading well below valuation, JP Morgan believes any good news is largely priced in.

For Atlas Iron ((AGO)) UBS expects the sale of lower grades will weigh on profitability but the expansions the company has planned could ensure guidance is lifted. Much about pricing and costs has already been said at the December quarter production reports and the results season is not expected to provide a lot of catalysts. Leading iron ore stock, Fortescue, has already revealed revenue (through volume and realised prices) as well as costs in the quarterly production reports.

In the case of nickel miner Mincor ((MCR)), UBS expects break even. The broker believes the focus here will be on whether the company declares a dividend, doubting that will be the case. Mincor has paid a dividend from cash reserves in the last two profit reports, even though reporting a loss. UBS expects Alumina ((AWC)) to report a loss, driven by a lower aluminum price and hence, no dividend.

Deutsche Bank finds the case for holding Australian general insurers compelling. The broker believes, while absolute value upside is more constrained in the likes of Insurance Australia ((IAG)) and Suncorp ((SUN)), high dividend yields and value discounts relative to market are reasons to own the stocks. Notwithstanding significant outperformance over the past year, the domestic general insurers are still trading at an average 10% discount to historical market price/earnings.

Suncorp is the broker's top pick. Why? There is greater upside to consensus earnings forecasts and higher dividend yield, including potential for special dividends. On the FNArena database Suncorp registers five Buy recommendations, two Hold and one Sell (Macquarie). Macquarie is still cautious vis-a-vis the risks from the recent flood and fire catastrophes. In the case of Insurance Australia, JP Morgan stands out as being the one Buy rating, expecting a strong underlying first half result. IAG has five Hold ratings and two Sell.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms