Weekly Broker Wrap: Aftermath Of Earnings Season, Where To From Here?

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            [6] => ((PRY))
            [7] => ((TEN))
            [8] => ((ORG))
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This story features DOWNER EDI LIMITED, and other companies.
For more info SHARE ANALYSIS: DOW
The company is included in ASX100, ASX200, ASX300 and ALL-ORDS

-Mining contractors face challenges
-Oil & Gas most promising
-Margin expansion hard going for insurers
-Wealth, gaming, healthcare and media
-Electricity generation profitability an issue
 

By Eva Brocklehurst

It's obvious contractors have challenges ahead as resource companies pare back capex intentions. Deutsche Bank still has Buy recommendations on Downer EDI ((DOW)) and UGL ((UGL)), which have enough diversity in the earnings stream to withstand these challenges. The broker did not expect spending reductions to the extent that companies have flagged across such a wide range of services, noting many mining services contracts are being taken in house while exploration budgets are being reduced and maintenance being deferred.

The pullback of exploration expenditure plans for FY13 is generally around 10-30%. Deutsche Bank notes some contracts are still being deferred and expectations of a recovery in the second half are a bit premature. Mining and metals equity raising activity is well down on 2011 peak levels and for UBS this is indicative of the issues being faced by junior miners in accessing finance for exploration programs. The broker notes, on a rolling 12-month basis to February 2013, total junior and mid tier miner equity raisings of around $22bn were down about 23% on the prior comparative year and down 52% on the twelve months to February 2011.

Deutsche Bank's preference in the maintenance sector has shifted to those with government exposure, in order to mitigate the resources exposure. Here, Transfield Services ((TSE)) and DOW have the largest revenue exposures to government. Peabody appears to be the miner that has plans to bring the most services in house and Leighton Holdings ((LEI)) and DOW are the most exposed, with Deutsche Bank expecting a gradual roll off in contract mining revenues for these two. While Xstrata has indicated it will take Collinsville in house and this affects LEI. UBS believes expansion of LEI's civil work at Gorgon should offset the loss of this contract. On the matter of repairing balance sheets, a number of companies announced plans to lower gearing. LEI, TSE and DOW have the greatest potential to reduce gearing, according to Deutsche Bank.

Oil & gas is the most promising resource sector for work in engineering and contracting services. While the market was bogged down in reporting season, UBS notes WorleyParsons ((WOR)) mopped up Bergen Group Rosenberg AS for around $186m. This company specialises in offshore oil and gas and should stand WOR in further good stead. DOW, UGL and WOR are the broker's top three picks in this space.

Diversified financials fared reasonably well in reporting season and Henderson Group ((HGG)) has become Citi's top pick in the sector. The broker is attracted to strong growth prospects in better markets, relatively attractive valuation and good prospects for an eventual turnaround in flows. Albeit, after UK updates recently, this now looks likely to take a little longer. Next is IOOF ((IFL)) which also offers leverage to improving markets. Third in line is ASX ((ASX)), despite the broker lowering the rating to Hold after the results. Citi finds the stock is fairly priced.

UBS remains cautious on the insurance sector, expecting margin expansion will be difficult to deliver. Preference? The view is slightly skewed to Suncorp ((SUN)) as opposed to Insurance Australia Group ((IAG)) . Minus the non-core banking segment, SUN's price/earnings discount to IAG has widened to 20% and, of particular note, special dividends of at least 15c for the next two years appear increasingly likely. As for QBE ((QBE)), UBS finds it hard to get excited even though QBE has a healthy balance sheet. The broker is not comfortable buying the stock on just macro economic themes.

On the gambling tack, Deutsche Bank has a preference for Crown ((CWN)) and Aristocrat Leisure ((ALL)), despite wagering operators surprising on the upside and casino operators disappointing with their results. Why? CWN and ALL are trading at discounts to the broker's valuation of 11% and 10% respectively, whereas wagering operators, Tabcorp ((TAH)) and Tatts ((TTS)), are trading at premia of 3% and 7% respectively. Echo Entertainment ((EGP)) is trading at a 19% discount, but is not preferred as the broker ascribes a 20% corporate appeal premium to the stock's valuation. The performance of Echo continues to disappoint Deutsche Bank, at both The Star and the Queensland properties.

There was a divergence in health care sector results. CIMB lines up the weak as Cochlear ((COH)), Ansell ((ANN)) and Sonic Healthcare ((SHL)) and the strong as Primary Health Care ((PRY)), ResMed ((RMD)), CSL ((CSL)) and Ramsay Healthcare ((RHC)). The broker notes the sector's usual stable earnings streams came under scrutiny. Longer term drivers are still favourable for the sector but there is a softening in the overall healthcare index. Systemic risk is expected to moderate through 2013, with sentiment shifting toward capital appreciation and earnings momentum limiting strong sector gains. On a sector relative basis, the favoured stock is PRY and the broker would take profits in CSL, RHC and COH as valuations have outstripped fundamentals.

BA-Merrill Lynch expects a small bounce in the media sector in FY13/14 characterised by flat/low single digit growth. Optimism comes from recent improvements in macro data such as consumer confidence, ANZ internet jobs and residential auctions. This should translate into higher advertising spending. Online share of advertising spending is estimated to reach 30% in FY14. The broker believes both Seven West Media ((SWM)) and Southern Cross Media ((SXL)) can grow sales by 2%. This is against Fairfax Media ((FXJ)) and Ten Network ((TEN)) which could see low single digit top line decline.

If the carbon price and renewable target were both abandoned, the outlook for thermal generators would be much better but that's not necessarily going to happen. UBS, therefore, believes betting on this in the hope that thermal generator margins improve will not be successful in the end. Regardless, solar and wind are here to stay and also provide jobs, hedge against rising fuel costs, while rooftop solar provides competition for the monopoly aspect of the grid. The broker notes electricity consumption has fallen 6% over the last two years and is not likely to grow much at all in the next six.

The cost of meeting the renewable target is not captured in the broker's forward electricity price estimates yet. Nevertheless, underlying costs of renewables are expected to continue to fall. Wind capital costs have come down about 25% and solar's underlying cost has fallen 75%, both partly as a result of the currency. This makes them more competitive. How do established names fare in all of this? From the UBS viewpoint, thermal generation profitability in Australia is an issue and preferred stocks are those with less thermal generation. Both AGL Energy ((AGK)) and Origin Energy ((ORG)) have significant generation portfolios. Thermal generation is 29% of AGK's enterprise value and 9% of ORG's. ORG is preferred.
 

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