Weekly Broker Wrap: Europeans Home In On Oz Infrastructure

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-Europeans target Aust Infrastructure
-Yield versus growth in infrastructure stocks
-Pressure on retailer margins continues
-General insurers, transport outperforms
-Who gains with media reform proposals?
 

By Eva Brocklehurst

Offshore competitors are circling. Citi has observed that European companies seeking growth are increasingly targeting Australian infrastructure projects. The broker lists Impregilo, Salini, Acciona, Bouygues, Balfour Beatty, Ansaldo and Obrascon as targeting Australian rail, road, water and power projects. The most exposed, overall, to this increased competition are Leighton Holdings ((LEI)) and Lend Lease ((LLC)). Citi believes Acciona's winning bid on Brisbane's $1.7bn Northern Link road project could be a test case for the Europeans' ability to undercut Australians on price and make a profit.

In resources, competition from international companies is greatest in LNG. Europeans have not actively targeted resource infrastructure projects to date, limiting involvement to mostly maintenance services. That could change. Citi finds the most exposed stocks in this respect are Monadelphous ((MND)), Downer EDI ((DOW)) and UGL ((UGL)). Orica ((ORI)) and Incitec Pivot ((IPL)) have enjoyed the mining boom mostly free from international competition but this too is expected to change. Citi notes the construction of the nitrates plant in Western Australia's Pilbara marks the first major investment in domestic ammonium nitrate production from an international producer, Norway-based Yara International. Orica is partnering with Yara and Apache.

Aurizon ((AZJ)) is BA-Merrill Lynch's top pick in the infrastructure sector, given balance sheet leverage and cost cutting potential. Asciano ((AIO)) will benefit from new grain and coal contracts and Transurban ((TCL)) will be driven by steady traffic and toll increases. TCL, AZJ and Qube Logistics ((QUB)) are considered to have the strongest 5-year compound annual growth rate.

The broker divides infrastructure companies into two broad camps. Companies such as Asciano and Sydney Airport ((SYD)) will show growth over the next three years as economic conditions improve, but these more cyclical stocks tend to offer a lower yield as capital is reinvested. On the flip side is DUET ((DUE)), Spark Infrastructure ((SKI)) and SP AusNet ((SPN)) which, being regulated utilities, have more defensive cash flow and offer higher yields. For example, on the FNArena database consensus forecast FY13 dividend yields are 6.8% for SPN, 6.6% for SKI and 7.5% for DUE. In contrast there's AIO (1.9%) and AZJ (2.4%). SYD appears to be the exception to the rule, showing a 6.9% yield. 

Some of these stocks, such as AIO, SYD and Australian Infrastructure ((AIX)) are more leveraged to GDP and the general economy. In contrast, the steady utilities such as DUE, SKI and SPN have more subdued growth profiles and exposure to the improved economic conditions. On Merrills' 5-year measure, QUB (14%), AZJ (10.5%), AIX (10.6%), TCL (10.3%) and AIO (8.85%) offer the strongest distribution growth. Although the regulated utilities currently have the highest yields in the sector, there appears to be little growth in distributions. The 5-year measure shows 3.3% for SKI, 2.9% for DUE and 1.5% for SPN.

Overlapping infrastructure for some stocks is transport and here Aurizon shines again for the broker. It is one of two notable structural turnarounds in the transport sector. The other is Qantas ((QAN)). Transport stocks outperformed the market in February, up a weighted average of 8.1% versus the ASX 200 at 5.4%. Asciano and Toll Holdings ((TOL)) were the key stocks for Merrills, up 15.7% and 17.7% respectively in the month. The broker puts the outperformance of TOL and AIO, as far as the financial results are concerned, largely down to margin expansion rather than top line growth and notes organic growth remains muted for each of Brambles ((BXB)) AIO, TOL and Virgin Australia ((VAH)).

There's been much talk about retailer margins. Citi finds Australian retailers seem reliant on gross margins to protect earnings. For FY13, most retailers are approaching record margin levels but the broker believes it can't last. Myer ((MYR)) and David Jones ((DJS)) are perhaps best placed to protect gross margins through greater private label sales and use of clearance outlets. Price discounting swings from season to season and, in Citi's view, the rise in FY13 gross margins reflects fewer discounts.

The other factor at play is price harmonisation, which can actually raise margin percentages but comes at the expense of sales growth. There are downside risks as new entrants and online shopping break down that margin advantage. Overseas retailers have responded to gross margin pressure in a range of ways such as private labels, clearance channels and service income. This is the sustainable path and where David Jones and Myer seem well positioned to leverage these gains. Other retailers may pursue the same opportunities but, in Citi's opinion, will only manage to offset natural margin pressure.

Credit Suisse notes general insurers have continued to outperform the market in recent months. They are now trading at a price/earnings premium to their five-year historical average. A slight premium is justified with the positive outlook continuing, albeit at a slowing pace. Despite QBE's share price being up significantly in recent months, it remains the broker's preferred pick in the sector. The broker supports the actions taken by QBE management and expects a continuation of underlying earnings improvement in coming years.

Insurance Australia ((IAG)) has recently widened the gap to Suncorp ((SUN)) on a price/earnings basis, a premium the broker considers appropriate. This is because IAG has most upside leverage to the local general insurance market and less downside risk from unpredictable natural peril events. Credit Suisse expects a slowdown in premium rate increases, a reduction in investment income and adjustment to new APRA capital requirements to play out for these stocks over the next one to two years.

This week new media reforms were proposed by the Commonwealth Government and, understandably, received a lot of press. Legislation is expected to be presented to the parliament within the next two weeks. The easy bit, and that which the Coalition is likely to approve, is a reduction in licence fees and mandating Australian content quotas. The Coalition intends to oppose a media advocate appointment, public interest test in relation to media mergers and a statutory press standards body. A parliamentary committee will be established to discuss potential abolition of the 75% audience reach rule while the Australian Communications and Media Authority (ACMA) will consider program supply agreements in determining control of free-to-air television. The Australian Law Reform Commission will to be asked to look at the possible implementation of a tort for invasion of privacy.

If a quick resolution is reached regarding the abolition of the reach rule, this will be added to the current package. Summarising the potential implications for the media, Credit Suisse notes a positive for Southern Cross Media ((SXL)) and Prime Media ((PRT)), which would both benefit from reduction in licence fees and the opportunity of abandoning the reach rule. Abandoning the audience reach rule would enable Ten Network ((TEN)) or Nine Network to take over SXL and Seven West Media ((SWM)) to take over Prime.

On the neutral fence is TEN and SWM, as the potential abolition of reach rules would be countered by the introduction of a public interest test, statutory press standards body and increased regulation of supply agreements. In Credit Suisse's wholly negative camp is News Corp ((NWS)), if a public interest test, press standards body and increased regulation of supply come about. Fairfax ((FXJ)) and APN News & Media ((APN)) are also in the negative camp because of the possibility of a public interest test and statutory press standards body.
 

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