Weekly Broker Wrap: FY14 Outlook May Be Overly Optimistic

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-FY14 outlook appears optimistic
-Budget impact minimal for health stocks
-Rise of self managed super funds
-Valuing Telstra's fixed asset base
-Drought rears again
 

By Eva Brocklehurst

The market's outlook for FY14 might be a bit optimistic in terms of stock performances. BA-Merrill Lynch finds there is an over-reliance on second half improvement when it comes to Computershare ((CPU)), Harvey Norman ((HVN)), UGL ((UGL)), Ansell ((ANN)) and Toll Holdings ((TOL)). Margin expansion is also optimistic for the likes of Metcash ((MTS)), Echo Entertainment ((EGP)) and Toll. The broker has looked at the earnings risk for two key sectors, domestic cyclicals and mining.

Recent economic data and company updates suggest the rally in domestic cyclicals could be unsustainable. Merrills finds retail, media and building stocks are not covering the cost of capital. Moreover, they operate in industries with poor pricing power. What's of concern is that some retail stocks have rallied while inventory turnover has deteriorated. In terms of resource stocks, the big caps offer attractive valuations, in Merrills' view. While sizeable earnings risks exist for small cap miners, the broker likes the bigger names, such as Rio Tinto ((RIO)). What is surprising is the amount investors are willing to pay for low-growth yield stocks, particularly banks. While struggling to see value in the sector, the broker thinks a catalyst for de-rating is unlikely near term. Material upside for the Australian market will be driven by miners.

Credit Suisse has reviewed government spending in health care, ahead of the federal budget being brought down on Tuesday. Pathology and the Pharmaceutical Benefits Scheme have borne the brunt of funding pressure. Cuts to drugs that treat Alzheimer's, diabetes and atrial fibrillation are likely but the impact on companies like Australian Pharmaceutical Industries ((API)) and Sigma Pharmaceuticals ((SIP)) is considered minimal. Both are large and can reduce trade discounts to pharmacists to offset revenue. Pharmacists will take the hit. Offsetting this cut is likely to be funding for additions to the PBS. The private health insurance rebate is not expected to undergo further drastic changes, after previous announcements, while GP practice incentives are a perennial target where cuts can be expected. Neither of these are expected to affect the health care sector in any significant way.

The rise of self-managed superannuation funds (SMSF) has gone relatively unnoticed despite a large amount of asset transfer. CIMB notes, between June 2001 and June 2012 the assets in these funds grew at a compound annual 17%, to reach $440 billion. This makes it the fastest growing, and largest segment, of Australia's $1.5 trillion superannuation industry. Market share gains for the funds over the last 15 years netted an additional $180bn over and above system growth. The portfolios tend to be concentrated in Australian shares (32%) and cash or term deposits (29%).

CIMB finds, as a result of the high allocation to Australian equities and rapid growth of market share, the direct ownership of Australian market capitalisation has risen to over 11% in 2012 from 4.7% in 2004. It appears, moreover, that the typical SMSF is less concerned about diversification. Large cap stocks are the beneficiary of increased market participation because of their blue-chip status. The S&P/ASX 200 still looks attractive with the market paying a post-tax gross yield of 5.2%, compared with 3.4% in term deposits. This yield gap is one percentage point wider than the 10-year historical average.

Casinos in Australia are being challenged by the weaker economy, particularly at a time when many of the properties are finishing major capex investment. UBS thinks it's not just economic data that heralds caution in this regard, but also the various industrial companies that have commented on the tough consumer environment. Victorian gaming revenue is also weak. The state government's statistics for non-casino slot machines shows softness and, while there are reasons specific to non-casino slot markets that may account for this, there is likely to be some impact on Crown's ((CWN)) earnings, in the broker's view.

The ACCC has raised the prospect of further changes to valuing Telstra Corp's ((TLS)) customer access network in the 2013 fixed services review. An access price rise seems likely. In CIMB's view, the Telstra economic model shows a divergence between the internal costs for use of the access network and the external regulated access charge. As values fall, average costs will increase relative to regulated prices. The decline in copper fixed services and the implied cross subsidy from retail to wholesale is expected to grow. CIMB thinks the trend of fixed volumes falling faster than expenses leaves the ACCC with little choice but to reduce the value of the regulated asset base.

The current value of the regulated asset base (RAB) is likely to produce an increase in regulated prices for a range of services. The ACCC may adjust the RAB down further to maintain current prices or manage price increases at a lower rate. The analysts do not see a workable price that would allow the RAB to be maintained at current levels. This is of concern to CIMB. The approach adopted in 2011 led to significant access price reductions, which are unlikely to see the reduced value of RAB recover before migration from copper to NBN fibre. This leaves Telstra shareholders holding part of the cost for the endorsement of the government's high-cost FTTP (fibre to the premises) NBN. CIMB notes that the review in 2013 will likely be done in the context of a reversion to the Coalition's FTTN (fibre to the node) NBN.

Drought is the word being bandied about again and the prevalence of herbicide spray rates has been subdued, lagging levels seen last year. CIMB surveyed the agricultural chemical sector and finds the lack of rain has also affected the distributor outlook for fertiliser application rates. Expectations for fertiliser demand were based on a reasonable winter and moisture levels. Incitec Pivot ((IPL)) is likely to experience more of the subdued conditions that persisted in the summer. As an aside, CIMB notes Incitec Pivot has reduced of of the volume risk following efforts to secure volume commitment from distributors, although acceptance has not been uniform. Dry conditions also pose obstacles for Nufarm ((NUF)). The company said in March the domestic backdrop was challenging because of the dry conditions and this, according to CIMB's feedback, has continued in April. The prevalence of weeds has been below average, according to 64% of respondents to the survey.
 

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