Weekly Broker Wrap: How Some Oz Stocks Fare In Low Growth Environment

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-Building materials get more lift from US
-Modest residential recovery this year
-NBN scope for TPM and IIN
-Bank dividends should hold up
-Lower $A and leisure stocks
 

By Eva Brocklehurst

June was characterised by a weakening job market with Australia's unemployment rate pushing to near 4-year highs of 5.7%. This should put downward pressure on inflation and, for UBS, cements a 25 basis points cut to the cash rate when the Reserve Bank next meets in August. This is of course, unless the June quarter CPI throws a spanner in the works. Of interest, by state, employment growth was faster in NSW and Victoria improved, while Western Australia has slowed sharply and Queensland was soft.

Meanwhile, the domestic building materials sector may have outperformed in the week to July 11 but Goldman Sachs finds it was primarily US-exposed stocks such as Boral ((BLD)) and James Hardie ((JHX)) that gained the advantage. Adelaide Brighton ((ABC)) and CSR ((CSR)) were more modest performers. Domestic dwelling starts appear to be recovering slower than anticipated, although the volatile multi-unit component has amplified the month-on-month moves. Building approvals for residences declined 1.1% in May and are down 3.2% for the year to May whereas the single family dwelling, which was up 2.8% on the prior month, is up 13.1% in the year to May.

The market recovery is modest but low interest rates are continuing to support home buyer optimism while auction clearance rates are now at a 3-year high. Despite this, with an expected rise in unemployment, BA-Merrill Lynch believes a more positive outlook for the domestic economy is needed to support a stronger residential recovery. The broker leaves forecasts for the major developers unchanged but expects the apartment sector to sustain most of the lift in approvals. Top picks for the sector are Mirvac ((MGR)) and Lend Lease ((LLC)) in large caps and Peet ((PPC)) as a pure residential exposure.

Despite the accommodative interest rates, recovery in housing has been quite tentative. BA-Merrill Lynch 's models suggest current house prices are around 7.6% below fair value and a lack of confidence may be restricting sharp increases in prices. Labour market uncertainty near term suggests price rises, and the general level of activity, will stay subdued throughout 2013.

Australia's National Broadband Network roll-out will expose players to narrower fixed line re-seller margins. This is a threat to TPG Telecom's ((TPM)) growth upside in JP Morgan's opinion. While expecting TPG can increase market share in the NBN world, the lower capital intensity and open architecture of the NBN suggests it will attract new entrants. TPG has limited ability to re-base costs as margins erode because it is already quite lean. The problem is that TPG lacks a content proposition which might protect margins. The company's recent spectrum purchase does raise the possibility that a mobile proposition will form part of its response to margin compression in fixed line. The concern is that, to be meaningful, this would require a link up with Vodafone Hutchison ((HTA)) and this is a problematic scenario, in JP Morgan's view.

JP Morgan expects the NBN will provide scope to drive broadband penetration and open up non-metro markets to greater competition. Overall, the size of the addressable market for both TPG and small telco competitor iiNet ((IIN)) should increase by 70% by 2020.

The broker has remodeled iiNet in the face of this re-basing of margins on the NBN and downgraded the stock to Underweight. Where iiNet has an advantage relative to competitors is a higher proportion of low-margin off-net customers compared with TPG. The Coalition's plans for the NBN, should it win government, are more negative for iiNet, in JP Morgan's view. This is because the NBN would roll out faster and margin assumptions put a net negative impact on iiNet. The broker has acknowledged the relative stability of iiNet's earnings in the near term and, along with a lower bond yield assumption, this offsets some of the NBN margin erosion. A lower discount rate, nonetheless, does not save the day and the broker's target at $4.41 is well shy of a share price that's had a strong run recently.

The banking sector may be slowing down. Citi forecasts the sector delivering earnings growth around 4% in FY14/15. On the broker's modelling, neutralising of the divided reinvestment plan could cease for two years but no bank would be forced to cut dividends, although National Australia Bank ((NAB)) would come closest. This reflects the much higher capital ratios that banks now have and the much lower leverage in corporate Australia compared with past slowdowns. The models show Commonwealth Bank ((CBA)) fares the best and NAB the worst through the slowing scenario. This reflects higher return on equity and better credit quality at CBA. With no threat to the dividend pay-outs from the slowing scenario, the sector's 5.9% prospective dividend yield remains compelling value for Citi. Prospective yields still maintain a 200 basis point premium to 10-year bonds and a 200 basis point premium to term deposit rates.

Investor appetite for leisure stocks should also hold up in the wake of a lower Australian dollar. Village Roadshow ((VRL)) and Ardent Leisure ((AAD)) have outperformed the ASX Small Industrials by 11% and 12% respectively since mid May. Deutsche Bank notes the lower Australian dollar will drive domestic and international inbound tourism and Ardent benefits further from the US dollar earnings of Main Event. The broker's preference is for Village, as it is trading at a 20% discount to Ardent with earnings upside. Deutsche Bank admits Ardent's yield and US dollar earnings are still attractive. It's just that this stock is on the expensive side, trading on a 2014 estimated enterprise value/earnings of 14.1 times. Hence Deutsche Bank has a Buy rating for Village and a Hold rating for Ardent.
 

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