Weekly Broker Wrap: Aust Healthcare, Building, Retail, Gaming And Transport

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-Solid defensives in Aust healthcare
-Conflicting stories in building
-Discretionary retail trends diverge
-Aust gaming subdued
-Transport dividends up

By Eva Brocklehurst

Australia's healthcare sector retains some attractive defensive characteristics but the valuations are not generally defensive, in Morgan Stanley's view. ResMed ((RMD)) holds the most upside potential for the broker. Sonic Healthcare ((SHL)) was upgraded to Overweight during August, joining ResMed, Primary Health Care ((PRY)) and Sigma Pharmaceuticals ((SIP)) in the category.

Morgan Stanley had been concerned that Sonic would miss expectations as a result of fee cuts across major geographies and a benign US volume environment. FY13 results surprised, however, and this provides a higher forecasting base. The broker understands that execution of the US cost cutting program is now complete and benefits are expected in FY14. This cost cutting may negate most known fee cuts in FY14 and provide the platform for growth which the broker was previously skeptical about. Sonic is considered a defensive volume growth story.

US device growth at 16% in FY13 was in line with expectations and ResMed benefitted from the shifting of the mix as home sleep testing accounts for a greater proportion of prescriptions. Mask sales growth in the US was over 8% in the second quarter but ResMed lost share. The broker expects new releases will claw back this lost share and revenue could surprise on the upside if the new devices gain traction. Home Sleep testing now accounts for over 30% of US volumes and is expected to approach 40% over the next year. The competitive bidding pricing is already known for the bulk of round two contract winners and this leaves ResMed with good forward visibility and confidence in the outlook.

Building materials stocks have seen price/earnings re-rating that was ahead of results, in anticipation of a growth recovery. Morgan Stanley thinks FY14 will provide some growth but for the most part consensus expectations are seen as still too high for the broker's liking. The most preferred stock is DuluxGroup ((DLX)), a high quality company generating a high return which justifies its P/E premium, in Morgan Stanley's opinion. Dulux has more defensive earnings characteristics than other building materials stocks, but still offers solid growth prospects. Earnings upside may come from a sharp fall in the titanium dioxide price, which is a significant input cost to paint. Working capital opportunities in the former Alesco businesses could drive further upside.

The broker's least preferred stocks are Fletcher Building ((FBU)) and CSR ((CSR)). Fletcher is exposed to a recovery in the New Zealand housing market, where it is the leading player through its vertical offering. This is the main positive. There is no FY14 guidance, and consensus expectations for FY14 and FY15 appear aggressive to Morgan Stanley. Revenue looks light across most of the divisions. No significant volume growth is expected in Australia while North America remains mixed – positive on the residential but flat on the commercial side.

CSR is positioned for a recovery in the Australian residential market but the broker sees challenges within aluminum and the Viridian turnaround requires proof. CSR offers some of the best exposure to an improving east coast property market but it's not enough to change an Underweight recommendation. Strength in building products is offset by execution risk in Viridian and risks around the aluminium assets.

JP Morgan has taken a look at the US operations of Boral ((BLD)) and James Hardie ((JHX)). Boral's performance through the downturn has mirrored that of the broader construction industry, i.e. spiralling losses, followed by deep capacity cuts and restructuring efforts. The future of the US business hinges on a number of factors, in the broker's opinion, principal among these being a recovery in brick intensity.

In contrast, James Hardie's performance through the downturn has been exceptional as it is one of the few building-related entities in the US to remain comfortably profitable. In fibre cement James Hardie stands out with a differentiated product and high market share. Boral has been affected by the volatility that is typical of fragmented industries such as bricks and tiles. In terms of pricing,  brick and tile that was resilient, although future increases will need to be considerable to restore returns, in JP Morgan's view. Again, in contrast, James Hardie has battled on the price front.

Australian retailers had a stronger second half of FY13 with earnings up 4% relative to the 3% lift in the first half. UBS finds household goods in terms of JB Hi-Fi ((JBH)) and supermarkets in terms of Woolworths ((WOW)) reported the strongest results. Billabong ((BBG)) and Pacific Brands ((PBG)) were notably soft.

For the staples, reactions were mixed while results were in line. Whereas Wesfarmers ((WES)) fell as the softer second half for Coles was construed negatively, despite Wesfarmers announcing a capital return, Woolworths ((WOW)) performed strongly, as the market reacted to the upbeat commentary on FY14 momentum. UBS views the grocery sector as fair value, but thinks Woolworths has the greatest scope to outperform. The third player, Metcash ((MTS)) sustained 5-10% downgrades in the wake of its AGM, as IGA sales were reported to be hit by heightened levels of fuel discounts by the major chains.

In discretionary retailing the trends parted. Household goods, underpinned by improving house prices, performed well while the department store/fashion area was soft. Looking forward, UBS expects this trend to continue, with increased competition in fashion to present a risk to department store forecasts and an improving housing backdrop to provide upside to those stocks such as Harvey Norman ((HVN)) and JB Hi-Fi.

Crown ((CWN)) and Aristocrat ((ALL)) remain Deutsche Bank's favoured stocks in the gaming sector. Australian gambling expenditure is expected to remain subdued through the remainder of 2013. Crown will benefit from its exposure to the higher growth Macau and Perth markets and has introduced some cost reduction initiatives in order to offset the weaker trends at Crown Melbourne. Aristocrat is sustained by the fact it generates just 27% of earnings from Australia. Of note to the broker, Crown and Tabcorp ((TAH)) were unusually quiet about trading in July and August. Echo Entertainment ((EGP)) and Tatts ((TTS)) reported positive trends. Echo was boosted by strong growth in the VIP segment while Tatts benefited from a favourable jackpotting sequence in lotteries.

The weakness previously seen in gaming machine expenditure has also affected gaming tables, and there's been a softening in wagering and keno expenditure. Conversely, lotteries expenditure has remained buoyant, although Deutsche Bank thinks this can largely be explained by the favourable jackpotting sequence. In order to offset the weaker than anticipated top line growth, some of the companies introduced cost reduction initiatives and there is an increased focus on cost control and margin improvement.

Transport produced three main themes from the earnings season. In Deutsche Bank's view, these are cost reductions, higher dividends and an uncertain outlook. Most results were in line with forecasts. Qantas ((QAN)) showed the largest variance because of an accounting adjustment to the treatment of ticket revenue. Dividends were generally higher, with Aurizon ((AZJ)) standing out. Asciano ((AIO)), Royal Wolf ((RWH)) and Toll Holdings ((TOL)) all delivered better-than-expected dividends. The changes to FY14 earnings expectations were mostly small, with the airlines being the largest downgrades on the back of fuel and capacity/yield pressures.

Deutsche Bank now has three Buy recommendations in the large cap transport space, these being Asciano, Aurizon and Toll. Toll is being more disciplined on costs and strategy but has less earnings visibility than the other two. Brambles ((BXB)) is no longer a top pick and was downgraded to Hold from Buy during the earnings season.
 

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