Post-Season Equity Strategy Updates

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            [9] => BHP
            [10] => FMG
            [11] => PNA
            [12] => BLD
            [13] => FBU
            [14] => DJS
            [15] => WOW
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            [17] => CBA
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            [36] => ANZ
            [37] => JHX
            [38] => CSL
            [39] => RHC
            [40] => ANN
            [41] => SUL
            [42] => GMG
            [43] => MGR
            [44] => AGK
            [45] => SFR
            [46] => SYD
            [47] => WDC
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This story features MACQUARIE GROUP LIMITED, and other companies.
For more info SHARE ANALYSIS: MQG
The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Greg Peel

Citi suggests the Australian corporate results season just passed “turned out alright”. Earnings growth was flat in FY13 as expected, with resource sector earnings down some 25% and non-resources up some 7%, which is close to trend. Sales growth was weak but cost cutting allowed for profit growth, Citi notes, and while higher dividend payout ratios imply less investment, there’s enough scope to drive operating leverage in the broker’s view.

There have been few downgrades of earnings forecasts flowing from the season or even from the pre-season confession session, notes Citi, outside of the resources and resource-related sectors. For FY14, bottom-up analyses suggest growth in FY14, with improvement in traditional industrial and consumer sectors as sales improve and more cost savings are targeted. Resource sector earnings should also now lift after the decline in prices as production ramps up, meaning solid earnings growth is possible for the market in general, Citi suggests.

Goldman Sachs is a little less sanguine. Goldman believes the Australian market is trading just above fair value given global settings (including the AUD) and suggests growth is likely to disappoint in the first half of FY14. The strategists have lowered their leverage to the Australian domestic economy (retail downgraded to Underweight, telcos downgraded to Neutral) but on a net basis maintain a pro-cyclical “tilt”.

Goldman’s preferred set of global industrials has now established a valuation premium but the strategists still see upside risk from structural growth and cyclical leverage. The set includes Twenty-First Century Fox ((FOX)), Macquarie Group ((MQG)), Brambles ((BXB)), Sims Metal Management ((SGM)), Amcor ((AMC)), Henderson Group ((HGG)) and QBE Insurance ((QBE)).

Goldman now has greater confidence volume delivery can be achieved by the energy sector, and here prefers Santos ((STO)) and Oil Search ((OSH)). The strategists are Overweight mining on generally positive momentum in China but not via pure-plays given metals are moving into oversupply. Hence BHP Billiton ((BHP)) good and Fortescue Metals ((FMG)) and PanAust ((PNA)) not so good.

Goldman is not a fan of the retail sector given a still subdued consumer despite rate cuts and AUD weakness. And the strategists do not subscribe to any theories of a boost after the election is out of the way. They are, however, optimistic regarding housing and like Boral ((BLD)) and Fletcher Building ((FBU)).

The strategists are no longer keen on the “yield trade” given rising bond yields and see bank risk skewed to the downside.

The current “market” PE for FY14, based on a 13.5% net earnings growth forecast, is 14.5x, Goldman Sachs suggests. The strategists have built a “fair value” PE model which encompasses short and long-term interest rates, the currency, market volatility and earnings revision trends and developed a result of 13.1x, implying 12% downside. On a sector basis, Goldman notes energy and mining are the only sectors below fair value while media, retail, banks and consumer staples are most expensive.

On a stock-specific basis, the strategists suggest David Jones ((DJS)), Woolworths ((WOW)), Newcrest Mining ((NCM)), Commonwealth Bank ((CBA)), Stockland ((SGP)) and Westpac ((WBC)) look expensive given the macro backdrop while ResMed ((RMD)), Computershare ((CPU)), Metcash ((MTS)), Woodside Petroleum ((WPL)) and Sonic Healthcare ((SHL)) appear to offer the greatest valuation support.

In emerging companies, Goldman has added Skilled Engineering ((SKE)) to its “focus list” of Buy-rated smaller caps.

The key takeaway for Macquarie from the result season was that there were no major earnings disappointments. Earnings growth for the market ex-resources was only modest but broadly in line with forecasts, Macquarie notes, and at least exceeded the negligible earnings growth delivered in FY12.

Macquarie is in the Citi camp in suggesting the outlook for earnings growth is gradually improving not only for the ex-resources sectors but for the resources sector as well. Upside for resources is noteworthy after two years of underperformance, and ensures Macquarie’s total shareholder return model is suggesting outperformance.

Macquarie’s model suggests a total shareholder return of 12.6% in FY14, broken down into 7.9% capital return plus a 4.7% dividend yield. On that basis the broker’s fair value target for the ASX 200 at the end of the period is 5571.

Like Goldman Sachs, Macquarie is shifting its portfolio focus away from yield and into cyclicals. The strategists suggest the long grinding down-cycle which has affected sub-trend global growth is now quietly swinging toward a long grinding up-cycle. Rising global bond yields (including in Australia, despite a falling cash rate) is the clearest signal to equity investors it’s time to rotate out of defence and towards risk, Macquarie believes. Australia’s GDP has weakened and will continue to weaken, the strategists concede, but RBA rate cuts and the lower AUD should begin to gain traction as we move into 2014.

The strategists have rejigged their model portfolio to reflect their new outlook. Out go Telstra ((TLS)) and Coca-Cola Amatil ((CCL)) and the strategists have dumped their post-split New News Corp ((NNC)) while retaining Fox. In goes Rio Tinto ((RIO)), and Mining in general moves to Overweight with an already substantial position in BHP. For domestic cycle exposure, Macquarie has added Wesfarmers ((WES)) and Seek ((SEK)) along with Flight Centre ((FLT)).

Wesfarmers, Seek and Flight Centre join JB Hi-Fi ((JBH)), Toll Holdings ((TOL)) and DuluxGroup ((DLX)) in the domestic cyclical industrials allocation of the broker’s model portfolio along with Commonwealth Bank and ANZ Bank ((ANZ)). Global cyclicals include Computershare, Amcor, James Hardie ((JHX)), Fox and Brambles, miners BHP and now Rio, and O&G companies Oil Search and Woodside.

For growth Macquarie includes CSL ((CSL)), Ramsay Health Care ((RHC)), Ansell ((ANN)), Super Retail ((SUL)), and Woolworths, while retaining income defensives Goodman Group ((GMG)) and Mirvac ((MGR)).

UBS agrees that the global picture appears to be brightening and cyclicals are shifting toward outperformance over defensives, albeit acknowledges markets are still on edge nevertheless with regards the Fed’s tapering decision. The broker can see a bit more of a correction after tapering is announced but does not see a wholesale bond-equity sell-off, remaining moderately positive on global stocks on a 6-12 month view and believing equities to still be reasonably priced.

The Australian stock market has outperformed since the May-June correction, notes UBS, on a combination of various factors, being improving sentiment towards China, the lower AUD, the “safe haven” view of regional investors, a better than feared reporting season and the promise of a change in government. The strategists remain Overweight beneficiaries of a lower AUD and a stronger US economy, Underweight yield, Overweight energy, Neutral mining, and Neutral domestic cyclicals (albeit stock-picking).

On that basis, into the broker’s model portfolio go AGL Energy ((AGK)), Amcor, Sandfire Resources ((SFR)), Sydney Airport ((SYD)) and Westfield Group ((WDC)) and out come Aristocrat Leisure ((ALL)), Brambles, Perseus Mining ((PRU)), Suncorp ((SUN)) and Telstra.

On a final note, CIMB’s quant boffins have been prompted by the recent run of stock spin-offs in Australia to do some modelling. They have concluded that companies recently announcing spin-offs had deteriorating return on equity expectations but rising share prices. On average, spun-off companies have outperformed their parent over the first year.

CIMB has thus looked for other potential spin-off candidates and decided Ausdrill ((ASL)), Fleetwood ((FWD)), Monadelphous ((MND)), NRW Holdings ((NWH)), Qantas ((QAN)), Seek and Seven Group ((SVW)) are all contenders.
 

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