Weekly Broker Wrap: Telematics, Media, Broadband, Wealth and Transport

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-Telematics take up likely to be slow
-What's likely on media reform agenda?
-Broadband returns decline, mostly for Telstra
-What issues ahead for diversified financials?
-Picking the best in subdued transport sector
 

By Eva Brocklehurst

What is telematics? Morgan Stanley has a survey which shows that 20% of Australian motorists are ready to give telematics insurance a go. Telematics measures how, when and where you drive in order to price insurance more precisely for the individual. The insured connects a BlackBerry-sized device to the car and that connects with GPS and mobile networks. All cars made from 2000 onwards are capable of telematics. The device can track location, and driving behaviour such as accelerating and braking as well as swerving and lane-switching. An actuarial logarithm then translates this data into a behavioural risk score. Presto! You're measured for insurance.

Morgan Stanley observes that, unlike the UK where the market is three years old, Australia does not have widespread market pricing failures that would accelerate the adoption of telematics. Moreover, in the US and UK insurance combines bodily injury and motor, making the economics more compelling. Telematics has a 0.6% share of the UK market and in the US, where penetration is higher, it's estimated at 2-3%. So it's not likely to take off like a rocket.

Morgan Stanley thinks that once telematics gains initial acceptance here it will fuel its own growth as community rating systems break down. The insurer absorbs the costs of the device which could cost $100 but Morgan Stanley thinks the economics make sense on a policy over $900. Telematics calls for more underwriting and more data handling, including the cost of connecting to a mobile network. The potential to bundle with CTP green slips would make it even more attractive. The benefits for insurers include the fact that less risky drivers are likely to select telematics first, and there'll be higher retention of such customers once they're "connected". Morgan Stanley thinks, eventually, car manufacturers, or telcos for that matter, risk displacing direct motor insurers if they do not enter this market. While the analysts at Morgan Stanley think this option is inevitable it is unlikely to grow fast. They estimate the current market potential is around 7%, but expect this to rise as technology gets cheaper and major insurers get involved.

The change in the federal government has caused JP Morgan to put a spotlight on potential media regulation reform. Such reforms are more likely to occur in FY15. The potential list includes the scrapping of the 75% reach rule and a review of the 4.5% FTA licence fee. The scrapping of the 75% reach rule is likely to be a trigger for regional and metro consolidation in the industry. In June a parliamentary committee supported the removal of the rule. The committee was of the view that the rule was becoming redundant with the advent of the internet and converging media. JP Morgan considers the most likely beneficiaries of the scrapping of the rule would be Prime Media ((PRT)) and Southern Cross Media ((SXL)). In the case of the potential review of the Free-To-Air licence fee, JP Morgan rates a reduction as a one-in-three chance.

In a speech to parliament earlier this year the now Minister-elect for Communications/Broadband, Malcolm Turnbull, noted that Australian FTA fees were relatively high by global standards. Should these fees be reduced further, JP Morgan would expect further legislative requirements for FTA stations, such as increased Australian content obligations. Modelling for a 0.5% and 1% reduction scenario, the FY15 earnings estimate for Seven West Media ((SWM)) rises 2% and 4% respectively. For the Ten Network ((TEN)) it rises 6% and 12% respectively.

Australian telcos may have attractive dividend yields of 5.3% for FY14 forecasts but Morgan Stanley thinks the 10-year government bonds at 4% offer a justifiable alternative. Slowing Free Cash Flow growth and the decline that's expected in broadband industry returns underpin the broker's Underweight call on Telstra ((TLS)). In contrast, NBN-driven regional share gains should see increasing returns for the likes of iiNet ((IIN)) and the broker is Overweight on that stock. Profit taking has been dominant in the telco sector recently but Morgan Stanley still views iiNet, TPG Telecom ((TPM)) and Singapore Telecom ((SGT)) as attractive.

Why does Morgan Stanley think Telstra's returns will decline? Telstra's competitors have new mobile pricing plans which could see a potential change in market share and this is yet to be priced in by the market. Based on the broker's analysis these are not domestic price decreases, so a seven times EV/EBITDA multiple is still applied to Telstra's mobile business, in line with global peers. Changes to international roaming fees are one genuine change to the industry, which could inspire consumers to move away from Telstra. Morgan Stanley expects Telstra to gain 0.5 percentage points of mobile market share in FY14. 

What the broker finds a major problem with is the market pricing in declining returns for all players. Broadband industry returns are set to decline, yet smaller ISPs, such as iiNet are expected to increase returns and take regional market share. Hence, Telstra's price/earnings ratio should contract to 14 times from 15 times on slowing cash flow growth, in the broker's view. The company's 3-year FCF compound annual growth rate should slow to 7-8% from 12-15%. Historically this measure is a predictor of multiples expansion and, hence, a slowing rate means multiples compression.

Citi has changed some calls on the diversified financial sector in the wake of reporting season. The broker lifted ratings on Perpetual ((PPT)) to Neutral and dropped Henderson Group ((HGG)) and IOOF ((IFL)) to Neutral. The broker became significantly more positive on Challenger ((CGF)), lifting it to Buy, following the best annual result in a very long while.

What has Citi deduced from the results overall? Equity market performance is still key to the sector performance with Henderson, IOOF and Perpertual earnings strongly leveraged to markets. ASX ((ASX)) and Computershare ((CPU)) are positively leveraged to trading and corporate actions. Citi maintains Computershare is the most leveraged it has ever been to short-dated interest rates. Despite the low interest rates, annuity sales momentum also looked strong in June and continued into July and August. While not out of the woods, the broker suspects funds management may be past a turning point.

IOOF has revenue pressures, including platform margin pressure, but cost control is a mitigating factor for Citi, even if IOOF is unsuccessful in its bid for Trust Co ((TRU)). Counter bidder Perpetual is relatively expensive, but Trust is seen as a worthwhile accretive acquisition. Meanwhile, ASX is considered relatively safe but unexciting. There is little sign of IPO or secondary capital raisings picking up materially, and new initiatives such as collateral management and OTC clearing are not expected to make a substantial difference for some time. Derivatives volumes did rise in FY13 but, in Citi's opinion, if interest rates are more stable then these too may subside.

Soft economic conditions and slowing resources activity meant a challenging end to FY13 for the transport industry. CIMB notes growth was below that recorded in the first half for all stocks except Toll Holdings ((TOL)) and Qantas ((QAN)). Toll was cycling a weak result in the second half of 2012, while Qantas benefited from an accounting estimates change. Overall, the airlines were hit the hardest as a combination of excess capacity in the domestic market and weak demand affected yields. Logistics operators, such as Toll, Brambles ((BXB)) and Qube Logistics ((QUB)) faced sluggish consumer demand, while Asciano ((AIO)) and Aurizon ((AZJ)) faced a softening coal market. All this is expected to persist in FY14, making earnings growth a challenge in the year ahead.

Qantas and Virgin Australia ((VAH)) have the most risk going forward because of excess capacity in the market and soft demand, according to CIMB. Toll and Qube also have risks, given the continued weakness in the broader economy and their exposure to the resources industry. Less risky are Asciano, Aurizon and Brambles. Brambles was re-rated Outperform at the FY13 result as CIMB thinks valuation multiples are now more reasonable. The broker's other key picks are Asciano, for its double-digit earnings growth profile combined with attractive valuation multiples, and Qantas, where there's an opportunity to add some cyclical risk to the portfolio with limited downside. CIMB finds downside risks continue for Virgin Australia while Toll and Qube are starting to trade above fair fundamental valuation.
 

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