Weekly Broker Wrap: Opportunities Abound Despite Modest Outlook

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This story features KMD BRANDS LIMITED, and other companies.
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-Opportunities despite modest growth
-Equity investment remains patchy
-Market runs ahead, now must earn gains
-Renewed optimism in mainstream media

By Eva Brocklehurst

The US Federal Reserve's decision to delay the tapering of it asset purchase program means the US dollar is unlikely to rally much over the next few months, even if there's stronger economic data. CIMB believes this means the synchronised global recovery will not hit its straps. Growth will be modest but it still creates opportunities for investors.

Where are the opportunities in Australia? The broker sees potential in materials, energy, industrials and financial stocks. Why? Using data from past cycles CIMB finds upside price appreciation is more likely in materials because of a currency-backed hike in earnings and in industrials and energy where there's scope, not only because of earnings growth, but from price/earnings expansion. In financials it's the low interest rates that have potential to lift earnings growth and push stocks higher. Underperformers are the telcos, utilities and health care sectors. Consumer staples are expected to perform in line with benchmark.

Drawing out further the implications for Australia, the broker does not think the current cycle will be driven by leverage and commodity prices as it was in 2003-7. This cycle caused a very strong performance in utilities, where leverage was used to maintain dividends and purchase assets, and in energy, based on a substantial rise in the oil price. Neither sector is likely to find the same factors significant this time around. Health care also rallied during the last cycle but this was after the sector was marked down heavily during the collapse of the tech bubble. Currently, while the US health care sector is seeing strong capital market activity this is not the case in Australia so far.

Specifically, the S&P/ASX 200 produced an average price appreciation of 45% and a price/earnings expansion of 2.5 points in the last cycle rebound. In the current cycle, the market has risen by 24% and the PE has risen by 5.2 points. This implies that, if the market is to repeat the performance of past cycles, earnings will need to grow strongly. In the current cycle, the PE of materials has already expanded by 2.8 points compared to the average trough-to-peak expansion of 1.3 points. In utilities (0.7 points) and financials (2.8 points), the PE has also expanded a little more in the current cycle than the average of previous trough-to-peak expansions.

The PE expansion in energy (1.5 points) so far in the current cycle is well below the historical average (3.0 points), suggesting to CIMB a significant PE expansion is likely. The PE expansion in the consumer discretionary sector (3.4 points) is less than the historical average (4.5 points), suggesting a further lift is possible. Industrials have produced an average 4.3 point PE expansion and in the current cycle the expansion is already 3.7 points.

Citi finds investment in Australia's equity market, while stronger, remains patchy. There are some decent prospects for growth but foreign investors have moderated their net purchases of overseas equities more generally in recent months. With the prospective tapering of QE and potential rise in the US dollar, US net purchases have still been fairly strong and continue to focus on developed markets. Data from Japan shows that Japanese investors have been heavy net sellers of Australian equities.

The foreign net selling of Australian equities appears to have coincided with the decline in the Australian dollar since May and, although a lower exchange rate has generally encouraged renewed foreign buying, Citi observes it hasn't always been immediate. Meanwhile, Australian households continued to show only a modest interest in equities. Although they are putting more savings into superannuation, they appear to be more attracted to property than shares. Super funds, while still buyers of equities, have also moderated purchases over the past year.

Typically, the market has run ahead of the economic rebound and will now have to earn its gains, in Citi's view. The August cut to the cash rate has finally reignited the appetite for credit appetite and the broker thinks a crossing point is looming, where the placing of savings in the bank is no longer viewed by households to be more attractive than investing in real estate. The lower Australian currency has partly eased financial pressures on businesses and economic and financial news across all major regions has turned more positive and exceeded expectations.

Citi now has greater conviction that Australia’s growth will pick up next year. Economic forecasts have not been changed but the broker is more comfortable about forecasts for GDP growth of 3.0% for next year. In particular, a moderate pick up in consumer spending, with the recovery in housing, is looking more likely. In contrast, a recovery in non-mining business investment is not expected before 2015. There is potential, in the broker's view, for upside surprises to earnings in sectors like building materials, airlines, retailing, media and some financials, where forecast earnings are still relatively low, but it remains just that, potential. Citi's target for the ASX200 is 5400 by end of this year and 5600 by mid next year, assuming a gradual rise in bond yields once the Fed actually begins to taper.

Goldman Sachs has an emerging companies focus list and this grew 4.8% in September compared with the Small Ordinaries Accumulation Index growth of 1.6%. Which stocks contributed most to this growth? They are Skilled Engineering ((SKE)), Kathmandu ((KMD)) and Trade Me ((TME)), beating the overall growth of the list by 13.4%, 11.6% and 8.3% respectively. Detractors in the month were OceanaGold ((OGC)) and Flexigroup ((FXL)), contracting by 22.2% and 1.5% respectively.

With the spotlight on media stocks Morgan Stanley finds there's some renewed optimism in TV/radio and print advertising spending for the first time in three years. The broker still thinks the shifting of advertising dollars out of traditional media and into new media will continue, maintaining investors underestimate the incremental impact on earnings, returns and valuation of each dollar of this shift. Online winners are REA Group ((REA)), where the broker also ponders whether the company can spend a bit of money on acquisitions with the backing of News Corp ((NNC)), as well as SEEK ((SEK)), Carsales.com ((CRZ)) and Trade Me ((TME)).

Loss of market share continues for Fairfax Media ((FXJ)), where the broker wonders whether an asset break up may be required, as well as APN News & Media ((APN)) and Seven West Media ((SWM)). Morgan Stanley still prefers Seven to Ten Network ((TEN)) in TV but acknowledges there is turnaround potential at Ten. On the regional sphere the broker thinks an acquisition of Prime Media ((PRT)) by Seven could make strategic and financial sense. Positive structural growth is coming from 21st Century Fox ((FOX)) because of the high proportion of earnings coming from Cable Networks and content. Any fall in the Australian dollar helps too as a substantial amount of earnings come from offshore.
 

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