Weekly Broker Wrap: Bumpy Economies, AUD, Medicare And Ad Spending

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This story features BRAMBLES LIMITED, and other companies.
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The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

-Oz growth likely subdued for some time
-Pain seen in emerging markets
-Rates still key for Aussie dollar
-Implications of Medicare changes
-Advertising spend still likely to grow
 

By Eva Brocklehurst

The reduction in official interest rates has lulled the market into a sense that consumer-exposed stocks are at the beginning of a substantial upturn. BA-Merrill Lynch disagrees with this case. The broker thinks the rate reductions only provided a temporary boost to sentiment and lift to earnings and this will dissipate. Australian households have only modestly de-leveraged by taking advantage of low rates and debt remains high by international standards. According to Merrills, there's limited capacity for more leverage which, along with the move from peak resource investment, implies growth will be subdued for some time. The broker thinks it would be a mistake to extrapolate recent strength in economic data too far, especially when the riskiest part of the transition from resource investment is still ahead.

Merrills considers building approvals and retail sales are near the peak in terms of impact from the bulk of Reserve Bank rate reductions, which were delivered more than 15 months ago. Any further improvement is expected to be modest with additional rate reductions less effective. This reinforces the broker's preference for cyclical offshore exposure, such as via Brambles ((BXB)), Iluka Resources ((ILU)), James Hardie ((JHX)) and QBE Insurance ((QBE)), and for structural growth, such as via Carsales.com ((CRZ)), ResMed ((RMD)), Flight Centre ((FLT)) and CSL ((CSL)). Merrills is underweight on banks and consumer stocks in the model portfolio and retains exposure to potential infrastructure spending via Lend Lease ((LLC)). For the broker, Australia's malaise is the lesser of two evils for international investors – there's pain out there in emerging markets at the moment.

Morgan Stanley's global strategy still favours equity and credit over government bonds. The global expansion is considered intact and aggregate equity and credit market valuations are not extreme by historical standards. The regional cycles are out of sync and, for the broker, this implies the risks differ around the globe. Deflation is the risk in Europe and the front end of the bond market is the source of risk in the US. Emerging markets reveal a big risk of underperforming and the broker is underweight in this regard. Morgan Stanley does not think a crisis in this respect would derail the bull market in developed market risk assets.

If emerging markets were to suddenly slow, Europe would suffer most in the broker's opinion. Hence, combined with the deflation pressures, this reinforces a preference for US equity and credit markets, and for German bunds over US treasuries. The broker accepts this is not the consensus view. Extreme weather and rising geopolitical pressure have made investors more bullish on US bonds. Morgan Stanley is most contrary regarding the front end of that market. The broker is also cautious regarding emerging market and commodity currencies. Morgan Stanley's most contrary view is that the yen will strengthen in the second quarter, expecting a US dollar rally will happen more broadly over a six month horizon.

On the subject of the Australian dollar and the relationship with the iron ore price, Deutsche Bank observes that, while the decline in the iron ore price has been significant this year the Australian dollar has actually moved higher against the US dollar. Given the importance of iron ore in the Australian export basket – at 30% of merchandise exports – the resilience of the currency may be surprising. Terms of trade is seen as the important long-term driver of the currency but, short term, interest rate differentials appear more important. The analysts have evidence that movement in spot iron ore prices only affects the currency in the near term when accompanied by shifting rate differentials. Contract prices are still negotiated some time in advance, which means a sustained decline in spot prices would take some time to show up in actual export and trade data. As the domestic economy's momentum is picking up, it makes sense to Deutsche Bank that the Australian dollar has not reacted to the weakness in iron ore prices.

Nielsen poll data has shown that, of those surveyed, more than half the respondents were in favour of an Australian government policy to means test access to bulk billing under Medicare. Merrills now considers this will embolden the federal government and, in combination with changes to free up vertical integration, this is the most likely area of health care reform to be proposed in the May federal budget. This would have negative implications for Sonic Healthcare ((SHL)) and Primary Health Care ((PRY)) based on the broker's assessment of the possible impact. Whilst it is unknown how the mechanics of means testing would work, Merrills considers the most likely outcome is frozen indexation for Medicare rates for those above the means test. The issue is whether the listed players chase volume over price/co-payments. Merrills thinks Sonic, which already co-pays in a large number of its centres, is less exposed.

The latest Standard Media Index reveals advertising spending fell 1.5% in February. Morgan Stanley continues to think 2014 will show spending grew, overall, around 3-4%. The broker observes this may not be a boom outcome but it is constructive after two years of declines. Investors are advised to look at individual media platforms to assess the performance. Notable in February was metro TV, which recorded ad revenue growth of 5.1%. In contrast, magazines fell 15% and newspapers 22%. The broker hastens to acknowledge that SMI data is not conclusive, because it only captures a subset of the market. The most interesting aspect for Morgan Stanley is that metro TV may have grown strongly but market share among the providers was relatively stable. Metro ratio advertising fell 3.7% in the month, which was a surprise, while internet headline growth was only 3.7%. For the latter, Morgan Stanley expects double digit growth to resume after performance-related deals are concluded.
 

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