Weekly Broker Wrap: Financial Inquiry, Transport, Fox And Salary Packaging

This story features NATIONAL AUSTRALIA BANK LIMITED, and other companies. For more info SHARE ANALYSIS: NAB

-NAB best placed after inquiry
-Upside for AIO and TOL
-What will replace FOX?
-Strong growth for MMS and SGF
 

By Eva Brocklehurst

The battle lines have been drawn in Australia's Banks And Financial Services Financial Systems Inquiry. Common themes found by Credit Suisse in submissions include tax reform, promotion of appropriate competitive neutrality and removal of regulatory overlap. The most contentious areas, in the broker's view, are related to new digital payment providers encroaching on major banks, funding of the Financial Claims Scheme – ex-ante opposed by the banks, the conservatism of the Australian Prudential Regulation Authority, mortgage risk weightings, regional banks seek a lower ceiling – and government intervention to promote a larger domestic corporate bond market, which Treasury opposes but many favour.

The interim report is expected by September and the final by November. Credit Suisse expects, over time, that the major's balance sheets will improve in terms of lending diversity and composition. The broker considers the likely winner from the inquiry will be National Australia Bank ((NAB)) with the bigger mortgage players, Commonwealth Bank ((CBA)) and Westpac ((WBC)), relative losers.

BA-Merrill Lynch thinks there's enough evidence the Australian economy is improving. Port volumes are up, a key indicator of activity given the flow on to rail and transport. Hence, the broker is warming to Asciano ((AIO)) and Toll Holdings ((TOL)). Nevertheless, just as cyclical risks look like easing there is evidence that structural risks are rising. The broker observes Asciano is facing disruptive price competition in terminals and Pacific National (PN) Rail and there are concerns around the take-or-pay contracts at PN Coal. Merrills thinks PN Coal's issues are manageable but suspects the others could entail downgrades to FY15 expectations.

Toll faces risks from the resources slowdown, and margin pressure from labour inflation as well as contract roll overs from the Singapore government. Both stocks are trading at 12-month lows so Merrills thinks there's opportunity for investors that are comfortable with the risks to wait for better activity levels to come through. Brambles ((BXB)) remains the broker's top pick in the sector based on a view the company is starting an earnings upgrade cycle because of its leverage to an improving US economy. 

21st Century Fox ((FOX)) will be removed from the Official List of ASX on May 8. Morgan Stanley has looked at what might take the stock's spot in the S&P/ASX indices. In the broker's order of highest probability IOOF ((IFL)) is the number one pick for the S&P/ASX 100 with Transpacific Industries ((TPI)) and Australand ((ALZ)) second and third respectively. In the S&P/ASX 50 it's Ramsay Health Care ((RHC)) and SEEK ((SEK)) in that order. In the S&P/ASX 200 the number one replacement pick is Sundance Energy ((SEA)) and number two is Steadfast ((SDF)).

Salary packaging, including novated leasing, and fleet management form part of a sector that is set to grow, in Macquarie's view. Salary packaging administration involves payment of pre-tax salary to a trust where money is then disbursed to cover employee's costs such as leases, superannuation, mortgages, school fees, entertainment accounts and so forth. Novated leasing is the largest part of salary packaging. It involves a three-way deal between a financier, employer and employee and these leases are sold to the corporate and government sectors. The novated lease market now accounts for an estimated 20% of the funded vehicle market. The growth drivers for the sector are employment, particularly in health and education, growth in new vehicle sales and outsourcing of fleet management. The broker also believes there are new product opportunities to help grow the market. Within fleet management there are products designed to improve driver safety and alertness and within the salary packaging there are opportunities to sell other services across an employer's employee base, such as credit cards.

Macquarie observes the two ASX-listed companies in this area have produced solid revenue and earnings growth and both generate high returns on equity of 25-30%. McMillan Shakespeare ((MMS)) has the longest listing history in the sector and is the largest player. Macquarie expects MMS to resume its long-term growth trend in FY15, after the interruption from the former government's proposed FBT changes last year. The broker thinks the acquisition of CLM in the UK last year represents a long-term growth opportunity. Newly listed SG Fleet ((SGF)), is the third largest in the sector and derives 37% of its FY13 revenue from novated leasing.

Goldman Sachs has initiated coverage of SG Fleet with a Buy rating and expects the stock to re-rate as it achieves FY14/15 prospectus forecasts. This broker sees growth opportunities too, as several large public authorities still manage fleets in-house and may look to outsource. The sector has high returns and as SG Fleet derives only 43% of its earnings from novated leasing versus McMillan Shakespeare's 60%, Goldman considers SG Fleet has less regulatory risk. Goldman has a Neutral rating on McMillan Shakespeare. Given the recent action by the federal government in ceasing subsidies to automotive manufacturer's the price/earnings discount applied to novated lease earnings has been raised to 40% from 20%. The broker's multiple on salary packaging earnings is now a 20% discount compared with a 10% premium versus the Small Industrials Index. Goldman's recent discussions with industry contacts have signalled salary packaging is sometimes priced at lower margins to win more lucrative novated lease work.
 

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