Weekly Broker Wrap: 4-Year Outlook, Oz Jobs, Oz M&A Targets And LICs

This story features SONIC HEALTHCARE LIMITED, and other companies. For more info SHARE ANALYSIS: SHL

-Growth spurt seen peaking in 2016
-Is the Oz jobs market that strong?
-Sonic Healthcare a target for US companies?
-What are the advantages of LICs?
 

By Eva Brocklehurst

Westpac's chief economist Bill Evans has peered into the crystal ball, with a four-year view of the world that sees markets becoming more interesting in 2015. A marked lift in global growth is expected, accelerating in 2016. From there a major slowdown is expected to eventuate in 2018. The cause? Developments in the US economy.

Key drivers of the expected surge in US growth in 2016 will be an overvalued equity market that forces firms to adopt growth policies to justify valuations. Pent up demand in the corporate and household sector after eight years of relative austerity will be signalled by a renewing of capital stock, upgrading of consumer durables and housing. This, in turn, is expected to lift wages and employment and thereby boost income. Supporting this growth spurt, according to Bill Evans, will be a dovish Federal Reserve, which is not expected to begin normalising official rates until the final quarter of 2015. The Fed will not be spurred on to act sooner as inflation is expected to stay benign.

The synchronised nature of the demand upturn – China and emerging markets will lift to some degree in response to stronger US growth as will Europe's external sector – will lift commodity prices. Australia's Reserve Bank is expected to begin raising official rates before the US Fed does and this will, along with commodity prices, support a significant rise in the Australian dollar. Australia's relatively stable financial markets will become more volatile from 2015 and Mr Evans expects the currency will once again be flirting with parity to the US dollar.

From late 2016, Mr Evans foresees a significant reversal in equity markets as a tipping point is reached as the lagged effect of the Fed's tightening of monetary policy starts to impact. Business investment, employment, household incomes and overall growth will start to reverse. China's growth in 2018 is forecast at around 6%, while merging markets will become stressed by capital outflows and falling commodity prices.  In 2018 Australia's growth rate is forecast to fall to 1.5%, the currency to be back at US80c and the Reserve Bank to start cutting official rates to 3.0%, having hit a peak of 4.75% in 2017.

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AllianceBernstein's senior economist, Guy Bruten, is not convinced about growth in the Australian labour market, despite the story that's unfolded so far in the job statistics. Employment grew 14,000 in April on top of a 22,000 rise in March. That's a little shy of the gain require to keep pace with the growth in the working age population. Massaging the statistics, the economist believes there's enough to stem a rise in the unemployment rate if, and that's a big if, employment numbers grow at the current annualised rate and the participation rate does not change. Australia's workforce participation rate has dropped in the last three years. Without this fall the jobless rate would now be above 7%.

Guy Bruten observes the debate around the globe as to whether falls in participation are demographically based or caused by discouraged workers. The latter is clearly the case in Australia, from his analysis. A sharp drop in 15-34 year-old male participation explains the greater proportion of the drop in the participation rate. Consensus expectations generally favour a smooth transition to employment growth in other areas as the mining surge winds down but Mr Bruten thinks the opposite will occur. The bigger fall in mining and related services employment is still to come, as the fall in mining capex is only starting. There is also a range of manufacturing job losses that will impact in the second half of the year.

Moreover, fiscal policy is set to be tightened and, while the extent of this is uncertain, Guy Bruten notes a substantial effect on confidence. Other aspects which signal a bumpy ride for employment are the shape of the housing recovery and subdued wages growth. This adds up to the Reserve Bank of Australia keeping official rates on hold for some time and the economist believes speculation regarding hikes before year end is misplaced.

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UBS observes the re-domiciling of US companies to another country through acquisitions and for tax reasons has recently accelerated. The test of whether this can be done requires 25% of sales or 20% ownership to be domiciled offshore. Six large transactions are in train or completed so far in 2014. The acceleration in the trend has largely come from corporates rushing to beat changes in the US 2015 budget, that propose increasing the threshold for re-domicile to 50% from 20%.

UBS thinks Australia's healthcare sector is a target for such undertakings and Sonic Healthcare ((SHL)) is a logical candidate. It makes strategic sense for the likes of US Quest and Labcorp. These two would gain geographical diversification and synergies from asset consolidation. CSL's ((CSL)) vaccine division could provide scale for an acquirer, but UBS observes separating the division may provide difficult. Ramsay Health Care ((RHC)) would provide diversification and synergies to certain acquirers but UBS notes the shareholder structure and valuation could prove problematic. One precedent which the broker highlights is the transaction involving Endo Health and Paladin Labs of the US which resulted in a re-domicile in Ireland, despite neither party being incorporated there initially. The combined entity is expected to enjoy an effective tax rate of 20%.

What are LICs? Listed Investment Companies provide access to a diversified range of investments in a single ASX-listed exposure. Morgans considers LICs have a place in every portfolio. So what should you look for? First objectives such as yield, growth or diversifying returns need to be taken into account, if choosing investments that are not correlated to existing holdings. LICs offer four main areas of exposure – Australian equities, international equities, specialist and absolute return funds. These entities do not regularly issue new shares or cancel shares as investors join and leave. Their structure allows the fund manager to concentrate on selecting investments without having to factor in the money flows. Therefore these instruments are generally long-term portfolio holdings.

LICs have emerged as a competing investment to managed funds but have some significant advantages over unlisted managed funds, in Morgans' view. Largely, as they are closed-end funds, managers need not be concerned about uncertain fund inflows and outflows, and the structure enables the smoothing and deferral of dividends which can be particularly useful for those in high tax brackets.
 

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