Weekly Broker Wrap: Broadband, IT, Retail, Mining, Electricity And Building Products

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-Value in small players in broadband
-More downside risk likely in IT
-Two-year budget drag on retail spending?
-Warnings on mining services stocks
-NSW power play heats up
-Will ACCC clear Boral/CSR brick JV?
-Aluminium positive for CSR
 

By Eva Brocklehurst

Broadband penetration is reaching maturity in Australia and changes to market share are becoming key to value creation. Morgan Stanley believes prices are the reason why consumers change providers and, having reviewed broadband prices for June, thinks this supports Overweight calls on TPG Telecom ((TPM)) and iiNet ((IIN)). Looking at broadband plans, TPG has the best value product in Morgan Stanley's opinion. Delivering slightly more expensive plans but better customer service is iiNet's strategy. Telstra ((TLS)) offers the least value in its plans compared with peers, but continues to gain broadband share from success in bundling, underpinned by the company's broader market reach. NBN pricing plans are in their infancy but Morgan Stanley believes they support the view that iiNet and TPG will win share as the NBN is rolled out, particularly in regional areas.

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Trading updates across the IT services sector have indicated downside risk to earnings. Morgans was hoping for a flat second half in FY14 with recovery in FY15 but suspects disappointment is in the wings. Data #3 ((DTL)), SMS Management & Technology ((SMX)) and PS&C ((PSZ)) have all downgraded expectations and the broker thinks Oakton ((OKN)) and UXC ((UXC)) are at risk of similar downgrades. Having said this, Morgans is convinced overall IT spending is not discretionary and businesses will be forced to upgrade hardware, systems and processes to improve productivity. Still, the delays and deferrals keep happening and, meanwhile, the broker waits.

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On another subdued note, Citi thinks the impact from the latest federal budget cuts will hit consumers' wallets in FY15 and FY16. While the immediate rush of negative sentiment may fade quickly, the drag on retail spending might continue for two years. The broker expects a 2% drag on spending in FY15. Retailers will need to rely on wages growth or lower savings and higher house prices to boost sales.

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Still more gloom appears. Naos believes it is time to be careful with mining services. Downgrades are still catching unwary investors trying to pick a bottom to the earnings cycle, hoping that current prices are providing long-term value entry levels. The asset manager finds evidence for this in Ausdrill's ((ASL)) recent downgrade. To make the right choices in the sector investors need to focus on the client base of the service provider, the miner. More specifically, the focus should be on that miner's commodity exposure, strength of its mines and nature of expenditure.

Listed investment company NAOS ((NCC)) offers the following warnings: avoid capex related business models, as they may look cheaper but the cliff in capex spending is approaching, and avoid exploration-related models, with commodity prices weak and falling. The focus needs to be on models that target maintenance, repair and replacement. NAOS believes this sort of spending is about as non-discretionary as you can get in mining services. Moreover, a preference should be shown for those servicing the major miners with the best assets and most robust operating margins.

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The potential privatisation of the NSW electricity wires and poles has been given a further push, with the government announcing plans to lease 49% of the electricity networks. The NSW government ultimately plans to sell stakes in state-owned network services such as Ausgrid, Transgrid and Endeavour, excluding rural network Essential. How this ends up being priced with be key to how enthusiastic investors become, in JP Morgan's opinion. The listed providers such as DUET ((DUE)), Spark Infrastructure ((SKI)) and SP AusNet ((SPN)), and to a lesser extent APA ((APA)), are expected to vie for the assets. The broker is not getting too excited just yet. The government will only undertake the sale of the poles and wires with an election mandate and, because privatisations have been unpopular in the past, the timing and final structure is difficult to predict.

The government has also flagged the money will be spent on infrastructure for roads, rail, schools, hospitals and water. UBS thinks this is good news for the construction materials sector. The broker expects electricity prices will fall in NSW by 5% in FY15 and regulated prices will grow at around the rate of inflation. Nevertheless, UBS notes the traditional utility model remains under long-term structural threat from solar and storage and this should be priced in to expectations.

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 CIMB has found a number of parallels between the proposed brick JV between Boral ((BLD)) and CSR ((CSR)) and the merger proposition between Boral and Adelaide Brighton ((ABC)) that was blocked by the competition regulator in 2004. This suggests that the current JV transaction may encounter regulatory headwinds. This has negative implications for the two businesses. Profitability is expected to remain under pressure in the absence of the JV being approved, as excess capacity remains in the system and competition is robust. The case is similar to the 2004 situation in terms of competitive threats.

CIMB expects the Australian Competition and Consumer Commission's definition of the market for clay bricks will rule at the end of the day. The companies will likely argue for a broader market definition but a narrower one is quite appropriate, in the broker's view. On this basis the JV would produce two players with a peak share of around 60% of a product that has a 65% share in wall finish. CIMB expects the ACCC's refusal to accept this proposition will prompt a fall-out. As neither party can deliver an acceptable return in bricks, it may force an exit by one of them. This would mostly likely be Boral, in CIMB's opinion.

Strengthening aluminium premiums are a positive development for companies such as CSR which have smelters. They can capture all additional upside at the earnings level. The strengthening premium remains a negative for end users of aluminium, such as Capral ((CAA)), which is unable to pass through the premium increases to customers. With scope for premiums to rise further by the end of the year, this signals to Bell Potter there is upside earnings risk for CSR and downside risk for Capral.
 

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