Weekly Broker Wrap: Earnings, Contractors, Utilities, Business Confidence

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-CIMB trims exposures ahead of results
-Competing forces for contractors
-Rising tariffs offset electricity demand
-Capital management potential in AIO
-Pressure increases on SE Asian airlines
-US real estate still subdued
-Oz Senate denting business confidence?

By Eva Brocklehurst

CIMB envisages more downside risks to earnings estimates during this reporting season compared with last year. The broker still thinks the upswing will continue but expectations need to be reset lower. A late rush of downgrades in contracts for resources and engineering may not be enough to mitigate all risks. Revenue growth is still relatively weak for BHP Billiton ((BHP)), Rio Tinto ((RIO)), Iluka Resources ((ILU)) and Alumina ((AWC)) and all of these companies are still reining in costs. Meanwhile, the broker suggests trimming exposure to Fortescue Metals ((FMG)), Atlas Iron ((AGO)), Arrium ((ARI)), Mount Gibson ((MGX)), Newcrest Mining ((NCM)) and Sandfire Resources ((SFR)), leading into their results.

Trimming positions in Myer ((MYR)), JB Hi-Fi ((JBH)) and Breville ((BRG)) are also recommended but these stocks should be accumulated afterwards. Consumer sentiment has rebounded and the broker thinks discretionary spending will lift in FY15. The broker thinks Cabcharge ((CAB)) and Qantas ((QAN)) should be reduced, because of the risk that demand for leisure and entertainment services has been hit by the federal budget. The broker recommends holding Downer EDI ((DOW)) into the result, but trimming positions afterwards. The contractor sector is expected to face headwinds and CIMB recommends selling WorleyParsons ((WOR)), Transfield Services ((TSE)) and Sims Metal ((SGM)) ahead of the results.

There is some growth on offer for contractors in the upcoming reporting season. Macquarie expects Downer EDI will achieve solid cash flow and be in a net cash position at year end. Cash flow is the focus for UGL ((UGL)) as well, given this has been relatively weak recently. The biggest issue for Monadelphous ((MND)) will be the 2015/16 outlook, while Macquarie expects WorleyParsons to guide for earnings growth in FY15 of around 18%.

JP Morgan believes the sector faces competing forces, with falling resources and energy spending in Australia offset by a meaningful medium-term recovery in economic infrastructure. The results season should highlight those that can benefit from this shift and those needing to do more work. There is a gap between the two drivers of growth which means those with other exposures will have a buffer. Balance sheet strength and progress on restructuring coupled with growth opportunities underpin JP Morgan's Overweight ratings for Bradken ((BKN)), Downer EDI, Lend Lease ((LLC)) and WorleyParsons. Those the broker is most concerned about are Ausdrill ((ASL)), Leighton Holdings ((LEI)) and Monadelphous, as well as Mineral Resources ((MIN)) with its direct commodity risk.

JP Morgan notes a mild start to winter has impacted on network utilities. Along with the impact of falling bond yields, demand for electricity and gas, or the lack thereof, tops the broker's list of themes at play in the sector. JP Morgan expects declining demand will have had a major impact on revenue but rising regulated tariffs will, in many instances, offset the decline. The broker retains an Overweight view on SP AusNet ((SPN)), believing the concerns over the stock's exposure to class actions and ATO rulings are overdone. APA ((APA)) and Envestra ((ENV)) recently surprised with upgraded guidance, while Spark Infrastructure ((SKI)), SP AusNet and DUET ((DUE)) all reduced medium-term distribution growth guidance because of rising regulatory risk.

UBS estimates final prices for NSW electricity customers could be 6% lower if the spot cost of debt was used as a benchmark rather than the price requested in the latest network proposals. The price rises are insignificant by historical standards, based on the proposals, and the broker anticipates the Australian Energy Regulator will make adjustments in any event, probably cutting revenue and changing from a price cap to a revenue cap model. The draft proposal is due some time after August. UBS notes there was nothing in the utilities' proposals to modernise networks and, specifically, there was an outright rejection of time-of-use metering. This surprised UBS, as the broker had assumed management would be keen to upgrade the networks as studies have indicated value benefits in Victoria.

Morgans has analysed transport stocks that have the greatest likelihood of increased capital management over the next couple of years, focusing on capex trends and free cash flow levels but also taking gearing and debt profiles into consideration. Asciano ((AIO)) stands out as the strongest contender, with significant improvement in free cash flow. Asciano will have 11c per share available in free cash flow after FY17 dividends. Aurizon ((AZJ))  features, too, but there is a decreasing likelihood of increased capital returns because of the potential investment in the port/rail assets of the West Pilbara project. The company should have 8c per share in available free cash flow after dividends in FY17.

Credit Suisse notes Indonesia's Lion Air is turning up the competitive pressure for airlines, with reports it is in talks to acquire the Qantas interest in Jetstar Asia. Were this to occur, Credit Suisse thinks it would intensify the level of regional competition amongst low cost carriers. It would also be unwelcome news for full service airlines such as Singapore Airlines and Garuda. Tiger Airways would be most affected, as Lion Air would be expanding into its back yard. Hence, the broker believes it is wise to exclude airlines of any model in Southeast Asia, with few players avoiding the challenges of excess capacity and competition.

Credit Suisse's US survey of real estate agents shows buyer traffic has been subdued for the best part of 12 months. Economic and employment conditions are still a concern and, in the face of house price appreciation, buyers appear to be sitting on the sidelines. In the absence of a material uplift in the coming months,the broker envisages risk to FY15 US house construction assumptions. This, in turn, implies risk for both Boral ((BLD)) and James Hardie ((JHX)). It appears there a few home owners willing, or able, to sell and new home supply has been slow to respond. The broker now thinks, tactically, Boral reflects better value on a risk/reward basis.

If Australia's Senate blocks more key budget measures it is possible the government may end up calling a double dissolution to break the deadlock. If so, a new election would likely be held between April and June of next year. This option would upset business confidence. Citi notes from its studies that increases in federal policy uncertainty preceded declines in investment share in the US and in some European countries, and there is reasonable chance the findings would apply to Australia. Business confidence has held up well since the budget while only consumer confidence has been dented. Citi said this could reflect the fact that business have enjoyed rising profit share of GDP and rising share prices. This is a positive for investment spending and hiring but there is a risk it could be undone if the Senate, where about two third of budget measures presently face resistance, decides to baulk further.

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