Weekly Broker Wrap: Buy-Backs, Electricity, Advertising, Airlines And Retail

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-More off-market buy-backs likely
-NSW electricity margins to increase
-Macquarie adds Transpacific as a key pick
-FY14 a likely trough for airlines
-Spending to improve but retailer outlook mixed
 

By Eva Brocklehurst

Credit Suisse suspects that off-market buy-backs will become more popular. The federal budget in May confirmed that on July 1 2015, the Australian corporate tax rate will fall to 28.5% from 30%. One implication from this change is it will make it incrementally harder for Australian corporations to distribute franking credit balances to shareholders. Hence, there is an incentive for those paying tax in Australia to distribute these balances ahead of the changes to the tax rate. One option is via an off-market buy-back.

Prior to the last reduction in Australia's corporate tax rate in 2001, when the rate was reduced to 30% from 34%, Credit Suisse observes there was a significant pick up in buy-back activity. Moreover, those companies that announced off-market buy-backs in the lead up to the 2001 tax rate reduction outperformed the broader market by an average of 15% over the year leading up to the announcement. Thus companies with the greatest potential for this form of capital management are likely to be rewarded by the market over the next year. The broker suggests investors tilt their portfolio to a basket of stocks exposed to this theme.

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The short term margins for electricity retailers appear to have increased in the past month and once the carbon tax is removed, the margin UBS measures will appear to reduce. Nevertheless, longer term, the broker believes the path of deregulation will lead to higher margins for incumbents. The broker cites Victoria's privatised network as an example and the broker's charts show the 5% reduction in price gained in Adelaide following full deregulation did not seem to last that long. Churn is a secondary indicator of competitive conditions and this remains subdued. UBS concludes that full deregulation in NSW will lead to higher margins for the incumbents as well as higher churn and gain of market share by new entrants.

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Macquarie has updated high conviction calls with the addition of Transpacifc Industries ((TPI)) to its list of best ideas. The stock is rated Outperform with a total return of 25% expected. The broker thinks the Australian waste market is a growth industry with low levels of cyclicality and Transpacific is now a substantially different company after the sale of its New Zealand business. AWE ((AWE)) is removed from the list of the broker's best ideas, having outperformed the ASX200 Accumulation Index benchmark by 16.6%. The broker still retains an Outperform rating.

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Goldman Sachs is lowering advertising market forecasts for 2014 given sluggish momentum in the first half. The new 2014 forecast is for growth of 0.7% compared with 1.6% previously. There are two areas of strength the broker has found. These are metro radio and job advertising. The broker remains wary of the weak momentum heading into the second half of the year, particularly given the sizable political spending in the prior period. The big picture shows the ad market has probably been flat for four consecutive years.

Hence, Goldman is focused on winners and prefers SEEK ((SEK)) for its strong job ads business, or audience winners such as Nine Entertainment ((NEC)), Seven West Media ((SWM)) and Prime Media ((PRT)). The broker is cautious on traditional media. The broker upgrades Prime to Buy from Neutral, on its strong revenue share outlook and attractive valuation and upgrades APN News & Media ((APN)) to Neutral from Sell based on improving metro radio. The broker thinks, in the near term, there is minimal impact on radio broadcasts from online streaming. As streaming gains scale it could become a serious competitor in advertising budgets in the digital radio area in around three to five years, in Goldman's view.

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JP Morgan expects FY14 will signal a trough in earnings for airlines. Qantas ((QAN)) has guided to no new domestic capacity in the first quarter of 2015 and Virgin Australia ((VAH)) has also shown restraint. This should signal the beginning of a more rational duopoly and allow excess capacity in the market to be absorbed. In addition, Qantas' $2bn cost savings and asset sale could allow it to repair the balance sheet and gain efficiencies. JP Morgan estimates an underlying pre-tax loss of $619.9m for Qantas and $247.1m for Virgin Australia. This represents a significant deterioration on FY13 for both companies. In the case of Qantas the broker thinks the poor result will reflect yield and load factor deterioration in both domestic and international operations. In Virgin Australia's case, underlying operating metrics will have improved so the decline in profitability is related to operations expenditure.

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Consumer spending should improve over the next six months in Morgan Stanley's opinion. Most consumer oriented companies have delivered their warnings so the broker does not think the results will surprise all that much. Myer ((MYR)) and Woolworths ((WOW)) have the highest risk of weak results and outlook statements and while Coca-Cola Amatil ((CCL)) has rallied on turnaround expectations, the broker thinks this is not warranted. The broker believes trading conditions will improve as cash rates remain low, the housing market is robust and savings rates are still high while the online retail headwind is ebbing. The broker just thinks it may take more time.

Morgan Stanley likes the healthy sales outlook for JB Hi-Fi ((JBH)), particularly in games, and the conservative expectations for Flight Centre ((FLT)), which continues to gain share across the leisure and corporate areas and improve internationally. Woolworths' Masters business break even point is likely to have been pushed out and the broker suspects food and liquor margin growth is slowing. For Coca-Cola Amatil, the broker thinks cost cutting is failing to offset cost inflation and weak carbonated soft drink trends.
 

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