Weekly Broker Wrap: Equity Strategies, Insurers, Electronics and Online

This story features HARVEY NORMAN HOLDINGS LIMITED, and other companies. For more info SHARE ANALYSIS: HVN

-Risks rising for banks, A-REITs
-Deutsche Bank likes yield & growth
-Lower insurer losses, lower risk cost
-Increased inventory, risk in electronics
-Online shares rise, so should earnings
 

By Eva Brocklehurst

One of the surprises this year has been the overall decline in US bond yields, even as the Federal Reserve has wound down purchases of securities. Citi observes, in terms of equities, this sustains investment in the Australian banks, real estate investment trusts (REITs) and other interest-rate sensitive sectors. Still, it may not be the case for long. The broker suspects upward pressure on yields may be building as a number of indicators show a further strengthening in the US economy. To this end short-term US Treasury yields continue to trend higher, resulting in a flattening of the yield curve. All these indicators suggest to Citi that risks may be rising in the Australian equity market for banks, A-REITs, utilities and infrastructure stocks thus trimming weightings in these areas may be a prudent move.

Deutsche Bank's strategists suggest interest rates could nevertheless remain lower for longer and this should support equity investments. Profits are unlikely to grow strongly but they are headed higher. Moreover, the pace of earnings downgrades appears to have stabilised. The broker observes forecast earnings growth for the ASX200 index is low compared with history and offshore markets, but this is largely because miners and banks weigh on the aggregate. Earnings from industrial stocks look likely to achieve 10% per annum growth over the next two years. Deutsche Bank continues to favour housing and financial market exposure, adding some defensive names, yield plays and cost cutting stories as well.

The banks are not exciting, although the broker is mildly drawn to the fact that business credit growth looks to be returning. Deutsche Bank is overweight on the energy sector, as earnings surge on the back of LNG projects, but remains underweight in miners, as sliding iron ore prices pressure earnings. Other observations are that low price/earnings ratio (PE) stocks are expensive versus history and recent momentum has been poor. The broker is no longer underweight on high PE stocks. Another observation is that the yield premium from pure yield plays has shrunk. Deutsche Bank retains a preference for both yield and some growth potential.

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The insurance industry is on the verge of major changes in technology. Morgan Stanley observes the multiplication of devices that are interconnected allows for new ways of selling and servicing product, whether it be motor, home, business or health insurance. Insurers are able to gain a better understanding of customers via new datasets, which means they assess risk in a completely different way. Risk pools are likely to shift and shrink, in the broker's opinion. An improvement in loss prevention is capable of delivering 40-60% risk reduction for home and 15-25% risk reduction for motor insurance. Moreover, consumer expectations have changed much faster than the industry, and insurers need to move ahead in terms of customer engagement, in the broker's view.

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There was a common theme regarding expanding inventory in the FY14 results of electronic retailers and CIMB fears this brings increased downside risk. Retailers have geared up for a surge in demand in the first half of FY15 and, while underlying conditions are stronger, the broker suspects there is not enough risk priced in should sentiment soften into Christmas. For example, Harvey Norman ((HVN)) franchisees are holding inventory at around 22% of sales, up from 20% in recent years. Dick Smith ((DSH)) ended FY14 with closing inventory up 49% on the prior comparative period.

Dick Smith management suggested the stores were underweight in inventory as of June 2013 and had to build up in order to drive sales growth. Still, CIMB observes the company is holding significantly higher stock levels than its most comparable peer, JB Hi-Fi ((JBH)). While Dick Smith operates a distribution centre the broker does not believe this supports a higher relative inventory. The broker highlights an extreme example in the second half of 2012, when JB Hi-Fi's profit margin contracted substantially as Dick Smith, then owned by Woolworths, and Woolworth's Sight & Sound cleared excess inventory in an already-soft retail environment.

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CIMB has reviewed its valuation consideration for Australian online media. Share prices and earnings multiples are at high levels and the broker's analysis indicates that valuation themes for Australian stocks are consistent with global comparatives. Yet expansion in multiples with no accompanied expansion in earnings does nothing to resolve valuation concerns, in CIMB's opinion. A case in point is REA Group ((REA)), which has grown its share price strongly over the past three months, driven entirely by price/earnings expansion as profit forecasts were revised slightly lower. Similarly, Seek ((SEK)) has enjoyed reasonable share price growth but the profit revisions were flat. Trade Me ((TME)) and Carsales.com ((CRZ)) are in the same mould, although the broker does envisages earnings upside at multiples which represent better value and a greater degree of safety with these two.
 

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