Weekly Broker Wrap: Ebola, Oz Pathology, Banks And Developers

This story features PERSEUS MINING LIMITED, and other companies. For more info SHARE ANALYSIS: PRU

-CIMB advises buying leisure on weakness
-More pathology centres erode margins
-Some value restored to equities
-Efficiency programs buying time
-Banks may underperform post results
-Regulation implications for developers
 

By Eva Brocklehurst

Ebola is capturing attention as it rages in West Africa. The disease is unlikely to become a global epidemic but Australian resources stocks that are exposed to West Africa are taking the threat to their operations seriously. CIMB considers the main risk to leisure and travel stocks is fragile investor sentiment, rather than earnings specifically, and investors are advised to buy these stocks on share price weakness generated by Ebola news flow. Disease experts note the virus is transmitted by body fluids only and is unlikely to change its mode of transmission. In this context, the SARS outbreak in 2002-3 was a much greater global threat as it was transmitted by airborne droplets, as is the case with influenza.

In terms of miners, CIMB observes Perseus Mining ((PRU)) has the largest risk with its only asset, Edikan gold mine, being in Ghana. Ghana has avoided the outbreak so far and the company has precautions in place to protect workers. Newcrest Mining's ((NCM)) Bonikro gold mine is in Cote d'Ivoire but contributes only 5% to the company's production. Ausdrill ((ASL)) obtains around 36% of its revenue and 53% of its earnings from Africa, contracting to five mines in Ghana, two in Burkina Faso and one in Cote D'Ivoire. None of these countries have yet reported an Ebola outbreak. There is marginal upside for health stocks Ansell ((ANN)) and CSL ((CSL)) in CIMB's opinion, if the virus is not contained, but it is notable that these stocks were not affected during the SARS outbreak.

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The roll-out of Australian pathology collection centres continues, with Medicare data showing 562 centres were added over the past 10 months. Primary Health Care ((PRY)) continues to have the largest base of collection centres while Sonic Healthcare ((SHL)) has been the most aggressive in rolling out centres recently. Healthscope ((HSO)) has also added 80 centres over the past 10 months. The roll-out is irrational in Credit Suisse's view and results in inflated operating costs and no apparent revenue gain for any particular provider. Should weak volume growth persist through FY15, Credit Suisse expects the increased costs associated with the roll out will likely procure margin erosion for all providers.

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The market correction from September has restored some value and UBS envisages some opportunity in US dollar-exposed cyclicals, given their recent underperformance. The broker remains Neutral on mining and Overweight on energy stocks, based on the strong growth in free cash flow expected from the energy sector. UBS has upgraded banks to Neutral from Underweight, given capital concerns are factored in and bond yield risk is receding. The broker adds James Hardie ((JHX)) to the portfolio, as the recent share price decline has meat the stock is trading below the price target for the first time in a while. This stock replaces Fletcher Building ((FBU)) as the broker prefers James Hardie's cyclical US dollar exposure. Westfield Corp ((WFD)) has been removed as it has outperformed since the market peak.

Deutsche Bank observes most of the growth in FY14 was driven by efficiency gains which are not sustainable drivers of earnings. With few signs of acceleration in revenue the broker fears the earnings recovery could fizzle out. Over the past year there appears to be a growing realisation that the macro environment is not bouncing back strongly, setting Australian corporates on the same cost cutting path that the US began several years ago. The broker expects a couple more years of delivering on efficiency programs should buy time for headline growth to return. Another question the broker attempts to answer is whether the equity market is back at normal multiples after being overheated mid year. In sum, Deutsche Bank does not view the current average price/earnings as appropriate, given persistently low bond yields.

Goldman Sachs attempts to identify stocks with the highest internal rate of return under a takeover and re-gearing scenario. While valuations are lower, the dispersion in multiples across the market has widened to more usual levels and the broker believes this development is an important driver which will facilitate more scrip-based mergers & acquisitions. Moreover, the lower Australian dollar should provide offshore acquirers with greater confidence to pursue Australian assets. The broker asserts the model's predictive performance is robust, as evidenced by Transfield Services ((TSE)) receiving a proposal this week. Top-rated large industrials in the model include Qantas ((QAN)), Downer EDI ((DOW)), Leighton Holdings ((LEI)), Orica ((ORI)), Myer ((MYR)) and nib Holdings ((NHF)). Resource stocks in the model include Alacer Gold ((AQG)), Western Areas ((WSA)), Sandfire Resources ((SFR)), Independence Group ((IGO)) and Imdex ((IMD)).

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Property is clouding the horizon for Australia's banks. Macquarie believe recent announcements regarding macro prudential regulation represent a significant change in view from the Reserve Bank while the government is getting serious about foreign buyers. International experience indicates 2-13% underperformance by banking sectors that are faced with this type of intervention. Domestically, the sector has not skipped a beat, which is mainly because of "dividend harvesting" leading into the FY14 results, in Macquarie's view.

The broker advises investors to be wary, as banks may give back the dividend, and more, after the results, considering the headwinds that are forming for the sector. Last time the RBA attempted to cool the market, in 2004/5, Macquarie observes the banks underperformed by around 7%. While there is no signal that cash rates will start moving higher any time soon, macro prudential actions are equivalent to a tightening of rates, the broker warns.

Macquarie expects the implementation of such measures will take some heat out of the housing market to the detriment of Stockland ((SGP)) and Mirvac ((MGR)). While a crash is not expected in the residential market, downside risks are rising. The RBA and Australian Prudential Regulation Authority have both recently stated that new policy is likely before the end of the year. The earnings implications for residential developers will depend on the extent of measures, but a 10% reduction in current volume assumptions means Macquarie's earnings forecasts would be reduced by 1-2% over FY15-16.
 

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