Equities: Brokers Urge Caution In Search For Value

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This story features COMMONWEALTH BANK OF AUSTRALIA, and other companies.
For more info SHARE ANALYSIS: CBA
The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

-Some value still not priced in
-Consolidation period ahead
-Modest growth & yield attractive
-Unease over macro economy

By Eva Brocklehurst

The December half year reporting season reflected the transition in the economy as the resources boom ends, brokers maintain. In the wrap-up, Macquarie finds FY15 growth forecasts are generally intact. Some slippage is line for the market, ex resources, but this is largely contained to a few stocks and offset by a small improvement in the resources outlook. That improvement is driven largely by a better cost performance from the major miners. Citi observes weak market earnings growth in FY15 is probable, after the large fall in resource earnings, but industrials are still growing at trend rates. 

Resource earnings were down for the third year in the past four and associated service industries remain under pressure. Beyond this, the larger industrials maintained steady growth in Citi's observation. The results revealed limited interest from companies in expansion and an emphasis on distributing earnings, with more firms lifting dividends. The mainstays continued to be Commonwealth Bank ((CBA)), Telstra ((TLS)), Wesfarmers ((WES)), CSL ((CSL)), Amcor ((AMC)) and Brambles ((BXB)), in Citi's view, with some strength noted in housing related stocks such as Stockland ((SGP)) and Boral ((BLD)) and capital markets players such as AMP ((AMP)) and Macquarie Group ((MQG)).

Is the market now expensive? Macquarie observes some valuations are now stretched, but modelling growth that is currently in share prices reveals long list of stocks where the prospects are not fully priced in. Those that stand out in this analysis include CSL, Amcor, Ansell ((ANN)), Computershare ((CPU)), Sonic Healthcare ((SHL)), Lend Lease ((LLC), Transurban ((TCL)), Westfield Corp ((WFD)), Goodman Group ((GMG)), Telstra ((TLS), Asaleo Care ((AHY)), Nine Entertainment ((NEC)), Austal ((ASB)) and Greencross ((GXL)). Those where the growth outlook is overplayed in the broker's view, suggesting valuations may be at risk, include ResMed ((RMD)), REA Group ((REA)), Domino's Pizza ((DMP)), Sirtex Medical ((SRX)), Iress ((IRE)) and Platinum Asset Management ((PTM)).

Macquarie now expects a period of consolidation rather than retracement, given interest rates are low. Ultimately, the gap between equity yields and fixed interest yields suggests more room for the equity market to move higher. Beyond this, stocks with a combination of more modest earnings growth plus yield will remain attractive from a total return perspective.

Fresh lows in interest rates appear to have driven equity price/earnings (PE) ratios higher. Yield aside, Deutsche Bank observes interest rates are low because economic growth prospects are weak and that sort of outlook could harm equity valuations. The broker's analysis finds that higher real rates are associated with higher PEs for equities – indicative of good growth – but when real rates rise above 4.0%, the impact turns negative as high rates may also indicate of serious policy tightening or imbalances.

Interest rates and inflation are not the only drivers of PE. Deutsche Bank's modelling suggests the market is currently around 10% above fair value. The size of this deviation is not uncommon or large, the broker observes, and the ratio is likely to be above fair value for some time. Moreover, rates as low as they are currently is a rarity and could continue to spur the search for yield. Hence, global investors are likely to be attracted to Australia's superior dividend yields. The broker expects the market PE ratio to be around 16 which prompts a lifting of its year-end ASX200 target to 6200. A near-term dip in the market would not surprise Deutsche Bank, given the unease at the macro level.

In terms of stocks that have not re-rated as much as they should have, Deutsche Bank flags Asciano ((AIO)), AGL ((AGL)), JB Hi-Fi ((JBH)) and Perpetual ((PPT)). Options for reasonable yield plus some growth include Fletcher Building ((FBU)), Harvey Norman ((HVN)), Iress, Stockland and QBE Insurance ((QBE)). Of note, high PE stocks are trading at less of a premium than has been the case historically compared with cheaper stocks Of these, Deutsche Bank favours CSL, James Hardie ((JHX)), Oil Search ((OSH)) and REA.

The result reports were all about costs and capital, notes Goldman Sachs. The consumer is showing some signs of life but the broker expects revenues will still disappoint. Consistent with the thesis that falling inflation in essential items will free up some discretionary cash flow, a number of relevant companies pointed to a pick-up in sales in Jan-Feb. However, with labour market conditions continuing to deteriorate, Goldman fears this may be short lived. Housing stocks continued to point to a strong cycle but the broader outlook across non-residential construction, infrastructure and mining was a disappointment to the broker.

Goldman Sachs warns about hunting for value. Industrials have not been as expensive for 20 years and, despite this, even high yielding defensive names where the valuation appear most stretched relative to history remain cheap versus bonds. Cheap stocks have never been more expensive is the broker's mantra, and the deteriorating macro picture suggests investors should be cautious about chasing value just because the broader market is hovering around peak valuations.

Goldman has cut its infrastructure sector rating to Neutral from Overweight to lower the defensive yield exposure and downgrades banks to Underweight from Neutral. Consumer staples are upgraded to Neutral from Underweight in order to include defensives with some valuation support. The broker remains Overweight on offshore earnings and domestic cyclicals and Underweight on resources.
 

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