Weekly Broker Wrap: Financials, Media, Insurance And Transport

This story features CHALLENGER LIMITED, and other companies. For more info SHARE ANALYSIS: CGF

-Need to scrutinise diversified financials
-Improved gearing flexibility in media
-Margin erosion ahead for insurers
-Nib vulnerable to consumer choice
-Heightened M&A in transport?

By Eva Brocklehurst

Diversified Financials

Credit Suisse considers diversified financials relatively inexpensive and poised for strong earnings growth. Among large caps the broker's preference is for Challenger ((CGF)). Among fund managers, Perpetual ((PPT)) is preferred, offering double digit earnings and valuation support. In the wash up of reporting season, the broker notes December quarter funds management growth was positive for all those under coverage, with Henderson Group ((HGG)) having an exceptional 12 months, albeit flows appear to be decelerating.

Fund managers are trading below their historical 15% premium to the ASX200 and offer earnings growth of 5.0% in FY15 and 12% in FY16, on the broker's estimates, driven not only by markets but by operational leverage, acquisitions and cost cutting programs.

Citi considers absolute value is hard to find in the sector and only has Challenger and Henderson on Buy ratings. Several stocks in the sector offer reasonable fully franked yields and solid earnings growth and this could put them in demand, in the broker's view. While a further market rally could take stocks above valuation, Citi remains hopeful of refining entry points for key stocks in the wake of any correction.

Media

There is an element of improved gearing/financial flexibility in those media stocks that announced a buy-back during the latest results and JP Morgan believes this also signals that no material media regulatory reforms are expected to occur in 2015. The metro TV ad market is expected to be flat in the first half of the year. Nine Entertainment ((NEC)) and Southern Cross Media ((SXL)) are most optimistic, given the impact of cricket coverage,  with a more subdued outlook at Seven West Media ((SWM)) and Prime Media ((PRT)). In online classifieds the broker envisages a period of reinvestment and movement down the value chain, resulting in lower longer-term industry earnings margins in a maturing growth profile.

First radio surveys of the year show a slow start and small decline for Southern Cross's commercial metro ratings share and JP Morgan believes it will take time to rebuild the audience. The company's metro radio's turnaround is the most pressing operational issue, given current gearing metrics. APN News & Media's ((APN)) ratings momentum continues to be strong but its gearing also remains at the higher end of the sector, the broker observes, with the company reliant on a strong radio performance to alleviate concerns.

Credit Suisse found APN News the clear number one in radio ratings in the first 2015 survey as its audience share expanded. Credit Suisse expects the Australian metro radio market will look considerably different at the end of 2015, with four more metro radio networks on board earning similar revenue with similar ratios and audience share. The broker retains an Outperform rating on APN News and Underperform on Southern Cross.

Insurance

February was a reminder to UBS that insurance is cyclical, with confidence in the maintenance of margins collapsing as GWP (gross written premium) declined. Suncorp ((SUN)) and Insurance Australia Group ((IAG)) no longer look as expensive and QBE Insurance

((QBE)) no longer looks as cheap. The broker believes investors are at a relatively early stage in acknowledging the cycle pressures that will translate into significant margin reductions.

There is no template for a typical insurance downturn, in UBS' observation, but GWP growth of 1.0% for the majors is well below the industry average of 3.0%. This scenario played out in FY05-08 with sustained pricing pressure across a number of lines. Eventually, the broker notes, margins were crunched. While GWP has slipped, there has been no acknowledgment to date among the general insurers that underlying margins are at risk. UBS factors in a 1.0% underlying margin erosion for both Suncorp and Insurance Australia for the next two years.

Health Insurance

Scale players are increasingly making their mark in this industry and this is becoming an important differentiator. The latest data reveals the top five health insurance players lost 60 basis points of market share in 2014, continuing a trend of policies moving to smaller players. Further, Deutsche Bank observes, net margins for small players fell much more than their larger rivals. The broker expects good margin head room is still there for Medibank Private ((MPL)) if it can extract scale efficiencies, but this may take time. For nib Holdings ((NHF)), its low-margin hospital book is at risk if consumers buy extras cover elsewhere. Nib's results were significantly affected by its loss-making Top-Extras 85 policy, reducing its gross margin for extras. Its hospital gross margins are also narrow, particularly in NSW, and this suggests that any shift in consumer buying habits could leave the company exposed.

Transport

Weak growth dominated the sector in the latest reporting season, reflecting a tough domestic economic backdrop. Cost cutting benefits were showing through but not enough to flow to earnings, in Deutsche Bank's observation. The broker continues to like Asciano ((AIO)) for its increasing cash flow and cost reductions as well as an increased dividend profile. Brambles ((BXB)) is attractive for its international business exposure while Qantas ((QAN)) has regained favour, given its expected restructure and lower fuel cost benefits. Going forward, cost inflation and weak headline growth may signal a turn up in merger & acquisition activity or restructuring to augment earnings, in the broker's opinion.

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