Weekly Broker Wrap: Supermarkets, Packaging, Airlines, Health Insurers And Media

This story features WOOLWORTHS GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: WOW

-Supermarket competition ramps up
-Globally focused stocks less constrained
-Lower AUD, oil benefits packagers
-Airline industry more rational
-Health insurer margins diverge
-Media heads for flat end to FY15
 

By Eva Brocklehurst

Supermarkets

Given elevated earnings risk, Morgan Stanley believes investors should continue to avoid the Australian supermarkets. Since March 2013 the broker has argued that aggressive store roll-outs and the emerging competitive threats form Aldi and Costco would impact on the major supermarkets' profitability. Woolworths ((WOW)) has recently indicated it will start to invest in price and Morgan Stanley expects this will slow industry growth further. The broker is alarmed by the chain's recent admission that it had lost share as consumers perceived its prices to be too high. The broker lowers its industry sales growth outlook for FY15-17 to 2.5% from 4.1% to reflect this looming price competition.

As a result, Morgan Stanley has downgraded Wesfarmers ((WES)) to Equal-weight from Overweight on slower growth expectations for Coles. Coles has, in recent years, employed more sustainable strategies to drive profit growth compared with its rival, Woolworths, but the broker does not consider it immune to a weaker outlook. Metcash ((MTS)) will be the most affected by competitor price investment because of its poor positioning and thin margins, in Morgan Stanley's view. Its weak balance sheet compounds the problem.

Morgan Stanley believes Australian supermarkets are fast becoming a zero sum game, and the big chains will increasingly take share from each other rather than the independents. While the Metcash-supplied IGA and specialists (greengrocers, delicatessens) control 22% of the market, the broker believes this overstates the opportunity to gain market share, especially from specialists. While the broker concedes its outlook for Woolies and Coles looks quite bearish in isolation, in the light of weaker industry growth it becomes more plausible.

Equity Strategy

Macquarie has reviewed the equity market outlook following changes to its currency and commodity price forecasts. In a demand-deficient, low-growth environment those stocks able to deliver sustainable, above-average earnings growth will stand out. The broker increasingly finds these are located in the international industrials space, reflecting the fact they are not constrained to the low demand currently being experienced domestically and have a larger pool of opportunities available, such as acquisitions. The lower Australian dollar will also boost translation of offshore earnings. Key picks? Westfield Corp ((WFD)), James Hardie ((JHX)), Amcor ((AMC)), Computershare ((CPU)) and CSL ((CSL)).

Paper & Packaging

Deutsche Bank considers the outlook for the packaging sector is positive, as companies benefit from lower raw material costs, stable trading and a depreciating Australian dollar. Balance sheets appear sound and the broker expects both organic growth and acquisitions are in the frame. Amcor is still experiencing good growth in emerging markets and there are signs of improvement in the US. Orora ((ORA)) is benefiting from operational improvements as is Pact Group ((PGH)). Considering valuations are more demanding Deutsche Bank believes Pact provides the greatest valuation upside, trading at 12.7 times FY16 earnings estimates, with a dividend yield of 4.6% and free cash flow yield of 7.5%.

Airlines

Goldman Sachs expects a rebound in the profitability of Australasian airlines. Qantas ((QAN)) and Virgin Australia ((VAH)) are expected to deliver a major turnaround in earnings in FY15/16, underpinned by cost cutting, lower fuel pricing and more rational industry conditions. The broker reiterates a Buy rating for Qantas and expects a return to pre-tax profit in FY15 of around $855m. Free cash flow should be stronger and lead to lower gearing in FY15-17. The broker has reinstated Virgin with a Neutral rating as, while a turnaround is still expected, the improved outlook appears captured in the share price. The broker also considers Air New Zealand ((AIZ)) is fairly valued and retains a Neutral rating, with strong earnings growth expected, backed by solid demand.

Health Insurance

Industry-wide margins fell in FY14 and Goldman Sachs observes gross margins are far from uniform across the sector. The margin of Bupa is 200 basis points better than both Medibank Private ((MPL)) and HBF, Western Australia's largest health insurance provider, and even further ahead of nib Holdings ((NHF)). Australia's largest not-for-profit health fund, HCF, continues to position with a much lower margin. Within the groups of smaller funds, Goldman notes the open funds generate margins similar to the leaders whereas the small restricted funds are much lower. The broker believes claims will continue to rise strongly, given the ageing cohort of policy holders. Hence, gross margins by fund may diverge even further, depending on that fund's particular focus. Hospitals cover is expected to be well placed, given the margins are in an upwards trend.

Media

Ad market agency bookings lifted by 1.5% in February year on year and brings year-to-date growth to 0.9%, UBS observes. Bookings were weaker in February for banking & finance, pharmaceuticals, household supplies, general retail and travel. Automotive, education, food and insurance spending lifted. Metro free-to-air TV spending was up 1.5% and regional TV was up 3.3%. Metro radio fell 2.7% and regional radio rose 20%. Newspapers fell 14.3%, digital ad spending rose 5.2% and outdoor bookings were up 8.8%.

UBS believes Nine Entertainment's ((NEC)) recent trading suggest revenues are up 8-9% in the current quarter with market share trending towards 40%. Guidance from both Seven West Media ((SWM)) and Nine suggests FY15 market growth will be flat for TV, with a recovery in the second half of 2015. JP Morgan notes the start to the second half of the financial year was modest and driven by non-traditional media such as digital and outdoor. This broker also expects a flat finish to FY15 with metro TV trends subdued and print still challenged.
 

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