Weekly Broker Wrap: General Insurers, Mobile Plans And Equity Strategies

This story features INSURANCE AUSTRALIA GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: IAG

-GI margins peak, modest premium growth
-Telstra counters mobile pricing with data
-Outperformance of bond proxies ending
-Super funds, households re-focus on equities
-Morgans warns against complacency
-Goldman re-evaluates high yielders
 

by Eva Brocklehurst

General Insurance

In reviewing the competitive environment facing the general insurance sector, Macquarie believes a focus on the premium rate cycle over-simplifies the changes that are occurring. The broker notes traditional supports are moderating, given a peak in margins and reduced reserve releases. Domestically, the broker expects insurers will focus on cost efficiencies. The competitive environment is also ramping up with new entrants amid moderate premium growth and claims inflation.

Macquarie observes the increase in competition reflects high industry profitability, controlled by a few rational players. Such an environment attracts new capital. Long term, the broker forecasts a margin of 11.5% for Insurance Australia Group ((IAG)) with a return on equity (ROE) of around 15%, a 11.0% margin for Suncorp ((SUN)) with ROE of 10%, and a margin of 10.0% for QBE Insurance ((QBE)) with ROE of 10%.

Telecoms

SingTel‘s ((SGT)) Optus has been aggressive in its pricing of mobile plans over the past month and competitors Telstra ((TLS)) and Vodafone Australia ((HTA)) have responded with increased data allowances. Morgan Stanley observes Telstra’s increased data allowance appears to be a direct response to competition from Optus. This may help defend market share but the broker suspects it  will also limit future data monetisation, reducing top line revenue growth for Telstra mobile.

As well as data increases, Telstra has increased its handset repayment fees by an average of 13% in March versus February. This is important, in Morgan Stanley’s opinion, because it decreases the subsidies Telstra absorbs and allows for margin expansion. The increase in these handset fees, the broker surmises, stems from Apple’s increased iPhone prices because of the fall in the Australian dollar. Consequently, Telstra is passing the price increase onto the consumer.

Strategies

Morgan Stanley believes the focus on yield remains relevant for Australian equities but there is a shift in market leadership, with growth yield outperforming blue chip yield. The broker also envisages the outperformance of bond proxies is coming to an end, while the underperformance of high-risk yield and low yield stocks should continue. Morgan Stanley believes bond proxies have been compressed to levels where valuations in a normal environment appear extreme and therefore remains Underweight on this group. The broker is still exposed to low-risk, blue chip yield but avoids stocks with expectation risks.

The sweet spot is where there is both above-market earnings growth and an attractive yield.  Five stocks the broker has in its sights which enjoy the best of both worlds are AMP ((AMP)), Macquarie Group ((MQG)), Perpetual ((PPT)), Super Retail ((SUL)) and Tabcorp ((TAH)).

Deutsche Bank believes the superannuation funds may be starting to rotate out of low-yielding deposits and bonds and into equities. Purchases of domestic equities have averaged around $10bn per quarter over the past nine months after there was no net purchasing in the preceding two years. The broker observes a large share of financial assets still sit in deposits earning minimal returns and expects the support from flows will keep market valuations above fair value for some time.

Households have been content to add to deposits and build savings through compulsory superannuation. Minimal purchase of equities have been made for some years now and discretionary super contributions have only been moderate. However, sentiment towards the equity market may improve, in Deutsche Bank’s opinion, with increased realisation of both the market gains and the limited real return that deposits offer. Foreign investors, meanwhile, remain steady buyers of Australian equities.

Morgans has become increasingly cautious, rationalising recent market strength against very low interest rates and worrying levels of growth. The broker’s high conviction ideas are selected carefully, as the broker awaits the market to normalise. Profits have been booked in NextDC ((NXT)) while Villa World ((VLW)) is added to the high conviction lists. The broker advises investors to tread cautiously this year and not become complacent about capital value as it is still possible to suffer capital losses on “yield” stocks, pointing out that the market will adjust when the abundant liquidity and ultra low rates inevitably come to an end.

Investors are also warned to expect higher levels of volatility when global interest rates start to normalise. Morgans recommends holding higher levels of cash to enable the flexibility to capitalise on any bouts of volatility.

Morningstar’s best stock ideas for the month, which feature highest quality investment ideas trading at attractive prices, include ANZ Bank ((ANZ)). The bank is considered the best placed of the majors to capitalise on strong growth in trade and investment flows in Asia. Goodman Group ((GMG)) also joins the list, with its geographically diversified and vertically integrated model.

Woodside Petroleum ((WPL)) was removed from the best stock ideas, as the analysts believe the stock’s fair value has declined meaningfully and the price discount has disappeared. QBE is also removed from the best stock ideas. The environment may be turning around for the insurer but the market has pushed the price into the broker’s “hold” zone.

Goldman Sachs has been increasing its underweight positioning in high yield stocks as yields continue to compress, even with the start of a US rate hike cycle looming. Adding complexity is the prospect of further easing from the Reserve Bank of Australia, which should help mitigate some valuation stress from higher US rates. The broker recommends avoiding the names that have been “manufacturing yield” i.e. by relying on leverage, asset sales or under-investing.

Stocks that can fund dividends or buy-backs from organic growth will fair better, in Goldman’s view, particularly as higher rates put pressure on firms which have borrowed to fund these dividends and buy-backs, or to acquire growth.
 

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