Weekly Broker Wrap: Mobiles, Retail, Insurance And The Australian Dollar

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-Handset repayments need scrutiny
-Competition tougher for supermarkets
-Homemakers top non-food retail
-Majors lose share in life insurance
-Pressure on AUD continues
 

By Eva Brocklehurst

Mobiles

Mobile sector activity was modest in August, with price cuts by all four major operators. Macquarie expects service revenues can continue to grow over the medium term, given the increasing demand for data. Rates of growth may be slower, nonetheless. The broker believes the current trends warrant close attention with regard to revenue per unit and handset subsidies.

Optus ((SGT)) and Vodafone reduced monthly handset repayments by an average of 5.0% and 6.0% respectively over the last two months. This is a turnaround from a rising trend since 2013. Morgan Stanley also believes this should be monitored, as it could negatively affect industry profitability, particularly when combined with a weakening Australian dollar. Most handsets are priced in US dollars.

Both brokers will be monitoring the launch of the new iPhone this month, particularly in the case of Telstra ((TLS)), which continues to increase handset repayments on average. Morgan Stanley forecasts Telstra will maintain a 40% mobile earnings margin in FY16 and decreasing handset repayments would likely have a negative influence.

Retail

Australian supermarket margins are unwinding and Morgan Stanley concludes consensus estimates remain too optimistic. Global average supermarket earnings margins are around 3.0%, compared with 5.4% and 7.8% for Woolworths ((WOW)) and Coles ((WES)) respectively.

The broker lowers earnings margins for FY20 for Woolworths and Coles to 5.5% and 4.7%, respectively. Morgan Stanley observes that the discounters' market share in Australia is only just going back to 1990's levels, a time when Bi-Lo, Franklins and Food for Less were in operation.

Aldi and Costco may appear to be aggressively taking share but at the 15% forecast by FY20 this remains less than the share of 20% the formerly mentioned discounters enjoyed. Nevertheless, Morgan Stanley expects the two new arrivals will achieve a similar market share and the Australian market is over-estimating the ability of the established chains to react.

Morgan Stanley calculates that returns for Australian supermarkets are high by global standards but are now decreasing. This has attracted players into the industry with deep pockets and vast experience in operating in different markets, with low return hurdles and disruptive discounting models.

Meanwhile, in the non-food department, Deutsche Bank considers conditions are the best they have been for some time. Non-food retail is growing at its fastest rate since 2008, which the broker attributes to strength in housing and some benefit from a weaker Australian dollar. However, not all categories are equal. Harvey Norman ((HVN)) is the broker's top pick, given late-cycle benefits from its exposure to homemaker categories.

Flight Centre ((FLT)) is attractive because of its valuation and improving outlook, while Dick Smith ((DSH)) also appeals on valuation. Wesfarmers is not considered cheap enough, although a solid FY16 is expected. Myer ((MYR)) has fallen since its FY15 results and, while there is still execution risk, Deutsche Bank notes some balance sheet head room and upgrades to Hold from Sell.

Retailing is about to get harder, in Credit Suisse's prognosis. The household goods sector may have a relatively more favourable outlook and should remain strong over 2015. Growth is expected to slow in other areas with the broker noting both clothing store sales and groceries weakened through the second half of FY15.

JB Hi-Fi ((JBH)) was the only company in the listed household goods sector to record an expansion in gross margin in FY15 for its Australian operations. Credit Suisse warns that consensus earnings forecasts for FY16 fell consistently throughout the past 12 months for the majority of retailers.

Insurance

Macquarie has reviewed and ranked Australian general insurers on premium growth, margin, capital flexibility and risks. QBE Insurance ((QBE)) tops the order of preference, with currency and interest rate tailwinds. Suncorp ((SUN)) is second, with strength in value metrics and the best expense ratio. Insurance Australia Group ((IAG)) brings up the rear and appears constrained without an imminent capital return, amid concerns about profitability of opportunities in Asia.

Changes in the remuneration of life insurance providers will start to take place in the lead up to the effective introduction of new requirements from January 2016. As reform takes place and lapse/claim challenges settle, UBS believes AMP ((AMP)) is right to prioritise margin over growth.

There are no signs the major players are stepping up to take back market share in life insurance. The broker observes AMP, National Australia Bank ((NAB)) and Commonwealth Bank ((CBA)) have given up 4.0% market share over the past two years. UBS does not expect this trend will turnaround in the medium term.

As a result, in-force growth for the three remains in a negative 1.0% to plus 2.0% range. UBS accepts, as new remuneration structures gain broader market acceptance, this may change. Still, the broker continues to forecast low single-digit in-force growth for AMP out to 2018.

Australian Dollar

With China and the rest of the global economy likely to stay weaker for longer, Asian currencies will probably fall further, analysts at Commonwealth Bank maintain. The Australian dollar is now expected to ease to US65c by the first quarter next year. The analysts foresee a risk for a larger fall to US60c in 2016.

The main reason underpinning the downgrade to forecasts is a pushing back of economic recovery in China. 2016 GDP growth is forecast to be 6.5%, down from prior forecasts of 6.9%. The main drag on China is decelerating growth in heavy industry and poor export growth, reflecting weak external demand. A hard landing for China is not expected, however, because a significant amount of policy stimulus is in place.

Other reasons for downgrading forecasts include the fall out for Asian economies from the easing back of growth in China, and the likelihood of subdued commodity prices as global demand fails to recover swiftly, following the largest global mining investment boom in four decades which continues to generate increased global supply.
 

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