Weekly Broker Wrap: Dairy, Strategy, Pathology, Tourism, Oil And Banks

This story features AUSTRALIAN DAIRY NUTRITIONALS LIMITED, and other companies. For more info SHARE ANALYSIS: AHF

-Dairies benefit as milk prices surge
-What is attractive as risk aversion fades?
-PRY more sensitive to pathology growth
-Tourism benefit flows to retail
-Discretionary retail benefit from lower oil
-Pressure continues on major banks
 

By Eva Brocklehurst

Dairy

The global dairy price index has risen 48% since the beginning of August. Macquarie believes the main driver of the price response at recent auctions is a significant reduction in Fonterra's offer volumes. These have fallen because of changes to product mix and more product being sold outside the auction marketplace. There is also a 2-3% reduction in forecasts for New Zealand's milk collection.

Macquarie believes Fonterra's reduction in its 12-month offer quantities for a third time last week amplifies worries about a shortage in global supply. Buyers that are only able to access the auction platform are being squeezed, the broker suggests, and may be bidding up the price to cover forward requirements.

A further recovery in dairy prices is good news for NZ farmers and could ease unit holder concerns about Fonterra providing further support to farmers. The problem for Fonterra, the broker maintains, is that the pass-through benefits of lower costs are eroded as input prices rise and this translates to lower earnings. Macquarie's preferred play on the dairy recovery story is Murray Goulburn ((MGC)), with a target of $2.70.

Movements in global dairy ingredient prices have a high correlation to Australian farm gate milk prices. Bell Potter notes Murray Goulburn, Australian Dairy Farms ((AHF)) and Bega Cheese ((BGA)) are positively correlated to rising dairy prices. Average forward curve prices in Australian dollars are implying gains of 10-11% for whole milk powder and butter, while skimmed milk powder is likely to be flat in FY16.

Strategy

Goldman Sachs adds Blackmores ((BKL)), Costa Group ((CGC)) and M2 Telecommunications ((MTU)) to its small and mid cap focus list. In September to date the list has performed in line with the ASX small ordinaries accumulation index. Over the past 12 months the list is up 1.8% while that index is down 10.6%.

Key performers in September have been Ebos Group ((EBO)), amaysim Australia ((AYS)) and Tassal Group ((TGR)), outperforming by 7.5%, 4.2% and 4.0% respectively. Detractors were Genworth Mortgage Insurance ((GMA)), Austbrokers ((AUB)) and Dick Smith ((DSH)), underperforming by 6.2%, 5.4% and 4.6% respectively.

Australia's equity market is down around 15% from its April 27 peak and has performed more in line with emerging rather than developed markets, UBS observes. This is probably because of Australia's relatively high commodity exposure and associated economic links to China. However, some of the apparent correlation may be countered by the banking sector, which has corrected under its own specific issues.

Taking out resources and banks the market appears closer aligned to the developed market, with pressure coming just in the last six weeks. UBS expects market growth to be around the low single digits in FY16 but it could rebound in the next few months on fading risk aversion in relation to China and the US Federal Reserve.

Stocks that have emerged with value and appear attractive to UBS include AMP ((AMP)), ANZ Bank ((ANZ)), Harvey Norman ((HVN)), Incitec Pivot ((IPL)), Lend Lease ((LLC)), Macquarie Group ((MQG)), Mirvac ((MGR)), Perpetual ((PPT)), Qantas ((QAN)), ResMed ((RMD)), Stockland ((SGP)) and Westpac ((WBC)).

Pathology

Credit Suisse is shifting attention for cost inflation to the main drivers of pathology volume growth. Long term, the correlation with Sonic Healthcare ((SHL)) and Primary Health Care ((PRY)) in terms of pathology revenue growth and Medicare pathology outlays growth is high.

The broker notes utilisation was the major contributor over the past five years, accounting for about half of the growth in pathology. This includes increased disease prevalence/test offering and collections. This is followed by population growth. The growth in the aged population is not a material driver.

Calculation of valuation sensitivity to utilisation growth suggests the risk to Primary Health Care is greater because of its higher weighting to pathology earnings. Tempering the broker's enthusiasm is the outcome of the Medical Benefits Schedule review, which could mean removal of certain pathology items. Sonic Healthcare presents as a better investment option in the broker's view because of a more geographically diverse business model.

Tourism

One of the brighter spots in Australia's economy is tourism, as it benefits for the steady move lower of the Australian dollar. Year on year growth in overseas departures has halved to around 3.5% in the first half of 2015, UBS observes. Arrivals have picked up, to be up 6.0% year on year. The broker expects this income from tourism should contribute more than 25 basis points to GDP growth over the past year.

UBS also notes that upswings in tourism contribute to improvements in retail sales, reflecting not only more inbound tourists but also more locals choosing to holiday domestically. The broker expects an increasingly positive impact on the tourism sector from the Australian dollar's decline with support for retail spending, non-mining capex and GDP growth over time.

Oil

Oil price declines should detract from global headline inflation around 0.5-1.5 percentage points in 2015-16, Commonwealth Bank analysts maintain. Australia is a net energy exporter and lower oil prices may lead to lower coal and LNG prices. The analysts calculate the negative terms of trade effect is equal to around 0.5% of GDP. 

The most positive impact is expected to come for those companies which are large consumers of energy, such as manufacturing, electrical and transport. The other positive impact is the boost to household spending. Oil prices are expected to remain at low levels over the next two years. At this stage, firms in the domestic market have not signalled a major intent to pass on lower oil prices to consumers and the analysts suspect lower prices will be absorbed in margins.

The analysts calculate the income gain for householders should equate to around 0.3% of household income from the drop over the past year in average petrol prices. There is also a second round benefit if lower transport costs are passed on. Discretionary retailers are also usually the first to benefit from a sizeable fall in petrol prices.

Banks

Recent commentary from the Australian Prudential Regulation Authority (APRA) chairman has suggested major banks still have some work to do to achieve the financial system enquiry's recommendations to be unquestionably strong.

JP Morgan does not believe this will translate into another round of capital raising, but does expect continued dividend reinvestment plan (DRP) support will be required. The more challenging task is to meet the broader benchmarks.

The leverage ratio, created as a simple metric by which regulators could assess appropriate balance sheets size, is recommended as a minimum range of 3-5%. Australia's major banks are currently at around 5.0%, lagging their top quartile global rivals which average a 6.0% ratio. JP Morgan expects returns on equity will remain under pressure, as the majors rely on further re-pricing initiatives to sustain returns.
 

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