The Wrap: Finkel, 4DS, Bellamy’s & Gas

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Weekly Broker Wrap: Dissecting the Finkel Review; 4DS Memory; Bellamy's Australia; tourism; the Australian Domestic Gas Security Mechanism.

-Limited impact seen in medium term from Finkel Review for Origin and AGL
-Major technical breakthrough for 4DS Memory
-Bellamy's strengthens business case for Chinese dairy market
-Positive trends continue for Australian tourism
-Questions continue for Australia's domestic gas security
 

By Eva Brocklehurst

Finkel Review

The energy market review by Dr Alan Finkel has been released, with a focus on grid security and reliability. The review advocates a more measured pace to replace existing thermal generation. The review calls for improved forecasting and better planning to address the impact of increasing reliance on renewables. The introduction of a clean energy target (CET) is suggested, to replace the renewable energy target (RET) by 2020 as the preferred model to reduce carbon emissions.

The review also recommends existing generators be required to provide a three-year notice period ahead of any closures. Given the priority of stability and reliability, the reliance on coal for base-load electricity until 2023 is no surprise to UBS. The broker suspects that although the review predicts gas will play a smaller role in future, it will continue to be the marginal price setter for electricity in an energy-only market.

UBS believes this should allay fears around AGL Energy ((AGL)) and Origin Energy ((ORG)) and high forecast gas prices and, in turn, higher electricity prices, combined with no tax on existing carbon emitters, should limit any impact in the medium term.

Morgan Stanley believes the introduction of a CET with bipartisan support should be positive for AGL and Origin and marginally favour Origin over AGL, in view of relative carbon intensity and retail & gas market positioning.

The broker found little new in the review in terms of energy efficiency. In relation to the electricity grid the review recommends increased funding for the Australian Energy Regulator, a review of capital expenditure and harmonisation of transmission planning. The review also supports the recent reform group recommendations in relation to gas pipeline information disclosure and arbitration.

Morgan Stanley suspects this may provide longer-term clarity around APA Group's ((APA)) growth prospects by the creation of more transparent pipeline projects.

Ord Minnett believes implementing the recommendations should reduce wholesale price volatility and put downward pressure on forward prices, as well as increase price visibility for retail customers.

One of the surprising aspects of the review, from Ord Minnett's perspective, was that it did not only address longer-term policy changes but also laid out ways to prepare the network for potential power shortages next summer. A range of measures have been recommended, including seeking assurance that generators have sufficient fuel and are able to run with the piloting of a new demand response mechanism.

4DS Memory

4DS Memory ((4DS)) has announced that tests of its interface switching technology have confirmed the required read speed and there were no read errors of significance. Shaw and Partners notes, for the layman, the combination of these two characteristics mean multiple benefits. The tests also ticks most of the boxes required to license or sell the technology.

The company is not aware of any other ReRAM technology that can make the same claim for read speed. The broker believes this news opens a door to business development discussions and the company has indicated it would look to partner to put the technology into a chip, possibly via a licensing deal or an acquisition.

The update is it major technical breakthrough, TMT Analytics suggests. Fluctuations in electrical currents within memory cells, that typically lead to reading issues in some other non-volatile memory technologies, appear to be very limited in the current version of 4DS technology. As only minor error correction code is required this results in very substantial gains in speed.

TMT Analytics believes this update is bound to spark some serious interest from the industry. The results should also inspire the company's joint development partner, HGST, to renew its agreement that is up for renewal at the end of June. The broker believes the market grossly undervalues the company's technology and market potential. Buy rating retained with a $0.12 target.

Bellamy's Australia

Bellamy's ((BAL)) has acquired a 90% interest in Camperdown Powder, a licensed canning facility in Victoria, for $28.5m. Additional capital is to be deployed to upgrade the facility. Management believes the acquisition will provide a path to China Food and Drug Administration registration and a strong case for major Chinese dairy business. The company intends to raise a total of $78.4m through an entitlement offer and vendor share placement.

The acquisition is likely to partly address the issues facing Bellamy's, Wilsons suggests, as CFDA registration is only required for products traded through off-line distributors and accounts for around 16% of FY17 forecast infant formula sales.

Management expects to have CFDA registration in place no earlier than July 2018, leaving the business without the required accreditation for Chinese label products for at least six months. Wilsons has a Hold rating and $3.90 target.

Citi believes the acquisition and capital raising address significant uncertainties around the business. Bellamy's will pay Fonterra $27.5m to obtain access to bulk powder at favourable pricing. As part of the revised agreement it will also be discharged of the $5.5m of annual shortfall payments due over the contract life.

The company has also indicated that second half net sales will be above the mid point of the company's $105-120m guidance range and Citi believes this better-than-expected performance is likely emanating from key competitor a2 Milk ((A2M)) experiencing a short fall in stock. Citi has a Neutral, High Risk rating and $5.75 target.

Following the update, Bell Potter upgrades underlying net profit forecasts by 36% for FY18 and 37% for FY19. The majority of these changes reflect the impact of the early payment to Fonterra and the assumption that the company will have direct market access in China following the acquisition of the canning line in FY18-19. The broker upgrades to Hold from Sell and raises the target to $5.49.

Tourism

Citi believes the trends over March and April are positive for the Australian tourism industry as Australians are travelling overseas at slower rates and more foreigners are visiting Australia.

Nevertheless, the broker suspects new regulations issued by the Chinese government that require Chinese banks to report foreign transactions with domestic banks, including cash withdrawals, exceeding RMB1000 from September could have a negative impact on expenditure by Chinese visitors. China, including Hong Kong, represents around 18% of total Australian visitor arrivals.

The broker believes increased Australian tourism trends are, nonetheless, positive for the small cap leisure sector and both Mantra Group ((MTR)) and Event Hospitality ((EVT)) should benefit from through their hotel operations. Meanwhile, Village Roadshow ((VRL)) and Ardent Leisure ((AAD)) should benefit through their theme parks.

Australian Domestic Gas Security Mechanism

Credit Suisse is left with more questions than answers after the release of the draft Australian domestic gas security mechanism (ADGSM). The broker considers it likely that no shortage of gas will be deemed for 2018. A shortfall year needs to be determined before October 1 of the prior year.

The broker finds many questions were not fully answered in the draft legislation, such as a lack of clarity on whether the "net-back" LNG price to be considered in assessing demand is contract or spot net-back, or net-back to the customer or Gladstone.

Moreover, Credit Suisse is in a quandary as to the price at which any diverted gas will be sold and, importantly, whether it will actually have to be sold or just made available. The broker believes, under this legislation, the market will be become very short term for all but the biggest buyers.

The logic for an import terminal is growing by the day, Credit Suisse suggests, as it may be cheaper to liquefy gas in Western Australia or PNG, ship it and re-gasify it in Victoria, than use the domestic pipeline system. The broker suspects that, with a risk of hitting capacity constraints on the ability to flow gas south, as the the map of gas production shifts further north, imports are likely to be more economical than building new infrastructure.

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