The Wrap: Power, AUD, Cattle & Aged Care

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This story features AGL ENERGY LIMITED, and other companies.
For more info SHARE ANALYSIS: AGL
The company is included in ASX100, ASX200, ASX300 and ALL-ORDS

Weekly Broker Wrap: Electricity; supermarkets; AUD exposed stocks; agriculture; aged care; and Audinate.

-Citi calculates cost increases of around 5% for some Oz companies from higher power prices
-UBS considers irrational behaviour and price reductions unlikely for supermarkets
-Professional services and education sector vulnerable to further AUD appreciation
-Correction in cattle prices underway, positive for AAC, less so for RHL
-UBS moves REG to top pick among aged care sector
 

By Eva Brocklehurst

Electricity

Citi reviews the impact on Australian companies from higher electricity prices. The broker expects commentary about strategies will be forthcoming over the next two years. AGL ((AGL)) is one beneficiary of higher electricity prices but the share price has already reflected the recent increase and Citi retains a Sell rating based on an $65/megawatt-hour long-term price.

Origin Energy ((ORG)) has a relatively smaller earnings benefit, given its more balanced portfolio. Packaging company Orora ((ORA)) is expected to sustain higher costs to the tune of around 5% of group operating earnings (EBIT) in FY18, although some of its cost savings in other areas should offset the pressure.

Chemical producer Orica ((ORI)) is similar, having recently settled east coast power contracts which Citi suspects may impact operating earnings by -5%, while business improvement savings will provide an offset. Meanwhile, in transport, Aurizon ((AZJ)) has pass-through clauses on electricity.

For consumer companies such as Inghams ((ING)) pre-tax profit could be reduced by -12% and Asaleo Care ((AHY)) by -7%. The broker suspects these two may hold contracts which will spread the impact over the next 2-3 years. The large store networks of Woolworths ((WOW)) and Wesfarmers ((WES)) will also suffer pressure on costs. The broker estimates the potential gross impact for each is -5% of pre-tax profits.

In mining the most significant impact is on aluminium smelting. Yet Citi notes Australian smelting operations are a small share of the relevant company earnings. Underground mines are more exposed to rising electricity costs and this could particularly affect those in NSW, while the least exposed area is Western Australia which relies more on gas and/or diesel.

Citi observes hard rock mines with large milling and/or refining operations such as Newcrest Mining's ((NCM)) Cadia, BHP Billiton's ((BHP)) Olympic Dam and OZ Minerals' ((OZL)) Prominent Hill are likely to be more exposed to higher power prices than bulk commodities where there is little upgrading done in Australia.

Supermarkets

UBS reiterates its view that irrational behaviour and consequent price reductions are unlikely in the Australian supermarket segment. The broker's latest survey highlights that cross-shopping rates are steadying and promotional fatigue is setting in, while loyalty programs are becoming more important.

The broker believes Woolworths is best positioned to benefit, as it offers the most medium-term upside among the listed grocers. Its food segment continues to grow share, while Aldi has re-accelerated and Coles ((WES)) has softened. Coles' fresh food still scored strongly and ahead of Woolworths.

Independents continue to lose share, driven by South Australia and Western Australia, while east coast trends are steadying. The broker believes this is a positive for Metcash ((MTS)). Aldi was the most positive in this survey, suggesting it has begun to regain traction on the east coast.

Strategy

Macquarie observes the recent strength of the Australian dollar is based mainly on US dollar weakness. The rally has been less impressive against the euro and other commodity currencies. At this stage, while the domestic economic outlook is not at risk, the broker believes the recent run of solid employment growth may not be sustainable if the currency remains around US$0.80 or pushes higher.

A recovery in employment is dependent upon traded sectors, such as professional services and education, which are vulnerable to further currency appreciation. Macquarie does not believe the Reserve Bank will intervene for now and easing policy is not an option unless domestic conditions deteriorate.

Meanwhile, the weaker Australian dollar has provided a tailwind for offshore industrial stocks but this is not the main game, rather exposure to faster growing markets, share gains and M&A opportunities are considered key factors.

Macquarie believes the sell-off in offshore-exposed stocks is overdone and Aristocrat Leisure ((ALL)), Brambles ((BXB)), Incitec Pivot ((IPL)), James Hardie ((JHX)) and QBE Insurance ((QBE)) are oversold on Australian dollar concerns. The broker notes Qantas ((QAN)) is a net beneficiary of the stronger currency and continues to look mispriced relative to the fundamentals

Agriculture

Bell Potter observes the first stage of a correction in cattle prices is under way. Margins appear to be returning to processors for the first time in around two years and this should benefit Australian Agricultural Co ((AAC)) via its Livingston processing facility. The second stage, the inverse correlation to grain prices, appears increasingly likely, as dry conditions mean volume returns to the domestic market as US production accelerates.

Bell Potter remains cautious on cattle prices. A decline in cattle prices without an offsetting gain in volume creates a headwind for livestock agents such as Elders ((ELD)) and Ruralco ((RHL)). A normalisation of the relationship between Australian and global cattle prices should be beneficial to the return of live export operators and be a partial offset to the headwinds in the agency business for Ruralco.

Aged Care

UBS reviews its outlook for the residential aged care sector after the latest Aged Care Funding Instrument data. A clearer regulatory framework is emerging and the broker envisages value in the sector, particularly for Regis Healthcare ((REG)), which is now the broker's top pick. The broker's analysis shows that the company is the clear leader in operating efficiency and portfolio quality, with higher occupancy versus its peers.

While remaining positive on long-run growth, the broker downgrades Japara Healthcare ((JHC)) ,as FY17 guidance looks challenging. The company's forward development pipeline is the largest relative to its current size and it maintains the more conservative balance sheet. Meanwhile, UBS believes Estia Health ((EHE)) has significant opportunity for organic growth if it can improve profitability and build out its forward pipeline.

Audinate Group

Audinate ((AD8)), an Australian based leader in professional digital audio networking, has grown its global original equipment manufacturer (OEM) base to over 360. This includes many of the world's leading AV equipment brands such as Bosch, Bose, Sony, Roland and Yamaha. The company stands to benefit significantly from the early-stage adoption of audio networking to replace legacy analogue conductivity in professional AV installations.

Shaw and Partners observes the company's growth strategy is multi-faceted, involving growing the adoption of its Dante product and increasing use of Dante within its existing customer base. The company also intends to drive other market participant's adoption of Dante and deliver new products and services to both OEMs and end users. Shaw and Partners initiates coverage with a Buy rating and $2.20 target. The company reports its maiden FY17 result in August 21.

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