Tag Archives: Agriculture

article 3 months old

Weekly Broker Wrap: Oz Retail, Focus Lists, Banks And Agriculture

-Oz retailer growth via offshore sourcing
-Morgans adds Seek to high convictions
-Goldman adds Fonterra to mid cap focus
-Banks may remain expensive
-Better outlook for east coast grain
 

By Eva Brocklehurst

Australian retailers need new avenues for profit growth. This is the conclusion Citi has come to after analysing the sophistication of each major retailer's product sources. Wesfarmers ((WES)) is the most advanced in offshore sourcing. The broker estimates Myer ((MYR)), Specialty Fashion ((SFH)) and Super Retail ((SUL)) could achieve double digit earnings upside if they increase their offshore direct sources.

Retailers may lobby for lower wages but Citi contends they should focus on lower cost-of-goods sold (COGS). COGS represents at least 40% of costs and often up to 80%. Australian retailers over-rely on China and still use agents or wholesalers. Citi believe there is margin upside in expanding sources to include Indonesia, India, Bangladesh and Vietnam. In many categories a retailer can also cut out the middle man. Profit margins can be expanded in two ways, by increasing private label sales and increasing direct sourcing from overseas factories. Citi notes Myer and Super Retail have clear plans to expand offshore sources. The broker advisers that while there is margin upside, investors should be aware of the currency and inventory risks, which will of course rise with increased offshore sourcing.

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Large cap stocks continue to dominate Morgans' high conviction list, which is returning an average annualised 35% return for positions sold in the last 12 months. The broker adds Seek ((SEK)) to this list as a preferred strategic exposure to disruptive technologies via the online services industry. The broker thinks the stock has potential to re-rate significantly after the August reporting season, given modest expectations for FY15.

Overall, the broker believes equities look fairly priced. The US market is trading around 8.0% ahead of fundamentals but Morgans considers this not uncommon during periods of economic recovery. That said, the broker warns that volumes and volatility are unusually low, which suggests markets are vulnerable to disappointment. The Australian market is finally growing after averaging an earnings contraction of 2% over the past four years. Morgans is confident the upswing will endure but thinks expectations for FY15 need to be tempered.

Goldman Sachs has added Fonterra Shareholders Fund ((FSF)) to its small & mid cap focus list. The broker's analysis suggests an extended period of surplus global milk production because of above-trend supply growth. This flows into lower New Zealand farm gate prices and higher margins for the company's ingredients and consumer brands. In July key performers in the list were FlexiGroup ((FXL)), Super Retail and Skilled ((SKE)), which delivered excess returns of 13.4%, 6.7% and 6.4% respectively. The key detractors on the list in July were Austbrokers ((AUB)), SG Fleet ((SGF)) and Alacer Gold ((AQG)), delivering negative returns of 12.2%, 6.9% and 6.9% respectively.

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UBS expects another strong result from Commonwealth Bank ((CBA)) in FY14. Revenue growth is solid, costs are under control and asset quality is benign. The broker observes that over the last few results briefings, the bank has been at pains to illustrate the strength of its capital position. This is significant, as UBS suspects the Financial Systems Inquiry is likely to require banks to materially increase their CET-1 capital ratios to reduce taxpayer exposure to failure.

The broker expects Bendigo & Adelaide Bank ((BEN)) to deliver a 12% rise in FY14 cash profit. Although lending growth has been subdued, improving deposit pricing should underpin margin expansion. Overall, the broker believes the outlook for the banking sector remains robust and trends are positive. Valuations look stretched but given a benign outlook for interest rates, banks may remain expensive for some time. The FSI outcome, due in November, remains the biggest issue they face.

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The Australian Bureau of Meteorology has downgraded the chance of an El Nino developing this summer to 50% from 70%. This is a positive development in Bell Potter's view for those stocks exposed to east coast grain volumes such as Ruralco ((RHL)) and Graincorp ((GNC)), as well as farming operations that have water as a cost, such as Select Harvests ((SHV)) and Webster ((WBA)). Pricing risk lies to the upside for Webster in the broker's opinion, as average US walnut export values are up 10% in the year to date. Webster is a counter-seasonal supplier and likely to benefit from higher export prices. Webster has rallied 27% from its recent low and plans to plant 900 hectares of new orchards over the next three years.

Live cattle export volumes are now up 65% year on year and this is a positive earnings driver for Ruralco. The southern hemisphere grape crush among top producers looks to be down 5-6% which is a positive for Australian Vintage ((AVG)), in the broker's analysis.
 

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Material Matters: Commodity Price Forecasts Revamped

-Supply issues plague bulks
-Steel demand revised higher
-Aluminium, zinc, lead prices elevated
-JP Morgan downgrades nickel for H214
 

By Eva Brocklehurst

Commodity markets are entering the second half of 2014 on a positive note but ANZ analysts expect the recovery to be far more gradual than in the past. The recovery will be tempered by lower liquidity and a stronger US dollar. The lack of a sustainable uplift in prices on the back of increased geopolitical risks recently suggests the market is complacent about the risks. The analysts expect supply-side issues will remain to the forefront of commodity markets, particularly for the bulks - coal and iron ore - while energy markets will find support from improved macro conditions and tightening US supplies. Supply-side issues are also expected to drive the base metals complex, while Chinese demand for physical gold is likely to remain weak. Improved global supply of grains appears to be priced into the market while the analysts expect cotton and sugar prices to languish. The outlook for beef prices remains strong.

National Australia Bank's non-rural commodity price index is expected to rise by around 1.7% quarter-on-quarter in September in US dollar terms, following a 7.3% decline in June. Stabilisation of prices for iron ore and metallurgical coal are the main drivers of the rise, while strong increases in some base metal prices in recent months are also making a contribution. In Australian dollar terms, commodity prices are forecast to rise a little across the remainder of 2014 and continue to edge higher in 2015, largely reflecting a depreciation of the Australian dollar as interest rates, particularly in the US, start to normalise.

Coal abounds in the market, depressing prices, and major producers are showing no sign of supply discipline. ANZ analysts observe demand is either waning or under pressure from alternative supply. The situation is not expected to improve in the near to medium term. Hence, the analysts have downgraded coal prices by an average of 10% over the next two to three years. Larger, short-term downgrades are specifically made for coking (metallurgical) coal to reflect the unsustainably strong export response from Australia while larger, longer-term downgrades are made to thermal coal as China's supply expansion continues. The ANZ analysts remain positive on the longer-term demand dynamics, as coal remains a base-load power source in China and industrial activity in India is gathering steam. Reduced capital expenditure in Australia and Indonesia should mean tightening supply in 2016 and 2017, and a price recovery.

Commonwealth Bank analysts observe coal miners seem to be tolerating short-term losses and relentlessly pursuing cost cutting, maintaining more output than previously assumed. Combined with higher mine closure thresholds, because of take-or-pay freight contracts, and expensive mine closure costs, the analysts expect supply will remain in the market for longer and prices will remain lower. CBA analysts have revised down coking coal price forecasts by 10% for FY15 and 16% for FY16. The long-run price has been revised down to US$135/t FOB Queensland. Thermal coal prices are revised down 16% for FY15 and 9% for FY16. The analysts retain a real long-run thermal coal price of US$80/t FOB Newcastle.

National Australia Bank analysts expect metallurgical coal prices will recover modestly from current lows, trending up to US$150/t for hard coking coal by the end of 2015. They note global metallurgical coal producers have cut production by around 20.8mt, with most of the reductions seen in North America. Thermal coal prices are expected to drift lower but there is limited downside in the NAB analysts' view, while increasing idle production capacity should limit any significant upside. They forecast thermal coal contract prices to ease to US$80/t in the next Japanese financial year. In addition, they observe the Australian government has approved what appears to become the largest domestic coal mine, Carmichael, forecast to produce 60mt of thermal coal per annum, which may further drive down already subdued prices.

The NAB analysts expect global steel production to increase, with profitability in China's steel sector improving in recent months because input costs have fallen more rapidly than steel prices. They expect the iron ore price will settle to around US$100/t at the end of 2014, and US$95/t at the end of 2015.

CBA analysts have downgraded iron ore prices across forecast years. Falling Chinese production costs, growth in new cheap seaborne supply and slower growth in Chinese pig iron output relative to crude steel combine to weigh on the market, even it global steel demand is being revised up. Miners around the world are commissioning new mines and reducing costs at existing mines and this should weigh more heavily than previously anticipated, in the analysts' view. They revise FY15 forecasts down 5% and FY16 down 12%. In the long run, iron ore prices are downgraded to US$85/t CFR China or US$73/t FOB Pilbara, assuming US$2/t in real freight costs. The CBA analysts have also upgraded steel demand forecasts, as a recovering global economy and strong Chinese infrastructure investment push up production. Even so, cost cutting, greater loss tolerance and new committed projects outweigh stronger demand.

Physical markets for some metals have become tighter than NAB analysts previously expected, from a combination of both demand and supply side factors. Prices for aluminium, zinc and lead in particular have risen more than previously forecast and look set to remain elevated. Consequently, price rises forecast for later in the year have been brought forward. That said, the analysts emphasise the uncertain economic and political environment poses significant risks to the outlook. Moreover, the amount of metal being held both in and outside of official warehouses is creating distortions in physical market. In aggregate, the NAB Base Metals Price Index rose 5.8% in the June quarter 2014, with large increases in nickel and smaller rises for aluminium and zinc, partly offset by a fall in copper. Following strong growth in base metals prices over 2014, prices are now forecast to grow much more gradually over 2015 and 2016.

JP Morgan has revised up price forecasts for aluminium in the second half and 2015, expecting that tight fundamentals ex China may lead to annualised price appreciation greater than 10%. The analysts remain neutral on copper and gold prices, expecting support to hold up at US$7,000/t and US$1,275/oz respectively. The analysts' nickel price forecasts are being downgraded for the second half as current fundamentals are not considered to be signalling a meaningfully tight market. Steep price appreciation is expected in 2015, as the refined nickel market moves into deficit. Zinc price forecasts are upgraded for 2015 as the global balance moves into deficit, although JP Morgan suspects the recent rally may be premature.
 

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article 3 months old

Weekly Broker Wrap: Gold, Banks, Travel, IVF And Discretionary Retail

-Russia ups gold purchases
-NAB likely to adopt IFRS 9 early
-AVG sells Yaldara, ELD sells Charlton
-Aussies increasingly heading overseas
-PRY becomes VRT competitor
-Costs a headwind for retailers
 

By Eva Brocklehurst

Central banks were buyers of gold in the first half of 2014. Macquarie notes sellers were few and far between. Three countries - Russia, Iraq and Kazakhstan - accounted for most of the purchases. Central banks and international financial institutions, as well as sovereign wealth funds, have historically been the most important holders of gold. Those that report to the International Monetary Fund reported holdings of just over 29,000 tonnes of gold as of June 2014. This understates total holdings as it does not count the gold held by some central banks which do not report, nor any gold held by sovereign wealth funds.

Why is this important to know? Annual flows in and out of the central banks are relatively small given their holdings, but can have a big impact on the gold market and the price. Extrapolating the purchases forward to the second half of the year, Macquarie estimates total net purchases of 226 tonnes, higher than 2013 but below 2012. The shift to higher purchases this year is largely Russian inspired and given that country's FX reserves have fallen, Macquarie suspects this might reflect a preference for gold over government bonds in the current political environment. The fact that gold has managed to rise in price this year should calm some nerves about its long-term outlook, in the broker's view.

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The new IFRS 9 provisioning standard for bank credit reporting is now on the table. This will come into effect on January 1, 2018. The most important aspect is a move to an expected loss-provisioning model from an incurred loss-provisioning model that is currently in place. This will, in turn, require more timely recognition of credit losses and early adoption of the new standard is permitted. JP Morgan expects annual provisioning charges will rise with a deteriorating credit environment, as opposed to banks building buffers in so-called good times.

The broker expects National Australia Bank ((NAB)) will be the most likely of the big four to adopt this provision early, as it has $550m in its general reserve for credit losses, versus major bank peer average of $170m. A move to IFRS 9 accounting by the major banks in the long run may result in early recognition of credit losses, but may not assist with smoothing out volatility in bad debt charges. Beyond expecting that NAB may be an early adopter of this accounting practice, the broker believes there are limited implications for sector valuations.

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In agricultural news, Australian Vintage ((AVG)) has announced the sale of the Yaldara winery and brand for $15.5m, while also executing a two-year processing agreement for its Barossa grapes. On face value the transaction is around 5% earnings accretive on an annualised FY15 basis, in Bell Potter's view. Meanwhile, Elders ((ELD)) has announced the sale of the Charlton feedlot for $10.1m which will provide a handy profit of $4m. A positive for the rural sector is that export markets for live cattle remain strong, with mid year reports indicating the number of head for 2013/14 is up 25% and export volume expectations for 2014/15 have been raised 11.4%.

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Bell Potter has examined how holiday travel expenditure and disposable income is shaping up after the federal budget knocked consumer confidence earlier this year. Holiday travel expenditure, including domestic and outbound, as a percentage of disposable income has been virtually unchanged at around 6.5% over the past eight years. This is consistent with the broker's view that Australians are prepared to spend money on a holiday regardless of circumstances. There is a clear shift in the numbers towards outbound travel and away from domestic - outbound has tripled the growth in domestic expenditure over the same timeframe - and the broker expects this trend to continue. In periods of material economic disruption outbound travel tends to slow. Bell Potter notes this impact tends to be transitory and periods of weakness are followed by a strong recovery.

The implications for stocks in the sector means the trends are positive for Cover-More ((CVO)). Cover-More remains the purest way to play the outbound travel theme in Bell Potter's view. Flight Centre ((FLT)) is also a likely positive beneficiary of any recovery in the household sector, given the sale of outbound travel remains the single largest driver of earnings. The trend shift from domestic has negative implications for Webjet ((WEB)),Virgin Australia ((VAH)) and Wotif.com ((WTF)). The latter has been a major loser in the shift to outbound travel at the expense of domestic.

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Primary Health Care ((PRY)) has debuted as a provider of IVF services, opening a clinic in Sydney and offering bulk billing. The offer of bulk billing should be able grow the market, given lower economic quartiles are under-penetrated because of the cost of the service. The model is in its early stages and UBS makes no adjustments to forecasts but, since a referral to an IVF specialist ultimately comes via a GP, believes Primary will have an opportunity to capture referrals from its own clinics in NSW. A risk for established IVF providers is that Primary-owned GP clinic referrals could now go "internal". At present the risk is contained to less than 2% for IVF competitor Virtus Health ((VRT)) volumes as Primary's GP base is concentrated in NSW.

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BA-Merrill Lynch expects fixed cost increases will continue to be an obstacle for discretionary retailers. In the past three years, earnings for this group have declined by 21% and the key driver of the decline was fixed cost growth. The broker expects fixed cost growth to moderate slightly in FY15 but still impose a 3.2% headwind. Margins also risk coming under severe pressure. The broker expects discretionary retailers will be dealing with Australian dollar buying rates that will be up to 10% below FY14 levels and this will put upward pressure on pricing. Price rises could be hard to pass through if sales are subdued. Even if gross margins remain flat, retailers will not enjoy the earnings benefit from gross margin expansion that they have sustained in recent years.
 

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article 3 months old

Select Harvests’ Profit To Peak In FY15

-Volume decline but price up
-No end to Californian drought
-FY15 could be peak year for earnings
 

By Eva Brocklehurst

Almond producer Select Harvests ((SHV)) has now harvested 80% of the 2014 crop, with an average 20% volume decline on 2013 largely attributable to wet weather and related insect damage. Victoria and SA crops are down 10% and NSW down 27%. Underlying profit in FY14 is expected to be better than FY13's $22.9m, but the company has not signalled to what extent.

In Select Harvests' favour is the fact that the Californian drought shows no signs of easing. The region supplies 80% of the world's almonds and expects a further 2.5% decline in 2014, with significant risks for 2015. The company expects to harvest 10,500 tonnes in 2014 compared with 12,600 tonnes in 2013, offset by an increase in the average price for the 2014 crop to $8.40/kg from $8.30/kg, despite the quality issues. The prospects for 2015 are also favourable, with good bud growth and local and export demand remaining strong.

Moelis has downgraded earnings estimates for FY14 by 10%, largely as the tonnage is lower and offset only somewhat by the average price increase for the season. The broker retains a Buy rating and $6.20 target. A strong earnings rebound in FY15 is expected, in the absence of a repeat of the adverse weather conditions. This should position the company for a positive FY16 outlook as well, with the broker forecasting profit of around $32m compared with $35m in FY15.

Bell Potter cuts FY14 profit forecasts by 20% and believes FY15 will be the cyclical peak for Select Harvests. The broker is mindful that yields have taken a hit in 2014 and price increases are not mitigating the lower volumes. Assuming a return to theoretical yield level and spot prices at $8.17/kg the broker expects a material 30% uplift to FY15 profit, largely reflecting the broker's sharper downgrade to FY14. Bell Potter has downgraded estimates for FY15 and FY16 by 6.5% and 7.1% respectively, to reflect more conservative yield assumptions, and expects FY16 profit to now fall to $21.4m, from around $33.5m in FY15. The largest risk lies in pricing assumptions, in the broker's opinion, with US dollar almond prices at all-time highs and every 1% fall in US dollar prices resulting in a 20% fall in Select Harvests' profit.

Bell Potter is typically a buyer of agricultural stocks when they disappoint, as there is generally a response in the share price that re-prices theoretical earnings after the event. Select Harvest appears to be at the end of a two-year upgrade cycle and, with prices so high and yields expected to return to their peak, the broker struggles to find the next positive earnings catalyst. Hence, a Hold rating is retained. The target is reduced to $5.21 from $5.45.

Goldman Sachs is of a similar view, believing FY15 will be the peak in earnings for the cycle. The broker downgrades crop yield and price assumptions for FY14 by 20%, but makes smaller changes (around 2%) to the outer years, given the source of the downgrade relates to FY15 crop issues rather than long-term factors such as the almond price or Australian dollar. The broker estimates profit of around $38.8m for FY15 and $34m in FY16. Goldman Sachs retains a price target of $6.11, based on a 40% price/earnings discount to the FY15 Small Industrials, to reflect the inherent agricultural risk. A Neutral rating is retained.

See also, Rain Dampens Select Harvests' Outlook on May 15 2014.
 

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Material Matters: Iron Ore Inventory & Price, Agricultural Stocks And Zircon

-Potential sharp drop in iron ore purchases
-Iron ore price risk still to the downside
-Discounts on lower grade iron ore widen
-El Nino potential to affect Oz east coast
-Chinese zircon imports rise in April
 

By Eva Brocklehurst

A rapid increase in lower-cost iron ore supply has brought down prices. High cost producers have responded and imports into China from non-traditional suppliers have been falling steadily this year. The displacement of high cost tonnage has been fairly orderly, Macquarie observes, but the fact that China's inventories have not fallen this year reveals an overhang in the market, with the next step being the clearing of the excess. This process will mean purchasing activity needs to drop below real demand, resulting in further downside risks to prices.

Macquarie asks how easy it will be to displace the incumbent producers at the top of the cost curve and notes, in this regard, the coal market sets a very negative precedent. High cost suppliers have proved to be some of the stickiest. As prices of iron ore have softened, imports into China from outside the big four - Australia, Brazil, India and South Africa - have declined steadily, with the biggest declines coming from regions that sell overland such as Russia, Kazakhstan and Mongolia, as well as South East Asian suppliers such as Indonesia, Vietnam and the Philippines. Chinese domestic iron ore mines also seem to be under pressure and, while output has not declined since January, there has been no rebound after the usual winter shut down.

The fact that inventories appear to have been high all year is not particularly reassuring and Macquarie thinks this has worked in favour of the steel mills, as they have been able to pass the cost and risk of holding inventory onto the traders and allow their own profitability to decouple from the iron ore price cycle. Traders, as a result of Macquarie's steel survey, appear ready to liquidate. 

There are two scenarios for rationalising inventory - what Macquarie calls the flash crash or the slow bleed. In the former the assumption is that five days of inventory is de-stocked over June and another two days over July. This would knock out 177mtpa of apparent demand and push down the cost curve to a point where support is slightly below US$80/t. This would be likely to be followed by a recovery. In the second scenario, where it takes five or six months to bring inventory down, this would mean prices hover in the US$90-100/t range and then move back above US$100/t in the fourth quarter. The risk in the latter scenario is that, what might start as a slow bleed, could turn more aggressive as traders cut losses and mills await better buying opportunities. All up, Macquarie advises investors to be positioned for a period of weakness in coming months but also be aware of the buying opportunity that should be presented once inventories are back at healthier levels.

Bell Potter observes discounts on lower grade iron ore have widened. The spread between 58% iron and 62% iron has widened to 22% from 12%. This comes on top of weak iron ore prices. Most Australian producers price off the 62% iron index, adjusted for grade and impurities, despite shipping mostly 57-59% iron ore. The recent discounting poses significant risk to their realised and break-even prices, the extent of which the broker suggests will not be clear until the miners' quarterly reports are published in July. Bell Potter has downgraded iron ore price estimates and assumes that prices average US$100/t in the December half.

UBS has observed that Chinese steel production and iron ore supply are running at record rates. Compounding high inventories is the fact that much of the increase in China's steel production ends up in the export market and thus signals domestic consumption may not be as strong as production data would suggest. The broker examines what is required for iron ore equities to break even. Rio Tinto ((RIO)) appears to be the stock requiring the lowest price to break even - at US$43/t. BHP Billiton ((BHP)) requires US$50/t while Fortescue Metals (((FMG)) requires US$72/t. This compares with Mt Gibson Iron ((MGX)), Gindalbie Metals ((GBG)) and Grange Resources ((GRR)), which require US$79/t, US$91/t and US$97/t respectively.

Taking this one step further, UBS analyses what long-term iron ore price is implied in these companies' current share prices. The calculation suggests Gindalbie, Mount Gibson and Grange are fully valued if the iron ore price does not recover from current levels. BHP and Fortescue look attractive in this analysis, while Rio Tinto stands out sharply as implying an iron ore price of US$72/dmt CFR. The broker does acknowledge that the market may be applying zero value to Rio Tinto's aluminium assets, in which case this would require a higher iron ore price to allow valuations to equal the share price.

Another negative is looming for agriculture. The Bureau of Meteorology has issued an El Nino alert, indicating at least a 70% chance of such an event developing this year. The El Nino results in below-average rainfall and above-average temperatures on Australia's east coast. Bell Potter has looked at the potential impact on Australian producers under coverage.

Australian Vintage ((AVG)) has the potential for lower grape yields to impact earnings and lift the cost of goods sold in 12-18 months time when the vintage is sold. Bega Cheese ((BGA)) has the potential for lower milk volumes while a lower east coast wheat harvest would affect GrainCorp's ((GNC)) receivals, exports and marketing volumes in the following year. Ruralco ((RHL)) would experience reduced fertiliser and crop protection sales, as well as lower earnings in livestock and wool agencies. This may be partially mitigated by stronger earnings in the water business. Select Harvests ((SHV)) has the potential for lower yields and higher water costs, and lower almond prices in the event California has an above-average year.

On a more positive note, China has increased imports of zircon. Imports were up 10% in April compared with March and up 12% from last year. The majority of imports came from Australia and South Africa. The data can be highly variable and imports do not necessarily mean sales to end customers but JP Morgan is encouraged by the uptick and believes it could be an early indicator of a recovery in demand. Moreover, imports from Australia were up 50% to 36,000t out of the total of 55,000t, as South Africa dropped away.
 

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article 3 months old

Rain Dampens Select Harvests’ Outlook

-Rain reduces yield/quality
-Strong almond prices compensate
 

By Eva Brocklehurst

Select Harvests ((SHV)) has a problem which is the envy of the rest of regional NSW. Rain. The company has been prevented from harvesting the remainder of its almond crop - around 16% - because of continued rainfall in the state's producing areas in the Riverina. Morgans believes it's too early to assess the earnings impact, but rain at harvest time is a negative and reflects the hazards in agriculture. Not only is the volume affected but quality issues resulting from rain at the wrong time can result in a fall in grade and prices.

At this stage, Morgans assumes that 10% of the crop is at risk and reduces its yield estimate by that factor, while increasing cost assumptions relating to production and harvesting. As a result, the broker's FY14 net profit forecasts have fallen by 18%. On the positive side, that forecast is still up 45% on FY13, because the almond price is materially higher. Almond prices were around $6.60/kg in 2013 and the company received $5.03/kg for the 2012 crop.

Assuming an average season in FY15, Morgans expects further strong earnings growth. Earnings are then expected to fall in FY16, as some of the older orchards need replanting and the broker assumes a more conservative price for almonds. Demand for almonds remains strong in global markets and many are low on inventory. Hence, prices are expected to stay firm and the broker retains an Add rating.

Moelis also expects some offset to the lower harvest from strong almond prices, as the average price has remained over $9.00/kg since last November and 55% of the crop is now sold. The broker is downgrading estimates primarily on the likelihood that final tonnage will be lower and there will be higher production costs from the adverse weather. The outlook for FY15 remains favourable, with management having previously indicated there's good bud growth. Moelis observes demand continues to rise, despite increases of more than 30% in the almond price over the the past year. The stock receives a Buy tick from the broker as, despite a 15% decline in the share price since the announcement of the harvesting problems, the multiples remain undemanding, given the company's position in the global almond market.

International almond industry dynamics are favourable, supported by a prolonged drought in California, which has over 80% of the world's supply. US shipments are up 4.3% year to date but the inventory carried over is 17% lower than at the end of last year.

Goldman Sachs has also downgraded yield as well as price assumptions, now expecting a crop of 12,200t and price of $8.20/kg. The company's previous guidance was for a FY14 crop of 12,600t at an average price of $8.30/kg. There is some upside risk of higher almond prices if the Californian crop falls short of the forecast 1.95bn pounds. Downside risk comes from Australia's climate, if Select Harvests' crop is further weakened by rainfall. The broker retains a Neutral rating, with Select Harvests trading on a FY15 forecast price earnings ratio of eight times. FY14 and FY15 earnings forecasts fall 10% and 4% respectively.

Goldman believes the stock is fair value. Given FY15 is regarded as a peak year for the cycle the broker expects earnings growth of 16.7% in FY15 but a contraction of 12.5% in FY16. The broker retains a target of $6.63, based on a 40% discount to the FY15 Small Industrials Index, reflecting the stock's inherent agricultural risk and the view that FY15 represents the peak in cyclical earnings. Moelis has a $6.75 target with forecasts for earnings growth of 10.7% in FY15 and a contraction of 8.7% in FY16.

 Select Harvests has a portfolio of orchards located in Victoria's Mallee, South Australia's Riverland and NSW's Riverina. 
 

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Weekly Broker Wrap: Tax, Crops, Budget, Earnings Risks And Advertising

-Tax burden douses confidence
-US corn, soybean prices overshot
-Oz budget may dampen spending
-Where's the FY15 earnings risk?
-Cinema poised to gain ad share
 

By Eva Brocklehurst

Macquarie observes that tax burdens have been rising on labour income in the world's major economies, as governments seek to rein in budget deficits. According to OECD statistics, personal income tax has increased in 25 of the 34 member countries over the past three years. Macquarie suspects that the increased tax burden amidst declining real wages will produce a negative effect on consumer confidence and growth in domestic demand.

The analysts maintain that, if taxation burdens on labour continue to rise, this will disrupt recovery in household balance sheets, reduce consumption taxes, increase income inequality, and constrain investment and GDP growth in the long run. Macquarie concedes many countries need to cut down on unproductive spending - increased as a result of the global financial crisis - and raise tax revenue. What the analysts question is the increased taxation of labour income.

Taking the OECD analysis on Australia, Macquarie notes the single average worker faced an increased tax burden of 0.8 percentage points between 2011 and 2013, higher than the OECD average of 0.3 percentage points. The average tax burden for single income couples with two children rose by 2.7 percentage points in those years compared with the OECD average of 1.4 percentage points.

What's important, in the analysts' view, is evaluating the implications of rising tax burdens on labour income, prior to resorting to tax-biased methods of fiscal consolidation. They believe policy reform for OECD countries should come via: implementing more progressive taxes, so that lowest paid workers face low marginal tax rates without discouraging labour force participation; shifting tax bases towards consumption to increase employment and reduce the efficiency cost to taxation; using tax polices to affect the number of hours worked rather than the participation choice; and increasing taxes on natural resources and energy consumption, in order to minimize the negative externalities on economies.

***

From one dry area to another. Macquarie's agricultural analysts note cold temperatures in the US have delayed corn planting but this has now started to pick up and the recent rally in corn prices may have caused farmers to increase their intended corn seeding area. Soybean plantings have just begun but the analysts are concerned at the late heading of winter wheat, developing at the slowest pace for the last 20 years. In the areas where soybeans follow on this could inhibit the farmer's ability to plant. The analysts note the delays have allowed a risk premium to remain in place but they remain bearish on soybeans, believing prices have overshot and are liable for correction, led by corn. As the farmer starts planting he starts hedging and this should drive a correction in prices. If reasonable pollination in soybeans and blooming in corn ensues, then a sharp dip in prices is expected at the end of the year.

Dry conditions in the southern US have meant some loss of wheat production is near certain. The cold winter and slow emergence of the crop from dormancy means there has been more time to see if rainfall can help in the critical growth stages. While a drop in US wheat production is likely, the analysts expect it to coincide with a large drop in demand because of a far smaller import program from China. Nevertheless, US wheat prices could be supported by any meaningful Chinese import volumes. This is because, if the El Nino develops as expected in in the southern hemisphere this winter, the Chinese may be compelled to buy US wheat, fearing Australian supplies will be weak.

***

BA-Merrill Lynch believes the federal budget could provide headwinds to consumer spending. Initiatives such as the proposed debt levy, potential cuts to welfare, unwinding of the School Kids bonus and the Medicare co-payments could be as much as $9.4bn, representing 4% of total retail sales and 11% of discretionary retail sales. Merrills' economists are predicting that household disposable income growth in FY14 will be the lowest since 1998.

The broker notes Australian Bureau of Statistics' data shows an increasingly greater proportion of expenditure is allocated to necessities such education, utilities, health and insurance. Pressure on discretionary purchases will come at a poor time for retailers, the broker contends. These retailers will have to deal with a lower Australian dollar going into FY15 by raising prices. If consumer spending decelerates after the budget the ability to pass on price increases may be limited, which would impact gross margins.

As the "confessions season" nears, when companies are likely to tweak guidance for the upcoming financial year, BA-Merrill Lynch has taken a peak at where the earnings risk in FY15 could be coming from. The broker sees downside risk for the industrials ex banks. Consensus forecasts expect sales growth of 4.6% to translate to earnings growth of 11%. The broker notes margin expansion of this magnitude has not been seen for at least five years. Hence, Merrills suggests treating the forecasts for Adelaide Brighton ((ABC)), Sims Metal Management ((SGM)), Monadelphous ((MND)), UGL ((UGL)) and ALS ((ALQ)) with caution. The broker is more comfortable with the forecasts for Amcor ((AMC)), Brambles ((BXB)), Flight Centre ((FLT)) and Suncorp ((SUN)).

In terms of the current year the broker, in aggregate, is comfortable with forecasts. Stock specific risk is the main concern, along with a greater-than-usual reliance on second half sales. In the latter bracket the broker includes Ansell ((ANN)), Treasury Wine Estate ((TWE)), Cochlear ((COH)), Qantas ((QAN)), Virgin Australia ((VAH)), UGL and Southern Cross Media ((SXL)). On the other side of the equation those that could beat because of a lower reliance on the second half include Beach Energy ((BPT)), Brambles and Super Retail ((SUL)).

The broker also lists stocks for which earnings forecasts have fallen, but the share prices have risen over the past three months, as having potential to correct. These are Graincorp ((GNC)), Qantas, Caltex ((CTX)), AGL Energy ((AGK)), Mineral Resources ((MIN)), Harvey Norman ((HVN)) and Lend Lease ((LLC)). The opposite, where earnings have been upgraded but the share price has fallen, occurs with Bendigo & Adelaide Bank ((BEN)), ASX ((ASX)) and Perpetual ((PPT)). Merrills remains underweight in consumer staples and miners in the model portfolio, and considers banks, diversified financials and builders have solid momentum.

***

JP Morgan has hosted a call with media buyers about the advertising market. The broker found the year was off to a strong start in TV, helped by the Winter Olympics and the World Cup. The buyers expect up front volumes to be up 2% this year and TV remains a crucial part of advertisers budgets. Live events, particularly sports, are seen as increasingly valuable. Advertisers are relying even more heavily on live events, as audience fragmentation continues. The broker suggests the premium difference between live sport and general programming could widen even further.

The buyers believe cinema is poised to gain share. Cinema's audience is stronger when TV is weaker - Friday and Saturday. The medium's high engagement through sight/sound and the lack of skipping ability underscores its attraction, as well as the skew to a younger demographic. The broker thinks the premium to TV has historically been a hurdle to advertisers but more aggressive pricing recently should unlock more demand.

There continues to be momentum in the move to digital. Advertisers are increasingly embracing digital video and the buyers noted significant improvements in both digital and cross-platform measurement, whereby advertisers can increasingly evaluate digital media on par with traditional media. While digital media is gaining share TV is still dominating. Even YouTube consumption significantly lags TV in terms of the hours watched per day. Viewing video on digital platforms, including mobile, is growing rapidly, but still only accounts for about 6-7% of total viewing.
 

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article 3 months old

Material Matters: Oil & Gas, Chinese Demand And Softs

-Big year ahead for LNG
-Chinese demand to pick up
-Investors favouring quality
-Better outlook for Oz beef
-Thai gold demand decline
 

By Eva Brocklehurst

What can the market expect from Australia's oil and gas sector in the upcoming March quarter production reports? UBS expects the first signs of higher pricing for LNG from Woodside Petoleum's ((WPL)) Pluto facility as legacy contract prices are phased out. Exxon, operator of PNG LNG, recently confirmed ramp-up was running ahead of schedule and budget, which the broker thinks could prompt another production guidance upgrade from Oil Search ((OSH)). The first LNG production from PNG should benefit stakeholders Oil Search and Santos ((STO)). Meanwhile, Santos' Gladstone LNG project is expected to commission its pipeline soon.

From Beach Energy ((BPT)) and Drillsearch ((DLS)) the broker will be looking for confirmation that Western Flank oil production in the Cooper continues at plateau rates and whether recent drilling success will extend this plateau period. Similar confirmation is sought in the case of the Beibu Gulf from Roc Oil ((ROC)) and Horizon Oil ((HZN)). Over the March quarter the best performing stock in UBS' energy coverage was Aurora Oil & Gas ((AUT)), operating in the US shale fields, thanks to the Baytex takeover bid. In contrast, Karoon Gas ((KAR)) suffered from the failed Grace exploration well.

UBS is still expecting the WTI oil price to fall through the second quarter to US$100/bbl, because of weaker demand growth and increasing supply from the US and Iraq. UBS notes the market seems to have shrugged off concerns around Ukraine. The broker's bearish long-term view is forecasting the long term oil price at US$92/bbl from 2017. UBS has raised 2014/15 US natural gas forecasts to US$4.75/mmbtu and US4.50/mmbtu respectively and maintained the long-term gas price forecast of US$5/mmbtu, although there is upside risk as the broker is bullish on long-term gas demand.

Citi suspects Chinese commodity demand has reached a cyclical low and growth should pick up as the year progresses. The analysts note recent signals of increasing government concern and a desire to support infrastructure investment and social housing. That said, Citi does not expect a large stimulus package along the lines of 2012. Rather, just as the slowdown last November was driven primarily by credit tightening last April, some easing of policy in the current quarter suggests better industrial demand in the second half of the year. This should add up to a better performance for most commodities but the most leveraged to an improvement in Chinese demand, in the broker's analysis, are steel, iron ore, metallurgical coal, zinc, copper, soybeans, LNG, naphtha and fuel oil. Incorporating supply considerations, Citi thinks steel, zinc, copper and LNG provide the best exposure to an improvement in Chinese demand.

Morgans believes resource sector stock investment is being steered towards the quality names, noting a bounce in valuations. The sector has been tough to call recently because commodity prices have been volatile and valuation multiples, in some cases, are at historical lows. The broker thinks there are some good companies for which share prices have not increased significantly. Morgans concedes it is too early to move on unfunded developers or early exploration plays but the process of identifying these, and singling out those with good resources and good management, should be in train. One of the stocks that caught the broker's attention is MetalsX ((MLX)), which is looking to expand on a number of fronts. Morgans' suggests MLX's valuation, much lower than the company's peers, is due to a lack of clarity on mine life for the company's Kalgoorlie assets. Morgans suspects this will change as production is expanded in 2015 and new projects such as Central Murchison are brought on line.

ANZ analysts believe sentiment in commodity markets appears to be turning more positive after a first quarter fraught with tight liquidity, soft demand and oversupply. These analysts also think the Chinese authorities are trying to shore up confidence. New supply dynamics in some markets such as copper and iron ore could curtail the gains. In the case of iron ore, increased supply from Australia is expected to cap prices, despite a seasonal pick-up in demand through the second quarter. If Chinese steel inventories continue to decline, the analysts expect further short covering in the market and this could prompt higher iron ore prices down the track. The analysts are generally positive about base metals but there is a supply overhang in a number of markets. The decline in global copper prices has resulted in a squeeze on copper scrap and has, in turn, forced some refiners to source higher quality cathode, particularly in the US and Europe. The analysts think this will keep end-user demand robust but is unlikely to avert the fourth straight year of copper surpluses.

The analysts are most bearish about soft commodities and proteins. In sugar, a large crop in Thailand is a negative for prices over the next six months. In Australia it's the opposite. Yields for the June harvest are reduced and Cyclone Ita is likely to have reduced volumes in the far north. Low prices are inhibiting a rebound in Australian production with current prices providing a margin return for most producers. In cotton, the April US supply and demand report showed stocks at the lowest level in 20 years. Nevertheless, the analysts observe this tightness is already priced in and demand at the yarn and fabric stage is reported to be weak across Asia. Moreover, the widening disparity with synthetic fibre does not bode well for cotton prices, in the analysts' view.

The ANZ analysts believe the preferential tariff rates that Australia has recently negotiated with Japan should provide a boost to Australian beef prices in 2015. Australia is the first global supplier to gain preferential tariffs on chilled and frozen beef into Japan. This is likely to coincide with high global beef prices and a normal wet season in northern Australia, reducing Australian beef supply next year. US slaughterings are down 8% year to date with the profit incentive for US farmers to retain heifers and cows remaining high. The analysts expect Australian beef prices to dramatically outperform over the next 12 months, partly related to a weaker Australian dollar, which the analysts expect to fall to US84c by early 2015.


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article 3 months old

Walnuts Explode

By Tim Moffatt, Head of Private Wealth SA and David Keating, Equities and FOREX Advisor, PhillipCapital

Webster Ltd ((WBA))

Bullish Internal and External dynamics; Walnut production to double by FY16 as Californian drought and Asian protein demand pushes Walnut prices to all-time-highs.

Walnut production growth, strong balance sheet, margin improvement, strong dividend growth…

Walnut production is expected to grow from 6,500 tonnes to 11,500 tonnes by FY16 – as trees planted 5-8 years ago mature and reach full production capacity.

A new cracking facility has recently been built at Leeton, allowing domestic processing of kernels (rather than exporting shells for cracking) – this will improve operational/margin performance. This facility will also allow kernel supply to the domestic market – WBA recently announced it was in advanced negotiations with a key domestic kernel customer.

Finally, post recent $15m CAPEX spend in FY14, the company has a strong balance sheet position with minimal net debt. The 1H14 dividend was increased 50% on the previous corresponding period, a strong sign management is optimistic about the future.

Global Walnut pricing tailwinds on Californian drought, Chile frost + Asian and “healthy eating” demand…

WBA presentation 26/3/14: “Australian price levels have opened strongly over last year. Pricing signalled to remain strong through 2014”. Local Walnut prices are indexed to Californian sales which is the largest export region. California is suffering an exceptionally bad drought (2013 the lowest rainfall year on record), underpinning strong pricing. Without a break in the drought here, supply is expected to remain constrained.

On the demand side of the equation Walnuts are experiencing demand from Asia, as developing countries increase per capital wealth and demand a higher protein diet (meat, fish, dairy, nuts). An example of this is China recently becoming a net importer despite being the largest producing region. In addition developed countries are consuming more Walnuts on the general shift toward healthy eating and recognised wide health benefits of Walnuts in particular (rich source of essential fats & omega 3’s).

WBA remains in strong uptrend, with short-term correction complete…

Technically WBA was at risk of a head-and-shoulders topping pattern and possible reversal of uptrend. This looks to have been negated on price uptick post site-tour and positive presentation update 26 March 2014.

Resistance is seen at $1.40 recent highs then all-time-highs $1.90.

Company Background

Webster Limited (WBA) is a land-based food production company with 2 main operating businesses: Field Fresh Tasmania, and Walnuts Australia. WBA focuses on export of onion and in-shell walnuts and production of counter-seasonal food to supply to northern hemisphere markets.

WALNUTS AUSTRALIA: Walnut Australia operates as the walnut orchard owner, manager and producer of walnuts with over 2,200 ha of orchards owned and/or managed in Tasmania & NSW. The operations include walnut tree nursery, orchard establishment and maintenance, harvesting and processing, grading and packing, and sales and marketing.

FIELD FRESH TASMANIA: Field Fresh specialises in growing and marketing of brown and red onions with operations based in northwest Tasmania. WBA has contract of brown and red onions with approximately 40 local farmers on over 700ha in the districts. Its primary markets are Northern Hemisphere.


Written & Edited by:

Tim Moffatt Head of Private Wealth South Australia PhillipCapital
Level 1, 16 Vardon Avenue, Adelaide, SA, 5000, Australia
tmoffatt@phillipcapital.com.au
www.phillipcapital.com.au

David Keating Equity and FOREX Advisor PhillipCapital Level 1, 16 Vardon Avenue, Adelaide, SA, 5000, Australia
dkeating@phillipcapital.com.au
www.phillipcapital.com.au

Please note the authors have an interest/shareholdings in WBA.
 

Reprinted with permission of the publisher. Content included in this article is not by association necessarily the view of FNArena (see our disclaimer).


 

This publication has been prepared solely for the information of the particular person to whom it was supplied by Phillip Capital Limited (“PhillipCapital”) AFSL 246827.  This publication contains general securities advice in relation to Foreign Exchange (Forex or F/X) strategies. In preparing the advice, PhillipCapital has not taken into account the investment objectives, financial situation and particular needs of any particular person.  Before making an investment decision on the basis of this advice, you need to consider, with or without the assistance of a securities adviser, whether the advice in this publication is appropriate in light of your particular investment needs, objectives and financial situation.  PhillipCapital and its associates within the meaning of the Corporations Act may take an equal or opposite side to the trades referred to in this publication.  PhillipCapital believes that the advice and information herein is accurate and reliable, but no warranties of accuracy, reliability or completeness are given (except insofar as liability under any statute cannot be excluded). No responsibility for any errors or omissions or any negligence is accepted by PhillipCapital or any of its directors, employees or agents.  This publication must not be distributed to retail investors outside of Australia.

article 3 months old

Nufarm Has A Competition Problem

-New entrants affect pricing power
-More positive when drought ends
-Company's measures considered modest
 

By Eva Brocklehurst

Mounting challenges from new entrants, and the loss of the distribution contract for a major product like Roundup, provoked Nufarm ((NUF)) into reviewing its Australian operations. Brokers welcomed the $13m in annual cost savings the company expects to achieve but remain concerned about a number of headwinds, including the erosion of market share coupled with a drought in eastern Australia.

Critical to the performance ahead is a break in the weather. Recent rain in Australia's cropping regions has provided some hope but brokers do not expect any benefit on that front in FY14. Macquarie observes the second half is the big season for the northern hemisphere and that's where most of the positives for the company lie for FY14. UBS, too, observes a significant skew to the second half earnings, with that broker's estimates implying a ratio of as much as 25:75.

The bulk of the Australian savings will come from the closure of two plants, one in Western Australia and one in Queensland, and the transfer of production to Victoria. Six out of 13 regional service centres will also be closed. The company is embarking on a review of the New Zealand operations as well. The Australian restructure is expected to improve the profitability of sales and reduce both working capital and a rather inflexible fixed cost base. The company has decided to target annual earnings of $70-80m going forward.

The restructure highlights a key concern for JP Morgan, in that new players have affected the company's pricing power and margins in Australia. The company has acknowledged this, noting an increase in the number of new product registrations. Management previously expected, after the announcement of the loss of key distribution contracts, that margins should remain stable, or even increase, given the higher margin generated on house product, along with the absence of royalty payments. JP Morgan assumes around 35% of the $13m of cost savings that are forecast will be retained in FY17, with the residual 65% being whittled away by competition.

UBS thinks this ramp up of competitive margin pressure could just be the start of continued inroads into the company's business. Australia has been the key profit centre in recent years and market share has been consistently over 30%. UBS notes the full impact of Sinochem's behaviour, after it attained full distribution rights to Roundup in September 2013, is yet to be seen. Moreover, BASF will take its products back in house from this month. UBS estimates a total sales loss of $165m and assumes 50% of lost sales are recovered.

The broker has raised the rating to Neutral from Sell, acknowledging the stock looks relatively cheap, but remarks it's difficult to become more positive. The company has levels of gearing that are uncomfortable. Total debt facilities are around $1.45bn and full year forecasts mean the company has around $500m in annual head room through FY14-16. What aggravates the situation for an agricultural company such as Nufarm is the problem of maintaining cash flow in line with earnings. Suppliers extend credit to growers and are paid once the crops are sold. Some of the mismatch is temporary but there's one issue that UBS thinks will persist as long as growth is pursued in South America. Here, the market dynamics are radically different to other regions. Instead of the typical 90-day creditor period the terms are over 200 days, particularly for Brazil. This situation needs to be incorporated in growth forecasts, in UBS' view.

BA-Merrill Lynch does not expect Australian earnings will return to the peak levels of $106m seen in FY12, largely because of a reduction in market share following the loss of Monsanto and BASF product distribution rights. The broker cites estimates of Australian pesticide sales, growing at a compound rate of just 0.5% which is the slowest among the developed world. Merrills expects Nufarm's Australian earnings will recover to only $60-70m beyond FY15. Merrills retains an Underperform rating.

CIMB considers the stock presents an attractive buying opportunity. The company will endure a second consecutive year hampered by adverse seasons but these internal initiatives will increase the leverage, in the broker's view, once normal conditions return. The broker concedes historical peak profits are out of reach, given the structural shifts in domestic crop protection, but thinks the review initiatives should help - along with some rain - to achieve the medium-term gross margin target of 23%, versus the 19% experienced in FY13.

Credit Suisse thinks the restructure is sensible to achieve the cost savings but is cautious about the ability to convert this to the bottom line. The broker suspects savings may be reinvested to protect market share but sees value in the stock beyond FY14 and the vagaries of the Australian weather, enough to raise the rating to Outperform from Neutral. Working capital management is likely to improve with fewer warehouses to stock. What's unclear to Credit Suisse is whether a reduction in the regional service centres will actually improve customer service. Nufarm expects to make more deliveries direct to the customer rather than from factory to warehouse to customer. The broker observes Nufarm has a strong reputation for same-day supply, having installed its multiple distribution centres in the past to enhance customer service.

FNArena's database reveals three Buy ratings, three Hold and one Sell. Price targets range from $4.10 (Merrills) to $5.55 (CIMB). The consensus target is 4.68, suggesting 13% upside to the last share price. 

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