Tag Archives: Banks

article 3 months old

IOOF Merger With SFG Increases Scale And Diversity

-Accretion targets achievable
-No allowance for attrition
-Underperforming IOOF share price offers potential for re-rating
 

(This story was re-published to remove incorrect information regarding a take-over of Equity Trustees)

By Eva Brocklehurst

IOOF Holdings ((IFL)) will acquire SFG Australia ((SFW)), expanding funds under management and advice by 25%. The scale achieved by the acquisition means IOOF becomes the third largest financial advice group in Australia after Commonwealth Bank ((CBA)) and AMP ((AMP)). Brokers believe the acquisition is priced reasonably and laud the company's discipline, given IOOF was previously out-bid on the acquisition of The Trust Company. The transaction has been recommended by the SFG Australia board.

Macquarie believes an FY16 earnings accretion target of 8% is achievable. The ability to retain advisers and maintain productivity will be central to the transaction, and the broker considers adviser attrition is the main uncertainty that will only become clear with time. Revenue synergies will focus the market but these are related to scale and buying power. Macquarie observes the stock underperformed the market after the earnings season, as wealth management stocks experienced a broad-based correction. IOOF now trades at a discount to the sector and presents an opportunity for a re-rating and two years of growth derived from this acquisition.

JP Morgan upgrades IOOF to Overweight from Neutral in the wake of the announcement, expecting material synergies from the combined businesses. Considering the stock has underperformed in recent months there is upside to the broker's valuation. The transaction is expected to create a better company structurally, and provide greater scale. JP Morgan is forecasting earnings accretion of 6% in FY16 from this transaction. The broker notes the company has a good record of achieving expense synergies from prior acquisitions and the scale from this acquisition should provide better negotiating power.

JP Morgan is now forecasting underlying earnings growth of 11% from FY15 onwards. Moreover, with speculation that ANZ Bank ((ANZ)) and National Australia Bank ((NAB)) are looking to divest some non-core assets, the broker thinks IOOF could be a participant in such a consolidation. The stock has underperformed but JP Morgan thinks this may be pending entry to the ASX100, which could lead to some small cap investors selling up, or using the stock to fund recent initial public offerings. In this scenario, the broker thinks trading weakness will unwind. Large cap managers are expected to become more interested in the stock over time.

To UBS, this merger is a timely and logical boost for IOOF. The transaction is expected to provide a 35% revenue uplift and create greater diversity across the value chain. The transaction will mean IOOF is less dependent on margin revenue from its platforms. The broker believes it is important that IOOF successfully leverages this enlarged footprint and drives organic growth, as accretive acquisitions of this size will become more rare. UBS is also wary of revenue assumptions that make no allowance for adviser attrition. The company is not making any allowance for attrition. Rather, it argues that the combined group will now present a more compelling proposition for planners, both from within and outside of the group. Aside from this, assuming full pre-tax synergies by FY16, the broker estimates the acquisition to be 8% earnings accretive in FY16.

Strategically, Credit Suisse believes the acquisition is a positive, providing scale and reducing the skew towards platform income. Even if SFG Australia did not grow over the next two years and IOOF only extracted $15m in synergies, the broker estimates the deal would still be accretive. The transaction is an all-scrip deal with an option for up to $100m in cash instead of scrip. The implied offer price of 85c per SFW share represents a 16% premium to the closing price ahead of the announcement and total consideration of around $621m. IOOF intends to fund the acquisition via 0.104 IFL shares for each SFW share. Credit Suisse is yet to incorporate the acquisition into forecasts and retains a Neutral rating.

On the FNArena database IOOF shows two Buy ratings, four Hold and one Sell. The consensus target price is $9.27, suggesting 8.8% upside to the last share price. This target has risen from $9.07 ahead of the announcement. The targets range from $8.35 to $10.60. The dividend yield on FY14 and FY15 earning forecasts is 5.5% and 6.0% respectively.

SFG Australia was formerly known as Snowball Group and operates a financial planning, accounting practice and stockbroking business.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

article 3 months old

Weekly Broker Wrap: The Aussie, Wesfarmers, Pharma Stocks And The Genworth IPO

-$A demand unlikely to wane
-CLSA prefers Wesfarmers
-Constrained growth in pharma
-Genworth IPO not so cool for CLSA


By Eva Brocklehurst

What will it take to push the Australian dollar lower? The currency has defied many analysts over recent years, surprising with its stubborn strength. Macquarie considers this resilience reflects an ongoing structural shift in the sources of demand for the currency and sustainability for commodity prices, as opposed to the 1990s and early 2000s. It also reflects the higher-than-usual differential between Australian official interest rates and the rest of the developed world.

Over the past decade the Australian dollar has appreciated by 50% in trade weighted terms, reflecting the boom in demand for resources. This is not all. Macquarie considers the currency is also underpinned by a fundamental shift in investor demand, reflecting the decoupling of Australian interest rates from other developed markets. The inflation-fighting success of Australia's central bank has driven inflation expectations lower and led investors to re-assess the relative risk in the Australian economy. This demand Macquarie expects to be sustained in coming years as a result of a less volatile and more robust commodity price cycle, relative strength of Australia's financial economy and attractiveness of Australian assets to a growing Asian middle class - to name a few factors. The Australian dollar may not be a major reserve currency but Macquarie notes it is gaining prominence as a well supported, relatively stable store of wealth.

Macquarie considers Australia has been among those economies affected by the US Federal Reserve's escalation of quantitative easing, driving demand for higher yielding Australian assets. This is particularly in the case of government bonds, which the analysts note reached an historical high at 78% foreign-owned in 2012, before edging back to 68% in late 2013, still well above the long-term average of 47%. Will a scaling back of QE have the opposite effect? Macquarie's not so sure. Recalibrating models to account for the impact of QE suggests other fundamental drivers of the currency remain very evident. The analysts calculate that to arrive at a US82c forecast for the Australian dollar by year end would require an iron ore price around US$85/t, coking coal at US$100/t and thermal coal at US$70/t!

***

CLSA prefers Wesfarmers ((WES)) to Woolworths ((WOW)). Woolworths may have matched Coles for the first time in 4.5 years in terms of quarterly like-for-like sales growth but CLSA thinks Coles can deliver at more than twice the rate of Woolworths, as it penetrates further into fresh categories and improves supply chain efficiencies. Wesfarmers is further advantaged by its Bunnings chain. The broker notes that hardware store's format has proven best in class and remains underpinned by a significant store roll-out that looks likely to provide 9% compound earnings growth rates.

In contrast, Woolworths' Master business is stalling. Masters' March quarter figures imply average sales per store declined by 9%, and CLSA does not think guidance for breaking even in FY16 will be met. Last but not least, Woolworths is trading at a premium to Wesfarmers despite offering less than half the rate of of earnings growth, on CLSA's calculations, so the Buy signal is entrenched for Wesfarmers.

***

Goldman Sachs expects revenue in the pharmaceutical wholesaling industry to remain flat over the next two years because of Pharmaceutical Benefits Scheme price cuts for a number of high volume products which have lost patent protection. Wholesalers will need to maintain a strong focus on growing over-the-counter and private label offerings to offset this. In terms of Australian Pharmaceutical Industries ((API)) Goldman has increased FY15 and FY16 earnings estimates on better sales from Priceline and better gross margins from a reduction in discounting. The broker retains a Sell rating as, while Priceline is improving and cost control is encouraging, the aforesaid pressures from the PBS and a competitive retailing environment should limit underlying earnings growth.

There's no change to Sigma Pharmaceuticals' ((SIP)) Sell rating either. Sigma is in a position to grow ahead of the market, in Goldman's view, given its faster growing customer base and the strength of key customer, Chemist Warehouse. The company's conservative balance sheet also means it can support capital management and potential acquisitions. Again, the combination of PBS price deflation and challenging trading for customers is expected to constrain the rate of earnings growth over the next 2-3 years.

***

Leading lenders mortgage insurer (LMI) Genworth's US parent is putting its Australian business up for initial public offering (IPO). CLSA is cool on the idea. The IPO is being presented as an earnings recovery story. The company expects recent premium increases and a subsequent improvement in loss ratios will generate improving returns. CLSA thinks the recent increase in high loan-to-volume ratio business and a booming housing market do more than offset any premium increases and three to five years from now loss ratios will deteriorate.

The broker also questions the returns, given the elevated levels of capital required to run a mono-line insurer. At 11% return on equity - the only way the broker believes one can value the stock - FY15 fair value sits at $2.44 in the broker's calculations, which equates to an IPO price of $2.20 today. At an issue price of $2.20 the stock is considered a Buy but this is the low end of the indicated offer price. At the mid point of $2.55 the broker would assign an Underperform rating.

What compounds the problem for CLSA is that, while there is a future in the lenders mortgage insurance market and the incumbents have it easy, Genworth is at the mercy of a client list which has the financial strength and capital base to carry mortgage insurance risk on their own balance sheets - the big banks. Hence, until Genworth breaks this nexus, and CLSA questions whether it will, it's likely investors will not achieve returns commensurate with the earnings volatility and risk they will run.

So what is lenders mortgage insurance? It's a necessary insurance enabling Australians to own their own homes and can generate excellent risk-adjusted returns. The downside is that it can be volatile and when losses occur they can be huge. CLSA notes this class of insurance can deliver nine years of excellent ratios only to have them wiped out in one disastrous event. Two players control this market in Australia, Genworth and QBE Insurance ((QBE)), and expansion equates to system loan growth. Sector players can only increase value by keeping a rein on pricing and costs. Forward pricing the risk of an asset bubble can have pitfalls, although CLSA thinks insurers have done a good job recently and been conservative in approach. There is the temptation to release profit after a few good years but insurers, and investors, need to stay focused on underlying risk. So, the sector demands lots of investor patience. Capital too, reflecting the volatility of the risk.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

article 3 months old

ANZ Pullback To Continue

By Michael Gable 

In the last week we have seen half year results from ANZ Bank ((ANZ)) and Westpac (WBC). Despite the record results, the market took the opportunity to sell off the banks instead. We can add “picking the top in the banks” to the list of popular Australian past times. So we will join in and, in the case of ANZ, show you were we think it is going to head over the next several weeks. Just like in November last year, the big four ex-CBA will present an opportunity to generate an “extra divided” by writing covered calls here.


ANZ Bank


 

The recent top of ANZ was met with a “3 black crows” formation (circled on the chart). This is a negative sign and is indicates a top in the share price. We cannot say that the longer term trend is over, but it makes it clear that over the next several weeks at the very least, ANZ should correct back to cheaper levels. The stock will go ex-divided on 9 May for 83c. The stock may have small bounce in the next day or two before then. That would be an opportunity to write a covered call as we then expect the shares to slide into support at $32.50. If that breaks, then the next level of support is down at $31.75.
 

Content included in this article is not by association the view of FNArena (see our disclaimer).
 
Michael Gable is managing Director of  Fairmont Equities (www.fairmontequities.com)

Michael assists investors to achieve their goals by providing advice ranging from short term trading to longer term portfolio management, deals in all ASX listed securities and specialises in covered call writing to help long term investors protect their share portfolios and generate additional income.

Michael is RG146 Accredited and holds the following formal qualifications:

• Bachelor of Engineering, Hons. (University of Sydney) 
• Bachelor of Commerce (University of Sydney) 
• Diploma of Mortgage Lending (Finsia) 
• Diploma of Financial Services [Financial Planning] (Finsia) 
• Completion of ASX Accredited Derivatives Adviser Levels 1 & 2

Disclaimer

Michael Gable is an Authorised Representative (No. 376892) and Fairmont Equities Pty Ltd is a Corporate Authorised Representative (No. 444397) of Novus Capital Limited (AFS Licence No. 238168). The information contained in this report is general information only and is copy write to Fairmont Equities. Fairmont Equities reserves all intellectual property rights. This report should not be interpreted as one that provides personal financial or investment advice. Any examples presented are for illustration purposes only. Past performance is not a reliable indicator of future performance. No person, persons or organisation should invest monies or take action on the reliance of the material contained in this report, but instead should satisfy themselves independently (whether by expert advice or others) of the appropriateness of any such action. Fairmont Equities, it directors and/or officers accept no responsibility for the accuracy, completeness or timeliness of the information contained in the report.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

article 3 months old

Suncorp Topping Out

By Nick Linton-Ffrost

Emerging Short

We suspect Suncorp ((SUN)) has achieved our short term upside break target as well as completing a five count which improves the odds for a pull back from 13.25 to 12.50-12.60 over the next week or so.

A move below 12.90-12.95 should get the ball rolling however given timing considerations enough work has been done to warrant opening shorts around 13.05.

The move needs to occur over the next few days otherwise we will reassess our view.

Trading tactics

Open shorts at 13.05 placing stop at 13.30 looking for a move to 12.50.

Otherwise wait for a break below 12.90-95 before opening shorts and placing stops at 13.20.

 


 

Another trading idea from

Fifth Wave | fwtc.com.au                                               

FW generates over 150 Trading Alerts on the ASX100 each year. We are a subscription service specialising in short term technical strategies based on 27years experience.

 AFSL 319830 | Disclaimer

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

Technical limitations

If you are reading this story through a third party distribution channel and you cannot see charts included, we apologise, but technical limitations are to blame.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

article 3 months old

Earnings Season: How Will The Banks Stack Up?

-Capital targets back in focus
-Competition for business banking
-Capital returns likely limited
 

By Eva Brocklehurst

Is it time to reassess the major banks? The sector has outperformed the broader market so far this year but several brokers think the banks may sell off over the next few months, with some key earnings reports on the way. Three major banks will report interim earnings over the next week or so. ANZ Bank ((ANZ)) on May 1, Westpac ((WBC)) on May 5 and National Australia Bank ((NAB)) on May 8. Commonwealth Bank ((CBA)) will deliver a quarterly trading update on May 14. Diversified financial Macquarie Group ((MQG)) will post FY14 results on May 2.

Overall, UBS notes credit growth has picked up, especially in housing. UBS expects limited capital management beyond dividends during the current earnings season, as the banks strengthen their capital ratios to meet banking system requirements. Potential upgrades are likely to come from cyclical sources such as lower bad debts and higher trading income but UBS would not be surprised to see the banks sell off through the reporting season. The major issues in Morgan Stanley's view centre on revenue growth and capital generation, with less emphasis on lower bad debts as a driver of share prices. Macquarie expects the impairment picture will improve across the sector, while capital generation should be strong at both Westpac and NAB. The broker thinks margins are still likely to be under pressure, particularly at ANZ and NAB, as competition for business banking continues.

UBS observes commentary around loss of mortgage share implies Westpac has used price discounting as a lever. The broker dismisses this as more a case of the bank getting its portfolio mix right. UBS acknowledges significant discounting is present across the major banks, but senses that Westpac has it mostly isolated to the St George brand. The broker also thinks bad debt charges should remain low at the bank. Given the acquisition of the Lloyds assets, UBS expects Westpac's CET1 (common equity tier 1) capital ratio to be 26 basis points lower at 8.84%. Neutralising the bank's Dividend Reinvestment Plan (DRP) and special dividends are considered more likely when this figure returns above the market's 9.0% comfort level.

Citi has downgraded recommendations on two of the three majors ahead of the results. The broker believes capital target ratios are back in focus and in this case Westpac is the best positioned to revise target ranges. Nevertheless, the uncertainty over capital targets means this broker also thinks it likely the special dividends are on hold for now. Citi's recommendation is downgraded to Neutral from Buy, as the stock has been the stand-out performer in the outperforming banking sector over the last three months. The other stock which has been downgraded is NAB - to Sell from Neutral. Citi thinks NAB's performance has been the weaker of the big banks while lacklustre demand for business lending is expected to continue to impact earnings growth.

UBS is also concerned about the revenue result for NAB. The first quarter update showed flat pre-provision profits and this looks likely to continue. UBS expects margins to be the focus of NAB's result, with significant ongoing pressure in business lending as well as mortgages. Morgan Stanley expects NAB's share price to fall. The broker expects the first half result will highlight headwinds in business banking revenue and an end to the positive surprises on costs. The broker also thinks normalising loan losses in Australia and strong earnings recovery in the UK is priced in, while the path to an exit from the UK remains difficult.

Goldman Sachs actually prefers NAB, given the low credit growth environment. Despite solid fundamentals the broker considers bank valuations overall are stretched. The broker favours those banks where sustainable profitability is not reflected in valuations. To this end, the assessment of NAB's sustainable returns implies the stock should trade at a 12% discount to peers compared with the current discount of 17%.

ANZ is expected to provide a solid first half result and BA-Merrill Lynch expects cash earnings to have risen 11% on the first half of FY13. Asian trade finance margins have stabilised and, while this is a relatively modest contributor to earnings, it is integral to the bank's regional expansion and important for sentiment on the stock, in the broker's view. Having said that, Merrills thinks the share price reflects all this and remains cautious on the Asian macro outlook for the rest of 2014, noting ANZ has most downside risk among the major banks. The broker retains an Underperform rating. ANZ is the bank most likely to cancel neutralising the DRP in order to preserve capital and this is the key negative surprise that Merrills expects from the result. 

ANZ is likely to be the strongest performer in the commercial banking group this season, with cost discipline and both housing and non-housing growth, according to Credit Suisse. UBS believes the bank will be buoyed by good cost control, currency benefits and lending growth in the domestic business. Asset quality improvements should offset losses on some large resource exposures.

Morgan Stanley expects Commonwealth Bank's share price to rise, with the trading update leading to upgrades to earnings estimates, underpinned by a combination of solid home loan growth and stable retail bank margins. The broker notes the stock has underperformed the major bank average in the year to date and its price/earnings premium to peers is only 8% versus a one-year rolling average of 13%.

According to Goldman Sachs, Macquarie Group should be underpinned by an improvement in impairments and strong commodity trading performance. The broker's activity data suggests the diversified financial group has benefited from recent IPO activity in Australia and abroad, with the completion of a series of deals supporting a solid second half performance. Credit Suisse expects Macquarie's profit to be up around 40-45% on FY13.

Looking At The Forecasts

When FNArena last assessed the big banks back in March, in the wake of CBA's interim and quarterly updates from ANZ and NAB, the comparative table looked like this:
 


 

ANZ was the most preferred bank on the basis of the FNArena broker Buy/Hold/Sell ratio (B/H/S) and CBA the least. This was despite NAB showing a greater upside to the consensus target (7.02%) than ANZ (4.08%). Westpac and NAB's targets had already been exceeded.

It is FNArena's reliable observation that when bank share prices exceed targets, either targets have to rise or share prices have to fall. If we now take a look at the standings today (below), using yesterday's closing prices, only NAB (2.39%) continues to trade below its target, and only just. All the other three have now exceeded their targets, including ANZ which has flipped over completely (-4.69%) to be the most "overvalued". Yet on a B/H/S basis, ANZ is still preferred over NAB.

But this may be about to change come results publications, or not. If brokers are given no reason to raise their ANZ target prices, ANZ's share price must, in FNArena's experience, fall. Ditto for Westpac and CBA, but then CBA has maintained an "overvalued" price against broker targets for, oh, years now.

 


 

Technical limitations

If you are reading this story through a third party distribution channel and you cannot see charts included, we apologise, but technical limitations are to blame.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

article 3 months old

Is Acquisitive Growth The Right Strategy For Bank of Queensland?

-Principals risk in deal
-Furthers growth options
-Share upside limited
 

By Eva Brocklehurst

Brokers have welcomed the turnaround in Bank of Queensland ((BOQ)) over the past year and now the bank will add the Investec Australia professional finance and asset finance & leasing businesses to its stable. The acquisition price is $440m, to be funded largely via a $400m entitlement offer. The transaction is expected to be around 2% accretive to FY15 earnings and 4% accretive to FY16.

This particular business finances the practice of doctors, dentists, vets and accountants and is also a mortgage broker to these customers with a mortgage book totalling $2.2 billion.The asset finance and leasing has a book in imaging technology, plant & equipment and vehicles. UBS thinks the operation will accelerate the bank's growth and diversification of the commercial book. Nevertheless, the broker notes these businesses centre on a client relationship and "key man risk" is material in this case. Citi goes further on this subject.

The acquisition looks a good fit, in Citi's view. The broker thinks the bank has a need to build out the quality specialist, Australia-wide business lending, given that pursuing growth in Queensland business lending exacerbates regional risk. However, Citi notes this is the third time the founders have sold a professional finance business while retaining key roles and their possible departure is the risk in the transaction. This management team founded MedFin and sold a majority stake to MLC before National Australia Bank bought MLC. The principals departed and founded Experien Finance which was ultimately purchased by Investec. Citi understands there are no special earn-out contracts or locks on the founders to incentivise them to stay with Bank of Queensland. They could leave and start a rival operation.

Bank of Queensland continued to de-risk its balance sheet and control expenses in the first half, with brokers giving the thumbs up to a "clean" result. To UBS it was the most straightforward result in over a decade. Citi notes, while some may question the bank's ability to integrate the Investec business, it has managed to absorb St Andrews and Virgin Money without incident. Citi is of the view that, as loan growth is weak, this was the best course for the bank to pursue.

Acquiring Investec's businesses is a positive move, given the strong position in a fast-growing niche market, but is not without integration risk, in Deutsche Bank's opinion. The broker thinks it may also dilute potential upside, should the bank achieve advanced accreditation on its mortgage book. Deutsche Bank believes the bank, despite struggling to grow the loan book because of the ru- off in its line of credit and impaired commercial banking portfolios, is well placed for strong growth in the medium term, particularly if Queensland recovers to national averages. Despite this prognosis, the broker contends the stock is trading broadly in line with the majors on an FY15 price/earnings basis and so much of the upside appears to be factored in.

Macquarie takes a different tack, seeing the acquisition as buying the bank some growth but providing little in the way of a strategic rationale. To Macquarie the complexity of the business is increasing not decreasing, with the bank owning and acquiring a variety of businesses such as medical equipment finance, computer/motor finance, insurance and a standalone online brand. Underlying growth is soft and that's what the broker's complaint is about. In the current environment a premium valuation coupled with an acquisition appetite can lead to earnings growth, but just how long this can last? Macquarie thinks, like Citi, the bank needs to pursue acquisitions to achieve growth and justify the premium at which it trades.

BA-Merrill Lynch expects the acquisition to be modestly accretive but thinks upside for Bank of Queensland is limited. The stock remains fundamentally attractive but has outperformed the sector by 8% since February and its comparative peer, Bendigo and Adelaide Bank ((BEN)), by 13%. It's all factored in, and Merrills downgrades to Neutral from Buy as a result. The broker prefers Mortgage Choice ((MOC)) outside of the major banks. This stock is a pure play on improving housing credit, an area where cyclical improvement in growth prospects should stand out against a fairly subdued outlook, in Merrills' opinion.

UBS thinks the stock offers solid growth opportunities but is no longer cheap. Hence a Neutral rating. Credit Suisse thinks the deal is strategically sensible and financially reasonable. It comes at a time when the bank has turned around its franchise but lacks momentum on the balance sheet and so "acquiring growth" will help. The broker also sticks with a Neutral rating, believing the deal will not be transforming for the bank.

FNArena's database shows brokers are of one mind on the stock, with seven Hold ratings. The consensus target is $12.25, suggesting 2.9% downside to the last share price. This has moved up from $11.67 ahead of the results. Targets range from $11.50 to $13.25. The dividend yield on FY14 estimates is 5.1% and on FY15 it's 5.6%.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

article 3 months old

Weekly Broker Wrap: Financial Inquiry, Transport, Fox And Salary Packaging

-NAB best placed after inquiry
-Upside for AIO and TOL
-What will replace FOX?
-Strong growth for MMS and SGF
 

By Eva Brocklehurst

The battle lines have been drawn in Australia's Banks And Financial Services Financial Systems Inquiry. Common themes found by Credit Suisse in submissions include tax reform, promotion of appropriate competitive neutrality and removal of regulatory overlap. The most contentious areas, in the broker's view, are related to new digital payment providers encroaching on major banks, funding of the Financial Claims Scheme - ex-ante opposed by the banks, the conservatism of the Australian Prudential Regulation Authority, mortgage risk weightings, regional banks seek a lower ceiling - and government intervention to promote a larger domestic corporate bond market, which Treasury opposes but many favour.

The interim report is expected by September and the final by November. Credit Suisse expects, over time, that the major's balance sheets will improve in terms of lending diversity and composition. The broker considers the likely winner from the inquiry will be National Australia Bank ((NAB)) with the bigger mortgage players, Commonwealth Bank ((CBA)) and Westpac ((WBC)), relative losers.

BA-Merrill Lynch thinks there's enough evidence the Australian economy is improving. Port volumes are up, a key indicator of activity given the flow on to rail and transport. Hence, the broker is warming to Asciano ((AIO)) and Toll Holdings ((TOL)). Nevertheless, just as cyclical risks look like easing there is evidence that structural risks are rising. The broker observes Asciano is facing disruptive price competition in terminals and Pacific National (PN) Rail and there are concerns around the take-or-pay contracts at PN Coal. Merrills thinks PN Coal's issues are manageable but suspects the others could entail downgrades to FY15 expectations.

Toll faces risks from the resources slowdown, and margin pressure from labour inflation as well as contract roll overs from the Singapore government. Both stocks are trading at 12-month lows so Merrills thinks there's opportunity for investors that are comfortable with the risks to wait for better activity levels to come through. Brambles ((BXB)) remains the broker's top pick in the sector based on a view the company is starting an earnings upgrade cycle because of its leverage to an improving US economy. 

21st Century Fox ((FOX)) will be removed from the Official List of ASX on May 8. Morgan Stanley has looked at what might take the stock's spot in the S&P/ASX indices. In the broker's order of highest probability IOOF ((IFL)) is the number one pick for the S&P/ASX 100 with Transpacific Industries ((TPI)) and Australand ((ALZ)) second and third respectively. In the S&P/ASX 50 it's Ramsay Health Care ((RHC)) and SEEK ((SEK)) in that order. In the S&P/ASX 200 the number one replacement pick is Sundance Energy ((SEA)) and number two is Steadfast ((SDF)).

Salary packaging, including novated leasing, and fleet management form part of a sector that is set to grow, in Macquarie's view. Salary packaging administration involves payment of pre-tax salary to a trust where money is then disbursed to cover employee's costs such as leases, superannuation, mortgages, school fees, entertainment accounts and so forth. Novated leasing is the largest part of salary packaging. It involves a three-way deal between a financier, employer and employee and these leases are sold to the corporate and government sectors. The novated lease market now accounts for an estimated 20% of the funded vehicle market. The growth drivers for the sector are employment, particularly in health and education, growth in new vehicle sales and outsourcing of fleet management. The broker also believes there are new product opportunities to help grow the market. Within fleet management there are products designed to improve driver safety and alertness and within the salary packaging there are opportunities to sell other services across an employer's employee base, such as credit cards.

Macquarie observes the two ASX-listed companies in this area have produced solid revenue and earnings growth and both generate high returns on equity of 25-30%. McMillan Shakespeare ((MMS)) has the longest listing history in the sector and is the largest player. Macquarie expects MMS to resume its long-term growth trend in FY15, after the interruption from the former government's proposed FBT changes last year. The broker thinks the acquisition of CLM in the UK last year represents a long-term growth opportunity. Newly listed SG Fleet ((SGF)), is the third largest in the sector and derives 37% of its FY13 revenue from novated leasing.

Goldman Sachs has initiated coverage of SG Fleet with a Buy rating and expects the stock to re-rate as it achieves FY14/15 prospectus forecasts. This broker sees growth opportunities too, as several large public authorities still manage fleets in-house and may look to outsource. The sector has high returns and as SG Fleet derives only 43% of its earnings from novated leasing versus McMillan Shakespeare's 60%, Goldman considers SG Fleet has less regulatory risk. Goldman has a Neutral rating on McMillan Shakespeare. Given the recent action by the federal government in ceasing subsidies to automotive manufacturer's the price/earnings discount applied to novated lease earnings has been raised to 40% from 20%. The broker's multiple on salary packaging earnings is now a 20% discount compared with a 10% premium versus the Small Industrials Index. Goldman's recent discussions with industry contacts have signalled salary packaging is sometimes priced at lower margins to win more lucrative novated lease work.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

article 3 months old

More Capital Return From Wesfarmers?

- Wesfarmers now out of Insurance
- $3bn to spend
- Acquisition or capital management?
- Regulatory approval pending


By Greg Peel

The new management of Wesfarmers’ ((WES)) insurance business looked to be performing well, suggests BA-Merrill Lynch, and there were positive plans to grow the underwriting business through Coles. But the broker acknowledges that volatility in the insurance game is elevated. Insurance delivered $20m in earnings for WES in FY11 but only $5m in FY12. The broker thus understands the logic in divesting of the business.

WES sold its underwriting business to Insurance Australia Group ((IAG)) in December, pending regulatory approval (the ACCC has approved but NZCC approval awaits), immediately leading the market to assume the company would also divest of its insurance broking business. An IPO was touted, but WES has saved itself the trouble and cost with its announcement yesterday that the broking business is to be sold to US-based Arthur J. Gallagher & Co, subject to approval. This time approval needs to be forthcoming from the FIRB as well as the ACCC and the equivalent New Zealand bodies. The approval process could take several months.

Credit Suisse believes approval is likely to be given, although most brokers have elected not to adjust their forecasts until this becomes more clear.

The insurance broking business will be sold for $1.16bn and a pre-tax profit of $310-335m is expected. As to whether or not this price is a good one depends on which broker one takes a starting valuation from, which is dependent on that broker’s earnings forecasts. Suffice to say the price represents a multiple that is either at, or a bit above, Wesfarmers’ group multiple and either consistent with, or a bit better than, recent comparable local insurance sector sales, being those of Austbrokers ((AUB)) and Steadfast ((SDF)).

On that basis, both JP Morgan and CIMB would have liked more of a control premium while four other FNArena database brokers and Morgan Stanley suggest a favourable price.

But there’s little benefit in quibbling about price. Let’s just say it will do. And there’s not much point pining for lost earnings as the loss of business will be only modestly dilutive while the proceeds sit in cash. But they will not sit in cash for long, and that is the important element. The two sales combined – underwriting and broking – will generate around $3bn.

What will Wesfarmers do with the money?

The first thing to do is to pay down debt, not that the group is highly geared to begin with. WES cannot actually pay down too much debt given most of it cannot be retired for at least two years. WES could then pursue capital management, as it did last year via a 50c special dividend, or pursue an acquisition. Balance sheet strength means the company could re-gear its balance sheet and maintain its A- rating from S&P while still having $4.5m to spend on an acquisition, notes CIMB. WES could comfortably fund a $5bn acquisition without compromising the balance sheet on Morgan Stanley’s estimates while UBS suggests up to $7bn.

Brokers are mostly looking at the decision between capital management or acquisition as indeed an either/or proposition. But neither is without its obstacles.

A share buyback is unlikely while the stock trades on a 20x multiple. There would be little earnings accretion gained in paying up. And given Wesfarmers’ franking credit balance is actually negative, a dividend payout ratio above 100% is also unlikely in CIMB’s view. A capital return is the most likely choice if distribution is WES’ preference, CIMB believes.

Yet the announcement of the special dividend did not ultimately prove particularly popular with retail investors at the FY13 result, notes CIMB, which is surprising given for the last few years one would not want to be caught standing between a retail investor and yield. In this instance shareholders appear to be more keen on future earnings growth potential. The big miners and energy companies may be increasing their yields but only because they see no value in further growth at present. Wesfarmers, already a conglomerate of disparate businesses, could surely find a growth opportunity somewhere.

This is not a stroll in the park either. Macquarie believes WES is eager to redeploy capital into another acquisition (Coles has worked out rather well) but the group’s track record would imply WES is not going to buy a business just for the sake of it. Deutsche Bank suggests that given stretched valuations across listed assets, it will be difficult for WES to generate an immediate return above its weighted cost of capital on any acquisition, unless synergies are sufficiently attractive.

Wesfarmers currently owns all of Coles, Bunnings, Kmart and Target. Anywhere the group could find any synergies among similar businesses would never get past the ACCC, one presumes. Insurance has now been cast out, leaving the group’s industrial divisions and coal. The industrial divisions are challenged due to the slowing resources market and operational factors, notes JP Morgan. So even a “cheap” acquisition in this sector would likely not go over well with investors. That leaves coal.

CIMB believes the group’s decision is one of either one of returning capital or buying a metallurgical (coking) coal asset “at the bottom of the cycle”. WES has previously discussed a desire to evaluate acquisitions that offer economies of scale or downstream benefits, much like the coal reserve extension in January.

Credit Suisse, on the other hand, is not even entertaining the acquisition option. The “focus remains capital management,” the broker declares. Unlike other brokers, CS is not hanging around to wait to see what the regulators decide.

The broker is now basing its forecasts on the distribution of proceeds from the two transactions to shareholders through a combination of special dividends and capital returns. Specials of 46c and 21c will be paid in FY14 and FY15 respectively along with capital returns of $1,338m and $0.783bn. Throw in ordinary dividends, and shareholder returns will represent 10.0% and 8.9%. Credit Suisse seems rather definitive. Unlike other brokers, who are mostly waiting to see what happens.

Macquarie is nevertheless continuing to forecast a special dividend of 50c in the first half of FY15 although the broker notes that the group retains significant capital for deployment into acquisitions or further capital returns.

Despite the potential on offer from Wesfarmers’ divestments, not one FNArena broker can afford the stock a Buy or equivalent rating at the current trading price. The insurance businesses were sold at around a 12x PE but the group trades at over 20x. Coles and Bunnings are quality assets, suggests Citi, but the other 33% of enterprise value in the group is cyclical in nature. Multiples of over 20x are mostly afforded either to defensive high cash flow stocks or stocks with strong earnings growth trajectories.

There are four Hold and four Sell or equivalent ratings for WES on the FNArena database. Target prices range from $38.00 (Deutsche) to $45.00 (Credit Suisse) for a consensus target of $40.50, 4% below the current trading price.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

article 3 months old

Weekly Broker Wrap: Exports, Jobs, Transport, Bank Credit And Retail

-Export boom on the way?
-SMEs still critical to jobs growth
-Subdued growth weighs on transport
-Baby boomers affecting bank credit
-Durable goods retailer prospects better
 

By Eva Brocklehurst

What is the prognosis for Australia's economy? Will it manage to revive without relying on mining investment? These are the questions economists at Citi are asking. It's not just whether demand outside of mining will generate enough investment to offset mining's decline but whether the timing of the transition can be coordinated as well. If not, there's a substantial amount of volatility ahead.

Can the fall in mining capex and loss of income from a deterioration in the terms of trade be offset by enough strength in housing construction, non-mining business investment, consumer spending and net exports? Citi calculates that major project capex across coal, iron ore and gas is likely to halve which implies a fall in mining investment by 2018 of around 4% of GDP from the peak of 7.6% of GDP in FY13. Timing is uncertain, but Citi analysts suggest the fall could be most marked after FY15, as LNG projects are set to hold up the level of capex this year.  Unlike investment booms in other areas, the analysts note the mining boom produces a ramp-up in exports as the production phase gets underway. The Bureau of Resource and Energy Economics is the benchmark for exports forecasts and its data suggests that mining and energy exports will increase the contribution to GDP through to FY18, the bulk of the increase being in the next two to three years.

The cumulative drag on real GDP from mining investment is likely to be at the bureau's largest in the next two years. So, with declining investment broadly matched by a positive contribution from net exports, the real pace of growth is likely to be determined by non-mining domestic activity. Thanks to stimulatory monetary policy, Citi thinks there will be a sufficiently robust rally in housing and consumer spending to achieve growth close to trend in 2014-2016 and possibly enable growth to strengthen even more in later years, with the help of recovery in non-mining business investment and a lift in spending on infrastructure. Citi acknowledges this number crunching looks suspiciously stable, with GDP forecasts close to trend, but emphasises that growth is more stable already, in terms of the trade downturn, compared with previous cycles, because of better policy and institutional reforms. All in all, an investment boom being replaced by an export boom means that domestic demand does not need to do all the heavy lifting in rebalancing the economy.

Where will the jobs come from? That's what UBS asks. The analysts looked at the sectors of the economy which have created the recent improvement in the job market. Around 80% are in public-dominated sectors, with some gains in manufacturing, construction, finance and real estate which were countered by weakness in retail, accommodation and food. Most of the private sector jobs over the same period came from mining related areas, reflecting strength in professional, technical and scientific jobs. From analysis of the labour hire and job advertisement data, the broker identifies an ongoing reality that the majority of jobs are in small and medium-sized enterprises and this is where the growth is likely to come from. It's not from large business, where there tends to be highly publicised job losses that mislead in terms of the proportion of jobs being churned in the economy.

The public sector is not expected to contribute such a level of job improvement in the near term but a lower Australian dollar should benefit those sectors such as tourism education and domestic manufacturing, according to UBS. Manufacturing performance has already recovered a little and tourist arrivals have risen 8-9% over the past year. Relatively labour-intensive and interest-rate sensitive sectors of the economy - retail, wholesale trade and construction - are also likely to reveal a jobs recovery. The key sectors which could, in the current environment, plausibly contribute jobs include retail, wholesale trading, accommodation and food, construction and general services. Those most likely to be shedding jobs include manufacturing, mining and related areas.

Goldman Sachs has recently revised Australian dollar forecasts and incorporated this into assumptions about the transport sector. Factoring in a lower Australian dollar has meant downgrades for airlines - Qantas ((QAN)) and Virgin Australia ((VAH)) - and upgrades for US dollar reporting stocks such as Brambles (((BXB)) and Recall ((REC)). This is also broadly neutral for Asciano ((AIO)), Aurizon ((AZJ)) and Toll Holdings ((TOL)), which are more exposed to Asian currency movements. Domestic economic growth is expected to stay relatively subdued over the next 12 months. The analysts believe the non-mining economy will need to accelerate to 3.75% by the end of the year just to meet a 2.0% GDP growth forecast, given the drag from mining investment. This weak outlook is expected to weigh on volume in the domestic transport sector, particularly for Asciano and Toll. Asciano remains the broker's preferred pick for the sector. A transition to positive free cash flow in FY15 and progress on cost of capital should help drive a re-rating, in Goldman's view.

BA-Merrill Lynch observes the demographic that supported the growth of bank balance sheets for the 20 years to 2010 is fading. Unless banks can convince retirees to dramatically increase debt levels the broker thinks household credit will struggle to grow at anything beyond nominal GDP on a sustainable basis. Smaller consumer loan books suggest ANZ Bank ((ANZ)) and National Australia Bank ((NAB)) are best placed to confront this structural challenge, although near-term business credit growth also appears cyclically weak.

The broker emphasises this is not the end of the housing rebound, rather that medium term growth will be slower and historical rates unlikely to be repeated. The broker also views the rise of investors in housing as a natural response to demographic change, although this contributed to a substantial rise in household gearing. As the pre-retirement 45-64 age group increased so did investor housing and overall debt. Now this demographic is approaching retirement and recent data suggests the 55-plus group reduced gearing from 2010-12. While Westpac's ((WBC)) greater investor mortgage exposure offers some appeal near term, Merrills thinks it is unlikely to offer substantial upside relative to peers.

Retailers have had mixed fortunes recently, with several finding it hard to balance top line growth with margin preservation. Either way, Merrills thinks the household/durable goods retailers have better growth prospects than department stores and apparel merchants. Why does the broker like the former? First there's industry consolidation. In the last three years store numbers outside of the three majors - JB Hi-Fi ((JBH)), Dick Smith Holdings ((DSH)) and Harvey Norman ((HVN)) have declined by 33% which provides a more favourable market dynamic for the majors. The broker also believes household goods face less competition from online than soft goods and the penetration of online sales will begin to plateau at levels below other developed countries. The level of store saturation in Australia in consumer electronics and appliances is behind global peers and this supports continued store roll out, to some extent, Merrills adds. The preferred stock is JB Hi-Fi , which the broker thinks has the ability to grow earnings by over 35% in the next three years, self-fund capex and maintain a dividend pay-out ratio of 60-65%.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.

article 3 months old

Macquarie Cooking With Gas

- MQG upgrades FY14 guidance
- Energy trading key driver
- FY15 a more critical period
- Brokers cite full valuation


By Greg Peel

In the late eighties your humble correspondent was a young proprietary trading trainee with Macquarie Bank and was sent to a global energy trading conference in Singapore with a senior colleague to write a paper on the state of the market. Providing hedging opportunities for major energy producers and consumers was, back then, a new frontier.

Jump ahead over 25 years and the now Macquarie Group ((MQG)) was yesterday able to tighten its FY14 profit guidance to an approximate 40-45% increase over FY13 and drilling down (sorry) into the numbers shows a big boost in energy trading profits as a primary driver.

I’m not actually taking the credit.

Macquarie’s fiscal year ends this month, so analysts are prepared to take yesterday’s update as almost a profit pre-release. Management included the usual caveats but has a history of being broad and conservative on guidance rather than specific and ambitious. Adding 40-45% to the FY13 result gives us a range of $1190-1235m and market consensus had been sitting at the low end of the range. Hence the update is not a shock but rather confirmation of broker expectations with some added upside. Brokers have mostly upgraded their forecasts slightly.

The only definitive factor provided as the reason for a more positive result was a change in guidance for Macquarie’s Fixed Income, Currencies & Commodities division. Previously management had expected FICC’s result to be “down on FY13, with the potential to be broadly in line with FY13,” but yesterday that was upgraded to “broadly in line with or slightly up on FY13”. Global investment banking peers have mostly delivered subdued FICC guidance of late, which means Macquarie has outperformed. Brokers agree outperformance is due to Macquarie’s 75/25% skew in commodities/fixed income as opposed to a typical industry balance closer to 50/50.

While commodities include metals and agriculture as well as energy, all brokers cite 2014 volatility in US energy markets as offering the hedging and trading opportunities that provide the difference. The severe winter in North America has, for example, seen the domestic natural gas price shoot from below US$4/mmbtu to above US$6/mmbtu and back again within weeks. The good news is such price volatility provides a greater potential for profit from proprietary trading activities. The bad news is not every winter is as likely to be as severe as this one.

In other words, analysts are not prepared to reset forecasts for FY15-16 and beyond to include a repeat performance. Morgan Stanley, for example, suggests that while the improvement in FICC profits is consistent with an improving cycle, “we’re reluctant to capitalise this pick-up given volatility in FICC revenues”. UBS suggests that “given the volatile trading nature of these businesses it is risky to extrapolate this good performance to future periods”.

But that is not to suggest Macquarie’s FY14 result is destined to be a flash in the pan. US gas volatility might have been a gift but the underlying trend for the investment bank has been improving over the past twelve months, as it has for all investment banks. As the ghosts of the GFC fade, global growth improves and markets re-rate, investment banks can only be a beneficiary. Indeed, the MQG share price has run from under $35 a year ago to over $55 today.

The market pushed MQG shares up 3% yesterday to adjust to this tighter, slightly more positive guidance update, but has the market already priced in any further upside from improving conditions?

Brokers agree that while the update has provided comfort around what they had been expecting anyway, Macquarie is really an FY15 story. Cyclical improvement in metals, energy and agriculture provide potential upside and these are key areas of expertise, as UBS notes, but can clearly be volatile profit sources. JP Morgan suggests attention now turns to the extent to which performance fees from Macquarie Infrastructure & Real Estate unlisted funds, increased deal activity and strong growth in domestic mortgages can potentially provide positive earnings revisions and a further re-rating to the MQG share price.

“We still think that future share price outperformance will be driven by earnings, not trading multiple expansion,” says Morgan Stanley in agreement.

UBS acknowledges an improving investment bank cycle but notes MQG is trading on a 1.5x multiple to book value and a 16.4x price/earnings at around 10% return on equity (ROE). “In our view,” says UBS, “further earnings upgrades and mid-teen ROEs are required to justify further price appreciation”. Goldman Sachs suggests the current multiple implies Macquarie can sustainably deliver an ROE of 13.4%. Given the first half of FY14 provided 8%, a good deal of improvement is already accounted for.

Four FNArena database brokers thus have MQG on a Hold or equivalent rating, as do Morgan Stanley and Goldman Sachs. Given Macquarie’s history of publishing final results that vary from earlier guidance, Credit Suisse sees upside risk to the final FY14 result despite books close being Monday. CS thus retains Outperform, joining BA-Merrill Lynch (Buy).

Merrills suggests that while MQG is trading near the top of its 10-year trading band in forward PE terms, this is justified given the group’s strong earnings growth prospects and greater mix of annuity-style earnings than in the past. And given that many cyclical divisions, such as Securities (eq equities broking) and Capital (M&A) are arguably still near trough levels, further improvements in these divisions can provide catalysts for further upgrades.

The FNArena database shows a consensus target price of $56.34 suggesting a mere 0.4% upside, but on a range from $50.46 (JP Morgan) to $62.15 (Merrills). In yield terms, MQG is offering, on forward consensus, 4.7% in FY14 and 5.6% in FY15 of which less than half is franked given the extent of offshore businesses.


Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" - Warning this story contains unashamedly positive feedback on the service provided.