Tag Archives: Banks

article 3 months old

Weekly Broker Wrap: IPOs, Life Insurance, H2 Skew And Climate

-Investors could trim positions
-Life insurance lapses
-H2 earnings skew grows
-Utilities exposed to global warming


By Eva Brocklehurst

There's been a dash to raise new equity before the year is out, with a spate of Initial Public Offerings (IPO) hitting the market. The suspension of hostilities over the US fiscal position and the decision by the US Federal Reserve to delay tapering has created the window of opportunity. This is also supported by market conditions with the S&P/ASX200 having reached a five-year high. CIMB notes, during the next two months, Australian companies intend to raise around $4.6 billion in new equity, with the bulk being IPOs. CIMB is positive about the US economic outlook, beyond a resumption of US fiscal fisticuffs in the new year, and the general outlook for the Australian market and thinks there should be solid interest from both institutions and retail investors.

Given the market is at lofty heights investors could trim positions in their portfolios, in CIMB's opinion. The broker thinks investors considering trimming positions in stocks, in order to fund a position in any of the upcoming IPOs, should consider Commonwealth Bank ((CBA)), Cochlear ((COH)) and Coca-Cola Amatil ((CCL)) as sources for funds. Cochlear, Fairfax Media ((FXJ)) and News Corp ((NWS)) have at least 9% of short interest as a proportion of free float an the analysts recommend they be used as funding sources. The average short interest for the market is around 3.3%.

Australia's life insurance industry has experienced a drop in growth. Both term life and disability income have seen growth drop to single digits in recent years. Most of the growth in life insurance is dominated by group business, which was up 14.5% in 2013. Credit Suisse thinks lapse rates are a big issue for the life industry and there's no sign this is being alleviated. As a result, the broker expects planned margins to take a further hit in the next 12 months and experience losses from income protection claims will continue to rise as well. AMP ((AMP)) and Suncorp ((SUN)) have the most exposure to life insurance as a percentage of total earnings. The broker prefers the pure general insurers, QBE Insurance ((QBE)) and Insurance Australia Group ((IAG)), over the former two.

Credit Suisse has observed that, over the last few years, there's been an increase in expectations for earnings to be skewed to the second half of a company's reporting period. Guidance of this nature assumes that operating conditions will improve but often the extent of recovery does not occur as expected. Currently, visibility remains low for businesses exposed to resources expenditure and domestic demand in FY14 is likely to remain somewhat soft so there is a risk that those stocks with the expected skew to the second half for earnings fail to meet guidance.To identify those at risk, Credit Suisse screened for June year-end industrial stocks that have a larger-than-usual skew to the second half for FY14. In particular, those where the skew is more than 5% above the average reported skew over the last five years.

Feedback from the mining services team reveals that there's downside risk for the second half skew on a sector-wide basis and particularly for Emeco Holdings ((EHL)). As well, the broker thinks this risk applies to SMS Management & Technology (( SMX)), Fleetwood ((FWD)) and Cochlear. Then there's the reverse potential, where the second half turns out to be materially better than expected. The upside risk here is with Myer ((MYR)) and Macquarie Group ((MQG)).

Hotter for longer. UBS has looked at policy trends on global warming. Short term economic costs appear to be too high for policy makers. As the world gets warmer, with difficult to predict and uneven impacts, at some point the net cost will become sufficiently obvious that the policy response will accelerate. Specifically, the analysts suspect that the electricity industry will have to live with low consumption, higher prices and ongoing renewable supply as electricity is at the forefront of global de-carbonisation efforts. The balance of risks means that, over the next 20 years, policy is likely to get harsher. The implications boil down to the fact that Australia's economy is heavily dependent on energy production, use and export. Specifically, Australia's number two export is coal, in terms of earnings. If global, and specifically Chinese, policy moves to reduce carbon output it will have an impact on Australia's coal exports.

Down the track the analysts expect ongoing efforts to reduce electricity consumption and ongoing support for renewables. There will be less and less enthusiasm for coal fired electricity, particularly in China and India. This may take time but, since power stations are built with long time frames and coal mine development is based around at least 20 years of planning, this likely to end up influencing investment decisions even now.
 

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article 3 months old

Emerging Sell On Macquarie

By Nick Linton-Ffrost

Macquarie Group ((MQG))

Trading tactics

Open shorts once a lower high forms below 55.00.

Rationale

Our wave count assumptions indicate MQG is in the process of forming a topping pattern between 53.00 and 55.00. The implication is for a pullback towards 47.00.

Trading below 53.00 should start the ball rolling given the break of a confirmed trend line, however we still require a lower high to form before opening shorts.

For those keen to short the line break we suggest placing stops at 55.30



 

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

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article 3 months old

Weekly Broker Wrap: Mortgages, Financial System, TV, Consoles And IPOs

-House price, credit growth diverge
-Mortgage standards loosened
-Do banks have too much power?
-FTA TV should be resilient
-New consoles don't excite Citi
-Recent IPOs perform strongly
 

By Eva Brocklehurst

House prices and credit growth are diverging. What's driving this scenario? JP Morgan has found that higher transaction activity on the housing front is not fuelling credit growth. Although the average loan-to-valuation (LVR) ratio is little changed there are big differences in categories.

The first time buyers of homes are not increasing in percentage, despite their focus on house prices where there's a higher LVR. So that's reducing credit growth. Those that are at the other end of the market, downsizing from from the family home, are growing in number but they're reducing debt. They're using the equity released from their homes to move into the investor category and the drag on credit growth they create is greater than the credit growth that's primarily being driven by the investor segment. As has been widely talked about - it's the investor segment that's responsible for pushing up house prices. Those owner-occupiers that are upgrading homes may be taking on more debt when buying more expensive housing, but JP Morgan notes the LVR uplift is less substantial than it has been historically.

In all, JP Morgan believes the rapid rise in house prices, in Sydney in particular, cannot go on. At some stage affordability will become a structural issue for the market. Perhaps there are some changes needed on the political or regulatory front. The broker's report canvases LVR limits, as they apply in New Zealand, and explores the taxation, incentives and regulatory environment.

UBS has looked at mortgage underwriting statistics which APRA has provided. The trend of loosening underwriting standards for mortgages continued in the September quarter. Interest only loans rose, hitting 40% of major bank mortgage approvals. Many were for investment property but also increasingly popular with owner-occupied borrowers. Those approvals that are outside serviceability - they fail the interest rate sensitivity/affordability test but still get approved - have grown by 36% and now represent 3.3% of all mortgage approvals. High LVR loans are relatively high at 34% of approvals but are down from the 37% peak that was seen during the period of first home buyer grants in FY09. Investment property mortgages are at record levels, at 35%. The figures show an improvement in asset quality and balance sheets but UBS suggests the looser standards are worth scrutiny, as these are potentially the impaired assets of the next cycle. This is especially the case with loans "outside serviceability" in this very low rate environment.

The Murray review of the financial system is at an early stage but JP Morgan has looked at what the issues are. What could affect share prices? This review will find the system much more heavily controlled by the big four banks than when the Wallis inquiry took place, and there is a risk they could be seen to have too much market power. This is a similar theme in general insurance as well. Wealth management has much stronger competition. Another focus is on the costs of regulation and this may result in some winding back of quite significant increases in regulation of the financial sector. This, in turn, could reduce compliance costs land lead to a more dynamic sector. Also, the new government's focus on infrastructure investment could procure some attention to encouraging retail super funds to reduce holdings of liquid assets. As for the choice to head the inquiry, former Commonwealth Bank CEO David Murray, JP Morgan suspects Mr Murray's strong prior involvement in the financial services may increase the likelihood he will listen to the views of existing providers.

Rumours of the death of television have been greatly exaggerated. That's Citi's view. Nevertheless, TV is changing. Consumers now have multiple devices for content and they're booking their time. Rather than being enslaved by live TV the tendency is to spend appointed time, which is growing at 1% per annum while live TV declines at 1% per annum. Appointment viewing, as Citi describes it, is now 14% of total TV watching, up from just 1% five years ago. Citi thinks broadcasters need to be aware that fragmentation of the viewing audience is growing. TV broadcasters need to deliver hits on a regular basis. The broker retains Buy ratings for Seven West Media ((SWM)) and Ten Network ((TEN)).

Goldman Sachs has reviewed the outlook for Free-To-Air TV and concluded that, despite facing headwinds similar to print media, the industry should be more resilient. Forecasts have been raised for this segment's advertising market share. There will be some leakage to new media but the analysts expect it to be modest. TV should be underpinned by the quality of the content and the ability to draw a large, mass market audience, as well as the regulatory protection in place and the expansion of the broadcast footprint to multi-channel. The defensive position on FTA TV is concentrated in the Seven and Nine networks, the broker believes. The analysts don't believe FTA TV will lose that much advertising market share. Goldman forecasts FTA TV ad market growth of 3.6% over 2013-18 versus the greater advertising market forecast for 4.3%. The broker likes the structural winners in the sector and has raised Seven West to a Buy rating.

New games consoles are about to be launched. Citi is not that excited.The broker has Sell ratings on JB Hi-Fi ((JBH)) and Harvey Norman ((HVN)). JB Hi-Fi could generate a 1.4% comparable store sales boost in FY14 but this could be followed by a 2.0% fall in FY15. There's likely to be negligible impact on Harvey Norman as the retailer does not have a strong presence in the category. Citi thinks long-term unit growth may disappoint and price deflation will erode any gains. These new consoles also provide an easier digital download for games, reducing an important category for JB Hi-Fi. The important growth is in games software, as gross margins are higher. This should fade as earlier version sales collapse and the games category will be dilutive to gross margins, in Citi's view.

What's a positive? The timing. It's been six years since an upgrade to consoles and it's just before Christmas. The most significant upgrade is graphics capability and there's a cheaper price point. In Australia pricing is 17-27% higher than in the US so this is a negative, in Citi's view. There's no step-change in innovation either. These new devices may appeal to mainstream game players but are unlikely to covert others, so there's no increase in penetration. Moreover, the analysts note, casual gaming has now moved to tablets and smart phones. Enter the fragmentation word again.

Finally, Macquarie observes the performance or stocks that have recently listed. There has been a raft of new IPOs and this is often an indicator of market sentiment, as they signal investor appetite for equity. The performance in 2013 has been strong, with average returns after one week of 3.8% and a stag profit of 4.64%. The larger IPOs had positive returns over the first week and this diverges from history where the aggregate performance is less compelling. The broker highlights Virtus Health ((VRT)) and Steadfast (SDF)) as two recent IPOs that continue to perform strongly. Volume is often considered a good proxy for investor attention too. The larger IPOs, with a deal size of more than $100m, are more likely to receive investor attention and are a better gauge of market sentiment. Stocks with high volume and high momentum tend to typically outperform.
 

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article 3 months old

OzForex: Money Market Growth Potential

-Well placed to grow strongly
-Partnering with key brands
-Established in a highly regulated market
 

By Eva Brocklehurst

Newly listed OzForex Group ((OFX)) has hit the ground running. Brokers are attracted to the medium-term growth profile as well as a strong balance sheet. The company engages in online payment services and international money transfer. This is a market that is growing rapidly and the size of the payments are increasing because of increased trade, foreign investment and cross-border movement of individuals. Online commerce is becoming sophisticated, and companies and individuals are attracted to the ability to assess the competitiveness of the options they have - online.

Macquarie recently initiated coverage on the stock with an Outperform rating and target of $2.80, noting OzForex shares a number of similarities with other online businesses that have gained significant market share through a focus on efficient and lower-cost service. The stock has performed strongly since it listed earlier this year and while the broker concedes the near-term multiples are demanding there's' still further upside potential, because of the numerous opportunities both domestically and internationally. Macquarie suspects the growth in demand for online payment services will outstrip the growth in the overall market.

Goldman Sachs retains a Neutral rating as the broker, while liking the growth aspect and high returns, thinks the stock is fully valued, trading on FY15 value/earnings of 18.3 times. Despite this, Goldman notes the online penetration of international money transfer services is very low, particularly among ordinary consumers, which represent 67% of OzForex's sales. The broker compares this with the fact that long-established money transfer company, Western Union, takes only 4% of revenue from online channels. So OzForex is offering alternatives to the banks and that is a key catalyst for the brokers. OzForex is now licensed to operate in 32 US states and hopes to add Singapore to its licences in the next few month.

Macquarie expects the global expansion will continue at high rates, having recently entered markets such as the US in 2012 and Hong Kong in 2011. Macquarie also observes that OzForex has also recently developed a solution for partners requiring international payment capabilities within existing service or software operations. Whilst currently an immaterial contributor to revenues, there are a large number of potential partners that would benefit from this service that could be added to this channel in the next few years.

OzForex acquires clients and converts registered clients into dealing clients. The company's revenue growth mirrors the number of client deals, value and the margin on those deals. The key driver of these deals is the number of registrations and the conversion rates. Partnering with brands such as ING, Travelex and MoneyGram means the company has instant access to a large existing client base. The partner brands the site and has access to the OzForex functionality, while OzForex owns the client and has the direct contact with them.

OzForex is supported by a high proportion of recurring revenue, high margins and strong free cash flow and remains confident of achieving prospectus forecasts. Its growth outlook, operational and financial characteristics are such that Macquarie thinks it should command a significant premium to the broader market. OzForex may not have the same dominant domestic competitive position as an REA Group ((REA)), Seek ((SEK)) or Carsales ((CRZ)), but what these companies lack is a strong international footprint which provides the significant global growth opportunity.

What's the competition like? There are a number of internationally listed companies that provide international payment solutions. Macquarie notes, for the majority, the international payment function is only a small part of the business. Either that, or they conduct their operations through a traditional network. Hence, comparatives are hard to find. For the brokers, the risks are with the potential for increased competition from existing providers and the potential for new entrants to the market. The international payments system is highly regulated so this is both a risk and a barrier to entry.
 

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article 3 months old

Weekly Broker Wrap: Patchy Conditions In Lead Up To Christmas

-Sentiment improving slowly
-Consumer confidence diverging
-Life insurance profits soft
-Further upside to bank asset quality?
-Pathology dilemma continues
-TV advertising growth strongest
 

By Eva Brocklehurst

Citi notes a surge in confidence in Australian consumers in November but thinks, while there's no doubt the outlook is improving, it is too soon to be sure of a particularly strong Christmas for retailers. Moreover, wages growth is slowing, reducing the growth of disposable income available for spending, and consumers still hold concerns about their finances. Hence, it's the wealth effect - the sense of having more to spend - and confidence in their savings rather than income that will have to drive consumer spending in the short term. This is not unusual at this stage, as the labour market is normally the last part of the economy to turn around. The broker envisages the better times are ahead in 2014, when real consumer spending should move closer to trend after a disappointing 2013.

BA-Merrill Lynch is seeing a division emerge in consumer spending in Australia. Rising property prices, reduced interest rates and increased super seems to be driving improved confidence in certain social classes and these people are spending. Those not exposed to these drivers are feeling the effects of higher utility prices and are not so inclined to spend. Which are the stocks most exposed to the former? Merrills draws out Wesfarmers ((WES)), Crown ((CWN)) and Telstra ((TLS)). The broker expects top line growth in the consumer sector will remain tough in FY14 as income growth is below average and unemployment is rising.

Wesfarmers has defensive appeal in terms of spending and, through Bunnings, exposure to an improving housing cycle. The class of consumer that typically spends on table games, hotel, food and beverage products is the professional-middle class and this is where the improved spending will benefit Crown. Slot machine players, the choice of the less well off, is showing weakness. For Crown, growth in other revenue segments should insulate the business. In the case of Telstra it's the age demographics of the consumer - the 50-64 year-old segment that has the most disposable income and ability to spend - that's most influential.

Statistics on life insurance show weaker profits for the industry because of a worsening in group risk claims experience and lower investment earnings. JP Morgan thinks additional reserve strengthening in this insurance class may be needed and this could continue to depress industry profitability in the near term. The industry did report September quarter earnings were up 13% on the prior quarter but down 41% on the prior corresponding quarter. Much of the improvement on the June quarter was driven by increased investment income. What was encouraging was that individual risk trends were stable. Profitability levels remain low but at least they are not deteriorating.

The asset quality of major banks improved in the September quarter. This underpins the recent declines in bad debt charges but Credit Suisse is cautious about prospects for further moderation in debt charges. Key trends include a decrease in impaired business to 0.57% from 0.59%. The four industries which continue to have elevated level of impaired business are accommodation, agriculture, construction and property, although there's been some improvement in the latter two and the former appear to have stabilised.

The housing market is recovering, with the latest statistics showing a rise in both the number and value of commitments in September. Macquarie notes, one area that is soft is first home buyers, representing 12.5% of the market and down from the low 30% range in 2009. The data aligns with the broker's expectations for an improvement in credit growth next year.

With lower rates and rising asset prices Macquarie thinks asset quality at the the banks could further surprise to the upside. National Australia Bank ((NAB)) is best placed to benefit because its second half impairment charge in 2013 was 7-18 basis points above its peers. The broker thinks, on a 6-12 month basis NAB and Westpac ((WBC)) should perform the best, with exposure to improving business lending conditions in the SME/corporate segment.

The pathology industry and the federal government have been negotiating a further round of cuts in pathology outlays to reduce overspending. In FY13 the outlays exceeded the agreement by 3.3% and the discussions have probably negotiated the overspending closer to 2.1%. UBS understands that the industry would likely cede a cut of 2% from January 2014 but is seeking a political commitment on the resolution of broader issues, such as excessive rents paid to GPs for collection centre sites. The de-regulation of centres made by the prior government exacerbated the long standing issue of excess rents and the economics of many GP practices now rely on this rent, leaving the government with a funding dilemma. The industry is divided on the issue and the unwinding of excessive rents is expected to take some time.

Advertising agency markets have shown modest growth, up 1.6% in the year to October. TV advertising growth continues to be the strongest, with metro free-to-air spending up 5%. Pay TV goes from strength to strength, up 15% in October. Print is the weakling segment, although there are signs, according to Credit Suisse, that declines may be moderating. October's 14% fall was materially better than the declines of over 20% seen in the first half of the year. Magazines continue to struggle, down 23% in October.

Traditional digital display is slowing although still is the growth engine in the market. The digital market was flat in October and while total spending was still up 8%, growth was entirely driven by search and emerging platforms. In terms of categories, retail advertising returned to annualised growth for the first time this year as improved consumer confidence filters through to budgets. Finance was the strongest of the categories, with growth of 17% year on year.
 

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article 3 months old

Australian Banks: Strong Balance Sheets, Benign Earnings

- Bank results solid on face value
- Balance sheets very strong
- No pre-provision earnings as yet
- Target prices increased


By Greg Peel

Bank reporting season came to a conclusion last week with a quarterly update from Commonwealth Bank ((CBA)), following on from full-year results for ANZ Bank ((ANZ)), National Bank ((NAB)) and Westpac ((WBC)). On face value, results once again looked solid. Yet breakdowns revealed flat “pre-provision” earnings growth.

Underlying earnings growth once again eluded the majors, with earnings per share increases entirely attributable to bad debt reductions. Banks put funds aside (provisions) on their balance sheets to cover risks from bad or doubtful debts (BDD), with those funds returning to the earnings line once risks have passed or eased. UBS notes BDD reductions accounted for 2.1% of net 3.2% earnings per share growth, and a lower net tax rate accounted for 1.3%, implying earnings from normal banking activities registered minus 0.2%.

Revenue growth remained subdued, rising just 1.1%, UBS notes. Margins were flat, with increased costs stripped 1.3% from earnings per share. Credit growth was 3% stronger but mostly due to currency movements. Treasury operation contributions (trading, broking and so forth) were soft, reducing net revenues by 0.6%, but analysts don’t like it when too high a proportion of bank profit is due to playing around in volatile markets.

On a profit & loss basis, it’s hard to be at all excited. The story is a lot brighter, nevertheless, when one turns to balance sheets. Strengthening capital ratios were an “outstanding feature” of the result season, Citi suggests, with the capital ratios of all three reporting majors beating the broker’s estimates. And what does a strong balance sheet mean? Room for higher dividend payouts. And don’t investors love it. A further expansion in payouts took dividends up 4.3%, UBS notes.

Credit “quality” also pleased analysts. Better credit quality implies lower potential for BDD increases. This is important given Australia faces another year of relatively weak domestic demand and below average GDP growth, which can impact on the capacity of businesses and individuals to repay loans and mortgages. It is also important because we may now be nearing the end of a post-GFC cycle which has seen the gradual unwinding of GFC-related provisions (no one knew exactly how bad things were going to get back in 2008, so banks spent 2009 shifting significant funds into provisions), and subsequent earnings growth in the face of low demand for credit.

The result season showed major bank loan impairment charges (cost of writing down bad loans) in the second half of FY13 ranged from 0.15% at Westpac to 0.32% at NAB. Westpac’s charge was the bank’s lowest since the 1990s recession. Morgan Stanley suggests loan loss “normalisation” in Australia and New Zealand is now largely complete, hence year on year impairment charges reductions will not be as big a profit growth differentiator in FY14 as they were in FY13. The analysts point out net 0.32% impairment charges were reported in FY07, pre-GFC.

Citi remains upbeat on the banks’ capacity to grow underlying earnings. Credit growth is strengthening, the analysts note, term funding costs are falling, and housing and SME (small/medium enterprise) margins are stable. Citi expects mid-single digit earnings growth in FY14, and suggests the banks are still in a “very sweet spot” in the cycle.

UBS is not quite so upbeat, seeing a lack of core earnings growth (pre-provision) in FY13 as a concern. Ongoing improvements in balance sheets were a highlight for UBS, but while strong balance sheets underpin dividend payout capacity, it is earnings from which the banks “pay out”. If BDD reductions are coming to the end of their post-GFC run and core earnings growth remains subdued, further dividend increases will be difficult to deliver. As UBS notes, the market seems to be investing in banks in a belief dividends will rise ad infinitum.

While balance sheets are strong, and among the strongest in the world, there is still a possibility capital conservation will need to continue from here, Macquarie warns. Next year sees the enforcement of the Basel III global bank requirements, and one of those requirements is that of a Domestic Systemically Important Bank charge. The DSIB charge is basically the newly introduced cost of being “too big to fail” in one’s own country. There has been talk recently that the DSIB charge may not be 0.5%, as assumed, but 1.0-1.5%. Anything greater than 1.0% will mean Australia’s banks will need to continue with capital conservation through a mix of dividend investment plans, which are really backdoor capital raisings, and lower dividends.

Special dividends would be an obvious first victim, but Macquarie notes special dividend specialist Westpac is actually in the best position of all the majors and thus the less likely to need to cut its dividends. CBA is next best, followed by NAB, with ANZ most vulnerable given faster-than-peer growth.

Which brings us to a breakdown of how the bank’s faired individually in FY13.

Let us first have a look at the FNArena bank table from prior to the result season, as highlighted in Upside to Oz Bank Earnings?:
 


 

The most notable column in this table is that of percentage upside to target. All four banks were showing negative upside before results were posted, implying each was trading ahead of its consensus target. When all banks run ahead of target one of two things can happen. Either the brokers raise their targets or bank share prices, having stretched themselves, have a bit of a pullback. Given bank analysts will always adjust their forecasts after an earnings result, it was possible we would see some target increases forthcoming rather than share price tumbles.

And indeed we did. The following updated table, based on yesterday’ closing prices, shows only CBA remains at a share price above target after all four banks saw net target price increases, while ANZ, NAB and Westpac paid out their final dividends.

 


 

CBA almost always trades above target given its greater popularity with investors than analysts and subsequent premium to peers. We can also see a reasonable share price increase in the interim for CBA, and an increase for ANZ, while NAB and Westpac have seen share price reductions (since the last update).

Forecasts have now shifted from FY13-14 to FY14-15. We see no change in consensus order of preference (and indeed there has been no change for some time) but the spread of recommendations has become more centred. The pre-season total Buy/Hold/Sell ratio of 14/11/7 has shifted to 12/14/6 post-season.

What is nevertheless clear from these numbers is that individual broker orders of preference are diverse. Just as an example, Macquarie’s order of preference is NAB, WBC, ANZ, CBA. Citi suggests CBA, WBC, ANZ, NAB, while Credit Suisse prefers ANZ, NAB, CBA, WBC. Each broker puts a specific case for its order of preference, usually focussing on different aspects of the banking outlook, and these are only three of the eight brokers in the FNArena database.

A confused investor might be tempted to invest in all four, if bank investment is sought, or a relevant ETF (exchange traded fund).
 

Technical limitations

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article 3 months old

Macquarie Flying Again But Airport Sale Raises Questions

-Sydney Airport sale welcomed
-Return on equity to improve
-UBS questions change to constitution
-Share price upside likely
 

By Eva Brocklehurst

Macquarie Group ((MQG)) will offload its 17% stake in Sydney Airport ((SYD)) via an in-specie distribution to shareholders. The investment banker confirmed the widely suspected decision at its half-yearly profit release. Brokers largely welcomed the decision to sell but some found the means a little curious.

Morgan Stanley has thought for some time that the more than $5 billion in equity investments were a drag on group returns on equity (ROE) and, therefore, this transaction makes sense. Moreover, a decision to make such a distribution to its own shareholders suggests Macquarie has no compelling alternative uses for the excess capital. The timing also suggestsSydney Airport is considered fully valued.

Citi has upgraded forward earnings on the anticipation of additional profit from the sale and expects the profit impact to be in the $80-100m range. The broker also notes the bank's capital strength remains intact after the transaction and Macquarie retains considerable capacity to acquire, or continue with, further capital management initiatives as other legacy investments, although much smaller, are also unwound.

The distribution in specie achieves several objectives. It crystallises a profit and distributes part of the capital surplus via a partially franked dividend and a capital return at a time when there is likely to be significant demand internationally for Sydney Airport stock once the restructure, that will be voted on this month, lifts the foreign ownership limit. This should support Sydney's stock price in the face of any selling pressure from Macquarie shareholders. Citi's return on equity for FY15 estimates is lifted by 50 basis points to 11% as a result of the reduced capital.

In scrutinising the proposal, JP Morgan notes one stapled security in Sydney Airport for each Macquarie ordinary share will trigger $380m revenue recognition through Macquarie's profit & loss in the second half, pre-tax and pre-bonus. Using a 45% compensation ratio and 30% tax rate, this would deliver an equivalent cash earnings benefit of $145m. The net capital return from the distribution, in addition to other initiatives, would translate into a net $250m capital return for shareholders, thereby resulting in cancellation of the current buy-back. While largely earnings neutral, the transaction will improve Macquarie's ROE, and demonstrate to shareholders Macquarie is seeking to improve returns.

Such a sale structure is not common among investment banks. UBS observes that investment banks usually balance the value attribution between staff and shareholders and utilise various forms of bonus pool or profit share arrangements. Directors of Macquarie have chosen to distribute the Sydney Airport stake on a one-for-one basis, subject to a shareholder vote. While in specie distributions are not unusual, UBS has concerns around the leaking of value. Given Macquarie's profit share arrangement, the staff bonus pool takes $200m, while $60m tax is crystallised. Thus, it appears costly for shareholders to gain access to assets they already indirectly own, in UBS opinion. One of the bank's core strengths is very large and strong distribution channels across retail, institutional and unlisted customers. This proposed transaction, if approved, adds another - shareholders.

Macquarie has stated that the shareholder meeting to approve this distribution will include a change to the constitution to undertake this proposal and future flexibility in distribution payments. As a result, Macquarie is asking shareholders to change its constitution to enable similar distributions in the future. UBS questions whether this is a good precedent. The bank may argue that Sydney is a unique asset but, should the environment change in the future, other transactions of this nature can be undertaken.

Sydney Airport stock is desirable and trades in a liquid market. Given this is the case, UBS asks why didn't Macquarie simply undertake a book build and sell into the market via Macquarie Securities. The broker sees the choice as a complex structure requiring meetings of shareholders and changes to the constitution. Macquarie still holds around $5.5bn of equity investments on the balance sheet. It is likely that many of these assets are less desirable than Sydney Airport. If in the future Macquarie is unable to distribute these assets via its retail, institutional or unlisted channels, there is nothing stopping a distribution to shareholders, at what Macquarie perceives to be the fair value. Will shareholders be happy the next time around?

Credit Suisse liked the proposal as it deals decisively with a sizable and long-standing non-core asset. The broker has been of the view that the relatively subdued returns have been primarily a function of capital allocation. Sydney Airport's strong share price, prudential regulatory rule changes and pending QE tapering are seen underpinning the timing of this decision. Credit Suisse would like to see further such capital management initiatives, but this may be unlikely until greater regulatory capital certainty emerges and/or rising asset prices facilitate the deploying of capital surpluses. Culturally, the broker suspects that Macquarie prefers deploying capital surpluses to the business rather than conducting buy-backs.

What of Macquarie's half year result? Solid was how most brokers viewed it. First half profit of $501m was up 39%. The interim distribution of $1.00 was short on Credit Suisse's expectations of $1.16 but this is compensated by the proposed distribution of the Sydney Airports security. Citi notes impairments were still significant, with $177m in investment impairment charges mainly from the resources sector. JP Morgan is maintaining FY14 and FY15 earnings estimates.

The strong share price in recent months in the absence of positive earnings revisions is a likely reflection of the growing expectations for deals as equity markets improve. This should return the market-facing divisions such as Macquarie Capital a Macquarie Securities to profitability. Transactions should flow too, as unlisted funds begin to wind down and this gives JP Morgan more confidence over fee streams. The stock is expensive relative to the broker's valuation but the Sydney distribution, and the absence of negative catalysts, could see it stay that way for some time and a Neutral rating is preferred.

Citi expects liquidity and the cycle will take the share price higher from here, assisted by continued upgrades in earnings and dividend estimates. This could lift the share price well beyond fair value. The broker expects cycle leverage is much reduced these days, and sees a peak cycle return of 16% compared with the mid to high 20% area in prior cycles. All up it leads Citi to maintain a Neutral rating.

Macquarie has a $48.68 consensus price target which signals 10.1% downside to the last share price. The target has moved up from $48.35 ahead of the report. The dividend yield is 4.4% on FY14 forecasts and 5.2% on FY15 forecasts. There are two Buy ratings (Credit Suisse and Deutsche Bank) and five Hold ratings.
 

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article 3 months old

Is Wesfarmers Priced Beyond Performance?

- Wesfarmers sales growth reasonable on a net basis
- Yield is attractive
- Coles appears to be slowing
- Analysts question a high PE

By Greg Peel

Wesfarmers ((WES)) reported its quarterly retail and coal sales last week and the story was mixed.

Brokers have been wondering for a couple of quarters now whether the Coles turnaround story had reached a peak following the supermarket’s success in silencing the early sceptics. Within a net 4.8% lift in first quarter retail sales, Coles like-for-like sales growth fell to 3.4% from the previous quarter’s 4.5%. To be fair, Coles was hit with double-digit price deflation in fresh food, a number consistent with figures within last week’s September quarter CPI release.

But is this the whole story?

Deutsche Bank concedes it would be hasty to draw a conclusion before rival Woolworths ((WOW)) releases its sales result this week. However, Deutsche notes irrespective of food deflation, volume appears to be slowing. Margin expansion in Coles’ food &liquor business was soft in the second half of FY13, which suggests to the analysts that “maintaining the earnings momentum may become increasingly difficult”. UBS further notes Coles’ market share gains “disappointingly” slowed in the first quarter. JP Morgan suggests the pace of the Coles turnaround “is moderating somewhat”.

Piffle, says Credit Suisse. “The Coles result was influenced mainly by higher than expected deflation in fruit and vegetables,” the analysts point out, “which from a profit perspective is of little consequence”.

CIMB picked up on another factor, with regard to petrol discounting. Coles made a tactical decision to redirect promotional spending away from petrol discounting in the quarter in question, but clearly the strategy has fallen short of expectation. Late in September, management decided to hastily reinstate significant discounts, despite the cost, which suggests a plan to reinvigorate momentum, the analysts believe.

Wesfarmers is nevertheless not just about Coles. Bunnings is posting its best numbers in years. Lower interest rates, the beginnings of a housing recovery, and even warm, DIY-friendly weather over winter has helped Hardware Hell along at a time the Woolies pretender, Masters, is clearly struggling to gain any traction.

K-Mart also posted a solid result, but the runt of the litter was Target. Despite negative sales growth, Target is at least showing indications of its own turnaround under new management and the figures are becoming less worse. But if Target starts to regain market share, who will it regain it from? The other low-price chain? Well that would be K-Mart.

Let us not forget that Wesfarmers also produces coal, and here a 5% increase in prices for the quarter was pleasing. Credit Suisse suggests the bottom of cycle earnings for coal may now have been reached and modest upgrades could follow over the next twelve months.

And Wesfarmers’ insurance division continues to show signs of recovery.

The good news for shareholders is Wesfarmers’ policy of providing attractive capital returns. The conglomerate generates a lot of cash and has now passed beyond the bulk of its turnaround-spend. FNArena database forecasts suggest an FY14 dividend yield at the current price of 4.6% and an FY15 yield of 5.1%, fully franked, which is not far off the big banks.

The bad news is the price. Wesfarmers is trading at around a 20x price/earnings multiple on FY14 forecasts while delivering only around 5% compound annual earnings growth. For many brokers, that equation just doesn’t add up. Notwithstanding Coles is appearing to wobble, Target still needs work and a resource sector recovery is not on the cards for tomorrow.

One is tempted to hark back, nevertheless, to when Woolies’ PE broke above 20x back in the noughties. At that stage, analysts started applying the Sell ratings. By 25x, analysts were dumbstruck at the market’s folly. As the PE approached 30x, some gave it away and started lawn mowing services. You just can’t justify such a lofty PE for a business that sells bread and milk.

As it was, the GFC saved the day. But we have to concede things were a little different back then. The economy was booming and Australians were spending money like there was no tomorrow. The supermarket business was undergoing a revolution as Woolies soaked up the spoils of its move into liquor stores and petrol stations, the latter in particular driving cross-promotional market share gains of epic proportions. The company also turned the screws on its supply chains, forcing market gate prices lower and lower. It was not just the farmers, butchers, green grocers, independent liquor store and service stations that suffered, and largely disappeared, Coles was hit for six. The rival (as yet not acquired by Wesfarmers) tried to mimic Woolies as best it could, but soon hit the ground and continued to bruise as Woolies continued to kick and kick.

Things are a little different post-GFC and new market initiatives are thin on the ground for the supermarkets. Coles may have posted a faster growth rate than Woolies since being acquired by Wesfarmers but only from a much lower base. Woolies is still a force. Metcash ((MTS)) is fiddling around at the periphery but genuine competition is now being offered by foreign competitors such as Aldi and Costco.

The Coles recovery now appears to have all but run its course and let’s not forget, Wesfarmers includes consumer discretionary, insurance and resource sector divisions.

Add it all up, and five of the seven FNArena database brokers covering Wesfarmers cannot justify a 20x multiple. UBS is at least prepared to hang at Neutral, while all of Deutsche, CIMB, Macquarie and Citi have ascribed Sell or equivalent ratings. Credit Suisse (Outperform) is a bit of a lonely bull, while BA-Merrill Lynch (Buy) admits retailing remains subdued and thus it’s becoming harder to feel confident in forecasts.

But there’s that yield. As we’ve seen with the banks, analyst claims of overblown multiples is not an impediment to further price rises in a yield-hungry world. We may be about to learn, nevertheless, that the earnings outlook for the banks is finally improving. The earnings outlook for Wesfarmers seems less encouraging.

The FNArena database shows a consensus target of $41.62 for WES, or 1% below Friday’s closing price. One should not expect too wide a target range for the conglomerate, but we see Citi the low market down at $34.60 and Merrills the most exuberant at $53.00.

Funny. Merrills was so critical of the company’s decision to acquire Coles back in the day.
 

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article 3 months old

What Odds A Correction For ANZ?


Bottom Line 23/10/13

Daily Trend: Up
Weekly Trend: Up
Monthly Trend: Up

Technical Discussion

Although ANZ Bank ((ANZ)) is well behind Commonwealth Bank (CBA) in terms of relative strength, all-time highs were penetrated a few days ago which means and if we are to see a decent leg lower it needs to kick into gear pretty much immediately.  That said, apart from the fact that technically the stock is in a position to see a retracement there is no evidence of distribution whatsoever at this stage.  And until it transpires we simply have to go with the flow and see where it takes us.  There is likely to be some resistance in this general area though the key will be in how any retracement unfolds.  Should we see price action similar to that seen from the May high then there is every chance that price could head back down toward the zone of support as annotated.  However, I’m not quite sure what the trigger for such a movement is going to be though that’s not to say something can’t come out of left field.  One thing’s for sure, should momentum continue then there is every chance that the pull-back we are looking for is going to evade us.  Not ideal from a pure pattern perspective although it would be a bullish proposition nonetheless.

Our wave count is now coming under severe pressure for two reasons.  First of all the prior pivot high made a few months ago has been exceeded by a small margin which in this instance also means the much larger degree wave equality projection made off the 2009 lows has also been overcome.  This alone adds weight to a more bullish case.  The other interesting fact is that symmetry from a time perspective is waning.  And by that I mean the time taken down to the low of wave-(a) has taken substantially longer than the bounce from those lows.  In fact the current rally has taken more then 2.618x the time taken by the prior leg which is almost unheard of unless a complex combination pattern is unfolding.  That’s always a possibility though extended corrective patterns are extremely difficult to decipher so hopefully one won’t transpire here.  The only slight positive for the bears is that the stock is looking overbought on both the daily and weekly time frames although at this stage no bearish divergence is in position.  However, a stock oversold and sitting at all-time highs or resistance is a little more significant and can’t be ignored.

Trading Strategy

Despite the trend continuing unabated there is no reason to jump on, especially as all-time highs are being tested.  Should price get up toward the $34.00 level and be followed by a consolidation pattern or even a smaller degree a-b-c correction that would be a different story.  The one thing we can’t get away from here is that an impulsive 5-wave movement completes wave-(a) which theoretically should not be the full extent of the larger corrective pattern.  Not that any form of analysis is 100.0% accurate though from an Elliott Wave point of view there should be another retracement to come lasting several months before the larger degree trend continues.  Time will tell.


Re-published with permission of the publisher. www.thechartist.com.au All copyright remains with the publisher. The above views expressed are not FNArena's (see our disclaimer).

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article 3 months old

Stop Reading The AFR If You Are Scared!

By Peter Switzer, Switzer Super Report

For all my subscribers who are getting worried about the soundness of Australian banks, well, I make one recommendation, and I do this with a heavy heart — stop reading the Australian Financial Review!

Don’t get me wrong, I read this respected newspaper but I’m qualified to cope with its broad range of offerings. As I’ve been a newspaper writer since 1985, a former academic economist, a financial adviser and a student of the best investors who’ve ever lived, I know I can cope with some of the scary pieces the AFR has been putting out, since the election.

On the weekend, my old friend Christopher Joye wrote a piece citing some unknown Aussie financial genius, who has managed billions in the USA for years, and who doesn’t like the vulnerability of our banks.  The really smart Christopher (who must be going through a mid-life crisis), seems to be surrendering his entrepreneurial past to his new passion of being the lead writer or scaremonger for the AFR. And he is really embracing the new task like a method actor of Russell Crowe proportions!

If anyone can remember a good-news story he has written, would you please remind me! He is warning about everything from a housing bubble to CIA conspiracies and, if you believed everything he has railed against, you’d simply go to term deposits.

The banks aren’t bad

On the weekend I bumped into CBA’s boss Ian Narev who said he noted the story but added “I didn’t agree with it.” Now remember Ian is the guy who the ultimate invested-bank-buck stops with, but you could argue that he would say that wouldn’t he?

Well there’s also Charlie Aitken’s view and this is what he said only this morning in his Ringing The Bell note: “The Australian Banks will give investors clear evidence why their money should be in bank equities not bank deposits. The pending bank full-year reporting and dividend season is going to be a cracker. That is obviously important for a wide variety of reasons.

“Fully franked dividend growth alongside the risk of special dividends is going to be the key. These bank boards are fully aware what their shareholder army wants and they will feed them it again.

“The Australia Bank reporting season has every chance of being the catalyst that drives the ASX200 into a new higher trading range.”

And if you think Charlie is an excitable broker, then there’s a very cautious guy called Glenn Stevens of the RBA, who would be giving Joe Hockey, our new Treasurer, a first up warning, if he thought there was an inherent problem with our banks.

Better value elsewhere?

Adding more support to my view was Tanya Branwhite, head of equities strategy at Macquarie Bank, who actually is not recommending bank stocks now. I was doing a speech with her recently and it prompted me to ask why?

She said that she did not have any reservations about the banks themselves but that she thought other investments had better upside and I think she is right.

That said, for safe investors looking for yield with a bit of capital gain, the banks are still a good play.

Of course, the banks one day will slide when the next crash comes along, and they do happen nearly every decade, and that’s when wise investors buy these good, no great companies, at very good prices.

The local fella-come-fund manager whiz that Christopher glowingly reported about is Matthew McLennan of First Eagle Investment Management, who told us what he looks for in companies he wants to invest in. “We love businesses that have been around for a long time. Businesses that have things that ought to make them persist — relative scale advantages, customer captivity and so forth. We are mindful that a business that can take market share quickly, can lose it quickly. So we look for evidence of historic durability in a company’s market position.”

I don’t know about you but that sounds like a pretty good description of the big four banks to me!

(By the way, McLennan thinks Joe Hockey is too complacent about a housing bubble, so this is another testing point we will be able to assess him on. I hope he is wrong but if he is right, I will remind you. I will remind you if he is wrong as well!  This is the upside and the downside of the commentary game!


Peter Switzer is the founder and publisher of the Switzer Super Report, a newsletter and website that offers advice, information and education to help you grow your DIY super.

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