Tag Archives: Building Material & Const

article 3 months old

Weekly Broker Wrap: Inflation, Accommodation, Gambling And NZ Building

-Low inflation is problematic
-Wotif.com battles competition
-More upside for Tabcorp?
-Echo Entertainment vulnerable
-Fletcher favoured in NZ residential
 

By Eva Brocklehurst

Low inflation. Is it good? Macquarie tackles the subject, noting that a structural legacy of the global financial crisis has been the onset of low inflation in many of the major developed economies. Low inflation becomes a problem when it turns into a deflationary spiral. The broker's analysis finds those countries which have specific numerical inflation targets prevent declines in short term inflation expectations from becoming entrenched. Ultra low inflation is considered a current problem in the eur zone and for financially stressed countries, as it implies higher real debt levels and higher real interest rates, less relative price adjustment and higher unemployment.

In Australia's case, the inflation targeting regime of the Reserve Bank means inflation expectations longer-term consistently stay within 0.1-0.2 percentage points of the mid point of the central bank's target 2-3% band. The recent strong and sustained appreciation of the Australian dollar has also played a key role in anchoring longer-term inflation expectations. Macquarie believes global investors should be alert to the risks of low inflation and should assess country/regional risks according to measures adopted by central banks to ensure inflation expectations remain well anchored.

***

Feedback from the accommodation industry conference suggests to JP Morgan that Australia's tourism environment is stagnant and the cycle is not supporting listed travel agents. This means the competition remains intense and there is pressure to increase spending on marketing, which in turn pressures margins. The broker observes the majority of global online travel agents are pursuing traditional advertising such as TV to complement their search engine marketing. This is seen as a better way to build brand awareness.

Global tourism operators are spending more on marketing and JP Morgan thinks this may continue to erode Wotif.com's ((WTF)) market share, despite the company's market-leading brand. The broker notes Wotif has mounted initiatives to regain share but thinks there's a clear need to preserve the relationship with hotel and accommodation providers to protect advantages, such as last room availability. Another observation was that room supply growth was flat in FY13 and room supply in FY14 is forecast to grow 2.7%. Despite little in the way of increased supply the average room rate has risen by just 1.5%. The broker notes the four main capitals - Brisbane, Sydney, Melbourne and Perth - are outperforming the national average on revenue per available room, while the leisure centres of Cairns and the Gold Coast are underperforming.

***

Australia's gambling sector can be classed as "mature". That view, combined with a more reserved consumer and modest top line growth, suggests to Morgan Stanley that investment opportunities remain very stock specific. The broker breaks from consensus on Tabcorp ((TAH)), expecting there's upside to earnings and distributions. Expanding margins are expected to offset lower turnover and provide for growth in wagering. A structural change delivers the most benefit, as customers increasingly bet online and on fixed odds. Turnover may decline, as UK bookmakers take share, but the broker still thinks Tabcorp can generate 14% 3-year compound earnings growth rates and raise the pay-out ratio to 100% from 80%.

Another area where the broker diverges from consensus is on casino operators Crown Resorts ((CWN)) versus Echo Entertainment ((EGP)). The broker believes Echo is more exposed to the swings in VIP table business, despite Crown having the larger VIP market share in Australia. This is because Crown's VIP business dominance is only on an absolute basis. VIP makes a larger relative contribution to Echo's earnings. Given the greater VIP earnings volatility experienced by Echo's domestic casinos, the stock deserves to trade at a valuation discount to Crown in Morgan Stanley's view. This is potentially offset if Echo can take some share of this market away from Crown. Crown will face earnings upside if it gains a foothold in the Queensland casino market, with up to three additional licences being issued. As a result, Echo faces significant risk as its Queensland dominance is set to be diluted. This will be compounded in 2019 when Echo loses NSW dominance with the opening of Crown's Barangaroo.

Morgan Stanley does not think the market has fully considered the possible impact of privatisation of Western Australia's TAB and/or lotteries. These are some of the last government-owned gambling businesses in Australia. There are opportunities and risks for both Tabcorp and Tatts ((TTS)). Morgan Stanley thinks opportunities for Tatts in the core lotteries division is limited. Tatts has lotteries exclusivity in NSW and Queensland until at least 2050. The Victorian licence is up for renewal in 2018. The broker does not think a potential WA transaction would be positive for Tatts, as there's limited scope for cost reduction. In wagering, Tabcorp has successfully renewed its licence in both NSW and Victoria and secured retail exclusivity. There could be upside to earnings if it is able to acquire WA TAB because of the cost reduction potential, in the broker's view.

***

CIMB has extended the home building survey to New Zealand, noting the rebuilding of Christchurch continues to gain momentum and is coinciding with a cyclical recovery in other major cities. The analysts have revised NZ residential construction forecasts and now expect 16% growth in 2014. In contrast to the nascent recovery in Australia, NZ's residential recovery is continuing at a rapid rate. CIMB believes there's further upside to come. Builder commentary suggests, while Christchurch and Auckland have been the drivers of the improvement so far, this is now filtering through to other cities and regions. All this leads CIMB to prefer Fletcher Building ((FBU)) in the building materials sector with the three C's - Cyclical leverage, Christchurch rebuild and Cost reductions - seen providing many years of earnings growth.
 

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 The Building Recovery Priced In?

-Boral a major beneficiary but is it expensive?
-Adelaide Brighton's yield provides support
-Fletcher Building CIMB's key pick
-James Hardie well placed in US market
 

By Eva Brocklehurst

Surveys of home building in the US, Australia and New Zealand have prompted several brokers to review the outlook for the building materials sector. Overall, the backdrop is buoyant and there's a strong recovery in train. Nevertheless, when it comes to individual stocks the general consensus is that much of this highly-anticipated recovery is priced in. In some cases the stocks are considered downright expensive.

CIMB's survey of home builders in Australia and New Zealand reveals the most positive and broad-based feedback since the survey's inception. Domestic residential activity is gaining momentum and NSW stood out in that regard. Both current sales and prospective buyer traffic have improved and these metrics are the leading indicators for building approvals, starts and ultimately materials demand. The positive trends are expected to continue for some time. New Zealand is the strongest market and, coupled with the US recovery that's underway, that suggests the materials sector has benefits mounting across key geographies. 

The broker expects a sustained recovery in Australian housing over the medium term, with a rise of 9% and 6% in FY14 and FY15 respectively. Despite the prospect of a concerted improvement across key markets for building materials, CIMB thinks attention should be paid to earnings leverage. On this basis, the broker thinks the sector is fully valued and much of the upside is factored in. CIMB sees no indication that the skew towards multi-unit construction will slow and this means that, on an adjusted basis, any given level of housing starts will be less valuable than in previous cycles. This could create a gap between market expectations and reality. This is why the broker urges caution regarding those stocks where significant improvement has been factored in.

CIMB thinks Boral ((BLD)) will be a beneficiary of an improving Australian and US residential market but remains concerned about the pace of recovery. Earnings should improve but at a slower rate than many anticipate. CIMB believes Boral is expensive on a multiples basis, trading at 16 times FY16 earnings forecasts. This is expensive when based on conditions that are in line with, or above, mid cycle activity levels. CIMB has a Reduce rating.

As demand for concrete picks up in the key states of NSW and Queensland, JP Morgan observes an opportunity to improve prices. Frequently, profitability in concrete has been undermined by the protagonists raiding market share. The tightening of the supply/demand balance provides the opportunity for that to change and Boral is Australia's largest producer of concrete. Concrete may be low margin but it's a critical element in both building and infrastructure. The prospect of major government-led infrastructure investment in the eastern states stands out as a critical growth catalyst, in the broker's opinion. The three largest concrete suppliers in NSW and Queensland are Boral, Hanson and Holcim, dominating 65% of the market. Hence, Boral is JP Morgan's preferred exposure in the sector and the broker retains an Overweight recommendation.

Credit Suisse has also surveyed home building, in the US, and observed increased value for the building materials sector with exposure to rising house prices. Credit Suisse notes, regionally, there's relative strength in those markets that favour James Hardie ((JHX)). The survey reveals competition for a limited inventory, suggesting a lift in house prices and implying that more construction projects will become economically viable for home builders. There has been some soft patches in US new home construction but a strengthening renovations market should provide some offset, according to Credit Suisse. The broker notes Boral has guided to a US divisional break-even run rate in the second half but thinks this is ambitious in the absence of strong volume growth, as cost cutting and restructuring has run its course. Credit Suisse has Neutral ratings for both Boral and James Hardie.

Either way, rising house prices underpin the renovations market, of which James Hardie is a key proponent. For James Hardie, around 65% of volume is exposed to the renovations sector and Credit Suisse believes the better price environment also allows the capacity to push through higher fibre cement prices. The company's primary exposure may be in the US, but CIMB still thinks James Hardie will be also be a beneficiary of the improving Australian residential market. The company's focus on capital management should provide significant yield support for shareholders although CIMB struggles to justify the current share price on a fundamental basis and maintains a Reduce rating.

Despite being cautious, CIMB has an Add recommendation on Fletcher Building ((FBU)), because New Zealand is still the strongest of the housing markets and Fletcher is a key beneficiary. Adelaide Brighton's ((ABC)) exposure to heavy construction and a skew towards Western Australia has provided a more favourable macro position for some time but, with the improvement in activity in both Australia and the US, the broker thinks Adelaide Brighton offers less leverage to improved conditions than its peers. The broker rates the stock Hold, acknowledging there is still an attractive dividend yield, supplemented by special dividends, which will provide some support at current levels.

CSR's ((CSR)) building product business is supported by the upturn, but CIMB notes a large portion is leveraged to the aluminium price and the exchange rate and this dilutes the stock's leverage to the improving Australian construction market. CIMB retains a Reduce rating, believing this stock is also expensive.
 

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

CSR/Boral JV Welcomed, If Approved

-JV to improve brick returns
-ACCC may oppose
-Savings seem conservative
-Potential cash from land sales
 

By Eva Brocklehurst

Brokers believe the proposed joint venture between Boral's ((BLD)) and CSR's ((CSR)) Australian east coast brick operations will be of benefit to the brick industry, offering site rationalisation, overheads reduction and an improved industry structure. Nevertheless, they're not being hasty and changing forecasts because at the heart of the proposal is a need for approval from the Australian Competition and Consumer Commission (ACCC) and the regulator could find some stumbling blocks.

Deutsche Bank expects such approval to take around six months and doesn't think it will be straight forward. The broker thinks most of the concerns will centre on Queensland, where the combined market share of the two is around 70%. In the other states the combined market share is more like 50%. Deutsche Bank thinks a JV adds value because the sector is struggling with over-capacity and disappointing returns. This is where Macquarie thinks the ACCC will come to the party. Both manufactures have found conditions challenging in the last several years and this JV is a clear step to improve the industry structure. This should mean that approval is more likely than would be the case if returns were strong. The broker also observes that similar steps have improved returns in masonry, for example the Adelaide Brighton ((ABC)) and Brickworks ((BKW)) tolling arrangements in north Queensland and Victoria.

CSR will own 60% and Boral 40% of the JV. Certain property assets are excluded and there is no cash impact. Boral will retain its ownership of Scoresby (VIC) and surplus land at Bringelly (NSW), with CSR retaining its Schofields (NSW) land and surplus land at Horsley Park (NSW) and Oxley (QLD). Citi thinks the JV will deliver a vehicle for both companies to unlock future value. What excites the broker is the property profits that can be unlocked, releasing capital tied up in legacy land sites. Citi expects the value created by re-zoning and developing surplus land at Horsely Park and Oxley, and then ultimately Schofields, far exceeds the value of the CSR share of the annualised cost savings for the rationalised brick business.

The key to the ACCC's decision is with the definition of the brick market, in Credit Suisse's view. If bricks are defined as a product that competes in the broader exterior cladding market then the transaction should receive approval as the broker observes the ACCC set a similar precedent when Brickworks acquired Boral's NSW masonry business early last year. JP Morgan agrees, observing that, on that basis, the JV would only have 31% of the "cladding" market. The broker also notes Brickworks dominates market share on the east coast, having 49% total installed capacity. Subsequent to the JV occurring, the position of the it and Brickworks would be even across all eastern states, with the JV having the dominant share in NSW and Queensland and Brickworks the larger in Victoria and South Australia.

BA-Merrill Lynch estimates that the JV would have 50-60% of the east coast brick market. Central to the ACCC's case will be this market share. The broker observes a structural loss of share for the brick market over the last 25 years because of unfavourable installed cost comparisons and architectural preferences. Macquarie also draws attention to the trend towards multi-residential construction, which has led to a substantial decline in the numbers of bricks per housing start, with the share of wall finish for detached housing dropping to 60-65%, from 88% 30 years ago. Double brick housing has virtually disappeared from practice and the labour intensity of bricks is higher than with other building product types.

Were the ACCC to reject the JV, UBS thinks the pair might be prepared to take the decision to court, with the costs negligible in terms of the potential benefits of winning. That is, the business operations could still continue on a stand-alone basis in the meantime. That said, UBS thinks Boral would have been better served leaving the industry altogether on the east coast and was disappointed not to see any exit strategy from the JV for either party down the track.

Several brokers think the cost savings cited are conservative. CSR and Boral outlined $7-10m of initial overhead savings but Deutsche Bank thinks synergies of at least $15-20m are likely, given potential revenue and plant rationalisation. The broker observes 33% of Boral and CSR's capacity is currently mothballed and this capacity is most at risk of closing after the JV is consummated. Merrills concurs, noting the JV is already operating at 86-90% utilisation so there is not much opportunity to close current operations, especially as Australian housing approvals are up 30% in the last six months. The opportunity, therefore, is to permanently close the mothballed sites in NSW and this would provide cash flows, although not necessarily improve earnings in the bricks business. 

Based on Deutsche Bank's calculations the JV would lead to a FY15 earnings uplift of 1% for Boral and 4% for CSR. Should the JV receive ACCC approval, the broker estimates Boral's valuation would increase 2.6% and CSR's 4.9%. Citi thinks evidence of the the recovery in building products earnings is vital to allay concerns about CSR's valuation, with the stock trading above the target of $3.00. In terms of Boral, Citi expects continued earnings and margin improvement with the return of pricing power in construction materials. CIMB also thinks the benefits are both real and understated at this stage, given the risks regarding ACCC approval. Still, the JV is not sufficient to change the broker's view that the pair are currently overvalued. Hence a Reduce rating is retained. Ultimately bricks are a "fashion" statement, in UBS' opinion as they serve no structural benefit and compare with alternative cladding systems. The JV does not obviate the need for both companies to find new products to gain market share, in the broker's' opinion.

CSR has three Buy, two Hold and three Sell ratings on the FNArena database. The consensus target is $3.05, suggesting 13.6% downside to the last share price. Targets range from $1.90 (Merrills) to $4.15 (CS). Boral has four Buy, two Hold and two Sell ratings. The consensus target is $5.85, signalling 2.1% upside to the last share price. The targets range from $5.20 (CIMB and Merrills) to $6.40 (UBS).
 

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

CSR Primed For Gains As Housing Accelerates

-Price rises for key products
-Key play for housing recovery
-Viridian losses reducing
-Aluminium price underpinned
 

By Eva Brocklehurst

The various strands of CSR's ((CSR)) building products business are coming together, given the step-up in the house and building recovery. Brokers suspect that, despite recent share price gains, there's more to come, as the construction environment shapes up favourably with a surge in detached housing amid low interest rates. The stock has languished relative to others in the sector because its aluminium and glass businesses have offset other building product earnings, notes UBS. This year CSR's building products business has benefited from restructuring and, as JP Morgan notes, plasterboard operations, in particular, have been robust. Moreover, some recent developments in the aluminium market augur positively for the company's smelter interests.

Moelis suspects the company's potential operational leverage is being underestimated, given its relatively early stage exposure to the housing recovery and a suite of market-leading building products. CSR has recently acquired AFS Products, a company which offers load-bearing permanent wall frames, a platform for CSR to enter this segment. The purchase price of $40m will be funded by debt and Moelis expects, having paid a FY14 earnings multiple of six times, that the acquisition will be accretive in the first year. CSR's primary housing exposure is via building products which contribute 85% of earnings. The broker also observes turning Viridian's glass business around remains a number one priority. The division lost $10.6min the first half but break even is targeted within the next two years.

Moelis likes the stock, despite the 75% appreciation in the share price over the past year and retains a target of $4.50 and a Buy rating. The broker concedes there are some risk variables such as the currency, the aluminium price and the need to reduce Viridian losses but these are all seen trending in the right direction.

UBS concedes that Viridian is not materially benefiting from an increase in high rise residential development, because of cheap imports. Nevertheless, the business is predominantly in detached housing so the stock is a key play on the recovery. In the sector residential building has been the strongest performer, with increased activity expected to flow into CSR's FY15 results. The company has a March year end. UBS expects this improvement will be sustained over the medium term. 

Deutsche Bank considers the price increases that occurred in March in plasterboard, bricks, insulation and glass should stick during the current recovery and has upgraded CSR to Buy from Hold on this basis. The broker believes consensus expectations for FY15 and FY16 are too low, envisaging as much as 15% upside potential in the share price. Moreover, if the aluminium ingot premium stays high in FY15 - around US$350/t - this could lead to further earnings upside of around 14% for FY15. Currently the Japanese ingot premiums are around US$257/t, Macquarie reports.

The likelihood of aluminium inventories being delivered from London Metal Exchange warehouses into a tight physical market, ex China, is much lower now and a prolonged period of elevated premiums looks probable to Macquarie. The broker cites the recent UK High Court ruling as providing near-term support for CSR's interest in the Tomago smelter and the first half. The ruling has vetoed the LME's proposed changes to warehousing rules. This defeat has positive implications for aluminium producers, as the potential for metal to flow from inventory has been reduced. Macquarie will be watching for the next move by regulators to tackle what the broker describes as a dysfunctional market, but believes the LME is likely to appeal the decision. In the short term, an elevated inventory is expected to overhang the aluminium market.

CSR's consensus target price on the FNArena database has risen to $3.15 currently, from $2.94 at the start of April, and suggests 12.7% downside to the last share price. The targets range from $2.60 (JP Morgan) to $3.68 (Deutsche Bank). There are two Buy ratings, two Hold and one Sell. 
 

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

Brickworks Enjoys Benefits Of Housing Recovery

-Increases interim dividend
-Improves multi-dwelling exposure
-Coal earnings decline
 

By Eva Brocklehurst

Brickworks ((BKW))  has maintained that FY14 earnings should comfortably exceed FY13. The proportion of the segments contributing earnings to the building material and investment conglomerate are seen changing, nonetheless. Brokers expect that building products will increase, thanks to a housing recovery, while the contribution from investments, notably in thermal coal, will decline. The property trust joint venture is expected to become increasingly important.

What makes Citi most confident is the increase in dividend. The company has not increased the dividend for two years and has raised the interim to 14c from 13.5c, signalling to the broker a meaningful improvement is likely in earnings.

The company's building products business is gaining momentum with the ramp-up in house building as well as an improved market structure in masonry, which should deliver a better performance in multi-residential business. Brickworks has shifted its pre-cast concrete focus to multi-unit dwellings from industrial sheds and warehouses, a move that Macquarie thinks bodes well for the future. Macquarie considers the business has been thwarted in achieving good returns because of a competitive market structure. Brickworks observed that the early stages of the housing recovery were slow to translate into increased demand for building materials, with the notable exception of bricks in Western Australia, but the company is now witnessing a more broad-based recovery in demand.

Brickworks did express dissatisfaction with the returns and margins in building products in the first half. To the company's credit Macquarie considers the margin decline appears to have stabilised somewhat and returns should improve as detached housing activity increases. Deutsche Bank was encouraged by a more positive outlook from management. Bricks have maintained their market position in terms of wall finish and the broker thinks the robust reduction in inventory, positive pricing momentum and improved conditions means a second half earnings margin of 8% should not be difficult to achieve.

Deutsche Bank also thinks the increased multi-residential exposure is positive and reiterates a Buy rating. Citi notes the building products market is behaving rationally for now an the company has committed to profitability rather than market share, implementing price increases. While the price increases are yet to be realised, indications are that it's tougher in the west of the country and more accommodating on the east coast.

Brickworks is now looking at how best to offset the potential for significant increases in energy costs in its building products business. Current contracts expire in December 2014 and the offers of gas that are forthcoming are at higher prices. The company is planning to implement a range of alternative fuels projects, including landfill gas and sawdust. Land and development produced the most significant contribution to earnings in the first half and this will rise in importance, according to Macquarie. Net trust income from property increased 20% to $6.1m. Brickworks is undertaking a number of developments within the trust to contribute to both revaluation profits and increased rental returns. Citi considers the land and development business is fairly valued at present, in the context of earnings volatility and the illiquid nature of land investment.

The third spoke in the company's earnings wheel is investments in other companies. Brickworks' investment earnings declined 17.8% in the first half, largely affected by lower returns from New Hope ((NHC)) because of depressed thermal coal pricing. Macquarie suspects that thermal coal prices will remain under pressure, with any upside capped by the ability of supply to re-enter the market. Brickworks holds 43% of WH Soul Pattinson ((SOL)). Citi thinks Soul's history of long-term outperformance is likely to help boost returns relative to peers.

On the FNArena database there are two Buy ratings and one Hold. The consensus target price is $15.25, suggesting 7.7% upside to the last share price. This compares with $14.87 ahead of the interim results. Targets range from $15.00 to $15.66. 
 

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

Oz Housing Construction Is Rising High

-Housing to contribute to growth
-Percentage of units increasing
-Shift in materials demand seen
-Interest rates supportive in 2014
 

By Eva Brocklehurst

New dwelling construction in Australia is expected to increase this year and stay elevated into 2015. Commonwealth Bank economists expect this should improve the alignment with population growth and address some of the affordability problems that have been notable of late. Increased supply will also weaken the upward pressure on rents and prices. Nevertheless, the economists expect changes to house prices and rents will stay varied across the cities and regions, reflecting local economic conditions.

The drivers of the dwelling construction - expected to rise by 8% this year - are continued low mortgage rates, pent-up demand, targeted first home buyer assistance and higher dwelling prices. In turn, improved construction activity should help overall growth and employment. The economists expect a significant contribution to GDP growth this year and forecast 110,000 new detached houses and 71,000 multi-unit dwellings to be built. This should bring construction closer to the CBA economists' estimates of underlying housing demand - at 175-180,000.

Secondary impacts will come down the track from spending on furnishing, white goods and electricals as well as landscaping. So what's different about the upcoming construction cycle? There's a continuing shift to multi-unit dwellings, expected to be around 40% of the total build and up from around 30% a decade ago. This means a shift in the demand for materials as construction processes become more involved - more concrete and steel and less brick, wood and roof tiles. Apartments also mean more elaborate wiring, security, parking and elevators. The demographics are also changing. The ageing of the population is likely to be a determinant in the type of properties that are in demand.

Credit for investors has been rising at a faster rate than owner-occupied credit, which the economists see as a natural response to lower interest rates. The economists expect lending to owner occupiers will increase over 2014 but investor finance might soften and the two growth rates converge. Rental growth has slowed and yields have recently fallen. As more housing comes on line vacancy rates are likely to rise. These factors are expected to result in a slowing of investor demand for housing toward the end of the year.

The main dampening impact on overall demand will come from consumer reluctance to take on more housing debt, in the economists' view. For some time households have been focused on repairing balance sheets and this cautious behaviour has meant the household savings ratio has returned to near 11%, where it was in the 1980s. The economists believe income growth needs to rise for consumers to both maintain savings levels and trade up on housing.

The economists believe the interest rate background will remain supportive this year. They expect the Reserve Bank will start to raise the cash rate in the fourth quarter, but this tightening cycle will be long and drawn out and the peak likely to be lower than in previous cycles. House price growth of 10%, that occurred in 2013, could be repeated in 2014, according to the economists, if mortgage rates remain unchanged this year. This has led them to expect affordability could deteriorate over the year. In terms of rental yields, these are expected to slide in 2014 as vacancy rates and house prices rise. Another impact to affordability is inflation. The economists note inflationary pressures are building. The lower Australian dollar also means imported prices are rising. Part of the problem with domestic inflation is that some of it looks to be structural, according to the economists, which means that substantial falls in prices are unlikely.

One aspect of the pick-up in building demand is that first home buyer lending has weakened significantly in response to changes in government concessions. The economists also suspect that this group is more susceptible to job related concerns and affordability pressures. This needs to change in their opinion before there's a turnaround in lending to this group. On a state basis, the economists think NSW demand will stay high. WA demand is elevated because of high population growth but this could slow at the end of this year, as employment ebbs in line with lower levels of mining construction. Victoria's home lending rose over 2013 but then slowed as the state's first home buyers scheme collapsed. The economists thinks high levels of construction activity in that state indicate that housing lending should pick up once first home buyer activity improves.
 

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: Farewell Toyota, Building Ramp-Up And Dividend Prospects

-Carmaker demise part of manufacturing decline
-Department stores still losing share
-Focus on Sydney, SE Qld construction in FY15
-Dividends from resources, energy?
-Oil price expected to strengthen
 

By Eva Brocklehurst

The Australian dollar is not to blame for the country being in a position in which local manufacturing of motor vehicles will cease in 2017. That's Deutsche Bank's take on the news that Toyota will follow Ford and Holden and shut up shop by 2017. In fact, Deutsche Bank analysts note history reveals the exchange rate is often a scapegoat for such closures but employment in the manufacturing sector, as a percentage of total employment, has been declining for 30 years. Manufacturing as a share of GDP has been falling since the 1970s.

In the case of vehicle manufacturing Deutsche Bank thinks short-run impacts are overstated while the long-run benefits are ignored. The analysts suspect the initial public policy response will involve additional government spending to ease the impact of the closures, probably regionally and sectorally focused, concentrating on the "high profile losers". That is, the employees of the car makers themselves. Deutsche Bank would prefer to see the high cost of cars in Australia addressed. As there is no longer a local industry to protect the analyst thinks the tariffs on motor vehicles should be abolished and widespread importing of second hand vehicles should be allowed. The argument is, if cars are cheaper, Australian households will have more money to spend on other goods. Additionally, Deutsche Bank thinks policy makers have not made enough effort to lower costs and prices than they could have done.

Christmas sales were OK but department stores continued to lose share, according to Citi. The broker notes David Jones ((DJS)) and Myer ((MYR)) engaged in less promotion during the last silly season and discounts were more targeted. As a result, the broker expects rising gross profit margins but doesn't think this will overcome the fact that department stores are losing share to specialty retailers and online. Sales trends may have stabilised but the broker observes department stores still need to deal with rising costs.

Citi also considers the building cycle activity will accelerate over the next two years and capacity constraints will loom. The broker welcomes the return of pricing power for the sector. The bright spot is Sydney, where road construction should pick up the slack when housing cools. The broker factors in a healthy housing market through to the end of FY15 and also thinks that year will see a 30% increase in the value of road and highway work, mitigating some of the housing decline. This leaves Citi favouring those plays which cover the whole domestic building cycle, expecting the reward will come through the combination of pricing power, robust demand and a synchronised improvement in markets. The view regarding the leverage to Sydney is focused on the early and late cycle construction materials but the broker concedes building products is where margin could surprise the most.

The broker also thinks many forecasts about the demise of the Australian engineering capex cycle are overdone. While spending could diminish over coming years, as the peak in energy and resources wanes, a material portion of engineering capex has no relation to construction or building materials volume. Instead, a broad based up-cycle increases customer numbers and enhances pricing power. That's not to say the broker doesn't favour exposure to construction materials. Product intensity tied to a wave of essential infrastructure projects should ramp up in FY15 and underpin construction materials. Citi is particularly drawn to businesses with leverage to Sydney and South-East Queensland construction activity. The broker observes cement, aggregates and concrete get earlier leverage than building materials and benefit as building gives way to infrastructure growth.

 This all leads Citi to favour Boral ((BLD)), which has been upgraded to Buy from Sell. Next down the ranks comes Brickworks ((BKW)), James Hardie ((JHX)) and CSR ((CSR)) with Neutral ratings.

UBS thinks the mood among resource companies during this earnings season will be more positive, with stronger commodity prices, a falling AUD/USD rate and a reduction in cost bases. That said, the gold sector is likely to be in line for further impairments with the gold price having declined markedly last year. The broker thinks companies will take a long look at the carrying value of assets in the light of changes to operating assumptions, asset closures and weak prices. Companies have been switching from growth to capital preservation. Hence, UBS expects to see the free cash flow improve and this is expected to be applied to debt reduction in the first instance. Still, the broker is holding out for a tidbit for shareholders from this reporting season. Iron ore miners, in particular, may look to return some capital. Then again, the broker warns, there's a lot to do to make balance sheets ship shape.

Peak years for capex in the Australian energy sector look like being 2012 and 2013, according to Morgan Stanley. The broker's forward estimates show a decline in capex for sanctioned projects. Capex for shale gas expansion of floating LNG projects is still in the planning phase and not included. The broker observes the debate has centred on LNG construction timelines and costs. Now, as delivery is more certain, attention is on what will be done with the cash flow. Will it be dividends, share buy-backs, debt repayment or re-investment? Morgan Stanley expects a modest increase in dividends across the LNG-exposed companies but also cautions investors not to expect large cash returns. Increased operating costs and "capex creep" are two factors present for over a decade which should keep investors' feet firmly planted on the ground. The broker prefers those companies with obvious growth options.

Morgans is overweight oil and gas and thinks the oil price will strengthen in coming months. Growth in developed countries is likely to stimulate demand and the strong season for the oil price is coming, as the US throws off its winter woollies. Most oil and gas companies are expected to benefit from the rising oil price. Still, Morgans thinks those with increasing production and/or reserves are typical outperformers. Morgans does not think oil is going up for just seasonal reasons. Developed economies are expected to grow at the fastest pace since before 2007. The analysts expect Brent to rise to US$124 per barrel this year. The broker's preferences include Oil Search ((OSH)), Santos ((STO)), Sundance Energy ((SEA)) and Senex Energy ((SXY)).
 

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: Oz Savings, TV Ads And Housing; China, US Reforms

-Aust savings rate an illusion
-TV ad budgets bleeding to online
-Sustained Aust housing rate needed
-China reform proposals
-US growth being held back
 

By Eva Brocklehurst

The official Australian household savings rate is 10% of income but Credit Suisse disputes this rate is showing a healthy position for consumer spending. This is a high rate by international and historical standards but the measure overstates discretionary saving, in that it includes compulsory superannuation and principal payments. Removing superannuation substantially lowers the savings rate to 2% from 10%. Accounting for principal payments lowers it further, to minus 3.6%. Hence, the pool that households can draw on to spend more is an illusion.

The general view is that households run down savings as interest rates are reduced and asset prices rise. Accordingly, consumption should grow faster than disposable income in the months ahead, enabling Australia's economy to move away from mining-led growth. Contrary to this notion, and because the official rate overstates the case, Credit Suisse thinks households are not saving much at all and therefore not in a position to increase spending. The discretionary saving rate is currently below the long-term average.

Moreover, even supposing that asset prices rise a little, further reducing the need for households to save income, the analysts find it hard to see the savings rate falling materially, because lending standards are tighter than before. So, either a major easing of lending standards, or a very strong increase in asset prices, is needed to persuade households to spend more. Over the next few years, the economy is likely to experience a drag from reduced mining investment. At the same time consumer demand will be patchy. Overall, it's low economic growth that's on the cards in Credit Suisse's view, and the risk to interest rates is to the downside.

Despite the tremendous growth in online advertising over the past 10 years, Citi researchers believe the majority of this growth has been derived from budgets for magazines, newspapers and direct response channels, such as mail. Top brand advertising, which is concentrated on TV, represents a significant and largely untapped market for online growth, at $62 billion. The researchers looked at survey data recently released by Adap.tv and Digiday that suggests marketers are increasingly looking to shift TV advertising spending to the internet.

This is consistent with Citi's observations of the industry and forecasts for online video advertising growth. Brands are allocating an increasing mix of spending to online video and tapping into budgets for TV broadcast, online display and print. Interestingly, what is holding back spending online is the ability to measure reach, target and performance across platforms and devices in a uniform way.

Australia's housing market is in recovery. How strong it becomes is the next guess. The recovery is led by NSW and Western Australia and characterised by falling housing starts in Victoria. Morgan Stanley suspects, for peak cycle numbers of 180,000 starts per annum to be achieved, Victoria needs to rebound. The broker sees downside earnings risk across the majority of the sector but earnings momentum is turning positive. This is strongest for Boral ((BLD)) and CSR ((CSR)). CSR has risks on the aluminium front but Morgan Stanley thinks the stock's leverage to a residential earnings recovery is underestimated.

Housing needs to be robust enough to be sustained for some time. Domestic building product margins have been in decline for the past decade and the peak in starts has not historically been enough to see a sustained recovery in margins. Morgan Stanley's base case is for housing starts to improve to 170,000 in FY14, peaking at 175,000 in FY15 before falling to 165,000 in FY16. The broker would be more positive about the sector if there's signs a residential recovery can last over three years, supported by low rates.

Rates are expected to remain on hold for the next 15 months, which would support a multi-year recovery, but it's too early to price this into stocks. Morgan Stanley wants to see, for sustained outperformance, a longer cycle than past cycles, such that utilisation and price flows through to earnings. The largest downside earnings risk is for those most operationally geared to a recovery such as Fletcher Building ((FBU)), Boral, CSR and James Hardie ((JHX)). There's less earnings risk seen for DuluxGroup ((DLX)) and Adelaide Brighton ((ABC)).

Reform proposals by an influential Chinese think tank will from the basis of a reform policy to be announced at the third plenary session of the eighteenth Chinese Communist Party Central Committee meeting on November 9-12. AllianceBernstein strategists suspect that even a 50-70% success rate for the proposals would contribute substantially to the long-term development of the country. The reform proposals include changes to state-owned enterprises and government reforms to reduce state monopolies, inviting private sector competition in strategic areas such as telecommunications, oil and gas, power generation and banking. They also call for tax reforms, including the introduction of a property tax and changes to the value-added tax to move to consumption bases from production.

The reforms are aimed at achieving a better balance between local and central government revenues and include a land reform, which will allow rural and farm land under collective ownership to be sold at market prices. The proposals highlight the importance of the opening of the Chinese currency, the renmimbi (RMB), and an endeavor to make it a major currency for trade settlement as well as a reserve currency in Asia within 10 years.

Although the US economy continues to grow modestly, the pace has not yet accelerated to levels that might be expected during an expansion. In AllianceBernstein's view, issues related to fiscal policy are partly to blame and  upcoming budget and tax debates will likely determine growth trends in 2014. Implementation of the new health care law has added a layer of confusion. At the margin it will raise cash outlays for existing health policy holders but people who are required to purchase new or revised plans in 2014 may face even larger expenses. It's hard to quantify the incremental burden on the US consumer but, based on AllianceBernstein's estimates, workers will be asked to pay a greater share of overall health care costs.

The recent US government shutdown, with almost 800,000 federal employees laid off for 17 days, will also have a dampening influence on the rate of economic growth in the current quarter. Not only did it disrupt activities directly it also weighed heavily on consumer confidence. Although the loss of output could reach as much as 0.5% annualised in the fourth quarter, the economists think it will be fully recovered by the first quarter of 2014.

Perhaps the biggest headache for the US government, and curtailing growth, is discussions on the budget and taxes. AllianceBernstein doubts that the tax reform negotiations can make any advance in the short term. US businesses will have to wait at least another year, or maybe longer, before Congress approves fundamental tax reform legislation. The growth opportunity is being lost because businesses would be willing to commit more investment to the US if they were confident that the outdated tax code was being reformed to welcome more capital.
 

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

Building Materials Set For Growth Recovery

-Growth outlook improves but mixed
-US contrasts for Boral, James Hardie
-AUD trend favours CSR, Boral, Hardie
-Benefit of carbon tax removal?
 

By Eva Brocklehurst

Building approvals look to be finally on the rise in Australia and Australian building materials stocks have seen price/earnings re-ratings in anticipation of growth recovery. Morgan Stanley thinks FY14 will provide some growth but is inclined to suspect consensus expectations are still too high.

The broker likes paint producer DuluxGroup ((DLX)) the best but does query whether market share growth can be maintained. Dulux has achieved 15 percentage points of gain in market share in the last 10 years. This has continued in the last five years, despite local players - Wattyl, Taubmans - being bought by larger offshore operators. The Alesco acquisition has also boosted the company's market position in a number of sub-sectors. The broker sees Dulux achieving 8% compound earnings growth to FY15. It may not be the strongest, but it is defensive.

CSR ((CSR)) is on the bottom of the list for Morgan Stanley as as the aluminium assets continue to weigh on valuation. Boral ((BLD)) is a preferred stock, although the US turnaround is taking longer than anticipated, while for James Hardie ((JHX)) the margin targets appear achievable. US margins recovered to 21.4% in the first quarter of FY14. Morgan Stanley notes, although US earnings margins are typically 280 basis points higher in the first quarter against the full year, an improved pricing trend through FY14 should mean the company's 20% can be met. JP Morgan thinks meeting the margin target will be a challenge.

JP Morgan has looked in depth at the US operations of both Boral and Hardie. The two are a contrast in terms of  their current performance, outlook and pricing. Boral has had to meet the downturn in the construction industry with deep cuts and restructuring and its US business is dependent on a recovery the intensity of building in brick. James Hardie, on the other hand, has weathered the downturn well and is one of the few building companies that remains comfortably profitable, in the broker's view. James Hardie has a differentiated product and retains high market share while Boral is in a more fragmented industry.

On the flip side, Boral's brick and tile pricing has held up better than James Hardie's cladding. Nevertheless, JP Morgan expects that future increases in prices will need to be considerable in order to restore returns. James Hardie has been trying to sort and stabilise its pricing for some years. JP Morgan contrasts Hardie's earnings over FY08-13 at US$1.1 billion with Boral's loss of US$449 million over that period. Ahead, both are expected to improve profitability.

In terms of a weaker Australian dollar and the impact on local building material company earnings, UBS finds CSR, James Hardie and Boral are most leveraged to the US dollar relationship. Exposures relate to imports, via import parity pricing and competition as well as US dollar denominated revenue/earnings, with US-based divisions or products priced in US dollars. CSR will likely have less import competition and higher prices and aluminum will obtain stronger Australian dollar earnings if the US dollar price of the metal holds up. As CSR's sales are hedged 32% in FY14 this will produce some lag for aluminium's impact. In Morgan Stanley's opinion, CSR offers the best exposure to an improving east coast property market in Australia but outweighing this is the aluminium issue and uncertainty over whether the Viridian business can be turned around.

James Hardie's Australian division earning will be weaker under US dollar reporting but favourable in the translation back into the local currency. Boral's US operations are not breaking even yet and there is also import related competition in timber and plasterboard that will weigh. UBS notes Fletcher Building ((FBU)) has limited direct US exposure and US dollar related import competition in steel and insulation. The Australian dollar weakness against the NZ dollar is neutral for Australian investors and negative for NZ investors in the stock. For Morgan Stanley, Fletcher may have leverage in the Australian assets to the domestic building recovery but may not benefit as much as listed Australian peers. Revenue growth across the company's divisions also looks light and it is one of the broker's least preferred in the sector.

Adelaide Brighton's ((ABC)) cost of importing clinker is expected to rise with the weaker Australian dollar, affecting cement margins should there some attempt by competitor Boral to pressure pricing. Adelaide Brighton's exposure to the lower Australian dollar is the most negative in the sector by UBS calculations. Morgan Stanley concurs it's all about the cement price and the Australian dollar. It may be a high-quality business, benefitting from a recovering Australian housing market, but the broker sees regional and resources related risks. Morgan Stanley prefers Boral over Adelaide Brighton.

The other aspect on UBS' radar for building materials companies is the carbon tax, or the removal of the carbon tax predicated on the incoming federal government getting the legislation through the parliament. UBS notes removal of the carbon tax should take out up to $5-15m in carbon costs per annum across what is a highly energy intensive sector. Boral and CSR earnings will benefit most. The impost of the tax has not been passed on to the customer given the level of import competition. Energy costs for the industry should decline as electricity prices fall if the carbon tax is removed. CSR's aluminium operations should be a key beneficiary of lower electricity costs, with electricity around 30% of the Tomago cost base and energy costs to fall around 15%. Offsetting part of the win is rising east coast gas prices, with Adelaide Brighton the most affected in that regard.

What's happening with import competition? In the insulation market where CSR and Fletcher supply around 90% imports are not significant, despite the cheap supply from Asia. This is an area where the production specifications in Australia defend the local pair. CSR's glass business is the sole manufacturer of flat glass in Australia. Globally there has been a glut and while imports represent a small share as yet of the local market, UBS notes they are on the rise. In timber, the weaker Australian dollar has provided some respite to timber imports while imports of cement and clinker have risen steadily, largely from Adelaide Brighton's adoption of an "import and grind" model.
 

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: Aust Healthcare, Building, Retail, Gaming And Transport

-Solid defensives in Aust healthcare
-Conflicting stories in building
-Discretionary retail trends diverge
-Aust gaming subdued
-Transport dividends up

 

By Eva Brocklehurst

Australia's healthcare sector retains some attractive defensive characteristics but the valuations are not generally defensive, in Morgan Stanley's view. ResMed ((RMD)) holds the most upside potential for the broker. Sonic Healthcare ((SHL)) was upgraded to Overweight during August, joining ResMed, Primary Health Care ((PRY)) and Sigma Pharmaceuticals ((SIP)) in the category.

Morgan Stanley had been concerned that Sonic would miss expectations as a result of fee cuts across major geographies and a benign US volume environment. FY13 results surprised, however, and this provides a higher forecasting base. The broker understands that execution of the US cost cutting program is now complete and benefits are expected in FY14. This cost cutting may negate most known fee cuts in FY14 and provide the platform for growth which the broker was previously skeptical about. Sonic is considered a defensive volume growth story.

US device growth at 16% in FY13 was in line with expectations and ResMed benefitted from the shifting of the mix as home sleep testing accounts for a greater proportion of prescriptions. Mask sales growth in the US was over 8% in the second quarter but ResMed lost share. The broker expects new releases will claw back this lost share and revenue could surprise on the upside if the new devices gain traction. Home Sleep testing now accounts for over 30% of US volumes and is expected to approach 40% over the next year. The competitive bidding pricing is already known for the bulk of round two contract winners and this leaves ResMed with good forward visibility and confidence in the outlook.

Building materials stocks have seen price/earnings re-rating that was ahead of results, in anticipation of a growth recovery. Morgan Stanley thinks FY14 will provide some growth but for the most part consensus expectations are seen as still too high for the broker's liking. The most preferred stock is DuluxGroup ((DLX)), a high quality company generating a high return which justifies its P/E premium, in Morgan Stanley's opinion. Dulux has more defensive earnings characteristics than other building materials stocks, but still offers solid growth prospects. Earnings upside may come from a sharp fall in the titanium dioxide price, which is a significant input cost to paint. Working capital opportunities in the former Alesco businesses could drive further upside.

The broker's least preferred stocks are Fletcher Building ((FBU)) and CSR ((CSR)). Fletcher is exposed to a recovery in the New Zealand housing market, where it is the leading player through its vertical offering. This is the main positive. There is no FY14 guidance, and consensus expectations for FY14 and FY15 appear aggressive to Morgan Stanley. Revenue looks light across most of the divisions. No significant volume growth is expected in Australia while North America remains mixed - positive on the residential but flat on the commercial side.

CSR is positioned for a recovery in the Australian residential market but the broker sees challenges within aluminum and the Viridian turnaround requires proof. CSR offers some of the best exposure to an improving east coast property market but it's not enough to change an Underweight recommendation. Strength in building products is offset by execution risk in Viridian and risks around the aluminium assets.

JP Morgan has taken a look at the US operations of Boral ((BLD)) and James Hardie ((JHX)). Boral's performance through the downturn has mirrored that of the broader construction industry, i.e. spiralling losses, followed by deep capacity cuts and restructuring efforts. The future of the US business hinges on a number of factors, in the broker's opinion, principal among these being a recovery in brick intensity.

In contrast, James Hardie's performance through the downturn has been exceptional as it is one of the few building-related entities in the US to remain comfortably profitable. In fibre cement James Hardie stands out with a differentiated product and high market share. Boral has been affected by the volatility that is typical of fragmented industries such as bricks and tiles. In terms of pricing,  brick and tile that was resilient, although future increases will need to be considerable to restore returns, in JP Morgan's view. Again, in contrast, James Hardie has battled on the price front.

Australian retailers had a stronger second half of FY13 with earnings up 4% relative to the 3% lift in the first half. UBS finds household goods in terms of JB Hi-Fi ((JBH)) and supermarkets in terms of Woolworths ((WOW)) reported the strongest results. Billabong ((BBG)) and Pacific Brands ((PBG)) were notably soft.

For the staples, reactions were mixed while results were in line. Whereas Wesfarmers ((WES)) fell as the softer second half for Coles was construed negatively, despite Wesfarmers announcing a capital return, Woolworths ((WOW)) performed strongly, as the market reacted to the upbeat commentary on FY14 momentum. UBS views the grocery sector as fair value, but thinks Woolworths has the greatest scope to outperform. The third player, Metcash ((MTS)) sustained 5-10% downgrades in the wake of its AGM, as IGA sales were reported to be hit by heightened levels of fuel discounts by the major chains.

In discretionary retailing the trends parted. Household goods, underpinned by improving house prices, performed well while the department store/fashion area was soft. Looking forward, UBS expects this trend to continue, with increased competition in fashion to present a risk to department store forecasts and an improving housing backdrop to provide upside to those stocks such as Harvey Norman ((HVN)) and JB Hi-Fi.

Crown ((CWN)) and Aristocrat ((ALL)) remain Deutsche Bank's favoured stocks in the gaming sector. Australian gambling expenditure is expected to remain subdued through the remainder of 2013. Crown will benefit from its exposure to the higher growth Macau and Perth markets and has introduced some cost reduction initiatives in order to offset the weaker trends at Crown Melbourne. Aristocrat is sustained by the fact it generates just 27% of earnings from Australia. Of note to the broker, Crown and Tabcorp ((TAH)) were unusually quiet about trading in July and August. Echo Entertainment ((EGP)) and Tatts ((TTS)) reported positive trends. Echo was boosted by strong growth in the VIP segment while Tatts benefited from a favourable jackpotting sequence in lotteries.

The weakness previously seen in gaming machine expenditure has also affected gaming tables, and there's been a softening in wagering and keno expenditure. Conversely, lotteries expenditure has remained buoyant, although Deutsche Bank thinks this can largely be explained by the favourable jackpotting sequence. In order to offset the weaker than anticipated top line growth, some of the companies introduced cost reduction initiatives and there is an increased focus on cost control and margin improvement.

Transport produced three main themes from the earnings season. In Deutsche Bank's view, these are cost reductions, higher dividends and an uncertain outlook. Most results were in line with forecasts. Qantas ((QAN)) showed the largest variance because of an accounting adjustment to the treatment of ticket revenue. Dividends were generally higher, with Aurizon ((AZJ)) standing out. Asciano ((AIO)), Royal Wolf ((RWH)) and Toll Holdings ((TOL)) all delivered better-than-expected dividends. The changes to FY14 earnings expectations were mostly small, with the airlines being the largest downgrades on the back of fuel and capacity/yield pressures.

Deutsche Bank now has three Buy recommendations in the large cap transport space, these being Asciano, Aurizon and Toll. Toll is being more disciplined on costs and strategy but has less earnings visibility than the other two. Brambles ((BXB)) is no longer a top pick and was downgraded to Hold from Buy during the earnings season.
 

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.