Tag Archives: Consumer Discretionary

article 3 months old

Weekly Broker Wrap: Oil Price, Property, Aust Dollar And Wagering

-Reduced demand for coal, gas?
-Authorities target property investors
-Aust dollar weakness likely preferred
-State, industry racing revenue broadens
 

By Eva Brocklehurst

What does a lower oil price mean for Australia? It is positive for household spending and Commonwealth Bank analysts calculate the fall of 20% since mid year equates to a lift of around 0.2% in household income. IMF calculations suggest that a 10% fall in the oil price equates to an increase in global GDP growth of around 0.2%. The current downtrend is not just about higher supply but also weaker demand. The supply-side shock is occurring as US output lifts from non-conventional sources. Supply has also surprised on the upside from countries such as Libya. On the demand side, there are indications growth from India and China will be lower than expected over the coming year.

For Australian households, secondary effects could occur as lower transport costs are passed on. Discretionary retail, where price elasticity is high, is usually a major beneficiary of a fall in petrol prices. The analysts point out a lower oil price has dampened inflation expectations and bond yields, and is already showing up in the inflation data. From a national perspective, lower oil prices will decrease demand for other substitute energy sources, namely coal and gas. This could result in a trade shock with some rough calculations suggesting a 20% fall in oil prices equates to a terms of trade reduction worth around 0.4% of nominal GDP.

There will be some offsets. Fuel makes up a considerable proportion of business costs and the industries with the highest consumption are transport, manufacturing and electricity. These will likely benefit. The choice of improving margins and profitability or passing on lower costs will come down to the competitive pressures, in the analysts' view.

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Domestic housing-linked stocks have been affected by concerns about macro prudential policies being tightened and a resultant pullback in housing approvals. Morgan Stanley is not overly worried, as the relevant authorities, the Reserve Bank of Australia and Australian Prudential Regulation Authority, will likely be scrutinising investors in established property. The broker anticipates higher serviceability buffers and capital requirements such as risk weights or capital ratios are most likely.

The RBA has described the housing market as becoming unbalanced but its concerns lie specifically with investors in established housing in Sydney and Melbourne and inner city apartments in Melbourne. Morgan Stanley observes Australia is along way from an oversupply in housing while a sustained construction cycle is helpful in boosting supply. Hence, the broker envisages building stocks can still outperform, even as more difficult comparables are cycled.

AllianceBernstein still believes the fundamentals are supporting capital markets even as investors express concern that valuations are stretched. The analysts observe that markets have been expensive before, even for lengthy periods, without enduring a calamity. Ordinarily, the analysts note, the Australian dollar would act as a shock absorber and fall to offset some of the income squeeze coming from lower iron ore and coal prices. As yet, the falls have only been modest relative to the slide in commodity prices and this is proving to be a headache for the central bank.

AllianceBernstein notes momentary easing was initially intended to boost the housing sector through construction activity but also resulted in a surge in lending to investors and in doing so may have been too successful. This highlights the potential for some form of policy restraint on the sector.

CIBC observes, despite attempts by the RBA to maintain a stable bias in rates, markets are pricing in easier policy amid uncertainties in the real economy and commodity market weakness. This points to underperformance by the Australian dollar. The analysts suspect the RBA may well prove to be another central bank that encourages a bout of currency weakness to counteract less-than-encouraging trends. The RBA would prefer conditions ease via the currency than via interest rates, as household debt levels remain high. The analysts acknowledge the currency does look rich when compared with other similarly based valuations and expect the Australian dollar to fall to US82c in the coming year.

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Investor updates from the likes of Tabcorp ((TAH)), Paddy Power and William Hill suggest to Credit Suisse that wagering industry growth is being stimulated by smartphone technology, led by the Europeans. Still, regulatory change could level the field and enable all three operators to grow revenue. The broker observes Paddy Power and William Hill are over-indexed to market growth drivers of mobile, fixed odds and sports betting and their high gross profit margins, unburdened by state taxes, allow them to spend more in terms of marketing their product.

Meanwhile, Australian racing industry regulators have shown a willingness to devise new fee arrangements that selectively tax corporate bookmaker products and favour incumbent tote operators. There are potential headwinds as the industry and governments seek to broaden revenue sources away from lower growth totes.
 

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article 3 months old

Can JB Hi-Fi’s Momentum Stretch Beyond Xmas?

-Stock undervalued for Credit Suisse
-Costs growth unclear
-Low-margin categories improve
-Citi considers outlook remains poor
 

By Eva Brocklehurst

JB Hi-Fi ((JBH)) provided much needed relief for brokers with its AGM update, signalling sales trends have ratcheted up a gear from the very weak conditions at the start of the financial year. FY15 sales guidance implies 3.0% year-on-year growth.

The stock has now sold down to a level which is too low to ignore, in Credit Suisse's view. The recent improvement in trading conditions should continue and the broker observes the shares offer significant relative value to the ASX200 and global peers. The stock is trading at a once-in-a decade discount of 15%, despite the unchanged investment proposition. Like-for-like sales declines of 2.1% in the year to date represent a significant improvement on the rate of decline, 5.5%, reported in July.

Moreover, there is additional upside to sales and gross profit from a depreciation in the Australian dollar. All this adds up to a compelling valuation in Credit Suisse's view, hence, an upgrade to Outperform from Neutral. UBS continues to forecast first half margin compression and expects profit to be flat before improving in the second half. While there were periods of increased promotional activity UBS observes it was rational. The biggest opportunity for expanding gross margins comes in lifting penetration in higher margin appliances via the home segment as well as accessories, in the broker's opinion. Still, the improvement from the start of the financial year is marked and there has been no major change in promotional activity so for UBS the trading update was a positive. 

JP Morgan is not so convinced. The broker makes a case for downgrading the stock to Neutral from Overweight, with operating costs and capex expected to rise and gross margins expected to remain in line rather than expand. There is a risk the cost of doing business will rise because of growth plans in newer categories. The broker could become more constructive on the stock when the extent of cost growth is clearer and the share price is more attractive against valuation.

Like-for-like sales may still be down to date but Deutsche Bank expects the company can achieve its FY15 guidance. This broker is also concerned about the lack of commentary on gross margins and suspects the market expectations for gross margin improvement may not be met, as sales are being driven by low-margin categories. Industry feedback suggests promotional activity in IT segments has been benign but Deutsche Bank is concerned that excess inventory may prompt aggressive discounting in this category. FY15 capex guidance is $50-55m, which represents an increase of 39-53% year on year, largely driven by the roll out of the home category.

Morgan Stanley expects that, as a greater number of games are released, the sales trajectory will remain solid. This category represents 17% of the company's sales. The issues surrounding tablets is largely over, with the prior period (to July) heavily impacted by weaker tablet sales and low confidence.

The good news was only on the surface, in Citi's opinion, with the company sacrificing gross margin to achieve better sales. The broker is not buying the improvement story, expecting the trends will peter out beyond Christmas, given the product pipeline is weak. The drivers of improved sales were iPhone 6, Surface Pro 3 and games consoles, all low margin products. Moreover, new store growth is likely to be low with the broker forecasting new store sales growth of 2.6% in FY15. Comparable store sales need to rise 1% to meet guidance and Citi considers the outlook is poor for the next 18 months.

FNArena's database contains four Buy, three Hold and one Sell ratings. Consensus target is $18.14, suggesting 15.0% upside to the last share price. This compares with $18.61 ahead of the update. Targets range from $15.10 (Citi) to $20.30 (UBS). Dividend yield on FY15 and FY16 is 5.4% and 5.7% respectively.

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article 3 months old

Gloria Jean’s Boosts Retail Food’s Potential

-Multiple growth drivers
-36% FY15 profit growth forecast
-Some structural issues
 

By Eva Brocklehurst

Gloria Jean's has put extra sugar into Retail Food Group's ((RFG)) morning coffee. Retail Food has substantially raised the ante on its medium-term earnings potential after announcing it has acquired the coffee shop chain.

Retail Food now boasts multiple growth drivers and the acquisition has inspired Morgans to upgrade to Add from Hold. The acquisition involves around 800 franchised Gloria Jean's outlets across 42 countries with 358 in Australia. While acknowledging the risks in an acquisition of this size, Morgans believes the potential is hard to ignore. The company also has a wholesale coffee business with two roasting facilities. The $163.5m price with $16.4m in milestone payments will be funded by a capital raising of $55m, $10m worth of scrip for the vendors, and debt. Morgans expects 25% underlying earnings growth in FY15/16 and sustainable double digit returns over the medium term.

Risks centre on the sustainability of the Gloria Jean's domestic footprint, given the decline in local outlets has not yet stabilised, after peaking at 500 in 2012. Retail Food has made provision for a further 40 shop closures. This may raise some questions about the brand but Morgans believes franchise capabilities, along with the broader opportunity within the segment, should deliver a solid outcome. A large part of the store rationalisation to date has been company-owned stores. After incorporating the acquisition Morgans' calculations suggest, at a valuation of $6.06, the stock would trade at a FY16 price/earnings multiple of 14.6 times and a 4.5% dividend yield.

JP Morgan is not so buoyant, believing the acquisition is at the top end of the range paid for historical acquisitions, although acknowledges 25% accretion to earnings in FY16. There are synergy opportunities and the potential for leveraging the wholesale coffee business but the broker questions the health of the Gloria Jean's model, given it re-exposes Retail Food Group to shopping centres. The company has upgraded FY15 guidance for profit growth to 36%, including both Cafe2U and the Gloria Jean's acquisition. This compares with 18.5%, including Cafe2U, that was previously forecast. Guidance is based on the closure of those 40 stores identified with extremely high rent-to-sales ratios. JP Morgan notes the company has actually only planned for the closure of 22, although provisioning for 40, which means there is upside to guidance.

Despite market studies conducted by Retail Food which found that Gloria Jean's had the best coffee sales up to 11am, JP Morgan is reminded that Gloria Jean's was close to insolvent in 2010. Still, Retail Food believes this background is outweighed by the synergies and the wholesale and international opportunities. JP Morgan maintains an Underweight rating, pending results from the capital raising.

To UBS the acquisition is transformational and deserves an upgrade to Buy from Neutral. This is based on achieving targeted synergies which would imply additional earnings of $37m by FY17, translating to earnings per share of 47c or higher. In the broker's sums the valuation range works out at $5.40-6.15, well above the current share price at around $5.30. UBS envisages abundant scale and network benefits but also a number of structural growth issues. Ultimately the broker's Buy thesis rests heavily on supply/cost synergies while execution remains the key risk.
 

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article 3 months old

Time To Buy Retail, But Not Supermarkets

-Tables turn on grocery suppliers
-Major supermarket profit growth to slow
-Discretionary price rises encouraging
-Reasons, now, to buy retailers


By Eva Brocklehurst

UBS has decided to put to rest the supposition that suppliers to supermarkets "over earn". In 2012 the broker's analysis found that Australian supplier margins were 210 basis points below the global average but their returns on investment capital (ROIC) were higher, leading to the conclusion that, while suppliers were under pressure, they had more to offer the retailers.

The broker has revisited its assumptions and now finds that gross margins have fallen more than earnings margins, suggesting suppliers have become more efficient and have cut costs. ROIC has fallen materially, and is now 13% compared to the global average of 21%. The magnitude of the decline in supplier profitability means UBS questions the ability of retailers to extract the same margins from their Australian supplier base. This could be a negative signal for Coles ((WES)), Woolworths ((WOW)) and Metcash ((MTS)) in the broker's view as, along with the emergence of Aldi and increased government scrutiny, driving margins via tighter terms with suppliers will become more difficult. Near-term margin growth for Australian supermarkets looks constrained with Metcash and Woolworths considered most at risk.

Morgan Stanley also observes the profit shift to Coles and Woolworths at the expense of suppliers and smaller food retailers. The broker suspects profit growth for the majors will slow and more regulation will become a headwind. The broker's analysis shows aggregated profits in the grocery industry have been reduced to $10.7bn from $11.9bn in FY10 but supplier profits have fallen to $3.7bn from $6.1bn, while Coles and Woolworths combined have increased annual profits to $4.4bn from $3.1bn.

Should the retail profit pool remain flat at the current run rate, the majors will control 100% of the pool by 2020. However, the broker observes the consumer regulator, ACCC, is now taking a more active stance to increase competition in this industry by removing restrictive lease provisions, taking retailers to court over unconscionable conduct and limiting fuel discounting. This will make it more difficult for the majors to expand margins, in the broker's opinion.

Checking the pulse of apparel retailers, Credit Suisse notes Myer ((MYR)) persisted with a big mid-season sale while apparel prices at David Jones, in contrast, were stable and even showed some inflation. Price increases have occurred for the fourth consecutive week at Dick Smith ((DSH)), with aggregate price points in line with January levels. Prices have rebounded more than 12% from peak discounting levels in mid September. Meanwhile, minor price rises have occurred at JB Hi-Fi ((JBH)) and Harvey Norman ((HVN)), which Credit Suisse finds encouraging for the sales and gross margin outlook at both retailers. One category where there is no sign that competition is abating is in white goods, with price points under pressure throughout 2014.

Sales growth is looking better but retailers are struggling to hold onto margins, given lower FX rates, while cost cutting opportunities are harder to find, in Citi's opinion. The broker likes those retailers that are in control of their margin gains through sourcing and supply chain savings such as Super Retail ((SUL)) and Specialty Fashion ((SFH)). The best performers in FY15 are expected to be in food-related categories or those tied to strong house price growth. While FY14 revealed the weakest margin performance among retailers in several years and a need to shift focus to sourcing opportunities and reduce mark-downs, the broker suggests there are some reasons, finally, to buy retail stocks.

Citi is more positive because petrol prices are lower and budgeted tax increases have not been implemented. This could boost retail spending by 1.7%. The broker now rates OrotonGroup ((ORL)) and Pacific Brands ((PBG)) as Buy and has upgraded Myer and Premier Investments ((PMV)) to Neutral. Household finances are in better shape but the near-term risk for retail spending is in initiatives stemming from the government's mid year fiscal and economic outlook, which is released some time before Christmas.
 

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article 3 months old

Leisure Drags On Super Retail

-Potential for Ray's Outdoors, FCO closure
-Share price fall mitigates some pressure
-Christmas trading the key variable
 

By Eva Brocklehurst

Super Retail ((SUL)) is a poster child for the struggle retailers are having with an inconsistent start to FY15. Several brokers have now put opinions on hold until the company decides what to do with its leisure division. Trading over the first 16 weeks showed a slight improvement, but at its AGM the company said it expects gross margins to be flat on a full year basis. That spells further discounting for brokers.

Deutsche Bank considers the performance is reasonable in a patchy retail environment. Leisure continues to disappoint and the broker looks for clarity around the future of Ray's Outdoors and New Zealand-based Fishing Camping Outdoors (FCO) before taking a more positive view. The problems in leisure are worse than JP Morgan feared, the broker downgrading its recommendation to Neutral from Overweight. There is also lower-than-expected margin recovery potential in the sports division. Like-for-like sales growth for the period revealed automotive division sales were up 4% and sports up 3% while leisure was down 8%.

JP Morgan acknowledges it underestimated several issues such as the systemic challenges in leisure, including cannibalisation from new stores and the reliance on resources industry business in terms of the BCF brand, as well as the ineffective changes at Ray's Outdoors and the deterioration in the FCO business. The broker considers the problems are probably beyond repair in leisure, while a recovery in margins in sports appears weaker than previously expected. Automotive remains the only division where the broker is confident the targeted 11% earnings margin will be achieved. It could be worse. The share price has already declined and achieved some valuation support and this averts a more negative rating, from JP Morgan's perspective.

Credit Suisse retains a Neutral rating on the stock and believes Ray's Outdoors and FCO will likely close. The broker thinks the company has misjudged the attractiveness of these markets and the expense associated with repositioning Ray's Outdoors. Under such a closure scenario it is likely a proportion of the stores could be transferred to the BCF brand. Discounting is hurting margins in UBS' view and the broker reduces FY15 earnings forecasts by 7% to reflect revised guidance, despite the expectation that like-for-like trends should improve into Christmas. UBS is confident that execution is improving and acknowledges, if trends continue to improve, there is upside to its revised forecasts. Moreover, the broker believes it highly unlikely the Ray's Outdoors chain will be closed or sold, although a major overhaul is likely.

Macquarie revises first half earnings forecasts down by 5%. The broker believes Christmas is the key variable, particularly for sport and leisure. Leisure was expected to be weak, but not as negative as is the case. The broker observes trading conditions in mining-related areas remain challenging and it will take until the second half to confirm any improvement in leisure. As the stock is now trading at a substantial discount to the market, Macquarie retains an Outperform rating on a medium term view. Citi expects some more disappointment may be forthcoming at the interim result but remains confident in management's ability to turn around the weaker parts of the business.

Given the performance of Ray's Outdoors is already weak, Morgan Stanley considers the impact of any closure will be small. The broker arrives at a cash cost of $81m for the closure of both Ray's Outdoors and FCO. Ray's Outdoors contributes 1% to profits so the future earnings impact is expected to be negligible. Moreover, 30-40% of stock could be migrated across to neighbouring BCF stores, which would limit the need to make heavy write-downs. Morgan Stanley believes the share price pull back is overdone, having declined 14% since the FY14 results. Long-term growth potential remains intact in the broker's opinion and an Overweight rating is retained.

FNArena's database contains four Buy and three Hold ratings on Super Retail. Targets range from $8.30 (JPM) to $10.90 (UBS). The consensus target is $9.42, suggesting 23.0% upside to the last share price, and compares with $10.03 ahead of the AGM. Dividend yield on FY15 forecasts is 5.1% and on FY16 it is 5.8%.
 

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article 3 months old

GWA Imports A Cleaner, Leaner Strategy

-FY15 dividend reduction, or absence
-Capital return probable from sales
-Eventually, a cleaner business
 

By Eva Brocklehurst

GWA ((GWA)) is setting the stage to primarily be an importer of home renovation products. Shareholders may have become used to the company's restructuring over recent years - Citi observes eight out of the past 10 have recorded restructuring expenses - but another nail in Australian manufacturing's coffin has been hammered home.

Among the initiatives the company has announced are the closures of both production facilities in Sydney and Adelaide. The Sydney vitreous china facility at Wetherill Park will close by the end of the year, to be sold and leased back, while the Norwood plastics facility in Adelaide will be phased out over three years, as the company manages the transition to sourcing material externally. Being an importer makes strategic sense to Macquarie but that does not mean execution risk is eliminated. The reduced reliance on Australian-based manufacturing capacity is another operational issue for the company to manage. Macquarie is cautious, and believes there are risks restructure may limit GWA's ability to capitalise on improving market conditions. The company will reduce its head count by 10% and further rely on offshore supply for its bathroom ware range.

Importantly, an impairment charge of $29m will affect the company's ability to pay franked dividends in FY15. Citi suspects dividends will be scaled back at the very least, or perhaps cancelled altogether. That said, upon divesting its Wetherill Park facility as well as the Dux and Brivis brands, the company could still return funds to shareholders as special dividends or via some other distribution mechanism. The broker believes GWA is well placed for the housing recovery and will turn out to be a leaner, cleaner business over time. GWA's profits come from housing completions and these are derived as the housing upswing matures, meaning the current improvement in housing is yet to show up in terms of volumes.

The changes to production mainly affect the bathrooms & kitchens division, which represented 89% of earnings in FY14. This figure includes Dux, which is underperforming and which the company intends to sell. The other businesses, Brivis, Gainsborough, Gliderol. collectively represent just 11% of earnings.

A strategic review in mid 2014 identified both Dux (hot water) and Brivis (heating & cooling) as non-core and UBS believes the sale of these would be positive, freeing up capital to deploy in divisions with stronger returns and more robust market positions. Without these two, the residual business should provide a cleaner play on the domestic renovations market, in UBS' view. Still, the broker agrees, until they are disposed of, there is a messy period ahead with closures, redundancies, sourcing offshore product and selling down inventory. UBS concurs that momentum in the residential market is yet to be fully reflected in GWA's turnover but it is the uncertainty regarding the execution of restructuring initiatives that will likely constrain the share price in the near term.

To Deutsche Bank, the move to source offshore was inevitable. The company expects to achieve $4m in annualised savings and, excluding the 3-year sale and lease back at Wetherill Park, annualised savings rise to around $8m. The broker believes the respective sales of Dux and Brivis are on track for FY15 and should be valued up to $100m. The broker expects a capital return is probable because of the lack of franking credits by the FY15 result. Deutsche Bank has upgraded to Hold from Sell, given 7% upside to the current share price.

Goldman Sachs considers a capital return is the mostly likely method of returning proceeds, although an on-market buy-back is also a possibility. The broker forecasts no dividends for FY15 but adds an 11c capital return from the sale of the Wetherill Park site. There is the prospect of greater returns if the Brivis and Dux businesses are sold. Goldman calculates that capital return and earnings-per-share dilution from the potential divestments, assuming the price/earnings ratio is unchanged, yield an uplift of 1.6%. Hence, these divestments are not a material source of value. However, add a potential 6.6% uplift in value from the retention of FY15 earnings and this results in a total potential net return to shareholders of 8.3% for FY15, despite no dividend being paid.

On FNArena's database there is one Buy rating - Citi. There are four Hold ratings and one Sell. The consensus target is $2.95, which suggests 12.2% upside to the last share price and compares with $3.01 ahead of the announcement. The dividend yield on FY15 forecasts is 3.8% and on FY16 it rises to 5.8%.
 

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article 3 months old

Treasure Chest: Confidence In Billabong’s Recovery Growing

By Greg Peel

In July last year it appeared the once dominant, Australian-founded global surfwear retailer Billabong International ((BBG)) was set to meet its demise. After a peak at close to $17.50 in 2007, the GFC and the company’s debt burden conspired to send the share price to a near terminal 13c.

At that point Billabong was rescued with a third party refinancing deal which saved the company but seriously diluted shareholder equity and earnings per share upside. Asset sales have helped shore up the balance sheet and takeover speculation saw Billabong’s price spike up a couple of times in the interim, but nothing eventuated and any earnings recovery was still proving challenging at the company’s first half FY14 result in February.

It was at the FY13 result the previous August that management outlined a seven point recovery plan for Billabong, and at the time neither management, nor stock analysts, assumed a swift and easy road ahead. The challenge was underscored by an FY14 result, released this last August, which showed a 35% drop in earnings from FY13. But sales growth had improved, at least in Asia Pacific and Europe if not so in North America, and this was enough to encourage Deutsche Bank to upgrade its rating to Hold from Sell.

Citi stuck with a Hold rating and the only other FNArena database broker left covering the stock after its fall from grace, JP Morgan, was unable to make a recommendation due to its role as advisor to the company.

That period of restriction has nevertheless now ended. JP Morgan is again able to make a recommendation and has effectively double-upgraded from its Underweight rating in place last February to an Overweight rating. The broker has lifted its twelve-month target price to 87c from 52c prior to restriction.

Progress is being made on Billabong’s seven-part turnaround plan and the broker retains confidence in a path of revenue growth, margin expansion and capital efficiency. Investors, too, have seen encouraging signs for the retailer, hence the share price has rallied from a previous low of 46c in August to 69c as at Friday’s close. But despite the rally, and despite a likely moderation in the pace of earnings recovery in FY15 and ongoing near term trading challenges, JP Morgan believes the risk-reward balance for investors remains attractive.

The company’s turnaround is still in its early stages but the broker can identify drivers of medium to longer term performance improvement, including the exploitation of Billabong’s well-known brand through marketing strategies, gross margin expansion through supply chain organisation and financial discipline, and capital improvement through capex discipline and working capital improvements.

While higher marketing costs will need to be absorbed, the strategy should deliver growing revenues, a lower overall cost of doing business and, subsequently, higher earnings margins, the broker suggests.

At 87c, JP Morgan’s price target is now a stand-out next to Citi on 60c and Deutsche Bank on 50c, both of whom retain Hold ratings to JP Morgan’s Buy equivalent.
 

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article 3 months old

Weekly Broker Wrap: Retail Sales & Stocks; Bank Merger Pondered; Aussie Dollar & Mining Stocks

-More muted retail sales cycle
-Department store share dwindles
-A merger could lift BEN's credit rating
-AUD fall impacts resource earnings
 

By Eva Brocklehurst

Australia's consumers seem to have hibernated again. Citi notes retail sales softened in August and exhibited slowing across most discretionary categories. Furniture appears to have escaped much of the weakness, while cafes & restaurants remain strong. Citi expects retail spending to grow by 4-5% over the next year. The good news is that online leakage and pressure from higher utility bills have eased. The bad news is the retail cycle is expected be more muted this time because income and credit growth are missing. The broker does not believe some of the lofty P/E ratios are justified for many ASX-listed stocks and has Sell ratings in place for JB Hi-Fi ((JBH)), Myer ((MYR)) and Premier Investments ((PMV)).

UBS also observes retail sales growth was below expectations in August. Looking forward, better gains are expected because of house price growth, stable consumer confidence and a moderately improving jobs market. The broker notes housing-related categories are doing well, but department stores are disappointing. UBS also observes furniture stood out, with 9% sales growth in the month, which supports Harvey Norman ((HVN)). Conversely the department store outcome was a negative for Myer. The broker reiterates a preference for Woolworths ((WOW)), as grocery majors continue to win share from the independents, and for Breville Group ((BRG)), which is increasing offshore market share.

On the subject of department stores, Citi notes these sales now only account for 6.3% of total retail sales, and this share is likely to decline further given the shift in consumer buying patterns. The broker does not believe the pick-up in dwelling investment and established house prices is providing the traditional strong boost to those retailers linked to the housing market, such as furniture, homewares, building/garden supplies and electronic goods. Sydney remains the hot spot in terms of house price growth and Citi expects, with weakness elsewhere in the domestic economy, regulators will announce some form of targeted policy to help contain the property market risks.

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Bell Potter has contemplated a tie-up between Suncorp ((SUN)) and Bendigo and Adelaide Bank ((BEN)), extolling the virtues in terms of the highly compatible culture, parochial markets and familiarity with multi-brand distribution channels. The broker estimates the value of the combined banks would be $11.7bn. The merger would also provide geographic and operating scale, particularly for agribusiness lending, as well as synergies of around 16% of the combined cost bases from rationalising and re-sizing the combined branch networks. Bendigo and Adelaide's long-term Standard & Poor's credit rating could also lift, with favourable consequences for overall wholesale funding costs. Financial outcomes are also considered compelling. Attributing a 75% probability of Suncorp divesting its banking business to Bendigo and Adelaide would lift the price target by around 40c per share, in Bell Potter's calculations.

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Morgans has adjusted positions in its cross-asset portfolio to make way for a new equity investment and raise funds for the Commonwealth Bank ((CBA)) PERLS VII hybrid offering. The broker sold ANZ Bank ((ANZ)) capital notes and AMP ((AMP)) subordinated notes to raise the funds for the PERLS VII offer. Since inception the portfolio has generated a return of 8.12% while the blended index has returned 7.37% and the bank bill index 2.00%. The broker added a new property name - 360 Capital Industrial Fund ((TIX)) - buying in at $2.36 a share following the recent equity raising and acquisition.

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UBS suspects earnings forecasts for most of its base and precious metal equities under coverage could be materially understated as the Australian dollar falls. The recent weakness in the local currency has more than offset the decline in US dollar metal prices for copper and nickel, while the gold price in Australian dollar terms is largely unchanged. Looking ahead to 2015 the spot Australian dollar copper and gold prices are 13% and 8% above UBS estimates, respectively, and this could drive potential earnings upgrades for relevant stocks. In contrast, the spot Australian dollar nickel price is 21% below current forecasts for 2015.

The broker observes that investors are nervous, with most equities pricing in substantially lower US dollar prices. It seems to UBS they continue to fear the US dollar's rise and the Chinese economic outlook amid perceptions of ample supply in key commodity markets. In this respect the iron ore price slump may also be rubbing off on other resource equities, in the broker's opinion.

Running the sensitivities ruler over the stocks under an Australian dollar at US85c means those with the most to gain are those with mines in Australia. This list includes Sandfire Resources ((SFR)), Independence Group ((IGO)), Western Areas ((WSA)), Panoramic Resources ((PAN)), Regis Resources ((RRL)), Silver Lake Resources ((SLR)), OZ Minerals ((OZL)) and Newcrest Mining ((NCM)). Offshore producers such as PanAust ((PNA)), Alacer Gold ((AQG)), Tiger Resources ((TGS)), Beadell Resources ((BDR)) and Perseus Mining ((PRU)) are less affected. The broker prefers the names with low cash costs and robust balance sheets such as Sandfire and PanAust in copper, Sirius Resources ((SIR)) and Western Areas in nickel and Alacer in gold.
 

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article 3 months old

Is There Any Value In Treasury Wine?

-Need to divest, create alliances
-CEO's strategy considered positive
-But many challenges remain
 

By Eva Brocklehurst

Treasury Wine Estates ((TWE)) has ended discussions with the two private equity concerns stalking the stock. After an eventful six months or so of due diligence, negotiations foundered as Treasury Wine's board rejected proposals from both parties. Treasury Wine's major shareholders concluded that the $5.20 indicative offer undervalued the company, whilst the private equity groups could not structure a deal at a high enough price for regulatory and financing reasons.

Credit Suisse describes the speculated takeover of Treasury Wine as a "hypothetical fiction of investor imagination" but believes CEO Michael Clarke has validated his business improvement plan. He remarked that one of the firms started out with a different idea about how to improve the business and eventually aligned its vision with that of management. Credit Suisse concludes the saga confirms the impracticality of breaking up the company to create value. It also reflects an urgent need to divest underperforming brands and engage in alliances. Two key areas in this regard will be Asian distribution alliances and commercial wine exposures. Nevertheless, Credit Suisse does not envisage any single potential transaction will dramatically change the value of the company.

Treasury Wine will now look for merger and acquisition opportunities and alliances to grow its Asian and European operations and focus on improving its "lazy" balance sheet. It will make more targeted marketing campaigns, cut overheads, separate the commercial wines from the luxury and masstige brands, invest in premium wine inventories and adjust vintage release dates. UBS cannot fault this strategy but does not believe it will be easy.

Macquarie was impressed by some of the initiatives the CEO outlined, particularly the focus on tighter marketing spending, more effective release dates for Penfolds and better earnings form the commercial end. Considering commercial wine accounts for around 70% of group volumes, lifting the profitability of this segment could be material. Macquarie was unsurprised at the inability of the bidders to come to a formal offer, noting that regulatory issues in the US would have been an obstacle.

US regulations require a three-tiered system of manufacturing, wholesaling and retailing alcohol and, in the case of Kohlberg Kravis Roberts, existing ownership of a retail business means it would be unable to buy Treasury Wine's US manufacturing operations. TPG was unable to proceed because a $5.20 price meant it was unable to obtain an acceptable level of debt funding. Macquarie believes further bids are unlikely to surface, so the focus is back on the challenging fundamentals.

The premium built into the stock on the anticipation of a successful offer is likely to take some time to wash out in JP Morgan's view. The broker remains concerned the share price is again being based on overly optimistic expectations regarding the timing and quantum of a turnaround. The broker could become more positive on the stock below $4.20.

The impact of the Australian dollar may also be overstated as the market fails to take into account the amount that is competed away, because of similar benefits accruing to other wine producing countries. The proportion of the benefit that Treasury Wine is able to retain from the fall in the currency comes down to the change in margins relative to its competitors. JP Morgan observes there is no cost advantage relative to other Australian wine producers from a falling Australian dollar. Again, the broker believes the market dynamics are difficult and there is much uncertainty around the near-term earnings outlook for Treasury Wine.

The private equity firms failed to proceed because, in Credit Suisse's view, there was no silver bullet to unlock significant value and rapidly retire debt, or partially fund the transaction. Divesting brands would not realise significant value because of their low margins, or declining revenue profiles, and divesting geographies would probably have resulted in complex licensing and distribution arrangements. Credit Suisse maintains Treasury Wine must be valued on cash flow, especially in a highly leveraged private equity situation where debt obligations, rather than investor perceptions, are the reality.

In looking at the last five years the broker finds there has been no financial improvement, as cash flow peaked in 2012 and has fallen since. The share price has appreciated 30% while earnings power and debt obligations have not improved. Credit Suisse observes investors seem to be valuing the company above its cash flow generating potential and this may relate to valuations of other luxury goods stocks.

So, Credit Suisse is also discarding a discounted cash flow valuation in favour of a comparative rating, for now. The argument for this approach is that the emphasis on the luxury end of the portfolio should ultimately yield luxury goods margins at a group level. Also, Treasury Wine's balance sheet is under-geared and this has potential to add around 10% to earnings. For the moment the broker is not arguing with those investors it calls optimists, but retains an Underperform rating.

Interestingly, on FNArena's database the above four constitute the Sell ratings and the remaining four have Hold ratings. There are no Buys. The consensus target price of $4.74 is down from $4.93 ahead of the news. It suggests 8.9% upside to the last share price.
 

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article 3 months old

Oroton’s Upside Lies In Asia

-New brands about to break even
-But margin recovery constrained
-Oroton Asia gaining momentum
 

By Eva Brocklehurst

OrotonGroup ((ORL)) has struggled to overcome the loss of the Polo licence and, with a lacklustre FY14 out of the way, the luxury goods retailer is intent on restoring its gloss via new licences and an expansion of the Oroton brand in Asia.

Both the newly acquired Gap licence and the Brook Brothers joint venture sustained small losses in FY15 and break even is possible for these brands in FY15. More stores will open and this should help diffuse costs. Still, the brands are in their infancy in Australia and Citi is cautious about their prospects, as competition is high and there is a long inventory cycle under the licence arrangements in the case of Gap. The working capital position is better than under the Polo licence because for Gap there is a long payment cycle. Citi expects margin recovery will be constrained by expansion of other global luxury brands in Australia.

The Oroton brand revealed good like-for-like sales growth in FY14 but brokers are wary that a large portion of this growth was attributable to discounting. The company has signalled a desire to restore margins, and Citi expects improvement is on the way, but gross margins remain a long way below peak levels of FY11. The broker believes the opportunities are well reflected in the share price and maintains a Neutral rating. Goldman Sachs is of a similar view, believing margins will remain under pressure in Australia as the company will find it hard to wean consumers off discounting, suspecting they may have become accustomed to a high level of price promotion.

OrotonGroup has significant potential, longer term, as it eliminates losses from the Gap and Brooks Brothers ventures as well as the new Asian stores. Goldman estimates that, in the FY14 results, the combined loss of these business represented over 30% of group earnings. Goldman also agrees most of the potential is largely factored into the share price and has a Neutral rating and $4.60 target.

After adjusting for the dilutive impact of lower margin sales from Gap, the core Oroton brand's gross margin declined domestically, which UBS puts down to excessive discounting. If the company can improve clearance in Oroton, reduce start-up losses internationally and deliver profit from Gap and the Brooks Brothers JV, then earnings growth could be strong for years to come, in the broker's view. Over the longer term UBS suspects OrotonGroup could also become an attractive takeover target as it gains a material presence in Asia.

Oroton Asia has five stores in Malaysia, three in Singapore, two in China and one in Dubai. Credit Suisse expects a further 4-8 stores will open in Asia over the next three years. Malaysia has already reached positive cash flow and Singapore should be currently nearing that status. Credit Suisse believes there is potential for OrotonGroup earnings to double, perhaps more than double, over the next three years. Oroton Asia is gaining momentum, while Gap delivered positive sales growth and the broker expects break even in FY16. Improved brand awareness for Brooks Brothers should complement the other two brands. What else is new? OrotonGroup is in discussions with Banana Republic for the launch of that brand in Australia. Credit Suisse does not include this in forecasts as a potential launch is unlikely prior to 2016.

FNArena's database contains two Buy ratings and one Hold for OrotonGroup. The consensus price target is $5.06, suggesting 16.2% upside to the last share price. Dividend yield on FY15 and FY16 forecasts is 5.0% and 7.0% respectively.
 

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