Tag Archives: Consumer Discretionary

article 3 months old

Treasury Wine Bid Not A Given

-Opens up potential rival bid
-Risk if bid unsuccessful
-Low risk of FY14 earnings miss
 

By Eva Brocklehurst

Treasury Wine Estates ((TWE)) has stared down Kohlberg Kravis Roberts (KKR) and obtained a higher bid. The private equity firm has raised its bid price for the wine distributor to $5.20 from $4.70 and consequently received the green light for due diligence.

Rhone Capital has joined KKR in this proposal. The initial bid back in May was conducted solely by KKR and the company deemed it insufficient. At the time several brokers observed KKR would not be able to increase the bid without significantly raising its risk profile. The revised proposal is subject to due diligence and final approval of the investment committees of the consortium, as well as a unanimous recommendation from the Treasury Wine board. The board has advised shareholders to take no action until the offer is formalised and recommended. The board's criteria include whether the value of the offer exceeds the expected benefits of management's strategic changes. The company recently announced a cost efficiency program, an increase in consumer marketing expenditure and a separation of the luxury/masstige brands from the commercial brands.

Citi upgrades its rating to Neutral from Sell on the back of the revised offer. The broker expects the bidders will break down the company, with the due diligence process critical to determining which brands can stand alone. The books are open on due diligence, so there is potential for a rival bidder to enter the fray. On Citi's forecasts the bid represents a FY15 enterprise value/earnings multiple of 12.8 times. This is above the multiple paid by Foster's to buy Beringer (12.0) but below that which Foster's paid to acquire Southcorp (14.8). The new bid price seems fair to Citi and the timing excellent. The company's Australasian segment is depressed while in the US the company is struggling with excess inventory. Management may have a compelling vision about turning the company around but, given the risks inherent in the wine industry, Citi doubts shareholders will be able to resist the new offer.

On the FNArena database there are three Hold ratings and four Sell. Brokers have observed for some time the company was facing structural and cyclical pressures as the advance of private labels threatens branded product margins. Prior to the KKR bid, brokers considered the stock was under-achieving its potential, given the quality of the assets. The announcements in June around marketing and separating the brands produced a positive response from the market. Now the share price is well above Deutsche Bank's view of fair value, even assuming a dramatic earnings improvement. The broker was surprised there was a bid at $4.70, let alone an upwardly revised offer at $5.20, albeit with KKR now in consortium.

Deutsche Bank suspects the due diligence process represents a considerable risk and there is a chance the consortium will walk, or lower its price. If the bid is successful Deutsche Bank believes it would be a very good outcome for shareholders. A return on tangible capital would need to be almost 16% to justify a $5.20 price target and the broker has not heard of such a return in the wine segment. Of note, the consortium stated that payment of any dividends or capital returns prior to completion of a transaction would affect the valuation of Treasury Wine and would need to be deducted from the proposed price.

Morgan Stanley observes wine assets tend to be traded on relatively high multiples, given their strategic and unique qualities. The broker offers the argument that as Treasury Wine is not achieving on its historical earnings record, a higher multiple could be justified. As the company has signalled the new bid price is a starting point for gaining access to the books the broker suspect this may dredge up other interested parties. Moreover, the timing of the offer indicates a low risk that FY14 earnings will miss forecasts. Treasury Wine announced a pulling forward of promotional activity in June, altering the timing of the luxury releases and pulling profit into FY14 from FY15. Morgan Stanley believes this indicates the promotional program has performed well. The new CEO may have only sat in the driver's seat since March but is now under greater pressure to deliver superior value.

See also, Surprise Bid Puts Spotlight On Treasury Wine's Value on May 21 2014.
 

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article 3 months old

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

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

By Eva Brocklehurst

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

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

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

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

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

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

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

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

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

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article 3 months old

Weekly Broker Wrap: Buy-Backs, Electricity, Advertising, Airlines And Retail

-More off-market buy-backs likely
-NSW electricity margins to increase
-Macquarie adds Transpacific as a key pick
-FY14 a likely trough for airlines
-Spending to improve but retailer outlook mixed
 

By Eva Brocklehurst

Credit Suisse suspects that off-market buy-backs will become more popular. The federal budget in May confirmed that on July 1 2015, the Australian corporate tax rate will fall to 28.5% from 30%. One implication from this change is it will make it incrementally harder for Australian corporations to distribute franking credit balances to shareholders. Hence, there is an incentive for those paying tax in Australia to distribute these balances ahead of the changes to the tax rate. One option is via an off-market buy-back.

Prior to the last reduction in Australia's corporate tax rate in 2001, when the rate was reduced to 30% from 34%, Credit Suisse observes there was a significant pick up in buy-back activity. Moreover, those companies that announced off-market buy-backs in the lead up to the 2001 tax rate reduction outperformed the broader market by an average of 15% over the year leading up to the announcement. Thus companies with the greatest potential for this form of capital management are likely to be rewarded by the market over the next year. The broker suggests investors tilt their portfolio to a basket of stocks exposed to this theme.

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The short term margins for electricity retailers appear to have increased in the past month and once the carbon tax is removed, the margin UBS measures will appear to reduce. Nevertheless, longer term, the broker believes the path of deregulation will lead to higher margins for incumbents. The broker cites Victoria's privatised network as an example and the broker's charts show the 5% reduction in price gained in Adelaide following full deregulation did not seem to last that long. Churn is a secondary indicator of competitive conditions and this remains subdued. UBS concludes that full deregulation in NSW will lead to higher margins for the incumbents as well as higher churn and gain of market share by new entrants.

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Macquarie has updated high conviction calls with the addition of Transpacifc Industries ((TPI)) to its list of best ideas. The stock is rated Outperform with a total return of 25% expected. The broker thinks the Australian waste market is a growth industry with low levels of cyclicality and Transpacific is now a substantially different company after the sale of its New Zealand business. AWE ((AWE)) is removed from the list of the broker's best ideas, having outperformed the ASX200 Accumulation Index benchmark by 16.6%. The broker still retains an Outperform rating.

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Goldman Sachs is lowering advertising market forecasts for 2014 given sluggish momentum in the first half. The new 2014 forecast is for growth of 0.7% compared with 1.6% previously. There are two areas of strength the broker has found. These are metro radio and job advertising. The broker remains wary of the weak momentum heading into the second half of the year, particularly given the sizable political spending in the prior period. The big picture shows the ad market has probably been flat for four consecutive years.

Hence, Goldman is focused on winners and prefers SEEK ((SEK)) for its strong job ads business, or audience winners such as Nine Entertainment ((NEC)), Seven West Media ((SWM)) and Prime Media ((PRT)). The broker is cautious on traditional media. The broker upgrades Prime to Buy from Neutral, on its strong revenue share outlook and attractive valuation and upgrades APN News & Media ((APN)) to Neutral from Sell based on improving metro radio. The broker thinks, in the near term, there is minimal impact on radio broadcasts from online streaming. As streaming gains scale it could become a serious competitor in advertising budgets in the digital radio area in around three to five years, in Goldman's view.

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JP Morgan expects FY14 will signal a trough in earnings for airlines. Qantas ((QAN)) has guided to no new domestic capacity in the first quarter of 2015 and Virgin Australia ((VAH)) has also shown restraint. This should signal the beginning of a more rational duopoly and allow excess capacity in the market to be absorbed. In addition, Qantas' $2bn cost savings and asset sale could allow it to repair the balance sheet and gain efficiencies. JP Morgan estimates an underlying pre-tax loss of $619.9m for Qantas and $247.1m for Virgin Australia. This represents a significant deterioration on FY13 for both companies. In the case of Qantas the broker thinks the poor result will reflect yield and load factor deterioration in both domestic and international operations. In Virgin Australia's case, underlying operating metrics will have improved so the decline in profitability is related to operations expenditure.

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Consumer spending should improve over the next six months in Morgan Stanley's opinion. Most consumer oriented companies have delivered their warnings so the broker does not think the results will surprise all that much. Myer ((MYR)) and Woolworths ((WOW)) have the highest risk of weak results and outlook statements and while Coca-Cola Amatil ((CCL)) has rallied on turnaround expectations, the broker thinks this is not warranted. The broker believes trading conditions will improve as cash rates remain low, the housing market is robust and savings rates are still high while the online retail headwind is ebbing. The broker just thinks it may take more time.

Morgan Stanley likes the healthy sales outlook for JB Hi-Fi ((JBH)), particularly in games, and the conservative expectations for Flight Centre ((FLT)), which continues to gain share across the leisure and corporate areas and improve internationally. Woolworths' Masters business break even point is likely to have been pushed out and the broker suspects food and liquor margin growth is slowing. For Coca-Cola Amatil, the broker thinks cost cutting is failing to offset cost inflation and weak carbonated soft drink trends.
 

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article 3 months old

Where Are The Returns For Wesfarmers?

-Liquor segment of most concern
-Capital management, acquisition probable
-High returns potential in Bunnings
-Reduced resources impact on profile
 

By Eva Brocklehurst

Wesfarmers ((WES)) is tidying its books. The company will take a goodwill impairment on retailer Target of $680m and a provision of $94m for a restructure of the Coles' liquor division in FY14. The company has also signalled the range of pre-tax profits from the divestment of the insurance underwriting segment will be $1.04-1.08 billion.

The charges did not surprise brokers but reinforce the preception of challenges facing some parts of this diversified business. Wesfarmers expects Target's earnings to be $82-88m for FY14, an earnings margin of 3.9%, and Citi compares this with five years ago when the business earned a 9.4% margin. The broker values Target at $1.9bn, with a long-run margin of 5.6%. Target and Kmart, combined, represent 10% of the broker's enterprise value. Approximately two thirds of Wesfarmers' value is generated from its retail operations.

Coles' liquor segment is the main area of concern. The business manages only half the earnings margin of the company's supermarkets and sales productivity is very poor compared with rival Woolworths ((WOW)). Citi thinks the problems are structural and there will be no quick fixes. The broker retains a Sell rating for Wesfarmers. The market seems to be already factoring in a substantial recovery in the cyclical components of resources and discretionary retail, but Citi thinks any recovery will be further off.

The impairment and guidance for Target indicate clearing of excess inventory and a clean start to FY15, in Credit Suisse's view. There is now a better chance Target can improve its mix of merchandise and establish a better base for sales growth but capital management is what Credit Suisse is most focused on. After repayment of debt Wesfarmers will have around $1.7bn in cash from the insurance sale and, based on past practice, a special dividend of around 34c per share is likely. The broker thinks there is probably equal potential for the remaining proceeds to be used for an acquisition or fund a capital return.

In the absence of an acquisition in the next six months, UBS expects Wesfarmers to return excess funds to shareholders. Trading at around 19 times FY15 price/earnings forecasts and delivering an 8% three-year compound growth rate means the stock needs underlying earnings upgrades or an accretive acquisition to drive outperformance, in the broker's view. Weak trading after the federal budget limits scope for near-term upside and, with no acquisition imminent, UBS finds few catalysts on the horizon and retains a Neutral rating.

JP Morgan does not expect further goodwill write downs at Target but thinks any turnaround is long dated and more difficult to put in place compared with Coles. The broker think the price Wesfarmers paid for Coles group was high and only notes Kmart has generated a strong return in recent years. Coles is only now delivering returns above its cost of capital, while Officeworks has never exceeded and Target has disappointed on that front. Positives? JP Morgan thinks the turnaround at Coles has more upside and is increasingly confident of Bunnings' ability to generate both strong returns and more modest margin compression over the medium term.

Liquor provisioning has potential to improve returns for Coles. JP Morgan thinks the task is much more difficult than turning sharemarkets around, but not impossible. Moreover, taking a provision on the segment signals a greater priority is being placed on turning the liquor business around. Other concerns? JP Morgan finds a lack of valuation support in the stock's price and is wary of the challenges in the company's industrial divisions. A Neutral rating is retained.

Given the challenges in liquor, Deutsche Bank is not surprised that stores will be closed and stock written down. The Target impairment was not a surprise given weak earnings outlook. The broker thinks the improving food inflation outlook will be much more important in driving Wesfarmers' performance in future, because of the relative size of Coles. Macquarie was not surprised at the provisions either. The company has not hidden the fact liquor has been underperforming and has previously flagged a restructure to improve operational efficiency. The positive aspect for Macquarie in the Target write down is that it is not being driven by a material change in cash flow expectations.

On the subject of Wesfarmers' resources exposure, Goldman Sachs makes the point that this segment is now a very low contributor to earnings. Thus, while metallurgical coal prices appear to have found a floor and industry capacity is reduced, the sector is unlikely to have as significant an impact on the company's earnings profile as it has in recent years.

On FNArena's database Wesfarmers has one Buy, four Hold and three Sell ratings. The consensus target of $41.40 suggests 3.5% downside to the last share price. The dividend yield on FY14 and FY15 estimates is 4.8% and 5.1% respectively.
 

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article 3 months old

Budget May Not Impact Consumer Spending

-Budget may not curtail spending at present
-Weather, Oz dollar have more impact
-Employment key and holding up
-Few signs of distress among retailers
 

By Eva Brocklehurst

It is widely accepted that the large fall in consumer sentiment after the May federal budget will translate to a decline in retail trade. Commonwealth Bank economists are not so sure this is a straightforward case. They expect retail spending growth, while below average, to be around 2.6% over 2014-15. Sure, anecdotes from retailers indicate the May retail numbers, due out on July 3, are likely to be weak, and the bank's economists are expecting a 0.2% fall. The reason for the softness, though, could more be a result of the unseasonably warm weather in May, reflected in falls in department stores and clothing, rather than any instant tightening of the purse strings after the budget.

The appreciation of the Australian dollar is also a negative input to retailing, as it encourages spending offshore via the internet or tourism channels. What the CBA economists suspect is that near-term retail trade will be little affected by the budget. The budget measures targeted at householders are back-end loaded and start on average from around 2016. Significantly, evidence suggests it is actual changes to disposable income that really drives changes in spending patterns. In this respect, wages growth may be subdued but the labour market has held up against expectations. The economists suspect the unemployment rate may have peaked at 6.0% in February and job fears are receding slowly as a result. A drop in fears over unemployment is an important offset to a fall in sentiment after the budget.

The momentum in retail trade has slowed in the past three months and some retailers have downgraded profit expectations. The economists note a build up of winter inventory ahead of the warmer-than-usual weather has been cited as one of the causes. Dissatisfaction with the budget has also been identified as an additional hindrance. Still, the economists maintain that consumer sentiment, historically, is a poor guide to near-term changes in retail trade, even though both measures tend to move in similar patterns as they are a reflection of the general economic environment. A return to average spending growth is one of the components of the expected switch to non-mining from mining sector growth. The economists believe the May retail numbers from the Australian Bureau of Statistics will provide the first look into whether spending was influenced by changes announced in the budget.

Credit Suisse has found few signs of distress from its monitoring of advertised prices across a selection of retailer websites. Normal discounting behaviour is in evidence among retailers of household goods and department stores. Subdued consumer confidence measures suggest relatively subdued spending in the short term and the analysts believe this presents some downside risk to the price and margin outlook. The analysts believe the risks will become clearer in subsequent weeks.

The analysts observe electronics goods prices in 2014 have so far not replicated the steep deflation seen last year. Electronics retailers are defending their margins and aggregate price increases have occurred across the retailers that were tracked. Gross margin expansion is either partly or completely offsetting weak volumes. Credit Suisse observes this is consistent with JB Hi-Fi's ((JBH)) mid June trading update, at which profit guidance was maintained despite sales revenue being materially weaker than previously indicated. Whether spending will pick up in the short term is unclear. If it does not, Credit Suisse envisages some risk of a damaging discounting phase. 

In white goods, pricing is marginally lower compared with overall price inflation in 2013. Heating products were discounted in early June following the steady inflation in prices in the lead up to winter. Credit Suisse believes the retailers were quick to discount as a result of the warm start to winter. With the exception of seasonal products, Credit Suisse notes pricing behaviour appears to be supporting margins.Department stores such as Myer ((MYR)) and David Jones ((DJS)) are conducting seasonal discounting consistent with 2013. It is unclear at this point whether this discounting reflects stock management or a lack of purchases. If it is the latter, Credit Suisse considers it likely the breadth or duration of the sales will extend beyond FY14. The analysts anticipate the discounting pattern over coming weeks will be informative in this regard.
 

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article 3 months old

Weekly Broker Wrap: Oz Tourism, TV Ads, Retailing, Credit And Gold

-Few catalysts for domestic travel
-Myer, DJs likely to disappoint
-Discretionary shopping hit
-Will credit growth recover?
-US$1000/oz a new gold cost rule?
 

By Eva Brocklehurst

Inbound tourism looks solid, but what about domestic travel? Domestic air seat capacity and passenger growth slowed in the second half of FY14 and UBS believes capacity growth into FY15 is 2-3% at best. Online traffic trends for the Australian travel agency sites look, at the very least, flat in recent months. The broker notes the speculation that Wotif.com ((WTF)) and Webjet ((WEB)) could be acquired by major players, for instance by Priceline or Expedia, given there is some strategic appeal and accretive value for these two as acquirers. UBS thinks the real question they would ponder concerns incremental returns: whether to win share via spending more organically or via an acquisition. The numbers suggest signals to the broker that, at current prices, M&A is unlikely to be on the agenda yet while positive catalysts for Wotif.com and Webjet are limited. A Neutral call on both stocks is retained.

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The metro TV advertising market produced a modest rate of growth in the March quarter but Deutsche Bank's channel checks suggest there was a double digit decline in April due to the timing of Easter and a reduction in spending by advertisers ahead of the federal budget. This pull-back does not seem to have been fully retraced in May. Hence, the broker has downgraded second half metro TV ad market growth forecasts to negative 0.3% from 2.9%, and this takes FY14 growth projections to 2.5% from 3.5% previously.

Nine Entertainment ((NEC)) remains the broker's preference as it pursues a subscriber video-on-demand offering. While this may be a potential long-term opportunity it could also be a drag in the short term as Nine increases investment. Deutsche Bank reduces Seven West Media ((SWM)) forecasts for FY14 by 3% to account for lower TV ad market growth and also expects Ten Network ((TEN)) will take time and more investment to turn around. Deutsche Bank does not factor in a material revenue share recovery at this stage.

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The federal budget has been blamed for poor retail results over recent weeks, compounded by a warm start to winter. Macquarie thinks Myer ((MYR)) and David Jones ((DJS)) could disappoint the market in the current half year. To date Kathmandu ((KMD)), Super Retail ((SUL)), The Reject Shop ((TRS)), Noni B ((NBL)), RCG Corp ((RCG)) and Pacific Brands ((PBG)) have all announced downgrades, citing warmer weather and reduced confidence. Macquarie thinks the outlook remains unfavourable for apparel retailers, with above average temperatures forecast for both Sydney and Brisbane in the final week of the financial year.

From a real estate perspective, Macquarie expects shopping centres owned by Scentre Group ((SCG)), GPT ((GPT)) and CFS Retail ((CFX)) will record more subdued sales relative to the centres occupied by less discretionary businesses, such as those of Charter Hall Retail ((CQR)), Stockland ((SGP)) and Federation Centres ((FDC)).

Macquarie suspects that the softer economic climate in May, as a result of the public counting the cost of the federal budget, is also likely to translate into softer credit growth. This may not necessarily be a cause for concern, unless it persists. New governments usually make their first budgets tough by introducing unpopular measures early in their term. Macquarie's analysis shows that it is normal for credit growth to fall after such a budget. Credit growth immediately after the Howard government's first budget in 1996 showed the largest drop in the sample. The more significant issue emanating from the analysis is that credit growth usually normalises in the two months after the budget, that is over June and July.

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Gold prices have jumped above US$1300/oz in reaction to the conflict in Iraq and a weaker US currency, reacting to geopolitical events for the first time in 12 months. Morgans thinks sentiment is improving overall and miners are seeing value from a positive news flow. The broker also reviews production costs and, taking the outlook for global gold heavyweight, Newmont Mining, on board, suspects US$1000/oz is the new benchmark for all-in sustaining costs. It appears Newmont is working hard to maintain production, let alone increase it. Investors are in turn demanding returns while risk capital is being deferred. The result is a focus on high quality, low cost assets.

Morgans expected that, as costs rose and margins were squeezed, gold miners would lift grade and increase production. However, it appears that as costs are rising production is falling, or going sideways at best, and this is lending support to the physical metal in the medium term, setting up the market for a squeeze. In the meantime, M&A deals are flowing. The broker observes corporates are finding value in cheap valuations and the promise of securing longer term production at costs below US$1000/oz.
 

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article 3 months old

Collins Foods Reveals KFC Has The Sizzle

-KFC the key to growth
-WA/NT acquisition to plan
-Valuation undemanding
 

By Eva Brocklehurst

KFC is sizzling but Sizzler is fizzling. That is the way UBS described the restaurant chain owner Collins Foods' ((CKF)) trading environment over FY14. The company's underlying profit in FY14 of $17.9m was up 9% and ahead of guidance. Excluding the contribution from the KFC franchisee acquisition, Competitive Foods, sales were flat on the prior year, with KFC growth offset by declines at Sizzler.

Moelis thought it was a solid outcome within a challenging quick service restaurant segment, and a reflection of the company's focus on efficiency and productivity. The integration of the Competitive Foods business has progressed to plan and Moelis retains the view that on FY15 estimates, a price/earnings ratio of nine times is undemanding in the context of the enhanced growth opportunities that are available to the enlarged group. The broker has a Buy rating and $2.40 target.

UBS agrees on the undemanding part but remains very concerned about the Sizzler chain. While the FY14 result beat the broker's forecasts by 3-4% because of better KFC margins, the Sizzler chain showed no sign of improvement. Management has signalled it expects KFC growth to continue but UBS has lowered FY15 profit forecasts by 8.0% and retains unchanged forecasts beyond that period. UBS strips out Sizzler and capitalises KFC's contribution, calculating that at the current share price, the KFC business is trading at a price/earnings ratio around 10.5 times FY15 estimates. The broker maintains there are risks to leverage involved, given the current valuation. Still, the stock offers significant leverage to an improvement in consumer sentiment and spending, relative to other consumer names in the small cap universe. Hence Sizzler is almost a free option, in the broker's view.

Other challenges include wage inflation which, when countered by operational efficiencies, is expected to keep margin growth flat. Traffic volumes are also challenging, particularly in the food court areas of shopping centres. UBS thinks this part of the business is likely to remain a drag on growth in the medium term, with no instant solution in sight. UBS retains a Buy rating and a target of $2.20, but recognises that the stock is subject to near-term volatility, particularly given the high operating leverage and uncertainty around Sizzler's future direction.

FY15 guidance was not provided but management did flag a positive outlook, supported by the positive trend for KFC, store openings and refurbishments, and the newly acquired KFC restaurants in Western Australia and Northern Territory. Management also expects Sizzler to return to growth and revenues to stabilise. The company reports same store sales growth of 1.5% for KFC in the first two months of FY15, reflecting a recovery from a soft fourth quarter. Collins Foods expects to build seven KFC stores, five in Queensland and two in WA, and remodel 11 stores in Queensland and five in WA.

The company's policy is to pay out 50% of profit from the old KFC Queensland and Sizzler businesses, with WA profits to be reinvested in WA. Management is also focused on lifting WA/NT operational margins. UBS estimates that portfolio is currently generating around 10.3% in earnings margins, compared to the Queensland stores on 15.2%.

There were few surprises in the results for Deutsche Bank, as the company appears relatively well positioned in its sector, even though vulnerable to a consumer downturn. The highlight was margin expansion, largely reflecting operating efficiencies. The broker expects solid medium-term earnings growth, underpinned by the KFC store roll-out and this has been augmented by the WA/NT acquisition. This broker also thinks valuation is undemanding and retains a Buy rating and $2.30 target.

Deutsche Bank does note some downside risks associated with any delays to store roll-out and refurbishment, which increases the likelihood of Yum! rolling out its own stores in Queensland, and the potential for Collins Foods to breach conditions of its franchise regarding KFC refurbishments. The overall risk of a termination in the franchise is low but Deutsche Bank observes Yum! has the balance of power as a franchisor and Collins Foods does not have exclusive territory rights to KFC in Queensland.
 

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article 3 months old

Weekly Broker Wrap: Oz Retailers, Liquor, Macro Views, Media And Credit

-Are Oz retailers appropriately priced?
-Coles wants to improve liquor business
-Morgan Stanley cautions on Oz equities
-Goldman selects winners in media
-Is commercial property credit a problem?
 

By Eva Brocklehurst

A warm start to winter has not pleased Australian retailers. A number of them have downgraded expectations and Deutsche Bank believes, of those that are yet to downgrade forecasts, Myer ((MYR)), Premier Investments ((PMV)) and Specialty Fashion ((SFH)) carry the most risk. Weakness in spending after a federal budget is not unusual in the broker's opinion. Property and equity markets are buoyant and this has historically supported improvements in sentiment. Thus, the broker believes the sector is appropriately priced after the recent contraction in multiples. Moreover, while the drop in sentiment has been across the board, the lower socioeconomic consumers are more affected. Hence, the broker envisages considerable risk to Specialty Fashion earnings, with Premier Investments and Myer being under more pressure than David Jones ((DJS)).

Upside risk is present for Flight Centre ((FLT)). Deutsche Bank thinks trends should improve as travel continues to be a structurally strong category. The broker likes Harvey Norman ((HVN)) for its exposure to the property cycle and potential for operating leverage, although acknowledges the stock is not immune to soft consumer sentiment. JB Hi-Fi ((JBH)) sales have probably been affected by the weak trends but the broker thinks robust margins should provide some reprieve. Myer may carry downside risk for FY14 but, longer term, free cash flow yield suggests the stock is cheap and there is potential for multiples to expand on even modestly positive news. Kathmandu ((KMD)) is also considered inexpensive, given its growth profile, and Deutsche Bank believes it offers substantial brand equity and offshore expansion.

***

The incoming Coles CEO, John Durkan, signalled his disappointment with the liquor business at the Wesfarmers ((WES)) strategy briefing. His principal concern was the lack of customer awareness and engagement. Coles operates Australia's third largest liquor business behind Woolworths ((WOW)) and Metcash ((MTS)). UBS estimates Coles liquor has an earnings margin of around 2%, which is below the industry leaders at over 6%. The broker estimates the earnings opportunity for Coles in liquor equates to a 4% uplift to Wesfarmers' FY15 pro-forma earnings.

The key to driving this uplift involves productivity, lifting traffic through brand and marketing, and increasing private labels in wine. That said, the broker believes Mr Durkan has a hard task ahead and margin growth, in the absence of an accelerated lift in liquor penetration, will slow in the medium term. The company has said it does not aspire to Woolworths' food and liquor margins, despite the market often touting the difference - 280 basis points on FY13 numbers - as a major opportunity. UBS believes this reflects the fact that the opportunity is not as big as it first seems.

***

Morgan Stanley has updated key macro views and model portfolio recommendations, becoming more cautious on the short-term outlook for Australian equities in the face of a weaker iron ore outlook and a stubbornly high Australian dollar. The federal budget has also created a mini crisis of confidence and, combined with the former two factors, increases the risk of earnings forecasts being delivered in FY14, and growth rate forecasts for FY15. A sustained recovery in housing will be crucial to achieving the transition from the resources boom and, should the recovery stagnate, the broker expects the Reserve Bank of Australia to consider a change in both rhetoric and action. Morgan Stanley does not rule out reductions in official interest rates should condition deteriorate more sharply.

In the model portfolio the broker adds Stockland ((SGP)) to enhance domestic housing links and switches to Henderson Group (((HGG)) from Perpetual ((PPT)) to gain exposure to a call on stronger European equities. Both James Hardie (JHX)) and ALS ((ALQ)) are added, as globally-exposed stocks with strong business models. Treasury Wine Estate ((TWE)) is removed, given recent movement in the share price, and DUET ((DUE)) is added for defensive exposure. The broker adds weight to high quality growth stocks such as Domino's Pizza ((DMP)), Navitas ((NVT)) and REA Group ((REA)).

***

The latest data on agency advertising confirms to Goldman Sachs that the strong market in the second half of 2013 did not continue into 2014. Total agency ad bookings fell 2.8% in May and all main media types endured declines except metro TV and online display. A lack of a rebound in May from April's decline of 6.5% suggests momentum has softened. The data reflects poor consumer confidence and patchy business conditions, in the broker's view. Goldman has downgraded ad market growth forecasts for 2014 to 1.6% from 3.6%, and for 2015 to 4.0% from 4.7%.

In the current environment Goldman is focused on winners, either structural winners taking market share or audience winners taking revenue share. In the former camp the broker prefers SEEK ((SEK)) and Carsales.com ((CRZ)) and in the latter Nine Entertainment ((NEC)) and Seven West Media ((SWM)). The broker is cautious about traditional media that is experiencing market share and audience losses such as Fairfax Media ((FXJ)) and Ten Network ((TEN)). JP Morgan thinks this latest advertising data signals a softer revenue outlook for the first half of FY15. This means leverage for traditional media and capital allocation for online media will be foremost in investors' minds. The broker is Overweight Carsales.com, Seven West and Prime Media ((PRT)) and Underweight on Fairfax and Ten.

***

UBS observes that a large portion of business credit is being allocated to commercial property. Data from APRA for the major banks indicates that, during the last year, exposures to office commercial property have grown by 9.1%, retail by 9.2% and industrial by 10.3%. Westpac ((WBC)) and ANZ Bank ((ANZ)) have shown the biggest increase in commercial property exposure, growing exposures 11.1% and 9.3% respectively over the last 12 months. The broker does not believe the growth in the major banks' exposure to credit in this area is a bad thing per se, especially as Australian property players have been de-leveraging since the GFC. Nevertheless, if underwriting begins to slow, leverage ratios rise, or occupancy and rental yields come under pressure, it may again become an issue for the banks. For now, with improvements in asset quality, the banks' earnings outlook remains robust and the recent rally in bonds provides a further tailwind.
 

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article 3 months old

Does Super Retail Present A Buying Opportunity?

-Not just budget and weather
-Persistent BCF weakness
-Automotive most resilient
-Buying opportunity seen
 

By Eva Brocklehurst

Super Retail ((SUL)) has delivered another downgrade to forecasts for FY14, issuing profit guidance of $107-109m and blaming subsiding consumer confidence in the wake of the federal budget and the warm start to winter.

Negative feelings about the federal budget have been highlighted by the extent to which retail sales have been affected in the last six weeks but several brokers believe, in Super Retail's case, there are some internal issues that need to be fixed as well. Deutsche Bank does not think weak post-budget consumer sentiment is only to blame. Sports and Leisure are deteriorating with issues around ranges and systems, exacerbated by the weak trading environment. A 40% retracement in the share price over the last six months, as well as revisions to FY15 expectations, means the stock is now trading at the widest discount in two years to the ASX Small Industrials Index. The issues that are specific to the company may take some time to resolve and Deutsche Bank's reluctance to take a positive stance, maintaining a Hold rating, is based on the risk of further downgrades in FY15. The Boating/Camping/Fishing (BCF) division has been affected by cannibalisation from the opening of additional stores as well as persistent weakness in regional and mining related areas.

Credit Suisse echoes the focus on the mix of internal and external factors at the heart of the downgrade. Super Retail is expected to cycle the re-basing of revenue in BCF, Ray's Outdoors is expected to improve on changes to ranges and store refurbishment, while Rebel and Amart remain well positioned. Hence, the broker views this as the opportunity to upgrade the rating to Neutral from Underperform. Execution risks from supply chain changes in FY15 are relatively high, Credit Suisse acknowledges, but benefits are likely to accrue from FY16.

The miss in sales in recent weeks leads Citi to downgrade forecasts by 7% in FY14 and 9% in FY15. The downgrade cycle may end soon but the broker thinks the first half of FY15 will still be difficult because of excess inventory. The business is high quality and valuation is appealing so the broker retains a Buy rating. Trends should improve in July and August but the federal budget is likely to drag down discretionary retail sales growth by around 2% on Citi's estimates. The broker expects to gain confidence from improved clarity on management changes in the leisure segment in the next two months. BA-Merrill Lynch also believes the stock remains a buying opportunity as profit is forecast to grow by 20% over the next two years on base case assumptions.

JP Morgan is sticking with an Overweight rating, largely on the back of multiple drivers from the fragmented markets to which the company is exposed. The elevated levels of operating and capital expenditure should eventually drive down operating costs and capital intensity should reduce. The broker also observes an increase in the share price despite such a negative trading update, which suggests this downgrade - the company's third for FY14 - was somewhat priced in. Moreover, JP Morgan makes the point that Super Retail has rarely reported negative like-for-like sales growth and the recent decline is over a very short period. Trading does move around significantly over a period of months.

UBS notes top line momentum has slowed across all divisions, with automotive segments the most resilient. The broker believes Super Retail remains a compelling investment although it will take some time to re-rate. The drivers of such a re-rating are threefold. Firstly, sales should improve in Sports and Leisure when the execution issues are cycled. Then there is margin improvement potential in the first half of FY15, as heavy discounting in Leisure is cycled. Finally, the delivery of supply chain improvements with the Queensland distribution centre should herald the release of $75m in working capital amid a 2% reduction in costs. The broker thinks now is the time to buy the stock.

On FNArena's database there are six Buy ratings and two Hold. The consensus target price is $10.39, suggesting 21.7% upside to the last share price. This target compares with $11.17 ahead of the update. The FY14 forecasts signal a dividend yield of 4.4% and FY15 forecasts signal 4.8%.
 

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article 3 months old

Not Yet Time To Buy Gold Stocks

By Michael Gable 

Aside from Iraq, the other hot topic affecting markets at the moment has been the hit to consumer confidence since the federal budget last month. This has resulted in some companies exposed to the consumer cycle being sold off and downgrades coming through for others. The Westpac-Melbourne Institute Consumer Sentiment Index was released last week and it rose 0.2% to 93.2 after falling 6.8% in May. So while it hasn’t bounced back strongly yet, it has certainly stopped falling.

An inevitable bounce would result in renewed support for some of the companies that have recently sold off. The key however, is to find those whose earnings are less affected and are likely to bounce back pretty strongly. As an example, companies such as The Reject Shop ((TRS)) highlighted the unseasonably warm weather as also being a contributing factor. So we need to find companies that are not also affected by the weather, only those that have come off due to a temporary setback in consumer confidence. JB Hi-Fi ((JBH)) is an example of a stock sitting at a good support level that is likely to bounce back from here. Another example that we have found is Flight Centre Travel Group ((FLT)). In this type of market it is hard to find value, but there is an opportunity here with FLT.

Also in today’s report we have a look at the spot Gold price.
 


In mid March, the USD price of gold started to come off sharply. You will then notice that for nearly two months after that, is started to consolidate before finally breaking down again a few weeks ago. That drop down doesn’t appear deep enough to end the move. The recent rally up in the last couple of weeks appears as though it is going for a retest of that recent breakdown. That is, at any day now we could see gold turn down again and find another low towards US$1200/oz. So although most gold stocks look like bouncing here, the overall picture for the commodity is more negative in the short term. We would therefore wait for gold to be back towards US$1200 before considering a play in this area.


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

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

Michael is RG146 Accredited and holds the following formal qualifications:

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

Disclaimer

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

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