Tag Archives: Consumer Discretionary

article 3 months old

Weekly Broker Wrap: Broadband, IT, Retail, Mining, Electricity And Building Products

-Value in small players in broadband
-More downside risk likely in IT
-Two-year budget drag on retail spending?
-Warnings on mining services stocks
-NSW power play heats up
-Will ACCC clear Boral/CSR brick JV?
-Aluminium positive for CSR
 

By Eva Brocklehurst

Broadband penetration is reaching maturity in Australia and changes to market share are becoming key to value creation. Morgan Stanley believes prices are the reason why consumers change providers and, having reviewed broadband prices for June, thinks this supports Overweight calls on TPG Telecom ((TPM)) and iiNet ((IIN)). Looking at broadband plans, TPG has the best value product in Morgan Stanley's opinion. Delivering slightly more expensive plans but better customer service is iiNet's strategy. Telstra ((TLS)) offers the least value in its plans compared with peers, but continues to gain broadband share from success in bundling, underpinned by the company's broader market reach. NBN pricing plans are in their infancy but Morgan Stanley believes they support the view that iiNet and TPG will win share as the NBN is rolled out, particularly in regional areas.

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Trading updates across the IT services sector have indicated downside risk to earnings. Morgans was hoping for a flat second half in FY14 with recovery in FY15 but suspects disappointment is in the wings. Data #3 ((DTL)), SMS Management & Technology ((SMX)) and PS&C ((PSZ)) have all downgraded expectations and the broker thinks Oakton ((OKN)) and UXC ((UXC)) are at risk of similar downgrades. Having said this, Morgans is convinced overall IT spending is not discretionary and businesses will be forced to upgrade hardware, systems and processes to improve productivity. Still, the delays and deferrals keep happening and, meanwhile, the broker waits.

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On another subdued note, Citi thinks the impact from the latest federal budget cuts will hit consumers' wallets in FY15 and FY16. While the immediate rush of negative sentiment may fade quickly, the drag on retail spending might continue for two years. The broker expects a 2% drag on spending in FY15. Retailers will need to rely on wages growth or lower savings and higher house prices to boost sales.

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Still more gloom appears. Naos believes it is time to be careful with mining services. Downgrades are still catching unwary investors trying to pick a bottom to the earnings cycle, hoping that current prices are providing long-term value entry levels. The asset manager finds evidence for this in Ausdrill's ((ASL)) recent downgrade. To make the right choices in the sector investors need to focus on the client base of the service provider, the miner. More specifically, the focus should be on that miner's commodity exposure, strength of its mines and nature of expenditure.

Listed investment company NAOS ((NCC)) offers the following warnings: avoid capex related business models, as they may look cheaper but the cliff in capex spending is approaching, and avoid exploration-related models, with commodity prices weak and falling. The focus needs to be on models that target maintenance, repair and replacement. NAOS believes this sort of spending is about as non-discretionary as you can get in mining services. Moreover, a preference should be shown for those servicing the major miners with the best assets and most robust operating margins.

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The potential privatisation of the NSW electricity wires and poles has been given a further push, with the government announcing plans to lease 49% of the electricity networks. The NSW government ultimately plans to sell stakes in state-owned network services such as Ausgrid, Transgrid and Endeavour, excluding rural network Essential. How this ends up being priced with be key to how enthusiastic investors become, in JP Morgan's opinion. The listed providers such as DUET ((DUE)), Spark Infrastructure ((SKI)) and SP AusNet ((SPN)), and to a lesser extent APA ((APA)), are expected to vie for the assets. The broker is not getting too excited just yet. The government will only undertake the sale of the poles and wires with an election mandate and, because privatisations have been unpopular in the past, the timing and final structure is difficult to predict.

The government has also flagged the money will be spent on infrastructure for roads, rail, schools, hospitals and water. UBS thinks this is good news for the construction materials sector. The broker expects electricity prices will fall in NSW by 5% in FY15 and regulated prices will grow at around the rate of inflation. Nevertheless, UBS notes the traditional utility model remains under long-term structural threat from solar and storage and this should be priced in to expectations.

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 CIMB has found a number of parallels between the proposed brick JV between Boral ((BLD)) and CSR ((CSR)) and the merger proposition between Boral and Adelaide Brighton ((ABC)) that was blocked by the competition regulator in 2004. This suggests that the current JV transaction may encounter regulatory headwinds. This has negative implications for the two businesses. Profitability is expected to remain under pressure in the absence of the JV being approved, as excess capacity remains in the system and competition is robust. The case is similar to the 2004 situation in terms of competitive threats.

CIMB expects the Australian Competition and Consumer Commission's definition of the market for clay bricks will rule at the end of the day. The companies will likely argue for a broader market definition but a narrower one is quite appropriate, in the broker's view. On this basis the JV would produce two players with a peak share of around 60% of a product that has a 65% share in wall finish. CIMB expects the ACCC's refusal to accept this proposition will prompt a fall-out. As neither party can deliver an acceptable return in bricks, it may force an exit by one of them. This would mostly likely be Boral, in CIMB's opinion.

Strengthening aluminium premiums are a positive development for companies such as CSR which have smelters. They can capture all additional upside at the earnings level. The strengthening premium remains a negative for end users of aluminium, such as Capral ((CAA)), which is unable to pass through the premium increases to customers. With scope for premiums to rise further by the end of the year, this signals to Bell Potter there is upside earnings risk for CSR and downside risk for Capral.
 

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article 3 months old

Burson Offers Upside In Automotive Sector

-Potential for margin expansion
-WA  a geographical catalyst
-Private label penetration important
 

By Eva Brocklehurst

Burson Group ((BAP)), Australia's largest distributor of aftermarket parts to the automotive trade, is now a listed entity and brokers responded warmly to the company's IPO, the main difference in viewpoints being just how much upside is expected in the near term.

The company sells 85% of its products to trade customers and Do-It-Yourself vehicle owners. The industry is relatively defensive, and trade customers value speed of delivery and knowledge about parts above pricing. The company's name is highly regarded. Structural changes occurring in the industry - vehicles are becoming increasingly complex - have led to a requirement for parts to be held in the supply chain. Burson is well placed to capitalise on these opportunities. Margin expansion also exists, through increasing direct sourcing and private label penetration.

Morgans thinks the scale and distribution of Burson's network provides the key advantage via an integrated supply chain. The broker expects the company to continue with its record of consolidating the industry and rolling out greenfield stores. Western Australia, where Burson has no presence yet, is expected to be the next target and presents a near-term catalyst. Funding is expected to come from operating cash flow and available debt facilities. The stock is trading on FY15 price/earnings of 14.5x and broadly in line with its peer group, in Morgans' calculations. The broker is attracted to the defensive nature of this industry and the company's acquisition potential. Morgans initiates coverage with a Hold rating, given the stock is already trading at a fair valuation. The broker's target is $2.00.

The company is targeting an increase in its private label penetration to 25% over four years, from 10% currently, which UBS believes will have materially positive impact on gross profit and earnings. The broker considers the company's targets are realistic, given Burson is not represented in some regions and vehicle workshop chains are growing their market share and increasingly demand national warranties. UBS values Burson using blended methodologies and initiates coverage with a Buy rating and price target of $2.30. The broker observes some risk that Burson becomes a takeover target in the future, maybe from Super Retail ((SUL)) or another domestic or large international competitor.

Morgan Stanley finds the company's model deceptively simple, yet robust, and initiates coverage with an Overweight rating and $2.25 target. The broker is looking for Burson to augment underlying 3% annual revenue growth with an expanding store network. Morgan Stanley does not see a changing industry structure, or ownership ratios, having a significant earnings impact on Burson in the near term, with the company's service and relationships a greater consideration for customers. The broker agrees the obvious step would be an acquisition in Western Australia and expects Burson to grow underlying earnings by at least 10% over the next few years.

The company's gross margin has widened to 42% from 39% in the past three years, initially through a re-setting of the price base and subsequently through better supplier terms. Morgan Stanley expects gross margins to continue to widen as a function of continuing revenue growth, improved supplier terms and through internal initiatives, such as increased direct sourcing and private label products. The broker also thinks the experience of the US automotive aftermarket parts industry is revealing. In the past ten years the ten largest competitors have increased their combined market share to in excess of 50%, from 31%. Also, in the case of market leaders such as O'Reilly, they have been able to lift gross margins above 50%. The relative size of the US market versus Australia raises the question of whether Burson can achieve equivalent margin growth but otherwise Morgan Stanley finds the company's outlook difficult to fault.

Burson was established in Victoria in 1971 and has grown store numbers to 114. It plans to increase the network to 175 over the next five years. The Australian after-market parts industry is fragmented, with over 1,000 independent distributors, and it should continue to rationalise and consolidate, in UBS' view. The market is dominated by Repco and Burson but there is a long tail of one-shop operations. UBS beleives risks for Burson lie with stronger competitors, which are likely to use their scale to ramp up the development of private label offerings.
 

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article 3 months old

Weekly Broker Wrap: Oz Tax, Banks, M&A Targets, Telcos And Retail

-FY14 and capital losses
-Optimism for asset managers
-Are Oz banks really expensive?
-Large number of potential M&As
-Optus ramps up mobile competition
-Which retailers benefit in the current climate?
 

By Eva Brocklehurst

As the Australian financial year draws to a close investor decisions are influenced by attempts to minimise capital gains in some instances. Macquarie highlights typical tax loss selling and notes stocks with shareholders sitting on large capital losses typically experience further selling pressure over the next month, as these losses are crystallised before June 30. Such ASX 100 stocks sitting on capital losses include Regis Resources ((RRL)), Graincorp ((GNC)), QBE Insurance ((QBE)) and Coca-Cola Amatil ((CCL)). Those sitting on strong capital gains, where there is likely to be less selling pressure over the next month, include SEEK ((SEEK)), Challenger ((CGF)), REA Group ((REA)) and Lend Lease ((LLC)). Macquarie observes that nearly 80% of ASX stocks are sitting on capital gains since July 1 2013.

Macquarie is optimistic about the outlook for equities, both Australian and global. Despite the prospect of rising US interest rates the broker thinks the cycle will be quite muted. Stocks which are positively leveraged to the equity market outlook should perform well. Emerging leader asset managers have sold off substantially in recent weeks but the broker thinks the fundamentals are sound. From this sector Macquarie rates Magellan Financial ((MFG)) as a top pick, on Outperform. The business has potential from an improving investment performance and within the wholesale distribution segment. Platinum Asset Management ((PTM)) is another stock in the sector rated Outperform, for which the broker observes improved momentum. The third is BT Asset Management ((BTT)). This stock is coming off a particularly strong FY14, in which performance fees feature prominently, so growth is under pressure going forward. Still valuations are attractive thus while lower in the pecking order, the broker has upgraded to Outperform.

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Australia's banks are not as expensive as they look, in Deutsche Bank's view. The broker thinks a simplistic analysis that looks only at the headline price/earnings ratio is misleading. From a comparison of relative valuations with historical levels the banks are slightly cheap or fair value. Moreover, dividend yields are supportive and the certainty of relative earnings favours the banks. The broker thinks the banks' PEs are based on very conservative forecasts and this relative conservatism could be inflating the ratios by around 2% for FY15 and 4% for FY16. Relative valuations show the banks are trading at a 3-4% discount to historical levels, based on the broker's forecasts. Deutsche Bank notes ANZ Bank ((ANZ)) and National Australia Bank ((NAB)) offer the greatest upside but given NAB's poor first half, its discount is likely to remain for some time. The ANZ discount is hard to justify, in the broker's view, given the bank's above-peer earnings growth profile for the next three years.

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CIMB observes the macro backdrop to equity investing reveals pent-up demand, currency weakness and stronger business confidence. Deal flows continue to be driven by cross-border interest and the US remains Australia's main source of offshore equity capital. Mergers and acquisitions could be underpinned by weak revenue growth and low interest rates continuing for some years. The broker estimates that around 48 stocks within the ASX 200 are actively considering M&A or asset divestment. The broker assesses the prospects for M&A based on balance sheet strength and valuation and expects more of this activity in healthcare, online media, food and staples. Prospects for M&A in capital goods, metals and mining look relatively low.

This research translates into potential targets, or those stocks likely to offload non-performing assets, such as Ten Network ((TEN)), OZ Minerals ((OZL)), National Australia Bank, Cabcharge ((CAB)) and Wotif.com ((WTF). Conversely, stocks like Telstra ((TLS)), Brambles ((BXB)), SEEK, Ramsay Health Care ((RHC)), CSL ((CSL)), New Hope ((NHC)), Wesfarmers ((WES)) and Myer ((MYR)) all look to be on the hunt, although the broker acknowledges that the deals need to be good for shareholders, with a skew towards cash or debt funding rather than equity.

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Singapore Telecom ((SGT)) has reiterated its intention to revitalise customer growth at Optus. JP Morgan suspects competition will heat up in the Australian telco market, particularly in mobiles. The broker thinks the plans for Optus to share data among devices challenges Telstra's hopes for growth in the mobile broadband network. Optus is not under intense pressure but the broker suspects the main brand lost significant ground in mobile in 2013. JP Morgan considers the company's strategy has two elements, addressing the value end of the market in order to head off a recovery in Vodafone ((HTA)), and tackling Telstra on what Optus perceives as its weaknesses. One of the tactics exploits shared data. Optus will allow up to five SIMs to be linked to the same data allowance. From this JP Morgan implies that any cannibalisation of Optus' own base is expected to be outweighed by gains from Telstra and Vodafone. Management has also reiterated a commitment to lower pricing in data roaming, an area in which Optus thinks Telstra is vulnerable.

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Citi observes retail sales data from the Australian Bureau of Statistics is very important for the information it provides regarding listed retailers. The accuracy of the data varies and online leakage is large but the broker still finds it useful for benchmarking the likes of Harvey Norman ((HVN)), JB Hi-Fi ((JBH)), Wesfarmers and Woolworths ((WOW)). Recent sales trends are not encouraging for electronics retailers and the broker has set Sell ratings on the former two stocks. The broker observes the relevance of the data is far higher for food & liquor, hardware, electronics and department stores and warns investors should avoid relying on ABS data for clothing, recreational goods and takeaway food.

UBS finds the themes across the retail sector have been consistent for the past six months, with housing related categories performing strongly and the major stores winning market share. Sales at supermarkets have now out-paced other specialised food providers for seven consecutive months. The broker is cautious in the near term for apparel names, particularly following recent downgrades from Retail Cube ((RCG)) and Noni B ((NBL)). UBS reiterates a preference for Woolworths because of its grocery exposure. This broker likes Harvey Norman and JB Hi-Fi for housing exposure, and highlights near-term earnings risk for apparel-weighted stocks Myer and David Jones ((DJS)), should the trends from May persist through June and July.
 

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article 3 months old

Clouds Gather For Retailing, Consumer Finance Outlook

-Subdued fashion retailer outlook
-A-REITs buffered by bond spread
-Financial stress set to worsen
 

By Eva Brocklehurst

The retail outlook seems ominous. The measure of Australian consumer confidence within the Westpac/Melbourne Institute survey which asks the question regarding family finances in the next 12 months fell 23% month on month in May, the largest such decline in over 30 years. UBS observes, historically, this measure has been the best leading indicator for retail sales. May retail sales in Australia appear to have deteriorated across the non-food sector and fashion leads the decline, driven by a warm autumn. While the analysts warn of the importance of not getting too anxious over one month's data, soft sales during winter inevitably lead to heightened promotional activity and pressure on margins. UBS also believes the negativity surrounding the federal budget will continue for some time and this increases the likelihood that weaker sentiment will continue into FY15.

What does this mean for stocks? UBS concludes that, despite the short-term noise, there is downside risk to confidence and this lands squarely on fashion retailers such as Premier Investments ((PMV)) and Myer ((MYR)) as well as discount stores such as Wesfarmers' ((WES)) Target and Super Retail's ((SUL)) Rebel. Where are the positives? Leisure sales appear to have stabilised in May and this provides some positives for Super Retail. Trends across furniture categories appear to be more resilient. UBS observes this is consistent with trade feedback that suggests housing-linked categories have been less affected by budget sentiment. The broker makes no changes to forecasts but does believe the weak trends deserve watching, particularly through the clearance periods of June and July.

The latest data also cause UBS to take a look at valuations for Australian real estate investment trusts (A-REITs). The sector's yield spread to the 10-year bond is supportive of valuations and this should provide a buffer against the softening in retail fundamentals. The distribution yield spread is running at 200 basis points compared with the 10-year average of 170 bps. The S&P/ASX 200 A-REIT index has outperformed the market by 3.5% since the 10-year bond has retraced to 3.7% from 4.4% in December 2013.

Nevertheless, soft retail sales could prolong a period of negative leasing spreads and impact operating income growth for the discretionary retail exposures in the sector. UBS includes Westfield Retail ((WRT)), Westfield Group ((WDC)), CFS Retail ((CFX)) and GPT ((GPT)) in this category. The broker prefers Federation Centres ((FDC)) and Charter Hall Retail ((CQR)) because of the resilient nature of retail centres dominated by food and retail services. UBS still expects retail fundamentals to start improving at the end of 2014 and maintains a neutral outlook for regional malls.

Dun & Bradstreet observes financial stress is set to worsen in the next three months as slow wages growth, high household debt and the cost of living impact on consumers. The D&B Consumer Financial Stress Index has risen to 18.7 points in April from 13 points in January. By July the index is expected to hit 24.8 points, the second highest level in its four-year history. D&B Australia & New Zealand CEO, Gareth Jones, said the upward trajectory is concerning, given the number of otherwise improving signals in the economy.

"Over the past months businesses have been reporting more positive expectations for sales and profits, and the jobs market has surprised on the upside - however, the financial position of consumers forms a significant piece of the recovery puzzle," he said. With the potential for the federal budget to weaken shaky consumer confidence, in addition to soft wages growth and the World Bank finding that Australia is the most expensive G20 nation, Jones would not be surprised if the financial position of consumers comes under more strain.

In terms of the states, the index shows Queensland has the highest financial strain index in Australia. This is forecast to rise to 37 points in July from 23.1 points in April, driven by the likelihood of a spike in small business failures as projected by D&B. NSW was the only state to record a month-to-month improvement in financial stress, as the economy benefitted from strong population growth, booming construction and a lion's share of the new jobs. Western Australian consumers experience much lower levels of financial difficulty, as the state's economy is relatively strong, but D&B notes the stress index is edging upwards and is expected to reach 9.2 points in July from relatively flat levels currently.

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article 3 months old

Weekly Broker Wrap: Stock Markets, Wagering, Online, Consumers And Financials

-Oz corporates growing again
-Chinese markets most risk sensitive
-Risks of race field fees overplayed
-Online sector valuations stretched
-Budget turns Oz consumers negative
-Cautious optimism on diversified financials
 

By Eva Brocklehurst

Alphinity Investment Management believes the time has come for the Australian share market to stand on its own account, as tapering by the US Federal Reserve creates a mixed outlook for US equities. Corporate earnings in Australia are growing again and should support positive returns from Australian equity markets. Alphinity envisages growth opportunities in the housing, consumer and energy sectors for the remainder of 2014. The banking sector should still provide decent returns but these are likely to stabilise, while the housing sector gathers momentum. Conditions for retail and consumer goods are set to improve, while resources are expected to remain soft. Alphinity believes the soft patch in the US economy was largely caused by a severe winter and continued improvement on this front will help those companies with international operations in the US and Europe.

On the other side of the Pacific, Australia's largest export market, China, is winding back growth forecasts, and there are implications for resources and other export sectors. The sourcing of goods from Asia has been an important theme for most retailers in recent years but Alphinity believes vetting of supply chains will become increasingly important, given worker conditions are increasingly being scrutinised. Alphinity observes China's shift to consumer-led growth from infrastructure and property investment is well in train. China's desire to clean up its environment and business practices and address unsustainable losses in steel is being dealt with at the same time that resource companies are ramping up supply of raw materials. Alphinity is, therefore, cautious on resources stocks.

Macquarie has surveyed investors and finds them optimistic, with 82% of global investors expecting 2014 will be another positive year for equity markets. Investors still favour equities over bonds and expect cyclical stocks to outperform defensives. Conviction levels have fallen away following a sharp rotation in recent months and Macquarie notes earnings momentum and value are increasingly in favour. Price momentum is expected to show the worst return through to the end of the year. Geo-political risk has been heightened and China is the most commonly identified location where markets could be derailed. Most upside risk is envisaged coming from the US and Europe over the next six months.

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Race field fees across Australia's horse racing industry look set to rise, following Racing Victoria's lead, but Morgan Stanley thinks the longer-term risks to the wagering industry growth, margins and valuation look overplayed, given the recent declines in share prices. Wagering operators can moderate increased fees by increasing pricing to punters. Moreover, the broker's feedback from the industry reduces concerns about the risk of continual fee increases as, if fees increase greatly, it would result in lower growth, which would hurt all involved. The broker remains Overweight on Tabcorp ((TAH)) on the prospects for margin expansion and increased dividends.

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UBS believes now is a good time to review the Australasian online sector. UBS, taking a sample of 30 internet stocks globally, notes the sector has fallen 4% over the last month. In comparison, local stocks are performing better. SEEK ((SEK)) has been the best performer while Trade Me ((TME)) has underperformed its Australasian peers. Still, UBS suggests valuations are now stretched. Valuing the domestic classified franchises based on the addressable market and long-term share implies the other assets of these companies are overvalued by up to 40%. UBS suggests Carsales.com ((CRZ)), Trade Me and SEEK are the most overvalued, while REA Group ((REA)) appears to be fair value. UBS retains a Neutral rating on SEEK based on fundamentals but believes the positives are more than priced in. In contrast, Carsales.com's international assets are now considered richly priced and Trade Me is expensive with limited earnings growth, so both these stocks warrant a Sell rating.

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Bell Potter estimates the federal budget initiatives together amount to a net increase to the burden on consumers of $32 billion over four years, with a skew from FY16. These initiatives include welfare cuts, healthcare changes, the re-introduction of petrol excise and the debt levy. Bell Potter expects consumer sentiment will remain negative over the short term as consumers adjust, and this will be reflected in weaker discretionary trading. Nevertheless, a recovery is expected in the final quarter of 2014 because business confidence should remain positive and drive an improvement in employment prospects, while the wealth effect should remain intact through buoyant house prices and equity markets. Through this volatile period the broker's favoured stocks are large caps such as JB Hi-Fi ((JBH)) and Premier Investments ((PMV)), mid caps such as Kathmandu ((KMD)) and small caps such as Retail Cube ((RCG)). Kathmandu and Retail Cube have vertical models which strengthen the scope to manage margins while JB Hi-Fi's dynamic store model strengthens its capacity to adapt to market conditions.

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Bell Potter has become more selective and pulled back from a strong Overweight position in the diversified financials sector. This is reflected in downgrading Computershare ((CPU)) to Hold and ASX ((ASX)) to Sell. The broker maintains macro drivers are supportive of the sector, but largely for wealth managers rather than the diversifieds. The possibility of a near-term correction is flagged but Bell Potter does not think this is an ongoing risk. The medium-term outlook remains positive and the broker expects the ASX200 to finish 2014 above 5,700. The sector is likely to be characterised over the next 1-2 years by a flow to riskier investments and a slow decline in safe haven investments.
 

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article 3 months old

Thorn Group Reveals Growth Potential

-Radio Rentals underpins outlook
-Newer businesses need scale
 

By Eva Brocklehurst

Thorn Group ((TGA)) is showing improved signs of growth. The company's core business, the well-known Radio Rentals chain, recorded 8% earnings growth in FY14 as smart phone take-up accelerated. Earnings for the group rose 6% as the newer businesses, including equipment financing and cash lending, were ramped up. Management has guided to earnings growth of 6.5% for FY15. Nevertheless, brokers are cautious as the benefits from a broadening of the company's business base will take some time to come through.

Goldman Sachs has a target of $2.40 and a Neutral rating. Thorn has a mixed track record outside of the core franchise and the broker does not think the market will re-rate the stock until the newer businesses demonstrate their credentials. This is 2-3 years away, in Goldman's opinion. Meanwhile, there should be more growth coming from the rental business with the launch of Thorn branded smart phones in FY15 and increased take-up of the new 48-month contracts for TVs and white goods.

When consumer lending and equipment finance reach a critical mass this should drive a re-rating. Goldman believes the market is ascribing little value to the receivables book. The credit management business, NCML, was boosted by a sale of bad debts. Excluding this sale, NCML earnings were up 4%. Thorn Financial Services (TFS) has launched Thorn Money as a brand to target a higher "mid prime" customer base. Bad debts increased as management staged a trial of selectively increasing loan approval rates. This trial has now ceased.

With so much still up in the air, Credit Suisse pins its outlook on Radio Rentals. There is growth emanating from the rental of furniture and new technology. The broker expects solid growth, overall, but also continued weakness in TFS and NCML. Credit Suisse considers the new initiatives are yet to reach a critical mass, as Radio Rentals remains at around 87% of earnings. The Thorn Money product will target a new customer base, providing unsecured loans up to $15,000 and secured loans up to $25,000. This venture has resulted in higher costs as well as higher receivables during FY14. The company has also set up a stand alone Cashfirst store and a solar leasing product with Ingenero.

Credit Suisse notes Thorn has a national presence, which stands it in good stead. Moreover, earnings are counter cyclical and there are medium-term growth opportunities. There is also a solid dividend yield. Regardless, the short-term risk profile is elevated because of the continued investment across all divisions and the recent underperformance of the new initiatives. Credit Suisse has a target of $2.25 and a Neutral rating.

While acknowledging the move towards a broader financial services offering, Moelis considers prospects for sustained upside are limited, despite the undemanding FY15 price/earnings ratio of 10 times. Milestones must be met to confirm the company is on track with its growth plans, given a mixed past performance, particularly with NCML. Moelis observes the smaller units are well below the necessary scale but Radio Rentals is a resilient business, being Australia's largest renter of household products. Moelis retains a Hold rating and a $2.25 target.

The company maintains a pay-out ratio of 65% and declared a final dividend of 6.5c compared with 6.0c in FY13. The dividend reinvestment plan is maintained at a 2.5% discount. Credit Suisse is the only FNArena database broker covering the stock and on its forecasts, forward dividend yields of 5.4% in FY14 and 5.9% in FY15 are implied.
 

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article 3 months old

Surprise Bid Puts Spotlight On Treasury Wine’s Value

-Bid appears generous
-Potential FY14 downgrade
-New strategy critical to outlook
 

By Eva Brocklehurst

The revelation of a takeover bid has astounded brokers and provoked a welter of commentary about the real value of Treasury Wine Estates ((TWE)). Private equity firm Kohlberg, Kravis and Roberts (KKR) has made a non-binding, conditional proposal at $4.70 a share.

Treasury Wine has rejected the bid as undervaluing the company and has refused due diligence. Macquarie thinks the bid is attractive, at 30 times FY14 earnings forecasts, and also believes the company's accompanying comments signal further risk of a downgrade to FY14 earnings guidance. The bid may not be the final word on a transaction but a material increase in KKR's proposition is far from certain. Macquarie notes another variable, and that is the board's willingness to sell. Further to whether the board is willing to sell is faith in the new CEO's turnaround strategy. Macquarie suspects that the board must be tempted to take the opportunity for a clean exit, after a prolonged period of trying to revive the company's fortunes. The broker thinks investors would be best served by taking profits now, rather than risking a generous offer falling through, especially given the market is pricing in an improved bid. Macquarie's rating is downgraded to Underperform from Neutral.

Deutsche Bank is puzzled. The share price is well above where fundamental valuation lies, even assuming a dramatic improvement in the company's business. The bid also seems to make no allowance for a long history of underperformance, and the risks associated with agricultural variability. There are no guarantees that a deal will be done but the presence of the bid provides valuation support and the broker does not rule out a bid from another similarly-focused financial entity. On this basis, Deutsche Bank has upgraded its recommendation to Hold from Sell. Management has announced a 50% increase in marketing spend in FY15, to be funded by $35m in cost savings. Deutsche Bank expects timing differences to constitute an earnings drag in FY15.

JP Morgan, in unravelling events that led up to the announcement of the proposal, suspects it may come to nothing. The broker found it strange the company decided to announce the proposal more than a month after receipt. Treasury Wine decided to publicise the offer, despite a request for confidentiality from KKR when the bid was made in April, because KKR approached some shareholders recently and there was a risk confidentiality would be breached. JP Morgan highlights the significant risk in the bid that, after extensive due diligence to determine the value of a potential break up, KKR would be able to walk away, or materially reduce the offer price. The broker also believes there is a high likelihood of a downgrade to FY14 guidance prior to reporting the results in August.

The company's marketing spending is to be consumer-based and allocated to the international brands such as Penfolds and Wolf Blass, as well as strong regional brands such as Chateau St Jean. These brands generate the strongest margins. The cost savings will come from a reduction in the workforce. Management is focused on the US business as a key growth platform and this suggests to JP Morgan this business is unlikely to be divested.

Morgan Stanley can envisage where KKR may be undervaluing Treasury Wine. The broker thinks the true value of the US business is $1.4bn with the inventory balance at $1.9bn. If these values are accurate, this implies the KKR bid values the Australasian assets at just $500m. In Morgan Stanley's analysis, KKR could afford to increase the bid. Wine assets tend to trade on high multiples, given their strategic nature, and Morgan Stanley suspects Treasury Wine is no different. Valuing Treasury Wine based on precedent transactions the broker comes up with $5.18 a share.

CIMB is of the view that a higher bid would be a challenge for KKR. Crucial to the bid was access to due diligence. There is increased probability that KKR walks away, as CIMB observes private equity firms are typically more disciplined than trade buyers. For KKR to increase the bid it would need to contemplate a more complex and risky asset sale process, in CIMB's opinion, and the appetite for many of the non core assets is likely to be low. UBS suspects the Treasury Wine board has not yet firmed up its view on the company's value, given the new CEO is yet to roll out his new strategy. The broker still thinks current guidance for earnings of $190-210m for FY14 is optimistic. UBS remains comfortable defending its valuation of Treasury Wine's US assets, noting speculation regarding global beverage player interest in these assets. Such speculation, combined with the KKR approach, is expected to support the share price for now, despite the challenging near-term outlook.

On the FNArena database the consensus price target is $4.44, suggesting 7.2% downside to the last share price. This target is up from $3.71 ahead of the announcement. There are one Buy, two Hold and five Sell ratings on the database.
 

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article 3 months old

The Budget And The Stock Market

- Minimal GDP/RBA impact
- Healthcare not a winner
- Infra not a loser
- Retail ups and downs


By Greg Peel

It could have been worse – that’s the general summation from stock market analysts. This is a typical response, of course, given Treasurers like to talk tough and then deliver something a little less painful to appear benevolent. Investors also need to take into consideration, as is the case in stock trading in general, that stock prices had already moved on anticipated pain before last night’s budget speech.

“If the reported drop in consumer sentiment associated with Budget speculation is reversed,” offers Citi, “then we don’t see any major implications from the Budget for the RBA and the equity market”. Macquarie suggests the overall view is one of short term negative but medium term positive for both the Australian economy and the equity market.

JP Morgan suggests “this is a reasonable outcome for stocks,” noting the cut in the corporate tax rate is a positive even if high income earners have to wear a debt levy for a while. GDP expectations should not take a meaningful hit, suggests JPM, given the balance of well-flagged tightening measures and the offset of high-multiplier infrastructure spending.

We must also be aware at this stage that the bill still has to pass through the Senate and may yet be watered down, assuming Labor, the Greens and the Pups all land on the same page.

Drilling down into sectors, it is clear the biggest loser is healthcare, and indeed perhaps more so than was feared. Having said that, uncertainty remains as to just how the consumer will respond to the new regime, and how healthcare providers will respond to the response. To that end, there is disparity among broker views. Infrastructure is a winner, although perhaps not as much as was hoped, making winners out of engineers & contractors to varying degrees. Retailers should find the carbon tax repeal offsetting the extent of middle class welfare cuts. Biotechs and education providers might see a boost.

Let’s start with healthcare. This is not the forum to list all the changes – no doubt readers will assess their individual impact from an avalanche of available media commentary.

The problem for healthcare analysts is that no real data exist on consumer price-sensitivity. Will the new (reasonably modest) medical co-payment measures and PBS changes force the sick to resign to dying at home rather than seeing a doctor? Will it simply make the snifflers and hypochondriacs think twice? Whatever the case, analysts agree the new budget measures are probably a bit worse than feared and will have their greatest impact from FY16. The impact on Primary Health Care ((PRY)), Sonic Healthcare ((SHL)) and Sigma Pharmaceutical ((SIP)) will by no means be positive, but analysts disagree on just how negative the outcome might be.

Macquarie believes the impact to Pathology and GP volumes could be “material” given the non-urgent nature of a fair portion of these services, and especially to those providers who currently bulk-bill.

BA-Merrill Lynch suggests net-negative impacts for all of PRY, SHL and SIP, mostly PRY and SHL, but while PRY is a majority bulk-biller, SHL already charges co-payments and thus will be less affected.

Goldman Sachs agrees PRY is the most exposed and also sees SHL impacted given its leading position in Australia, but believes SIP and fellow pharma wholesaler Australian Pharmaceutical Industries ((API)) will suffer little impact.

CLSA calculates volumes would have to decline by around 4% for medical centre and pathology services for PRY and SHL revenues to be revenue negative but notes that when PRY introduced GP co-payments at selected medical centres in FY10, a 5.3% decline resulted.

Citi, on the other hand, suggests the new co-payments are “probably neutral” for PRY and SHL, but will depend on any moves by the two to waive part of the co-payment in order to gain market share. The other new healthcare measures will “likely have only a modest impact,” says Citi, on PRY, SHL and SIP.

So the jury’s out on the healthcare sector. Watch this space. But there are also winners, with Macquarie noting private hospitals and insurers will win. This puts Ramsay Healthcare ((RHC)) in the frame, for one. The new Medical Research Future Fund may also be positive, Merrills suggests tenuously, for the likes of CSL ((CSL)), Cochlear ((COH)), ResMed ((RMD)), and Mesoblast ((MSB)).

CLSA believes new charges won’t impact on IVF providers such as Virtus ((VRT)) given the highly discretionary nature of the spend, while Macquarie suggests IVF providers “appear to have a small win”.

The market may be a little disappointed by the lack of new initiatives on infrastructure in the budget, says Morgan Stanley, although Citi notes that of all the budget initiatives, the $11.6bn infra increase seems to represent a substantial rise on previous projections. Whatever the case, all brokers agree it’s a shot in the arm for (parts of) the engineering & construction sector.

CIMB suggests Transurban ((TCL)) comes out with the most to gain. Just about everyone else believes Leighton Holdings ((LEI)) is the biggest winner followed by Lend Lease ((LLC)), with benefits also flowing to Downer EDI ((DOW)), Transfield ((TSE)), UGL ((UGL)), Monadelphous ((MND)) and RCR Tomlinson ((RCR)).

With regard to retail, CIMB does not believe the budget places a significant burden on the consumer. The reversal of the carbon tax in FY15 should more than offset the negatives, the broker suggests, although the cuts do look more significant from FY16. CIMB retains its Overweight rating on the consumer discretionary sector and its Add ratings on JB Hi-Fi ((JBH)), Harvey Norman ((HVN)), Dick Smith ((DSH)) and Myer ((MYR)).

If the potential $6.7bn decline in consumption expenditure is spread proportionately across discretionary subsectors, posits Macquarie, the biggest impact will be felt in clothing & footwear, furnishings and household appliances. On the other hand, the supermarkets might benefit if consumers respond by eating at home more.

The broker thus believes the budget is a negative for JBH and HVN but a positive for Metcash ((MTS)). The negative for clothing & footwear, and thus discount department stores, and the positive for supermarkets, splits Woolworths ((WOW)) and Wesfarmers ((WES)) down the middle.

Macquarie goes to the next step and assesses the impact on shopping centre landlords. Sales at more discretionary-weighted sectors are likely to be impacted while food-based centres might actually benefit. Thus on the negative list are Westfield Group ((WDC)), Westfield Retail Trust ((WRT)), CFS retail property ((CFX)) and GPT Group ((GPT)), on the positive list are Charter Hall Retail ((CQR)) and Shopping Centres Australasia ((SCP), while Federation Centres ((FDC)), Stockland ((SGP)) and Mirvac ((MGR)) sit somewhere in the middle.

So that’s the rub. We must consider that analysts have only had since yesterday afternoon’s lock-up to recalibrate their views, and much appears to depend on just how the consumer will ultimately respond. Certainly there were no McMillan Shakespeare-type clangers.

Over to the Senate…
 

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article 3 months old

Treasure Chest: Oroton Set To Re-Enter High Growth Phase

By Greg Peel

Australian luxury fashion house OrotonGroup ((ORL)) successfully exploited the value of its brand, its loyal customers, and its early-mover online offerings in the period from FY07-12, rising from around $1.50 to around $9 over the period, notwithstanding a brief GFC stumble in FY09. There was no doubting, Oroton was hot.

By 2012 the momentum began to ease for Oroton and as the anticipated rebound in Australian consumer spending failed to materialise, ORL started to roll over. Around the time the broad market was shaping up for its big PE rally from mid-2013, the rapid inflow of competitive international brands in Australia had served to knock Oroton off its perch. Things went from bad to worse, and ORL traded down to $3.50.

The company posted somewhat of a shocker of an interim earnings report back in March, but brokers weren’t surprised. Oroton had taken to discounting its luxury goods to compete with the foreign infidels but while margins were slashed, volumes failed to respond. The boot was put in when the company lost its distribution licence with Polo Ralph Lauren. “The exit of Polo,” said Citi back in March, “was a painful experience”.

But management did not lay down for the count. Rather, deals were signed with global brands GAP and Brooks Brothers, discounting was ditched and Oroton looked to improving its factory outlets and increasing its number of promotional events. When reporting on the result release, analysts called the bottom for ORL.

Citi upgraded to Buy from Neutral, forecasting double-digit earnings growth over the next three years. Credit Suisse held its existing Outperform rating, seeing the potential for earnings to double in five years. ORL’s share price bounced, but has since wavered around the $4 mark.

At the time, UBS -- the other of three FNArena database brokers covering Oroton --  remained more cautious on Neutral. This morning however, UBS has upgraded to Buy, thanks to a new senior analyst. That analyst can see a return to the glory days of FY07-12.

UBS estimates the top ten international luxury brands took 400 basis points off Oroton’s market share over 2009-12. The company is responding now with its own global “face of the brand” marketing campaign and reinvesting in high impact store refurbishments. It’s all going to mean a structural jump in marketing costs and capital expenditure, but UBS believes this is essential for the long term health of the brand.

Oroton is also now transitioning GAP to a “seasonally matched” model, which worked for Polo RL before the licence was lost. The Banana Republic brand will have strong appeal in Australia, UBS suggests, with the first store expected to open late next year. New Oroton stores are planned for Singapore and potentially China and will increase ORL’s longer term takeover appeal, the analysts believe.

UBS sees ORL as entering a new high growth phase and is forecasting a compound annual growth rate of 19.7% in FY14-17. With the stock trading at a 13.3x multiple of forecast FY15 earnings, UBS believes it is cheap.

UBS has lifted its twelve-month price target to $5.20 from $4.15, leaving the other brokers in its wake at $4.20 (Citi) and $4.65 (Credit Suisse).


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article 3 months old

Weekly Broker Wrap: Tax, Crops, Budget, Earnings Risks And Advertising

-Tax burden douses confidence
-US corn, soybean prices overshot
-Oz budget may dampen spending
-Where's the FY15 earnings risk?
-Cinema poised to gain ad share
 

By Eva Brocklehurst

Macquarie observes that tax burdens have been rising on labour income in the world's major economies, as governments seek to rein in budget deficits. According to OECD statistics, personal income tax has increased in 25 of the 34 member countries over the past three years. Macquarie suspects that the increased tax burden amidst declining real wages will produce a negative effect on consumer confidence and growth in domestic demand.

The analysts maintain that, if taxation burdens on labour continue to rise, this will disrupt recovery in household balance sheets, reduce consumption taxes, increase income inequality, and constrain investment and GDP growth in the long run. Macquarie concedes many countries need to cut down on unproductive spending - increased as a result of the global financial crisis - and raise tax revenue. What the analysts question is the increased taxation of labour income.

Taking the OECD analysis on Australia, Macquarie notes the single average worker faced an increased tax burden of 0.8 percentage points between 2011 and 2013, higher than the OECD average of 0.3 percentage points. The average tax burden for single income couples with two children rose by 2.7 percentage points in those years compared with the OECD average of 1.4 percentage points.

What's important, in the analysts' view, is evaluating the implications of rising tax burdens on labour income, prior to resorting to tax-biased methods of fiscal consolidation. They believe policy reform for OECD countries should come via: implementing more progressive taxes, so that lowest paid workers face low marginal tax rates without discouraging labour force participation; shifting tax bases towards consumption to increase employment and reduce the efficiency cost to taxation; using tax polices to affect the number of hours worked rather than the participation choice; and increasing taxes on natural resources and energy consumption, in order to minimize the negative externalities on economies.

***

From one dry area to another. Macquarie's agricultural analysts note cold temperatures in the US have delayed corn planting but this has now started to pick up and the recent rally in corn prices may have caused farmers to increase their intended corn seeding area. Soybean plantings have just begun but the analysts are concerned at the late heading of winter wheat, developing at the slowest pace for the last 20 years. In the areas where soybeans follow on this could inhibit the farmer's ability to plant. The analysts note the delays have allowed a risk premium to remain in place but they remain bearish on soybeans, believing prices have overshot and are liable for correction, led by corn. As the farmer starts planting he starts hedging and this should drive a correction in prices. If reasonable pollination in soybeans and blooming in corn ensues, then a sharp dip in prices is expected at the end of the year.

Dry conditions in the southern US have meant some loss of wheat production is near certain. The cold winter and slow emergence of the crop from dormancy means there has been more time to see if rainfall can help in the critical growth stages. While a drop in US wheat production is likely, the analysts expect it to coincide with a large drop in demand because of a far smaller import program from China. Nevertheless, US wheat prices could be supported by any meaningful Chinese import volumes. This is because, if the El Nino develops as expected in in the southern hemisphere this winter, the Chinese may be compelled to buy US wheat, fearing Australian supplies will be weak.

***

BA-Merrill Lynch believes the federal budget could provide headwinds to consumer spending. Initiatives such as the proposed debt levy, potential cuts to welfare, unwinding of the School Kids bonus and the Medicare co-payments could be as much as $9.4bn, representing 4% of total retail sales and 11% of discretionary retail sales. Merrills' economists are predicting that household disposable income growth in FY14 will be the lowest since 1998.

The broker notes Australian Bureau of Statistics' data shows an increasingly greater proportion of expenditure is allocated to necessities such education, utilities, health and insurance. Pressure on discretionary purchases will come at a poor time for retailers, the broker contends. These retailers will have to deal with a lower Australian dollar going into FY15 by raising prices. If consumer spending decelerates after the budget the ability to pass on price increases may be limited, which would impact gross margins.

As the "confessions season" nears, when companies are likely to tweak guidance for the upcoming financial year, BA-Merrill Lynch has taken a peak at where the earnings risk in FY15 could be coming from. The broker sees downside risk for the industrials ex banks. Consensus forecasts expect sales growth of 4.6% to translate to earnings growth of 11%. The broker notes margin expansion of this magnitude has not been seen for at least five years. Hence, Merrills suggests treating the forecasts for Adelaide Brighton ((ABC)), Sims Metal Management ((SGM)), Monadelphous ((MND)), UGL ((UGL)) and ALS ((ALQ)) with caution. The broker is more comfortable with the forecasts for Amcor ((AMC)), Brambles ((BXB)), Flight Centre ((FLT)) and Suncorp ((SUN)).

In terms of the current year the broker, in aggregate, is comfortable with forecasts. Stock specific risk is the main concern, along with a greater-than-usual reliance on second half sales. In the latter bracket the broker includes Ansell ((ANN)), Treasury Wine Estate ((TWE)), Cochlear ((COH)), Qantas ((QAN)), Virgin Australia ((VAH)), UGL and Southern Cross Media ((SXL)). On the other side of the equation those that could beat because of a lower reliance on the second half include Beach Energy ((BPT)), Brambles and Super Retail ((SUL)).

The broker also lists stocks for which earnings forecasts have fallen, but the share prices have risen over the past three months, as having potential to correct. These are Graincorp ((GNC)), Qantas, Caltex ((CTX)), AGL Energy ((AGK)), Mineral Resources ((MIN)), Harvey Norman ((HVN)) and Lend Lease ((LLC)). The opposite, where earnings have been upgraded but the share price has fallen, occurs with Bendigo & Adelaide Bank ((BEN)), ASX ((ASX)) and Perpetual ((PPT)). Merrills remains underweight in consumer staples and miners in the model portfolio, and considers banks, diversified financials and builders have solid momentum.

***

JP Morgan has hosted a call with media buyers about the advertising market. The broker found the year was off to a strong start in TV, helped by the Winter Olympics and the World Cup. The buyers expect up front volumes to be up 2% this year and TV remains a crucial part of advertisers budgets. Live events, particularly sports, are seen as increasingly valuable. Advertisers are relying even more heavily on live events, as audience fragmentation continues. The broker suggests the premium difference between live sport and general programming could widen even further.

The buyers believe cinema is poised to gain share. Cinema's audience is stronger when TV is weaker - Friday and Saturday. The medium's high engagement through sight/sound and the lack of skipping ability underscores its attraction, as well as the skew to a younger demographic. The broker thinks the premium to TV has historically been a hurdle to advertisers but more aggressive pricing recently should unlock more demand.

There continues to be momentum in the move to digital. Advertisers are increasingly embracing digital video and the buyers noted significant improvements in both digital and cross-platform measurement, whereby advertisers can increasingly evaluate digital media on par with traditional media. While digital media is gaining share TV is still dominating. Even YouTube consumption significantly lags TV in terms of the hours watched per day. Viewing video on digital platforms, including mobile, is growing rapidly, but still only accounts for about 6-7% of total viewing.
 

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