Tag Archives: Consumer Discretionary

article 3 months old

Sales Up But Challenges Ahead For JB Hi-Fi

-Sales upgrade buoys market
-Brokers question the resilience
-What will replace software as a category?
-Apple, key product and key challenge?

 

By Eva Brocklehurst

JB Hi-Fi ((JBH)), the appliance and consumer electronics retailer, may have buoyed the market with its upgrade to sales figures for the four months to April but most brokers need more convincing that better times are here to stay.

Deutsche Bank observes that consumer electronics is highly dependent on the product cycle and typically suffers from deflation and device consolidation. The broker's main concern is that 24% of the company's sales are derived from software, a category which is in structural decline. One of the reasons JB Hi-Fi has remained so relevant has been the fact that it offers a broad product catalogue. Reducing floor space in this category could undermine the value proposition, such that floor space will become less productive over time. Although the broker commends the agility of management, citing the move to IT from car audio, there's no evidence there is a new category to replace software. Digital sales may help but, because that area is very competitive, the benefit for JB Hi-Fi will likely be modest. The new commercial category will only help a bit.

CIMB has come out in favour of the stock, suggesting sales growth is a good sign, particularly in the appliance category. The broker highlights comments from management that electrical items within the concept stores have not been affected by the addition of whitegoods to the range, a positive sign for expanding the format. Moreover, Australia is not experiencing the level of discounting seen in the prior comparative period, although the New Zealand business is considered patchy. CIMB upgraded the rating to Buy from Hold.

Most earnings estimates were upgraded following the trading update, which confirmed that sales in the four months to April grew 3%. Macquarie notes this sales performance occurred despite March and April cycling the launch of the new Apple iPad in the prior comparative period, which may have affected sales in those months by up to 5%. JB Hi-Fi indicated the new commercial division has a sales potential of around $500 million. Macquarie finds there's no timeline for this but notes the recently acquired 51% stake in Network Neighbourhood provides an entry opportunity to the Victorian education market. As yet, the broker ascribes no earnings or value to the commercial division.

Another area of potential is video streaming. JB Hi-Fi has partnered with Ultra Violet to provide digital access to movies purchased to stream on any device via its NOW Video application. Macquarie sees an advantage from this in building customer digital libraries with JB Hi-Fi.

Citi, on the other hand, decided to plumb for a Sell rating as did Credit Suisse. The reason? They're just not convinced there is enough to drive continued improvement. Australian comparable stores sales were up 3.3% in the second half compared with being down 3.4% in the first half. Citi observes the major positives have been tablet sales, better computer game sales and software market share gains. The key here is "have been". These numbers will be difficult to improve on in 2014. Particularly, Citi notes, as the tablet category is susceptible to a hangover, with price deflation likely to overtake volume growth next year. The broker highlights the fact that JB Hi-Fi has less operating leverage than most retailers, given a low gross margin of 22%. The fact that better sales only contributed natural leverage suggests theres no incremental upside in gross margins, and the IT category is just so competitive.

BA-Merrill Lynch believes the stock is too expensive. This broker finds, to justify the current share price, earnings forecasts would need to be upgraded by a further 10% at least in FY14 and this is just too optimistic. Especially, as there is risk around the softening macro environment and continuing strength in the Australian dollar. As well, there is the lack of significant new products in the pipeline. BA-Merrill Lynch also thinks that deteriorating industry trends and willingness of competitors to operate off lower margins could see JB Hi-Fi's margins coming under pressure. This will be exacerbated by the limited ability to reduce costs and the fact that the new store roll-out is nearing the end.

A challenge for JB Hi-Fi is that there has been a significant change in the market structure of consumer electronics retailing since last year, according to JP Morgan. There could be more to come. Any further consolidation could be driven by the challenging environment for discretionary retailers and the lack of compelling new product development to drive purchases. A reduction in the risk appetite of credit insurers could also act as a catalyst. JP Morgan also notes the increase in Apple stores in Australia could present challenges. The broker emphasises that JB Hi-Fi is not expected to lose its re-seller status with Apple but does suggest the competitive threat is increasing. JB Hi-Fi has built a reputation for selling Apple product and this distinguishes it from peers such as Harvey Norman ((HVN)), David Jones ((DJS)) and Myer ((MYR)).

For JP Morgan, the price/earnings multiple has increased for the stock but it isn't onerous and not unreasonable, given the FY13 earnings growth and lack of weather risk for the retailers. The dividend yield, while lower because of the recent share price performance, provides a reasonable return in a market focused on yield, in the broker's opinion. On consensus estimates for FY13 and FY14 on the FNArena database the dividend yield is 4.1% and 4.2% respectively. The consensus target price is $14.77, signalling 13.8% downside to the last share price.

There are mixed ratings on the FNArena database. The three Sell ratings are held by BA-Merrill Lynch, Citi and Credit Suisse. There are three Hold ratings, and two Buy - Macquarie and CIMB.
 

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article 3 months old

Weekly Broker Wrap: Which Retail & Building Stocks Are Returning To Favour?

-Department stores well placed for upturn
-Supermarkets expanding too fast
-Wesfarmers' retail and dividends attractive
-Which building materials stocks benefit most?
-Competitive market in gambling
 

By Eva Brocklehurst

Which stocks are best placed as consumer appetites grow?  Morgan Stanley analysts think we're past the worst of  the retail cycle as the drivers of recovery are improving. Underpinning this recovery is the housing market, equity market, interest rates and consumer confidence. Retail sector growth will probably be limited to 3-4% per annum as non-retail categories take a greater hold on consumer wallets. Best placed in discretionary retail are the department stores as they are adapting to cope with the new retail environment, optimising networks and online offerings. David Jones ((DJS)) is the broker's top discretionary pick. Morgan Stanley finds the retailer is under-earning against local and global peers but has the potential to double earnings over the next five years with private labels, store optimisation and online growth. Myer ((MYR)) is also attractive, and an improving top line performance and cash flow shows the company's strategy is working, in the broker's view.

Supermarkets on the other hand haven't had to face the online challenges of the likes of Myer and David Jones and this sector is over-confident. Morgan Stanley believes Woolworths ((WOW)) and Metcash ((MTS)) are overvalued. Part of the problem is that supermarkets are embarking on what the broker describes as irrational store roll-outs. Very bullish plans have been outlined. Morgan Stanley finds retail space growth is 3.5% per annum over the next three years, well ahead of population growth of 1.6%. Incremental returns will be therefore be reduced as new space is not as productive as existing space.

Over-capacity also increase the risk of more price-based competition and the broker suspects a price war could easily develop, robbing the industry of growth and returns as the majors take bites off each other. Wesfarmers ((WES)) is a bit different as it has a wider reach, with Bunnings and Kmart as well as Coles supermarkets. It also has the advantage of being a strong dividend provider and many brokers expect this dividend should grow significantly over time.

BA-Merrill Lynch comes down hard on supermarkets too but is more bearish on the general outlook. The analysts at Merrills think the situation is likely to get worse before it gets better. The high Australian dollar is pressuring Australian business and unemployment is expected to increase over the year. Wesfarmers, Woolworths and Coca-Cola Amatil ((CCL)) have been spending heavily and pursuing growth that doesn't exist, in Merrills' view. Here again, Wesfarmers gets away with it because of strong cash generation. The broker expects dividends to increase to $2 a share in FY14 and free cash flow after dividends is expected to be a positive 22c a share in FY14.

Coca-Cola Amatil generates less cash but Merrills lauds the stated intention to cut back on capex in FY13 and FY14. Coke dividends are also expected to increase, after a sizeable increase in FY12. Woolworths remains the least preferred because, and here Merrills closes ranks with Morgan Stanley, the company is spending too much on growth, such as new stores, renovations and new business. Merrills finds Woolworths unappealing as an investment despite a very strong domestic supermarket business.

Goldman Sachs expects a more sustained recovery in the areas which drive retail spending as we stride through FY14 and FY15. This broker, too, prefers Wesfarmers and has downgraded Woolworths to Sell because of a much more modest earnings growth outlook. As for discretionary retail stocks, the broker recently upgraded Harvey Norman ((HVN)) to Buy and has a Sell rating on David Jones. The difference? Harvey Norman is more leveraged to a strong recovery in the building cycle. 

UBS is on this tangent too, noting housing is picking up and this benefits retailers in two ways. Firstly, via selling items used in new houses such as hardware, note Bunnings, and appliances, note Harvey Norman. Nevertheless, the broker finds these retailers that are directly exposed to increased housing activity only deliver modest upside. The second way is related to the high correlation between house prices and consumer confidence. Further analysis suggest that those retailers offering high earnings leverage to improving sales, via a housing-driven lift in sentiment,  are the best way to play the ball. The broker's preference on this basis is Myer and Premier Investments ((PMV)), owner of Just Jeans, Jacqui E, Peter Alexander and Portmans stores. Here, every 1% surprise in FY14 revenue would deliver earnings uplifts of 2.9% and 3.3% respectively on UBS estimates.

It stands to reason that improved housing starts will support building materials stocks, such as Boral ((BLD)), Adelaide Brighton ((ABC)) and James Hardie ((JHX)) but CSR ((CSR)) is not in the same league this time, as the company's exposure to aluminium prices will have a negative impact, UBS maintains. The picks are Boral and Adelaide Brighton. In terms of Fletcher Building ((FBU)), UBS finds the stronger NZ dollar reduces the NZ earnings impact too much, whereas the likes of Boral offers leverage to housing both in Australia and the US. James Hardie is well exposed to the US but UBS believes the share price is too expensive. In contrast, CSR and Fletcher are considered fair value. Adelaide Brighton recently revised earnings lower. The broker does worry about the medium term but is comforted by the fact that the stock has a low price/earnings ratio and forecasts are undemanding.

Goldman Sachs has taken a look at what's changed in the gaming business. For the March quarter, gambling advertising was up 19.8%, making it one of the fastest growing advertising categories. This is even more significant in the context of an overall legacy ad market that declined 2.4% in the quarter. Rising advertising spending highlights a competitive market. In the broker's view this reflects competitive wagering and sports betting and companies striving to grow share in an increasingly crowded space. TV dominates. Tabcorp ((TAH)) is the most exposed to rising advertising costs as corporate bookmakers are one of the major drivers behind the increase in ad spending. Managing the business to contain costs may see pressure mounting on Tabcorp's market share, in Goldman's view. The broker's preference is for Crown ((CWN)) in the gambling stakes.
 

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article 3 months old

Sofa, So Good For Nick Scali

-Sofas2Go roll-out deemed successful
-Strong earnings growth profile
-Robust dividend yield
 

By Eva Brocklehurst

Furniture retailer Nick Scali ((NCK)) has picked a winner, it seems. Amidst a soft retail environment over the past year the company has managed to successfully roll out the Sofas2Go brand and stores. Analysts at Moelis recently met with management and came away comfortable that the growth profile of the company has improved markedly.

Nick Scali reported a 23% increase in net profit for the first half and a 17% increase in sales. Three new stores opened and there are now 38 in all. Moreover, earnings margins increased to 14.1% against 12.8% in the prior corresponding half, reflecting operating leverage from the higher sales base and an increasing contribution from Sofas2Go. Management has also attributed sales growth to gains in market share via internal factors such as product mix and successful promotional activities.

Moelis had flagged the concept of Sofas2Go as something to monitor over the past 12-18 months and now views the brand having the footprint of success. Moelis thinks a roll-out of four stores a year is in train. The six stores, four in NSW, one in Victoria and one in ACT, are approaching a scale that is generating gross margins just below the 60% level of Nick Scali. Management believes there is long-term potential for around 100 stores. The traditional Nick Scali brand has 32 stores and a long-term target of around 70.

The share price may have increased more than 30% since the first half result in mid February but Moelis thinks the price earnings ratio of 13 times FY14 estimates is still attractive. The FY13 earnings guidance is for growth of at least 20% and the broker has no problems envisaging that. Moelis has forecast earnings growth of 29% for FY13, 17% in FY14 and 13% in FY15. Dividends of 10.5c, 12.5c and 14c are expected for those years and equate to a yield of 4.6%, 5.5% and 6.1%, respectively. The stock is trading around $2.29 and the Moelis' target price is $2.65 with a Buy rating.

The NSW-based retailer has been in operation for around 50 years and imports over 4,000 containers of furniture per year, believing such volumes enable good buying and pricing power. The ranges cover dining, lounge and entertainment furniture. Stores are located in NSW, ACT, Queensland, South Australia and Victoria.

Nick Scali is not covered by brokers in the FNArena database.
 

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article 3 months old

David Jones Transforming But Going Where?

-Focus on margin expansion
-But at the expense of sales growth?
-Broker sentiment divided on turnaround


By Eva Brocklehurst

David Jones ((DJS)) is transforming. For brokers it's not a moment too soon, as department stores have been plagued by a soft consumer environment and a need to respond to new trends in shopping. In its first half results the company has flagged progress with its strategic plan, reducing costs and expanding margins. Earnings were ahead of expectations for the half but sales growth was not. What pleased was the increased margin. What concerns brokers? A lot of things. Most importantly, a lack of sales momentum.

There's no Buy rating on the FNArena database. Two brokers have downgraded ratings to Sell in the wake of the results. There are five Sell ratings. There was one upgrade to Hold - JP Morgan, and there are three Hold ratings. The consensus target price is $2.73, suggesting 11.5% downside to the last traded share price. A dividend yield of 5.5% is reflected in consensus earnings forecasts for FY13.

David Jones is concentrating on improving quality sales. The company has decided to pursue more private label business, increasing this to 10% of sales against the current 3.5%. To reinstate the retailer's stamp on quality and higher margins, sales growth will be affected as the store exists music, DVDs and games. More store space will be allocated to fashion/beauty and home. Some home categories such as electrical are on the exit plan and stores with the wrong demographics will be closed. Macquarie has noted that the company did not specify any closures and, as all stores are profitable, doubts the retail footprint will actually be reduced. The broker suspects the planned review of expiring leases, something all retailers do at the time, is just a shot across the bows to the landlord. Macquarie flags the planned opening of seven stores over the next few years, with four of these by end FY15.

The broker finds David Jones trading at a premium to domestic peers and, given a loss of around $25 million in financial services business in FY14, the company will have to move ahead forcefully just to maintain ground. Macquarie dismisses the strategic plans regarding margin expansion, omni-channel retailing, credit cards and property as not having enough focus on sales growth. In terms of credit cards, Macquarie believes the number of cards issued needs to be boosted as does the spending rate on the cards. The broker observes that the DJS/Amex card relationship is hampered by the fact that customers tend to view it as a "special occasion card" rather than the preferred card.

CIMB is concerned there are no big cost savings identified in FY14 to offset the decline in financial services earnings. The broker hails the improved margins but notes there is little opportunity for earnings growth without a cyclical recovery. The broker believes increasing the footprint of fashion/beauty and exiting certain areas may be alright but argues that this undermines the place as a full service store that the company has treasured.

JP Morgan has gone the other way, finding there are enough reasons to be more confident in the future direction of the company. Reasons include more detail on the quality sales focus and drivers of gross margin expansion. Earnings growth is coming closer too. Although financial services earnings should halve in FY14 the broker is confident that FY15 will produce the improvement in department stores necessary to be a bigger driver of future earnings. Moreover, the share price performance was poor over the past 12 months but has improved a bit recently. Signs, in the broker's view, of  an impending turnaround.

There's comfort to be had in the progress being made on the strategic plan but for Deutsche Bank the big concern is sales decline, particularly as other retailers are showing some improvement. Like Macquarie, the broker believes gross margin improvement, while helpful, doesn't compensate for sales growth. Deutsche Bank agrees that a premium department store should not be leading the market with discounting, but sales declines are not part and parcel of that. Moreover, management was coy about how the current quarter's sales were going, providing more uncertainty. Another thing, Deutsche Bank ponders whether increasing private label percentages may cannibalise existing branded sales.

Morgan Stanley (not a contributor to the FNArena database) has decided the consensus is too bearish. The broker now has a Buy rating on the stock, believing the dividend yield is sustainable and will rise with improved gross margin. All the parts of the strategic plan coming to fruition should be enough to turn the company around after a long downgrade cycle, in the broker's view. In Morgan Stanley's words: we would prefer to own the shares before signs of the turnaround emerge as when they do they will likely be capitalised into the share price.
 

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article 3 months old

Breville Brews Potential Despite Keurig Loss

-Keurig distribution to end
-Growth potential still strong
-UK a key market going forward
 

By Eva Brocklehurst

Appliance manufacturer Breville Group ((BRG)) has confirmed the Keurig brand distribution agreement in Canada will cease from June 2013. The company had flagged the possibility at the time of the first half results and, for brokers, the confirmation removes an uncertainty and they can get down to evaluating the company's trajectory. Brokers find growth potential greatest in the US and Asia as well as the UK. Home base Australia is likely to be more modest.

On the back of the announcement, Macquarie expects Breville to take a restructuring provision in the second half and scale down the Canadian infrastructure over the coming year to fit with the remaining Breville electrical business. The question will be how much of the operating cost infrastructure was shared with the existing Canadian operations and what can be eliminated. Macquarie is upbeat about the Keurig loss, believing the remaining earnings streams from the Breville brand are of higher quality. The broker flags the strong growth prospects in the US and solid sales in Asia and Europe. Moreover, the company will launch the new Nespresso range in mid 2013.

Goldman Sachs has downgraded earnings forecast to take into account the loss of Keurig revenue and the reduction in scale in the Canadian operations. This is offset by a rise in the price/earnings premium the company has to the broker's small industrials coverage. Goldman believes the removal of uncertainty over Keurig will actually result in a higher P/E rating for the stock. Strong growth in underlying earnings, favourable international prospects and a healthy balance sheet means the broker is not bothered by the loss of the Keurig revenue.

For CIMB the stock continues to offer reasonable value given the growth proposition is market penetration rather than overall system growth. The broker flags a net cash balance of $50m by the end of FY14 and wonders whether capital management is a possibility, should the share price remain at current levels. A buy back of up to 5% of share on issue at the current price could cost the company $35m and still leave the balance sheet debt free.

One thing the broker does foresee is that there are trailing overheads unaccounted for from the Keurig closure and these could take six to 12 months to eliminate. CIMB has allowed for $6m in trailing costs. Despite gaining market share and signs of an improving operating environment, CIMB has factored in only modest top line growth in Australia, about 2-3% for FY13-14 with a slight margin decline, despite Breville edging away form the competitive low end of the market.

UBS had already adjusted forecasts for the Keurig loss scenario and has reduced North American earnings forecasts by 22% for FY14. While the news of potential one-off costs with the Canadian restructure could still impact sentiment, the broker hastens to add the company still has significant growth potential internationally. UBS is yet to add in value for the UK opportunity, which should be launched in three months.

Breville intends to launch a premium range into the UK market, starting with 17 high-end units under an alternative brand. UBS notes critical mass could take some time but there is no reason why the region could not be a meaningful contributor to the company's business. The broker envisages that, should UK penetration reach just one fifth of that in Australia, Breville's earnings would be raised by 6%, assuming similar 10% margins. This is the story the broker expects investors to focus on going forward. On this rests the broker's Buy rating.

On the FNArena database there are three Buys and one Hold for Breville. The stock carries a dividend yield of 4.9% on FY13 consensus forecasts. The consensus target is $6.12, from a tight range of $6 to $6.30, with 12.7% upside suggested to the last share price.
 

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article 3 months old

Weekly Broker Wrap: Europeans Home In On Oz Infrastructure

-Europeans target Aust Infrastructure
-Yield versus growth in infrastructure stocks
-Pressure on retailer margins continues
-General insurers, transport outperforms
-Who gains with media reform proposals?
 

By Eva Brocklehurst

Offshore competitors are circling. Citi has observed that European companies seeking growth are increasingly targeting Australian infrastructure projects. The broker lists Impregilo, Salini, Acciona, Bouygues, Balfour Beatty, Ansaldo and Obrascon as targeting Australian rail, road, water and power projects. The most exposed, overall, to this increased competition are Leighton Holdings ((LEI)) and Lend Lease ((LLC)). Citi believes Acciona's winning bid on Brisbane's $1.7bn Northern Link road project could be a test case for the Europeans' ability to undercut Australians on price and make a profit.

In resources, competition from international companies is greatest in LNG. Europeans have not actively targeted resource infrastructure projects to date, limiting involvement to mostly maintenance services. That could change. Citi finds the most exposed stocks in this respect are Monadelphous ((MND)), Downer EDI ((DOW)) and UGL ((UGL)). Orica ((ORI)) and Incitec Pivot ((IPL)) have enjoyed the mining boom mostly free from international competition but this too is expected to change. Citi notes the construction of the nitrates plant in Western Australia's Pilbara marks the first major investment in domestic ammonium nitrate production from an international producer, Norway-based Yara International. Orica is partnering with Yara and Apache.

Aurizon ((AZJ)) is BA-Merrill Lynch's top pick in the infrastructure sector, given balance sheet leverage and cost cutting potential. Asciano ((AIO)) will benefit from new grain and coal contracts and Transurban ((TCL)) will be driven by steady traffic and toll increases. TCL, AZJ and Qube Logistics ((QUB)) are considered to have the strongest 5-year compound annual growth rate.

The broker divides infrastructure companies into two broad camps. Companies such as Asciano and Sydney Airport ((SYD)) will show growth over the next three years as economic conditions improve, but these more cyclical stocks tend to offer a lower yield as capital is reinvested. On the flip side is DUET ((DUE)), Spark Infrastructure ((SKI)) and SP AusNet ((SPN)) which, being regulated utilities, have more defensive cash flow and offer higher yields. For example, on the FNArena database consensus forecast FY13 dividend yields are 6.8% for SPN, 6.6% for SKI and 7.5% for DUE. In contrast there's AIO (1.9%) and AZJ (2.4%). SYD appears to be the exception to the rule, showing a 6.9% yield. 

Some of these stocks, such as AIO, SYD and Australian Infrastructure ((AIX)) are more leveraged to GDP and the general economy. In contrast, the steady utilities such as DUE, SKI and SPN have more subdued growth profiles and exposure to the improved economic conditions. On Merrills' 5-year measure, QUB (14%), AZJ (10.5%), AIX (10.6%), TCL (10.3%) and AIO (8.85%) offer the strongest distribution growth. Although the regulated utilities currently have the highest yields in the sector, there appears to be little growth in distributions. The 5-year measure shows 3.3% for SKI, 2.9% for DUE and 1.5% for SPN.

Overlapping infrastructure for some stocks is transport and here Aurizon shines again for the broker. It is one of two notable structural turnarounds in the transport sector. The other is Qantas ((QAN)). Transport stocks outperformed the market in February, up a weighted average of 8.1% versus the ASX 200 at 5.4%. Asciano and Toll Holdings ((TOL)) were the key stocks for Merrills, up 15.7% and 17.7% respectively in the month. The broker puts the outperformance of TOL and AIO, as far as the financial results are concerned, largely down to margin expansion rather than top line growth and notes organic growth remains muted for each of Brambles ((BXB)) AIO, TOL and Virgin Australia ((VAH)).

There's been much talk about retailer margins. Citi finds Australian retailers seem reliant on gross margins to protect earnings. For FY13, most retailers are approaching record margin levels but the broker believes it can't last. Myer ((MYR)) and David Jones ((DJS)) are perhaps best placed to protect gross margins through greater private label sales and use of clearance outlets. Price discounting swings from season to season and, in Citi's view, the rise in FY13 gross margins reflects fewer discounts.

The other factor at play is price harmonisation, which can actually raise margin percentages but comes at the expense of sales growth. There are downside risks as new entrants and online shopping break down that margin advantage. Overseas retailers have responded to gross margin pressure in a range of ways such as private labels, clearance channels and service income. This is the sustainable path and where David Jones and Myer seem well positioned to leverage these gains. Other retailers may pursue the same opportunities but, in Citi's opinion, will only manage to offset natural margin pressure.

Credit Suisse notes general insurers have continued to outperform the market in recent months. They are now trading at a price/earnings premium to their five-year historical average. A slight premium is justified with the positive outlook continuing, albeit at a slowing pace. Despite QBE's share price being up significantly in recent months, it remains the broker's preferred pick in the sector. The broker supports the actions taken by QBE management and expects a continuation of underlying earnings improvement in coming years.

Insurance Australia ((IAG)) has recently widened the gap to Suncorp ((SUN)) on a price/earnings basis, a premium the broker considers appropriate. This is because IAG has most upside leverage to the local general insurance market and less downside risk from unpredictable natural peril events. Credit Suisse expects a slowdown in premium rate increases, a reduction in investment income and adjustment to new APRA capital requirements to play out for these stocks over the next one to two years.

This week new media reforms were proposed by the Commonwealth Government and, understandably, received a lot of press. Legislation is expected to be presented to the parliament within the next two weeks. The easy bit, and that which the Coalition is likely to approve, is a reduction in licence fees and mandating Australian content quotas. The Coalition intends to oppose a media advocate appointment, public interest test in relation to media mergers and a statutory press standards body. A parliamentary committee will be established to discuss potential abolition of the 75% audience reach rule while the Australian Communications and Media Authority (ACMA) will consider program supply agreements in determining control of free-to-air television. The Australian Law Reform Commission will to be asked to look at the possible implementation of a tort for invasion of privacy.

If a quick resolution is reached regarding the abolition of the reach rule, this will be added to the current package. Summarising the potential implications for the media, Credit Suisse notes a positive for Southern Cross Media ((SXL)) and Prime Media ((PRT)), which would both benefit from reduction in licence fees and the opportunity of abandoning the reach rule. Abandoning the audience reach rule would enable Ten Network ((TEN)) or Nine Network to take over SXL and Seven West Media ((SWM)) to take over Prime.

On the neutral fence is TEN and SWM, as the potential abolition of reach rules would be countered by the introduction of a public interest test, statutory press standards body and increased regulation of supply agreements. In Credit Suisse's wholly negative camp is News Corp ((NWS)), if a public interest test, press standards body and increased regulation of supply come about. Fairfax ((FXJ)) and APN News & Media ((APN)) are also in the negative camp because of the possibility of a public interest test and statutory press standards body.
 

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article 3 months old

Troopers Circle Billabong

-Further guidance downgrades
-Profitability still weak
-Will the suitors' enthusiasm wane?
-Debt issues remain
 

By Eva Brocklehurst

The pressure is truly on Billabong International ((BBG)). The half year results came with yet another downgrade to earnings estimates for FY13 and, as brokers rushed to incorporate the data, the picture painted was not pretty. The trouble is, the action clothing retailer faces challenges at the internal level as well as from the retail sector and the macro economy.

The revised earnings guidance is $74-85 million for FY13, compared with $85-92m previously. This reflects lower earnings from Nixon and poor European trading conditions. For JP Morgan, interim earnings were assisted by cost savings and further mask the underlying deterioration in revenue. In Macquarie's opinion the half year results are irrelevant because the banks are likely to become involved in the company, unless a white knight rides up quickly. There are potential suitors. The company has two in train and they are conducting due diligence.

One thing remains certain. Billabong has a debt covenant issue. To resolve it, the banks agreed to reclassify debt as non-current with a repayment date of July 2014 but this was done just to provide time to complete negotiations with the bidders. Macquarie would be surprised if the arrangement survives, unless a definitive bid ensues. The one positive to take from the results is that weakness may make the board more ready to cut a deal. Citi takes that view. The negative is the suitors may have lost their enthusiasm in the wake of the numbers.

Citi flags the large write-down of the brand Billabong, noting this is another indicator of weak profitability. The company acknowledged that brand Billabong has been an poor performer across the regions, even in core markets of Australia and the US. Moreover, sales trends are still murky. Citi notes the company may be able to close stores and cut costs but the sales and earnings outlook for Europe will influence the risk premium that potential bidders attach to the company. Credit Suisse concurs, noting the troubling aspects for a buyer are the constrained timeframe for a turnaround in the business. The retail legacy issues have become worse in Canada and this raises the cost of exiting that part of the business. On the positive side, Credit Suisse finds Rvca is performing well and presents value for a buyer. Moreover, that business would be bought at a time of cyclically low profits from Europe.

Macquarie notes the rate of deterioration in the top line seems to be accelerating with little evidence the company's transformation strategy is reducing costs faster than falling revenue is reducing profits. JP Morgan believes the transformation strategy is on track but there's a risk of impairment for intangible assets as previous carrying values were based on FY16 earnings from this strategy. Management refused, or was unable, to issue guidance for FY16. CIMB sums up the company's situation as a toss up between a successful bid and the need to raise capital and finds the latter not a pleasant thought.

Many brokers believe the company would be better off privatised. Further assessment of that likelihood will come in March, when due diligence should be done. Deutsche Bank suspects things will get real tough if a firm bid is not forthcoming but finds a major obstacle for such a bid in the deteriorating outlook. The stock is trading well above the broker's valuation but the potential for a bid prevents a Sell rating. Macquarie sticks with a Hold rating, noting the equity value now appears to be worth no more than a $1.10 per share (indicative bid) and perhaps less than discounted cash flow valuation.

The number of Buy ratings on the FNArena database is one - Credit Suisse. The broker highlights the large difference between target price of $1.10, set on the basis of a bid, and a discounted cash flow valuation of 46c a share, set on the basis of the existing profit trend. There are five brokers rating Hold on the database and the primary reason is they have set their judgment aside, awaiting the potential bid. There are two Sell recommendations - BA-Merrill Lynch and UBS. UBS just doesn't believe the stock is compelling value at current levels and has moved to a price target of 80c. The range of price targets on the FNArena database is 65c to $1.10 and the consensus target of 88c reflects 3.6% upside to Friday's closing share price.

Should a takeover not proceed, Citi expects Billabong's share price to fall to between 62c and 83c, which reflects the broker's valuation range. The balance sheet may be stretched, but the broker expects an asset sale or more structured debt and working capital are the options if banking facilities cannot be rolled over in 2014. Citi places a 45% probability on a takeover deal proceeding. Credit Suisse is a bit more confident, but assesses there a lower chance of an offer emerging at the $1.10 indicative bid price than was the case ahead of the result. The broker still thinks a bid has a better than 50/50 chance of proceeding.

See also, Billabong Between A Rock And A Hard Place on December 20 2012.
 

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article 3 months old

Weekly Broker Wrap: Time To Take On More Equities?

-More growth in Japan can help
-Legal risks for supermarkets?
-Web turning positive for department stores
-Time to take more equity risk?
 

By Eva Brocklehurst

The new Japanese government may signal important changes for Australia. Morgan Stanley notes the trading link is still significant, despite being eclipsed by China in recent years. An improvement in Japanese growth should provide a moderate boost to local exports, although it is still likely that growth in Asia, ex-Japan, will remain the single most important global influence on Australia. The broker notes a 2% lift in Japanese GDP adds the same to global growth as a 0.7% lift in Chinese GDP and while that's good, it's not huge.

Japan accounts for 7% of global steel production, down from 25% in the early 1980s, so as a trading partner for Australia's major exports of iron ore and coal it is less significant. Morgan Stanley notes Japanese-Australian trade is most significant in the seaborne coal market, both of which are already in moderate oversupply. In the tourism sector, once a highlight, the Japanese share of Australia's inbound tourism market has also fallen. According to Morgan Stanley, this is partly from the very large change in bilateral exchange rates over the past decade, as the Australian dollar has risen sharply against the yen. It is another indicator of where Japan's importance for Australia has been overtaken by China. Nevertheless, any recovery in Japan's stagnant economy should deliver some moderate support for Australia.

Citi has had a look at the Australian Competition and Consumer Commission agenda on Coles and Woolworths ((WOW)). A breach of consumer law through unconscionable conduct, or misuse of market power, could result in legal action and penalties. The ACCC has collected information from suppliers about the retailers' behaviour that may be illegal, if proven accurate. Citi notes examples include the way retailers decide on whether to add or delete ranges, the request for direct payments and demands for lower cost of goods sold.

In defence, both retailers have codes of conduct that include relationships with suppliers. Citi believes the critical issue is how these are implemented in practice. The retailers take the view that shelf space is a scarce resource and they are trying to grow profit. In the broker's estimation, both supermarkets require gross profit margin expansion to satisfy market expectations for earnings growth. If private label growth is limited or negotiating is affected by potential legal action, then margin expansion may slow. Citi says the explicit earnings risk from unconscionable conduct is $1.1 million for each breach. Misuse of market power is $10 million or more for a breach. So, it could be substantial.

Citi notes these risks are not reflected in the companies' share prices -  Wesfarmers ((WES)) in the case of Coles - given consensus forecasts imply margin expansion for both retailers over the next three years. The broker has a Hold rating on Woolworths and Sell on Wesfarmers but on fundamental valuation. Therefore, Citi maintains, legal risks do pose downside potential. To put this in perspective, on the FNArena database there are three Buy, three Hold and two Sell ratings for Woolworths. The consensus target price is $29.65, offering 13.5% downside to Friday's closing share price. In the case of Wesfarmers there are one Buy, four Hold and two Sell recommendations on the database. Here the consensus target is $36.60, offering 8.1% downside.

Moving from downside risks to upside, Credit Suisse believes the web is turning positive for department stores this year. The broker looked at growth in web traffic and conversion rates for David Jones ((DJS)) and Myer ((MYR)) and found upside risk for sales and earnings estimates over the next three years. Conversion rates are estimated at around 10%. Myer's unique audience is estimated to have risen 10% year-on-year in December as David Jones' audience by 74%. The broker has a Buy rating for Myer and a Sell rating on David Jones, but notes the rating on David Jones is primarily because of uncertainty over cost structures. On the FNArena database there are five Hold and three Sell ratings for David Jones. Myer is more mixed. There are two Buy, four Hold and two Sell.

Rising home prices should put consumers in a better frame of mind. Macquarie, channeling economist Milton Friedman, notes consumers spend a portion of what they regard as permanent income while windfall gains are saved. Increases in wealth may have been seen as a windfall in the past but many now regard this as more permanent and, when it comes to wealth effects, the family home is the biggest asset. So, consumption in countries with higher rates of home ownership tends to respond more to changes in house prices.

On a macro view, in 2013, the broker believes the consumer will notice the effect of quantitative easing when the price of homes start to rise again and the most positive impact will be on markets where house prices have had a large correction. Macquarie think the US is likely to have the largest gains in house prices. The broker notes UK house prices are still falling, but at a slower rate. Here, with credit easing and real income growth accelerating, there is upside risk to house prices. This, in turn, should be positive for financial stocks, which are a large part of the UK equity market.

House prices in Germany are still rising, but at a slower rate, so the wealth effect is fading. Macquarie does not see a positive wealth effect in the rest of Europe in 2013, but with credit expected to ease, the worst is likely to be over. Given negative sentiment, the broker views Spain as the contrarian opportunity. House prices there are still falling, but the rate of decline slowed at the end of 2012. Confirmation of a trough would be bullish for Spanish stocks.

Changes in stock prices can also affect consumption but in Friedman's thesis, these are less powerful than a rise in house prices. It takes longer for gains to be seen as permanent, and hence an income source that can be spent. Here, Macquarie notes Australia appears to be an anomaly. While house prices do impact consumption, the impact of stock prices seems to be stronger. The broker sheets this home to the comparatively higher rates of participation in the equity market.

For investors not wanting to invest in equities, property is a good alternative, according to Macquarie, as it is more bond-like but also provides some hedge against the inflation that is expected to result from quantitative easing. The broker notes cheap liquidity is already boosting house prices and having an impact on the consumer.

In summary, Macquarie thinks now is the time to buy growth assets. Government and corporate bonds do not provide high enough yields to compensate for the potential interest rate, inflation and default risks. On a horizon of six months global equity markets look overbought to the broker, and there may be a mid-year correction. Despite this, money is moving back into stocks for the first time in years, global growth is improving and rising house prices should provoke the consumer to spend. As a result, Macquarie believes the best days for bonds are over. Bond prices no longer account for inflation or credit risks. The broker favours financials that benefit from the shift to equities, and rising interest rates.
 

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article 3 months old

JB Hi-Fi Makes Margin But Sales Disappoint

-JB Hi-Fi results prove resilient
-Stock valuation now fair
-Concerns about sales growth
-Sustaining margin not enough
 

By Eva Brocklehurst

Specialty retailer JB Hi-Fi ((JBH)), ahead of reporting season, had become a litmus test for the retail sector. So, what are brokers interpreting from the company's first half earnings results, released yesterday? To some extent it depends on where they sat on the performance line beforehand. There's convergence towards the neutral or middle as the stock's recent rally fulfills expectations. The divergence is in outlook and depends on just how confident the broker is that this retailer can sail through the storms that continue to batter the sector. Macquarie remains the most gung ho on the FNArena database, the only one with a Buy rating, noting the stock is still trading at a discount to its peers. The company's 3% profit increase was close to Macquarie's forecasts and gross margins expanded as anticipated. Moreover, January's trading margins have improved. All-in-all, for Macquarie it was a competent result.

UBS called it a great result in a tough market. As the stock's valuation is now considered fair, UBS has downgraded to Hold from Buy. The broker takes a positive view that the sector is becoming more rational but emphasises any upside for the stock hinges on this. To be rational the company must clear inventory at a reasonable margin and maintain the momentum in new product launches. This broker heeds the company's note that it is holding an increased level of aged stock and that excess inventory is expected to be sold at full margin.

Deutsche Bank notes expectations for the stock had probably overshot on the downside ahead of the result and welcomes the improved margin. It's just that sales were not given the attention they deserved and they were not robust. The broker said sales growth of 2.3% was the weakest ever seen. On a like-for-like basis sales declined by 3.5% across JB Hi-Fi branded stores and 3.4% in Australia. Deutsche Bank poses the question of whether the company walked away from lower margin sales which could have had the effect of increasing profits but decreasing sales. This was denied by the CEO at the conference call so Deutsche Bank is a bit confused as to what's underpinning the weak sales growth. Moreover, headwinds persist in the sector, particularly with structurally challenged categories, and this is why this broker is sticking with its Hold recommendation.

CIMB is also taking the middle road. This broker remains concerned about the inventory turnover as it appears the company is using capital-intensive goods to drive sales. Specifically, there is increased inventory from funding private label expansion (Soniq and Yellowstone) and new categories such as musical instruments and white goods. CIMB maintains that, if the company decided to advance its white goods strategy even further, inventory turnover would move even lower. This could tie up the balance sheet and, potentially, limit the magnitude of future capital returns.

JP Morgan opted to upgrade its recommendation to Hold from Sell, because of earnings upgrades and a less demanding valuation. This broker admits it missed opportunities to get more upbeat about JB Hi-Fi, hence the upgrade. Nevertheless, it's not that euphoric, believing the cloudy earnings outlook and risk/reward do not justify a Buy. What prompted Credit Suisse to go the other way, downgrading its rating to Sell from Hold, was the strong relief rally in the stock post the result. This broker is mindful that underlying sales growth will remain low, dragged down by declining sales of software and the maturation in the audio visual category. Credit Suisse finds insufficient initiatives to predict a trend increase in gross margin to compensate for the slow top line growth.

Two others have a Sell rating on the FNArena database - Citi and BA-Merrill Lynch. Citi puts it bluntly. Near-term earnings have been protected by higher gross margins and a resumption in like-for-like sales growth is needed to improve the outlook. The broker expects continued weakness in sales to result in falling profit margins over the next three years. Moreover, Citi finds the company's inference that gross margins and like-for-like sales can grow at the same time difficult to accept. BA-ML frames its outlook for JB Hi-Fi as "buyer beware". The broker just doesn't like what it suspects is margin protection at the expense of sales growth, believing the value proposition of the stock is being eroded. Again, the summation is familiar: there's too many structural headwinds in this industry for the market to maintain a focus just on margins.

While the headline result came across as a positive surprise to the market, the fact that JBH was at that point the most highly shorted stock in the market provided an obvious short-covering boost within yesterday's 17% rally, clouding any simple re-rate. As it stands, the FNArena database now shows one Buy, three Hold and four Sell (or equivalent) ratings with a consensus target of $11.89, some 6% below the current traded price.
 

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article 3 months old

Retailing Ain’t Broke, Just Changing

-Retailing is changing, not broken
-Traditional relationships are weaker
-Online versus foot traffic well entrenched
-How about a merger or two?


By Eva Brocklehurst

Retailing's business model ain't broke, according to several analysts. Hence some suggested "fixes" aren't going to... fix. JP Morgan simply sees the sector suffering because the once extremely strong relationship with disposable income and consumption has weakened. Macquarie says it's a volume thing. Morgan Stanley thinks there's opportunity for some very unexpected outcomes as the year progresses.

JP Morgan finds the outlook for consumer stocks quite mixed but it's not just the bricks and mortar versus online story. There are cyclical and structural factors which are impacting, such as a renewed propensity among consumers to save (cyclical), an increased focus on buying "experiences" such as travel rather than goods (structural) and more international players wanting a slice of pie.

JP Morgan is Underweight in its position on consumer discretionary stocks, with consumer staples preferred on a sector relative basis. The analysts see reduced leverage to income growth for the retail sector, particularly listed discretionary retailers. International entrants also pose a threat, lifting the competitive bar for domestic bricks and mortar retailers. This year, JP Morgan sees themes such as value-focused consumers, a continuing shift online, with retailers needing a compelling and improving online offer, and increasing competition. Therefore, value-focused mass retailers with high traffic levels and/or customer insights are well positioned.

Macquarie points out that clothing, footwear and accessories retailing is a large category within the sector but less visible because of the high percentage of unlisted ownership. Nevertheless, there is a perception that they, as well as the sector as a whole, are in distress. Business models are seen failing due to rising costs, new market entrants (competition) and disruptive new technologies (online, mobile). However, Macquarie says things are happening that contradict this. Australian retailers continue to have the highest earnings margins in the world in five of the six retail categories the analysts examined (discount department stores the exception). Furthermore, gross profit margins are rising or stable in most retail categories. For example, the analysts find that grocer gross profit margins have risen around 300 basis points since 2007. Interestingly, in Macquarie's view, so have speciality apparel retailer average gross profit margins.

So, where is the negative perception coming from. It appears, in Macquarie's analysis, that it's mostly on seeing declining foot traffic in stores. ABS chain store volume data shows volumes declined in the apparel, footwear and accessories category by 3% per annum across FY10-12. However, retail volume growth has accelerated over the last 12 months to approximate growth in the consumer base. Hence, Macquarie does not expect large mass or mid-market apparel retailer failures and, where these occur, it will more likely reflect brand relevance and loyalty issues. Macquarie expects traditional retailing cycles will return but at a lower growth level.

On the subject of major retailers -- department stores in particular -- Morgan Stanley speculates, as one of the broker's "potential surprises", about David Jones ((DJS)) and Myer ((MYR)) merging. Warming to this thesis Morgan Stanley says, collectively, tate broker consensus is overwhelmingly negative on these two: 75% of ratings are either Sell or Hold. So, both stock prices would react positively to news of a merger and the rationale has now never been greater. However, the broker says it's unlikely anyone is even pondering the thought.

Other interesting "potential surprises" are Wesfarmers ((WES)) continuing to improve even after an impressive 2012 and maybe achieving a record share price as well as JB Hi-Fi ((JBH)) reducing its store count for the first time ever. Harvey Norman ((HVN)), viewed quite negatively by the market at present, could also surprise by reducing its consumer electronics footprint. However, Morgan Stanley suspects that company would rather raise capital and be the "last man standing" in the category as opposed to closing stores. Morgan Stanley sees the large property portfolio as a drag on HVN's balance sheet.

Other quirky ones are Coca-Cola Amatil ((CCL)) delivering a flat beverage volumes in a dry and thirsty summer or discretionary retailers providing more earnings upgrades than supermarkets.

In terms of CCL, Australian beverage volumes have been in decline over much of the last two years and investors generally expect them to pick up with the hot, dry summer. However, Morgan Stanley sees scope for this dry-wet theory to be dumped on. Aggressive pricing strategy from Pepsi, competition and a growing avoidance by the health conscious of carbonated soft drinks underline that "surprise" potential.

As for underperformance in discretionary retail, Morgan Stanley thinks investors have focused on the structural issues facing discretionary retail and not appreciated the cyclical element enough. Discretionary retailers are relatively cheaper, generate better dividend yields and arguably have more scope for earnings upgrades than the supermarkets. Online retail sales growth has exploded over the past few years. Morgan Stanley sees the consensus view that this growth will moderate being put to the surprise test, citing retailers aggressively improving online offerings with shopping online only beginning to hit the mainstream.

Morgan Stanley also thinks wine sales could improve and exceed CPI for the first time in 10 years. Why is this a surprise? Many analysts still doubt the industry, coming out of a long period of oversupply, can obtain better prices from the consumer, given the brand fragmentation and consolidated retail structure in Australia. 
 

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