Tag Archives: Consumer Discretionary

article 3 months old

Pacific Brands Headed For The US

-Recognises turnaround in key assets
-Suggested sale of Dunlop Flooring, Tontine
-Large synergies expected
 

By Eva Brocklehurst

A takeover of Pacific Brands ((PBG)) is considered highly likely to proceed, following a strong bid from HanesBrands, a US-based apparel business with a similar offering.

Brokers expect the considerable synergies on offer will ensure the bid goes ahead. Citi calculates a 26% premium to the three-month average price of the stock and a 45% premium to comparable global acquisitions. A 9.4c special dividend, fully franked, is proposed by Pacific Brands, to be paid upon completion of the deal.

The company calculates eligible shareholders will receive 4c in terms of the full benefit of the franking credit. To the extent this special dividend is paid the cash consideration will be reduced.

The proposal recognises the sound work the company has done to turn the business around, Ord Minnett contends. The work is still in progress and HanesBrands plans to divest Dunlop Flooring and Tontine, identifying significant earnings upside in FY19 for the Bonds and Sheridan businesses.

The largest opportunity brokers envisage is in the supply chain synergies as the businesses leverage the global scale of HanesBrands. Ord Minnett calculates the offer represents an attractive operating earnings multiple of 12. The broker downgrades its recommendation to Hold from Accumulate, given the takeover bid matches its target of $1.15.

Could the proposal attract another bidder? UBS is doubtful, given the high implied multiple, but does not rule it out. Premier Investments ((PMV)) is the only Australian listed apparel company that could acquire something of this size.

The broker calculates Premier could generate 5.0% earnings accretion by offering $1.20 a share and still keep net debt/earnings ratio below 0.5. However, UBS expects this earnings accretion would largely be a function of increased leverage, with some potential synergies and would probably involve, at the least, some scrip.

HanesBrands currently produces the majority of its apparel in house – it owns brands such as Hanes, Lovable and Playtex - while Pacific Brands uses external manufacturers. This is key to the bidder's belief it can use manufacturing efficiency to drive down average unit costs. This could potentially drive substantial synergies between the two businesses.

The offer is solid, Deutsche Bank agrees, noting the significant improvement in Pacific Brands after assets were divested and the balance sheet was placed in a net cash position. The company's retail strategy produced like-for-like sales of 22% over the first half. The broker considers Pacific Brands to be a multi-year turnaround story with he first benefits only coming to fruition in FY16, given the upgrade to the company's guidance at the first half result.

The broker envisages upside risk to that forecast and believes its forecasts are conservative when it comes to the assessment of the success of Bonds and Sheridan in both the retail and wholesale channels.

HanesBrands expects that it can growth Pacific Brands sales at mid to high single digits, which is above Deutsche Bank's assumptions. The broker does not capture any option for additional scale through M&A in its forecasts, adding that this is the clear attraction for HanesBrands in the acquisition.

The Pacific Brands board has unaniminously recommended to bid in the absence of superior proposal and the independent expert's report. Shareholders will have the chance to vote at a scheme meeting in June.

There is one Buy rating (Deutsche Bank) and three Hold on FNArena's database. The consensus target is now $1.13, suggesting 2.4% downside to the last share price.
 

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article 3 months old

Treasure Chest: Tough Road For Billabong In The Short Term

By Greg Peel

Consumer sentiment in the US has declined over the past few months. North America’s large action sports chains, department stores, teen retail and tourist retail have suffered subdued activity for the past several quarters, Moelis & Co notes.

As a result, price discounting and promotion wars in-store and online among retailers has been rife. Action-wear retailers have been bemoaning a weak outlook and confidence has not been boosted by retailer PacSun electing to restructure under Chapter 11, which will likely imply further discounting. For the Lazarus of the Australian surf, skate and ski-wear scene, Billabong International ((BBG)), the long turnaround story is presently riding over a bumpy patch.

Analysts at Moelis & Co believe Billabong will successfully turn around in the longer term, and investors willing to back this view should garner strong returns as a result. However in the shorter term, the company is facing headwinds.

Critical to Billabong’s turnaround is targeted cost savings through to FY20. In valuing the stock, Moelis has applied a familiar, bear case, base case and bull case methodology. The broker’s bear case assumes Billabong misses its cost savings target. The base case is $20m in annual savings by FY20 and the bull case is $25m in annual savings by FY19 and a revenue boost from e-commerce.

Management’s ability to lift margins is currently running into a currency dampener, Moelis notes. The company has borrowed in US dollars and thus has faced increasing AUD interest payments over 2016 as the Aussie dollar has depreciated. The flipside, nevertheless, is higher revenues in AUD from sales in the Americas and Europe. Sales in Australia have also improved online as offshore products have become more expensive in AUD.

On the balance of longer term upside and shorter term issues, Moelis has initiated coverage of Billabong with a Hold rating and $1.70 price target.

Three of the major brokers in the FNArena database cover Billabong. Deutsche Bank and Citi both retained Hold ratings following the company’s full year result release in February. Ord Minnett’s forecasts were beaten, and as such the broker upgraded to Accumulate from Hold.

The consensus target price in the database is $1.92, suggesting 26% upside, though price targets might be subject to revision when brokers update in light of the latest market developments.
 

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article 3 months old

Weekly Broker Wrap: Aquaculture, Slots, Retail, Sharing Economy And Investment Strategy

-Balanced outlook for salmon
-Aristocrat likely to retain dominance
-China tax policy tempers tourist outlook
-International retailer assault to continue
-Property services negative re sharing economy
-Australia a preferred market for investment
 

By Eva Brocklehurst

Aquaculture Producers

Tassal Group ((TGR)) has withdrawn from domestic retail supply tenders to Coles, indicating to Credit Suisse a previously signalled unwillingness to tender at sub-optimal levels relative to other channels.

The broker was surprised, nonetheless, that the entire contract to Coles changed hands. It appears Petuna has secured the fresh deli contract. Credit Suisse does not believe the Simplot contract has been finalised yet but expects it to go to Huon Aquaculture ((HUO)).

Tassal has also noted supply restrictions and increased pricing as a result of the impact of the long hot summer, which Credit Suisse believes applies to all operators. Importantly, while growth has been affected, mortality levels have not.

The broker reduces expectations in terms of volumes and margin assumptions, with a negative earnings revision for Tassal of 5.0%. Gaining additional retail exposure is considered a positive for Huon, as is reduced competition in wholesale channels. The broker considers the industry supply and demand outlook is increasingly well balanced.

Slot Machine Makers

Macquarie's analysis suggests Aristocrat Leisure ((ALL)) has continued to take market share at the expense of Ainsworth Game Technology ((AGI)). The broker notes patent applications and absolute R&D spending signal Aristocrat can maintain its dominance.

Both companies have strong balance sheets and liquidity which, combined with increased annuity earnings, suggests to the broker that compared with global peers, the Australian manufacturers are likely to increase ship-share in both Australia and North America.

Macquarie upgrades Aristocrat to Outperform (from Underperform) as the trends are clearly supportive form an earnings and sentiment perspective. The broker downgrades Ainsworth to Underperform (from Outperform) as in contrast, market share and momentum are considered headwinds.

McGrath

Bell Potter considers it appropriate to compare real estate business McGrath ((MEA)) with offshore listed comparables rather than other consumer facing stocks in Australia, as none of these operate within the Australian residential real estate market.

Key offshore peers include Realogy, Foxtons and Countrywide. The broker notes the price/earnings ratios for these stocks on FY16 and FY17 forecasts are well above the average for McGrath.

Bell Potter retains a Buy rating and $2.25 target and continues to believe the company will at least achieve its pro forma prospectus forecasts in FY16, believing it undervalued in both a relative and absolute sense.

Australian Retail Property

New Chinese tax policies could temper the outlook for tourist oriented shopping malls, Morgan Stanley contends. New taxes for cross border e-commerce and international parcel deliveries become effective on April 8.

The broker suspects stricter enforcement and increased scope and quantum of the tariff on imported goods could reduce demand for goods purchased from offshore and outbound tourism.

Tourist exposed centres account for around 20% of the Australian Real Estate Investment Trust retail stock. GPT Group ((GPT)) has the highest exposure by portfolio value, Morgan Stanley observes. Vicinity Centres (VCX)) has the largest number of malls.

With redevelopments increasingly relying on the introduction of new luxury retailers the broker questions the potential risk/reward of future development activity.

Discretionary Retail

Macquarie has analysed the recent financial performance of the international retailers H&M, Zara and Uniqlo. Cumulatively these earned $460m in sales across 29 stores in their latest financial year results. They continue to add competitive pressure to the department and discount department stores as the majority are co-located.

Sales of the three have deteriorated from initial elevated levels, Macquarie observes, with some cannibalisation and lower sales productivity expected as they expand into the suburbs from more productive CBD locations. Still, the broker does not expect this to deter the continuing trend of offshore retailers entering the Australian market.

In terms of the listed property sector, these international stores are typically anchoring retail development activity in Australia, the broker notes, and taking market share away from domestic retailers.

The broker is concerned about the impact, given their typically low price points, which means domestic competitors cannot raise prices to offset the cost of goods impact of a lower Australian dollar. Increased financial stress is considered likely in domestic specialty apparel chains.

Moreover, international retailers are receiving generally lower rents and higher incentives which will continue to hinder shopping centre development returns in Australia. That said, the cost of doing business for these retailer in Australia is expensive, and returns are expected to moderate.

Sharing Economy

This is a rapidly growing economic model based on access to, rather than ownership of, physical and human assets such as time, space and skills. Examples are Airbnb, where people can list and book accommodation, and Uber, the ride sharing application.

Advances in technology, spearheaded by the internet, have enabled the economy to grow. As a result, some traditional business models have been disrupted while for others it provides a cost effective platform with which to compete.

Among the key findings of the National Australia Bank's report on the sharing economy, the analysts note that while large firms are the most positive about the impact, small firms are the most confident going forward. This may reflect the fact large firms have a better understanding of the sharing economy, as none of them signalled a lack of knowledge.

Small firms operating in the health services and construction industry indicated a lack of knowledge about the impact of the sharing economy on their business. Overall, around one in 10 Australian firms believe the sharing economy had an impact on their business over the last 12 months.

Businesses operating in the property services industry were the most negative in regards to the impact followed by retail businesses.

Investment Strategy

Participants at Credit Suisse's Asian Investment Conference were bullish regarding the short term but cautious for the long term. The broker suspects Chinese stimulus measures have caused many investors to re-assess their near-term outlook as there remains a considerable overhang of debt and an unbalanced economy.

Australia is now a preferred market in the region but investors are cautious regarding materials and financials stocks, which make up two thirds of the benchmark. The broker observes foreign investors are not smitten by the sector mix in Australia but suspects they want to gain exposure to the appreciating currency and the highest dividend yields in the region.

The relevant presentations at the conference for Australian investors included evidence that VIP gaming volumes in Macau should gradually recover. The acquisition criteria for the Hong Kong Exchange suggests to the broker it would not be interested in ASX ((ASX)) while Singapore Telecom's Optus is looking to differentiate its business in Australia via content. The recent acquisition of English Premier League rights for Australia is part of this strategy.
 

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article 3 months old

Weekly Broker Wrap: Strategies, Exports, Retail, and Health Care

-Are pay-out ratios sustainable?
-Risks to exports from AUD strength?
-UBS expects modest retail sales growth
-Subdued federal budget for healthcare likely
-Yet further reforms unlikely to be announced
-Medical Developments' key product in trauma

 

By Eva Brocklehurst

Portfolio Strategy

On face value Goldman Sachs finds pay-out ratios in Australia appear unsustainable. Over the past 12 months the ASX200 has paid out 83% of reported earnings in the form of dividends. This is the highest pay-out ratio in 30 years, the broker notes, and well above other developed markets. The fact that a number of resource stocks have made substantial cuts to dividends over the past few months highlights the focus on sustainability.

Goldman expects growth in shareholder returns will be more muted going forward, and believes there has been too much focus on Australia's high dividend yield relative to other global markets.

The broker agrees with the underlying basis for suggestions that Australia's imputation system and record low bond yields put pressure on firms to maintain a high level of dividend payment as opposed to making future investment opportunities. Nevertheless, this does not account for two important points.

Firstly, the pay-out ratio, while still high, looks better compared with free cash flow than it does when compared with earnings. Secondly, when the cash returned via buy-backs is included, Australia drops to the middle of the range globally.

Ordinarily the broker would argue that firms are better off implementing buy-backs than making dividend payments that are potentially unsustainable, because of the negative price signal a cut to dividend sends. That said, given equity market valuations have been quite high relative to history in many developed markets, Goldman Sachs suspects capital management actions in Australia might prove to be more conservative than many international peers.

Top Picks

Credit Suisse includes Amcor ((AMC)) in its top picks for Australia. The broker considers the stock defensive and well managed, providing exposure to the global packaging market. Bolt-on M&A opportunities are also on the rise. The broker notes 32% of the company's revenue is derived in higher growth emerging markets.

Amcor is expected to generate 6.0% earnings growth in FY17 from the US$200m in acquisitions made over the past 12 months, a sequential improvement in flexibles trading in China and no further drag on reported earnings from US dollar strength. Credit Suisse retains an Outperform rating and $15.30 target.

Services Exports

Net services exports contributed one sixth of Australia's 3.0% GDP growth in 2015 and ANZ analysts expect this segment will slow in 2016, amid a waning stimulus from the Australian dollar.

A stronger-than-expected currency then raises the risk of an earlier and sharper slowdown. There is already some evidence that Australians are holidaying more overseas while education exports have already slowed.

On the optimistic front, the analysts argue that growth in inbound Chinese tourism has been less sensitive to the currency and this is a key driver of services exports. Additionally, given the extent to which a more resilient currency reflects better fundamentals, a weaker outlook for net services exports is less of an issue, the analysts acknowledge.

Retail

Retail sales for February were up 3.3%, below the 12-month run rate of 4.2%, UBS observes. Supermarkets were weak, household goods continued to moderate, driven by a weaker result in electronics, reflecting a tougher comparable as well as the unwinding of Dick Smith. Department stores provided a strong result, recording 7.0% growth.

UBS expects mid single digit growth to continue in 2016, driven by support from the housing market. The broker contends Harvey Norman ((HVN)), JB Hi-Fi ((JBH)) and Adairs ((ADH)) offer the best listed exposure, with Harvey Norman having further upside via successful execution of its efficiency strategy.

The broker also expects the department store sector, namely Myer ((MYR)), should also perform well. Sell ratings for Woolworths ((WOW)) and Metcash ((MTS)) are unchanged. The broker retains its relative preference for Coles ((WES)) within supermarkets.

Healthcare

The upcoming federal budget is expected to update projections on recent shifts in policy regarding bulk billing incentives, the Pharmaceutical Benefits Scheme (PBS) and the freeze on Medicare benefits.

UBS suspects it is too early to book material savings from the key reviews but, equally, the growing budget deficit remains a constraint on largesse. Given major reform processes are under way the broker generally expects a more subdued approach to further healthcare reform in this budget.

Monthly aged care data recently released recently showed 200 basis points in over-spending versus forecasts. While UBS believes this was dealt with in the government's Mid Year Economic and Fiscal Outlook (MYEFO), when a top up was applied and the scoring matrix changed, a modest correction may be considered at this budget.

Still, the broker suspects it is more likely that with scoring matrix changes yet to take effect, and given the political climate, the government may wish to reassess the situation later in the year at the 2016 MYEFO.

Aged care funding growth of 7.1% in the four months to October was in line with Deutsche Bank's expectations and the broker does not expect material reforms to be announced at the May budget, given the cuts already announced at the MYEFO are yet to be implemented.

The broker believes the funding reforms proposed in the MYEFO were largely intended to rein in growth in the complex health care category of funding. The risk of further reform, therefore, will depend on the success of these cuts, the broker maintains, and growth should decelerate in 2016 as providers react to the changes. Further cuts in July may be required to slow growth to the budgeted level, Deutsche Bank suggests.

Medical Developments International

Bell Potter initiates coverage on the specialist health care company, Medical Developments International ((MVP)), with a Buy rating and $7.50 target. The company offers industry-leading products in the areas of pain and respiratory devices.

The company’s Penthrox product is a self-inhaled, fast acting, non-narcotic analgesic for trauma pain. Approval for marketing in the UK, Belgium and Ireland was received in the first half.

The broker notes emergency trauma pain is under-served and a growing market. Increasing use of emergency departments has put them under pressure and Penthrox can facilitate a 3-hour turnaround performance standard and provides an attractive alternative to opioids.

The company's respiratory product is Space Chamber, designed to be used with metered dose inhalers to improve the delivery of asthma and COPD medications. Bell Potter forecasts double digit revenue and earnings from FY16 and considers the valuation reasonable relative to the stock's aggressive growth potential and risk profile. The broker expects 3-year compound growth in earnings of 66.4%.
 

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article 3 months old

Smiggle Surprises For Premier

-Slower earnings growth likely in second half
-Smiggle a material earner over long term
-Selling conditions deteriorate in Feb/Mar
 

By Eva Brocklehurst

Premier Investments ((PMV)) hit a high note in its first half results, impressing brokers with the quality of earnings and the progress so far in the UK roll-out of its fun Smiggle stationery stores.

Deutsche Bank lauds the company for getting the job done in negotiating the current retail environment and managing the mix of growth and margins. The broker believes the stock warrants a premium to the discretionary retail sector, given its superior growth profile and balance sheet.

Yet Citi is not swayed by the impressive headlines in the half year results. Instead, the broker is looking at the slower retail growth that portends for 2016, as well as the margin pressure that will materialise for Premier Investments as FX benefits disappear. The broker downgrades to Sell from Neutral, with the share price considered fair value but weakness expected as growth slows.

Premier's first half earnings beat forecasts, with profit up 26% on the prior corresponding half. Like-for-like sales growth was 6.9% and all the company's brands made a positive contribution.

Several issues, such as a warmer February/March, early Easter and an election cycle, may mar the retail environment and make it harder to manage, Macquarie suggests, but management does not appear perturbed, remarking that the fourth quarter was more important than the third and the business is well set to execute in that period.

Macquarie's second half forecasts assumes no like-for-like sales growth in established brands. Still, the broker continues to believe Smiggle will be a material driver of profit over the medium to long term. Forecasts contain room for established brands to decline materially and so the first half results are considered to be supporting Macquarie's conservative expectations in that regard.

The broker believes Premier Investments can hold its premium valuation while Smiggle performs. Premier Investments has upgraded its target for store roll-outss. Revised guidance is for 100 Smiggle stores by the end of 2016, with 40-60 per annum over 2017-2019.

Meanwhile, Peter Alexander sales grew 22.6%, Online sale rose by 48% and Portmans was up 19%. Jacqui E sales rose 2.2% and Dotti by 7.4%. The company declared an interim dividend of 23c. The company decided not to pay a special dividend, as it did in the first half of FY15, stating it intended to use cash for future investment.

Bell Potter strengthens gross margin assumptions and lowers cost/revenue ratio estimates. The broker also raises the multiple in its valuation, given the effectiveness of the company’s strategic initiatives and the outperformance of Smiggle. The net effect is an increase in FY16 and FY17 forecasts of 8.0% and 10.0% respectively.

Bell Potter, not one of the eight stockbrokers monitored daily on the FNArena database, retains a Buy rating and raises the target to $17.40 from $13.40. Despite competition increasing and a lower Australian dollar the broker has confidence in management's ability to drive growth.

The significant improvement in gross margin surprised Credit Suisse, which suspects the main reason for this, outside of a mix shift towards Smiggle and Peter Alexander, is a strong Christmas sales period. This contributed to a very strong sell-through at full margin.

Hence, the broker suspects this situation will partly reverse in the first half of FY1. In terms of sales growth and gross margin improvement for established brands, Credit Suisse factors in a more normal Christmas trading period, noting the company is fully hedged for purchases through FY17. The broker believes the stock is fully valued and retains an Underperform rating.

The second half is expected to be more challenging in the lead-up to the federal election and is heavily dependent on seasonal conditions. Selling conditions have not been favourable seasonally to date in the second half, and the broker adds the proviso that its forecasts are based on normal seasonal conditions through the key period May to July.

UBS believes the results are of the best quality the company has ever delivered. Sales growth was strong across all brands and flags the potential for 1500 Smiggle stores globally to open over the next decade. The broker's optimism, despite acknowledging that several retailers have flagged the negative impact of a warm start to autumn, as well as political uncertainty, is based on the Smiggle proposition.

The seemingly unique proposition to 5-12 year-olds continues to show global appeal, the broker maintains. The UK has opened 18 stores and continues to have over 10 of the top 20 global Smiggle stores In portfolio. The first stores in Malaysia and Hong Kong will open in the next few months. UBS believes upside risk is building to forecasts, increasing medium-term earnings estimates by 6-10% and long-term earnings forecast by 20-25%.

That said, given increased risks to the discretionary retail outlook, and a general skew to the first half for UK Smiggle earnings, as well as a normal 26-week period - there was one extra week in this result - the broker does not expect the growth rate to continue at the same clip. Still, UBS continues to have confidence in the company's ability to increase its gross margin in core brands through sourcing initiatives.

FNArena's database shows two Buy, two Hold and two Sell ratings for Premier Investments. The consensus target is $14.67, signalling 6.2% downside to the last share price. This target compares to $12.69 ahead of the results.
 

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article 3 months old

Brokers Expect More From Myer

-Reliance on concessions growing
-Flagship stores driving growth
-Rationalisation continues
-Competition heightened


By Eva Brocklehurst

Brokers were heartened by department store chain Myer's ((MYR)) first half result, which showed progress for its transformation strategy. Nevertheless, they expect more to be done and believe more needs to be done.

Credit Suisse observes sales were less reliant on private labels in the half as concessions made a larger contribution. This led to a decline in gross margins of 187 basis points and this was further affected by depreciation in the Australian dollar and clearance activity from the first quarter. The broker expects the continued store optimisation should take costs out and help offset the gross margin decline while profit should stabilise.

The fact that concession sales substantially supported earnings in the half year disappointed Citi, along with the fact earnings were down 6.0% and the gross margin was under pressure. Guidance was upgraded to the top end of the prior forecast range, to $66-72m for FY16. Cost guidance for restructuring was also reduced to $20-30m from $35-45m. An interim dividend of 2c added a surprise sweetener to the results.

Of most concern to Morgan Stanley is that clearances, concessions and a robust Christmas period have likely camouflaged the fact that foot traffic has not altered. The broker believes Myer is still relying on cost reductions to hold profitability at certain levels, and getting costs out of the business is obviously a finite goal.

Although margins are considerably lower, which implies longer-term upside, and the balance sheet has improved, Morgan Stanley considers the valuation now looks reasonable and downgrades to Equal-weight from Overweight. The broker suspects the structural pressures faced by the incursion of foreign retailers remain in force.

Myer is having difficulty emulating its strength in cosmetics across its apparel and accessories departments, Ord Minnett believes. In cosmetics the brand portfolio is strong and there a fewer competitors but in apparel and accessories there are brand perception issues and greater competition. The competitive environment in department stores is intensifying the broker suspects, especially from rival David Jones.

The company's flagship stores are driving growth. Moreover, while the closure of stores in the last 12 months affected total sales the remainder were more efficient, Macquarie observes.

The Brookside store in Queensland will now close from January 2017 and Myer has confirmed it will not open new stores in Tuggerah (NSW) and Coomera (QLD) as previously planned. Macquarie also expects the company to cancel the Myer opening in Darwin (NT) although this has not been flagged. Management has suggested potential to rationalise up to 20% of the footprint to increase productivity.

The broker also observes the mix-shift towards concessions has allowed a reduction in costs and improved efficiency across the whole business. That said, while the indications at this stage of the transformation are positive, there are challenges in executing the strategy in store and further network rationalisation.

Macquarie notes David Jones and specialty retailers continue to aggressively roll out stores and take market share. One interesting snippet Macquarie highlights is the fact that online sales continue to experience strong growth, with 25% of this sales growth emanating from in-store purchases on tablets.

Deutsche Bank flags some signs of progress but maintains this is priced into the stock. The broker suspects the move towards concessions will make the profit & loss account difficult to interpret and reduces visibility but acknowledges Myer is benefiting from better trading conditions. Still, Deutsche Bank only upgrades estimates modestly, believing the composition of the results remains weak.

FNArena's database shows two Buy ratings, four Hold and one Sell (Ord Minnett). The consensus target is $1.25, suggesting 2.3% upside to the last share price. Targets range from $1.10 (Ord Minnett) to $1.40 (Citi). The dividend yield on FY16 forecasts is 4.4% and 4.5% on FY17.
 

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article 3 months old

Weekly Broker Wrap: Global Outlook, Resources, Building Materials, Gaming And Electronics

-Global economy vulnerable to shocks 
-Central banks likely to ease further
-Resource equities lag general market
-Morgan Stanley more optimistic on Boral
-Gaming stocks below Deutsche's valuation
-Strong outlook for JBH and HVN


By Eva Brocklehurst

Global Outlook

Morgan Stanley is no longer looking for an acceleration in global growth in 2016. The risk of a global recession has increased and the broker attaches a 30% probability to the event. Solid spending, subdued oil prices and expansionary monetary policy counter the likelihood of recession, but the global economy in a low-growth environment remains vulnerable to shocks as well as a broad range of geopolitical risks, in the broker's opinion.

A stable growth rate of 3.0% on downwardly revised forecasts reflects a slowing in developed markets, led by the US, and a stabilisation in emerging markets, led by Russia and to a lesser extent India. The broker does not expect a recession but the declining impact of lower oil prices and easier monetary policy is becoming a concern.

The broker now only expects one rate hike from the US Federal Reserve in late 2016, an additional 10 basis points cut from the European Central Bank (ECB) and a 20 basis points cut from the Bank of Japan before the July elections. Both the Chinese and Indian central banks are expected to ease later than previously envisaged.

AllianceBernstein is of the view that the global economy is still growing modestly. Developed economies are expected to expand slightly faster this year at 2.2% compared with 1.6% last year. Developing economies are expected to grow 3.8% in 2016 versus 3.4% in 2015.

Nevertheless, the lacklustre environment and low inflation is likely to force central banks to ease further, with the analysts highlighting the experiment in several cases with unconventional policy and negative interest rates. Both the ECB and Bank of Japan are expected to push rates deeper into negative territory.

The wild card is China. The analysts note strong capital flows point to more currency weakness, while increases in credit use and the rebound in spot commodity prices for industrial materials suggest that the economy might be in the process of bottoming. AllianceBernstein expects that China will overcome this soft patch in its economy and post growth of over 6.0% this year.

Global Resources

Pengana Capital asks whether the recent rally in resources is sustainable. First glance suggests commodity prices have run too hard, too fast. Prices could fall back but the analysts are mindful that prices are now equivalent to levels seen in 2004, some 12 years ago. This generates the observation that the Chinese economic boom, which drove prices higher, could be construed as never taking place.

However, resource equities have lagged in the run-up in commodities. Industrials, financials and technology sectors have outperformed resources by nearly 100% over the last few years, the analysts contend. Hence, much of the pessimism appears to be priced into resource stocks and much of the optimism priced into general equities.

The analysts suggest it may be time for the relationship to normalise. Moreover, structural shifts in the US economy, with market expectations going from a potential for four US rate hikes in 2016 to just one, suggest that the undervalued resources sector could be a beneficiary.

Building Materials

Current conditions in south east Queensland appear robust to Morgan Stanley. Price growth in the Brisbane apartment market is slowing and interstate investors remain dominant, given the attractive entry point and strong yields.

Underlying demand, nonetheless, is weak, and the job market relatively poor, so this comes with risks on a 24-month view. The Gold Coast is strong ahead of the Commonwealth Games construction program.

Morgan Stanley expects concrete volumes to remain at high levels and while apartment activity may slow nationwide, some major projects such as the Kingsford Smith Drive upgrade and northern NSW Pacific Highway are expected to sustain activity for the next 2-3 years.

Morgan Stanley is incrementally more positive on the outlook for Boral ((BLD)), given the likely sustainability of the strengthen in south east Queensland. Queensland account for 22% of the company's revenue from construction materials and cement. Morgan Stanley forecasts a 10 basis point improvement in margins across FY16-18.

Gaming

Deutsche Bank is positive on the gambling sector, given its robust earnings forecasts and sound balance sheets. The broker expects expenditure on gaming domestically will continue to benefit from low interest rates, high property prices and stable employment. Casino operators are also benefitting from Chinese tourism.

All gaming stocks are below the broker's valuations although Aristocrat Leisure ((ALL)) and Star Entertainment ((SGR)) remain preferred exposures. Value is also seen emerging at Tabcorp ((TAH)) and Tatts Group ((TTS)).

CrownResorts ((CWN)) is boosted by the prospect of a corporate restructuring which could involve a bid for the remainder of the company by James Packer. Deutsche Bank retains a Hold rating on the stock.

Consumer Electronics

Harvey Norman ((HVN)) and JB Hi-Fi ((JBH)) are both enjoying sales momentum in Australia. Deutsche Bank expects this to persist, with housing volumes and the wealth effects a tailwind. Relative to the population, housing starts are not seen at record levels and the broker believes the recent surge in construction is merely a catching up after decades of limited growth.

The exit of both Dick Smith and Masters should deliver meaningful benefits as well. The broker estimates Masters will vacate $120m in appliance market share as a complete shutdown is the most likely scenario. Apportioning the sales by existing market share suggests Harvey Norman is the largest beneficiary, with a boost of 0.7% expected to Australian sales.

In terms of Dick Smith's closure, JB Hi-Fi is expected to benefit with a 10% sales uplift, Harvey Norman 6.0% and Officeworks ((WES)), 3.6%.
 

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article 3 months old

Super Retail Outlook Not That Super

-Positive focus on auto maintenance
-Should Ray's be closed? 
-Minimal profit growth a concern
 

By Eva Brocklehurst

Super Retail ((SUL)) delivered a soft first half result, missing broker forecasts on the numbers but predictable in that the automobile and sports categories performed strongly while leisure remains challenged.

Deutsche Bank queries the company's strategy as it does not appear to be having the desired effect. The most positive aspect was that automobile categories are resilient and the company noted an increasing focus on auto maintenance. Momentum in the sports segment was also encouraging.

Ray's is considered the difficult part to fix, although Deutsche Bank is encouraged by early results of the trial store format. Leisure segment sales were actually in line with Deutsche Bank's expectations but the comparables are highlighting the current weak conditions and intense competition in that market.

Morgan Stanley just wants more clarity on the outlook. Earnings guidance has been missed a number of times and the broker wants more detail on whether the drivers of the continued earnings misses are one-off or whether they will return to haunt the company in the future.

The result signals further delay in the turnaround in the leisure segment, in Goldman Sachs view. The decline in margins at both Ray's and BCF highlight the difficulties management faces in changing the format amidst a competitive trading environment at Ray's, and driving sales growth at BCF without significantly affecting margins.

Nevertheless, the broker, not one of the eight monitored daily on the FNArena database, believes the valuation is already factoring in some of the downside risks for leisure and retains a Neutral rating.

The financial year is shaping up to reveal a subdued result and Macquarie expects, with the stock still trading at a market multiple despite the sell off, a return to higher rates of growth will be required before the stock is re-rated. Hence, the broker downgrades to Neutral from Outperform.

Ray's is understood to have delivered a $20-3m loss with a $20m impairment of the brand name being taken. Commentary also suggests to Macquarie that BCF turned negative in the key November-December trading period.

This should be a temporary blip and the broker expects management to address pricing and marketing issues. Ray's require some harder yards and its viability is more uncertain, in Macquarie's view.

Trials of the three new format stores are encouraging and a further five are to be opened in the second half. These are attracting a new type of customer. Management, subsequently, believes it may need to relocate 35 stores, more than first anticipated. Hence the brand impairment.

On the other hand the Rebel brand continues to perform strongly and Macquarie observes the Amart brand is getting traction in new markets. Macquarie believes leisure is under-earning and is yet to realise the significant investment made in the supply chain and IT in recent years.

The problem with Ray's is manageable, Credit Suisse believes. While the future of the brand in its current format is less certain following this result, the perceived need to re-locate more stores suggests this will work against brand continuation.

Credit Suisse calculates closure costs associated with Ray's, if that were to eventuate, might be $100m or 50c a share. This results in a valuation around $8.07, only marginally below the closing share price after the announcement.

As a result the broker is inclined to the view that the valuation risks are slightly favourable at this point in time. Credit Suisse retains Ray's as a continuing business in forecasts. Rating is upgraded to Neutral from Underperform.

The result was not “super” but not that bad either, UBS asserts. The broker accepts the leisure segment needs work but can be turned around. UBS reduces FY16 earnings forecasts by 12% and makes smaller reductions to estimates from FY17 onwards.

This reflects significant reductions to leisure margins, improving margins in sport and automobile segments and higher corporate costs. UBS considers its Buy thesis is still intact and believes the stock screens cheaply.

Morgans takes a dimmer view and downgrades to Hold from Add. While acknowledging the share price reaction might be extreme, the minimal profit growth, once again, suggested in FY16 estimates remains of concern.

The broker believes BCF can be turned around but is wary of the amount of time and investment need in Ray's. The broker also contemplates whether Ray's is worth the effort.

The performance of the converted stores has been above initial expectations, but Morgans believes a lack of scale, brand awareness and store locations could well prevent the format from ever delivering a meaningful profit. Still, the broker allows for the company having one last crack at trying to get the business back on the rails.

Super Retail has three Buy ratings, four Hold and one Sell on FNArena's database. The consensus target is $9.30, suggesting 14.4% upside to the last share price. Targets range from $8.50 (Deutsche Bank) to $10.70 (Morgan Stanley) The dividend yield on FY16 and FY17 forecasts is 5.1% and 5.8% respectively.
 

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article 3 months old

Greencross Continues To Dominate Attractive Market

-Co-location strategy lauded
-Weak H1 in WA but turning
-DRP suspension welcomed
 

By Eva Brocklehurst

Greencross ((GXL)) continues to dominate the pet care and veterinary market, as management consolidates its network of stores and clinics and executes its online strategy.

Earnings were up 17% in the first half, with like-for-like sales growth of 5.1%. Western Australian-based City Farmers was softer, which was the main drag, brokers observe, on an otherwise solid result. City Farmers represents 17% of retail sales. Veterinary services earnings grew 22% while New Zealand growth was 7.0% .

Deutsche Bank considers the company is well placed to leverage its position in an attractive market, despite increased competition for veterinary practice locations. Cash conversion improved, which highlights better supply chain management in the broker's view, although this needs to deliver more proof of its sustainability in the second half. The broker considers the stock, trading on a forward price/earnings ratio of 18x, is fairly valued and retains a Hold rating and $6.60 target.

Net debt improved, easing pressure on the balance sheet. Despite industry feedback pointing to increased competition and price pressure, CLSA highlights management's commentary that there has been no pressure on Petbarn's gross margin to date. Hence, broker's confidence in the outlook has improved, along with the more solid balance sheet. Minimal upside is envisaged to the current share price and CLSA retains an Underperform rating and $7.00 target.

The top line was a little weaker than expected but UBS acknowledges cash generation was much stronger and net debt was reduced. The broker likes the new data that reveals cross shoppers are increasing across the retail and veterinary divisions.

Greencross reports the number of customer who shop in retail stores and use the veterinary services now amount to 3.5% of active customers The company will increase the number of retail stores that are co-located with a clinic to 30 by the end of FY17. Longer term Greencross plans to roll out over 350 retail outlets and veterinary clinics.

While Western Australia is materially weaker than the business on the east coast, UBS notes the sales performance has turned positive in the current quarter. The broker believes the City Farmers brand could be converted to Petbarn over time and, should this occur, there is material risk of goodwill impairment.

The broker expects inventories will build over the medium term as the company's private label is extended. Although gearing has eased, UBS notes, with the extension of debt facilities and the suspension of the dividend reinvestment plan (DRP), the company still has the highest leverage in its Australian retail coverage. Still, raising additional equity is considered an unlikely scenario. UBS retains a Buy rating with a $8.00 target.

Greencross is favourably positioned to fend off unwanted and opportunistically timed corporate approaches, Canaccord Genuity asserts, while capitalising on its market position. The broker notes significant improvement in net debt to equity ratios in the half year but expects some retracement in the second half. To this end, Canaccord Genuity takes comfort in the suspended DRP.

The broker also observe the co-located clinics are currently performing ahead of expectations, delivering revenues around $600,000 per annum per clinic. While these sites are in preferred locations, a material acceleration in revenue should validate the company's strategy and further insure against increased competition for some locations.

Another highlight is that 80% of retail sales domestically and 94% of NZ retail sales are on loyalty cards, which represents significant customer engagement and opportunity for cross selling, in Canaccord Genuity's view.

Upside to retail margins is expected going forward as the dilutive impact of new stores continues to reduce. The potential for margin expansion is also enhanced by the progressive lift in private label product, which the broker notes reached 18% of retail sales in the first half. Management has a long-term target of 25% but Cannaccord Genuity suspects this will take time to achieve.

Making only modest medium-term change to forecasts, including a reduced expectations for future DRPs, the broker increases valuation and target marginally, to $9.15 from $9.05. Buy rating is unchanged.

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article 3 months old

Healthy Start To Baby Bunting’s First Year

-Substantial store roll out in progress
-Margin expansion and scale potential
-Dominates fragmented industry
 

By Eva Brocklehurst

Baby goods retailer Baby Bunting ((BBN)) has made a strong start to its life as a listed company, delivering a maiden first half profit well above expectations and upgrading its FY16 prospectus estimates. Brokers believe the upgrade will give investors renewed confidence in the company.

Total sales roses 30%, driven by 9.2% like-for-like sales growth and an aggressive store roll-out program. The company's fortunes were also boosted by the entry into voluntary administration of competitor My Baby Warehouse during the half year. Baby Bunting is a dominant player in a fragmented industry and the majority of its sales growth is expected to come from increasing scale and market penetration.

Morgan Stanley notes retail peers are struggling to obtain sales growth amid a weakening Australian dollar. The broker finds many reasons why Baby Bunting performs well in the current environment. The store roll-out is substantial, with the company having 35 stores and targeting 70 or more. Increasing awareness of the brand provides for growth off a low base.

The company is also advantaged by the travails at its major competitor and the under-invested nature of the sector. Sales growth is outpacing cost growth as the company invested in its systems and warehousing early in the business cycle.

Private label expansion, with 90% of stock bought in Australian dollars, supports gross margins. Morgan Stanley expects increased private label ranges to drive an expansion of gross margin of around 20 basis points per annum.

The broker notes the cost of doing business as a percentage of sales fell by 50 basis points in the first half. FY16 earnings guidance is upgraded to $16.5-18.5m and Morgan Stanley upgrades its forecasts by 8.8% on fairly conservative assumptions for the second half. Like-for-like sales growth is assumed to be 5.5%.

An easing in sales growth is expected in the second half, as 14 of the My Baby Warehouse stores have been re-branded to Baby Bounce and will start to operate under more normal conditions. Baby Bunting also expects some cannibalising as new stores gain traction, particularly in Queensland where three of the four stores that opened in the first half are located.

Increased purchasing scale is having an impact, which Macquarie notes is offsetting higher sourcing costs. The broker expects the company will gain a significant share of the specialty baby goods market. The regulatory framework in Australia sets up barriers for international and online competitors while the lack of scale and funds from existing peers softens any local threat.

Morgans is of a similar view, believing the group is less than 45% through its roll-out potential. From FY17 Baby Bunting will also be in a position to leverage its recent investment in a head office support structure and distribution centre.

Management expects life-for-like sales will moderate over the balance of the second half as the fulfilment of online “Click & Collect” shifts to individual stores from the distribution centre. With around 33% of stores not included in the like-for-like calculation this will affect the growth rate. Still, Morgans does not expect the effect will have a major impact, with online sales only contributing a small proportion of total sales.

There was one minor negative in Morgan's opinion. Gross margin of 34.8% was slightly below expectations. Management suggests there was little impact from the Australian dollar and the broker suspects the miss on margin was largely attributable to higher growth in hard goods such as prams and car seats which are typically lower margin compared with soft goods.

Brokers believe the stock warrants its premium rating although Macquarie asserts the company can afford no slip-ups. FNArena's database shows three Buy ratings and a consensus target of $2.78, suggesting 12.9% upside to the last share price.
 

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